Trade Compliance Best Practices in Mergers and Acquisitions

‘Twas the night before merger and all through the office, not an associate was sleeping not even the bosses. The diligence was due, and the T’s were crossed but (oh no) the I’s were not dotted!

One of the biggest concerns for companies in mergers and acquisitions is successor liability, but many companies are not focused on how impactful this could be in the trade compliance sense. Successor liability occurs when a company acquires another entity through a merger or acquisition and inherits the burdens and liabilities of the previous entity.  The impact is that U.S. government agencies or other parties claiming damages against the acquired entity can now pursue the successor company for those liabilities.

For export compliance, the landmark case establishing successor liability in mergers and acquisitions is Sigma-Aldrich Business Holdings (2002). In this case, a Bureau of Industry and Security (BIS) Administrative Law Judge (ALJ) found that successor liability exists for violations of the Export Administration Regulations (EAR). Three Sigma-Aldrich entities acquired different parts of a company that had several export violations pre- and post-acquisition, unbeknownst to Sigma-Aldrich. By the time the violations were identified by BIS, Sigma-Aldrich tried to escape liability for the violations by claiming the terms of the agreement between buyer and seller of the companies expressly claimed liabilities were left with the seller. The BIS ALJ rejected this argument by interpreting one of the four exceptions to the traditional rule of successor liability of “asset purchasers are not liable as successors.” The four exceptions include: (1) if purchaser expressly or impliedly assumes liability; (2) if the purchase constitutes a de facto merger; (3) if the purchasing entity constitutes a “mere continuation” of the selling entity; and (4) if the transaction was fraudulently conducted to avoid liability. The ALJ interpreted “mere continuation” broadly to include “substantial continuation,” meaning “a literal purchase of assets is not required to establish successor liability so long as there is some form of a transfer of assets.” The five factors to consider whether there is a transfer of assets are whether the successor: (1) retains the same employees, management, and production facilities; (2) produces the same products; (3) retains the same business name; (4) has the same assets and operations; and (5) holds itself out as a continuation of the previous entity. The ALJ concluded there was a transfer of assets in this case.

On the import side of things, United States v. Shields Rubber Corporation (1989) is still instructive that merger does not protect the surviving company from liability of violations performed by the merged entity unless a complete dissolution has first occurred. In this case, the violation was the destruction of country of origin markings that was conducted prior to a merger. The court held that the surviving entity is still liable for acts and import violations of the merged entity because it is viewed as a continuation of business.

The broad analysis in Sigma-Aldrich and Shields Rubber Corp. tells us that U.S. export and import compliance should be considered when conducting due diligence reviews.  In our experience, we recommend taking the following actions, at a minimum, when conducting such reviews:

Exports

• Review export compliance procedures to understand current compliance framework
• Review terms of sale and PO terms and conditions
• Analyze voluntary disclosures (both historical and current) and internal audit reports
• Review CJ decisions, CCATS determinations, and advisory opinions
• Review list of current licenses and agreements, including applications currently pending, and consider whether any need to be amended as a result of the merger or acquisition
• Determine if authorizations need to be obtained before controlled technical data/technology is exchanged between the seller and foreign buyer
• Obtain list of exported goods to assess accuracy of ECCNs and Schedule B classifications
• Consider special requirements for ITAR registrants (e.g., submit 5-day notification of material changes to DDTC)
• Determine if the target company has foreign subsidiaries and whether they deal with embargoed/sanction countries or any prohibited parties
• Consider if there are any deemed export compliance issues
• Evaluate screening process and whether end user/end use statements are used
• Understand record retention process and determine where records are stored
• Analyze company’s ACE export reports to identify any additional risks

Imports

• Review import compliance procedures, including C-TPAT security policies, to understand current compliance framework
• Review foreign vendor/supplier agreements and PO terms and conditions
• Analyze prior disclosures (both historical and current) and internal audit reports
• Review binding Customs rulings and scope decisions
• Determine if any detentions, seizures, liquidated damages, penalties, redelivery or remarking orders have been issued
• Review any CBP Form 28s  or 29s issued to the company
• Obtain list of imported goods to assess accuracy of HTSUS classifications and whether any goods are subject to AD/CVD orders
• Evaluate the company’s basis of appraisement and whether the correct value is declared to Customs
• Verify qualification process for free trade agreements and/or special duty programs to determine if items are subject to duty-free treatment
• Understand record retention process and determine where records are stored
• Analyze company’s ACE import data to identify any additional risks

Sigma-Aldrich ultimately settled the case with BIS for $1.76 million for the EAR violations, while Shield Rubber Corp officials faced criminal liability. The main takeaway here is that these cases put corporate buyers and sellers on the naughty list for thinking ignorance is bliss. BIS and Customs are like Santa, they’re always watching and are not afraid to put coal in your stocking.