Acquisitions, due diligence and successor liability: What about export controls?

By Lizbeth Rodriguez-Johnson

Our company is in the process of acquiring all assets of a competitor. It has a large share of the marketplace and the acquisition will help consolidate your company’s business objectives. The target company is particularly attractive because it has a substantial international market. Your company has been exploring the possibility to expand internationally. You expect that taking over the operations of the target company will facilitate your company’s expansion into the international marketplace.

The intent is to structure the transaction as an asset purchase agreement. It was determined that this is the preferred structure to avoid the assumption of sellers’ potential liabilities. The agreement will also make clear that the sellers retain all liabilities incurred prior to closing. On closing, the sellers would retain ownership of the current legal entity, which they intend to dissolve once all known liabilities have been addressed. The operations of the target company, therefore, will continue just as they are today until they are fully integrated into your business.

As part of the due diligence process for the acquisition, you provide the target company with a checklist of information required to assess their business. According to your corporate counsel, the due diligence checklist is comprehensive and complete. The information obtained as part of this due diligence effort should allow you to fully assess the target company and any potential liabilities that you may need to consider.

The due diligence checklist includes: a request for information regarding the company’s corporate documents, ownership structure, affiliate companies, assets, financial data, tax matters and indebtedness information.

The checklist also generally requests information regarding the company’s compliance with regulatory requirements, including: environmental matters, operational matters, employees, legal proceedings, material agreements, sales and marketing information. In addition, the request seeks information regarding the target company’s intellectual property rights.

But, what about export controls?

U.S. Export Controls and
Successor Liability

Many companies fail to consider U.S. export controls and trade sanctions when conducting due diligence in relation to acquisitions or mergers. Structuring a transaction as an asset purchase agreement does not necessarily prevent the buyer from acquiring the target’s liability for failure to comply with U.S. export control laws. Substantial continuity of the target’s business may result in the buyer being responsible for any violations that may have taken place prior to the acquisition, even if unidentified at the time
of acquisition.

Successor liability, in a business law context, refers to the assumption of burdens of an acquired entity by the surviving company in a sale, merger or acquisition transaction. Generally, a corporation purchasing the assets of another does not succeed to the liabilities of the selling corporation. With relation to export controls, the issue centers on which party or parties in an acquisition are liable, after the acquisition deal is closed, for any violations of export control laws committed by the acquired company before the deal was concluded. There is always the possibility, however, that both the seller and the buyer may be determined  responsible for export violations incurred by the seller.

Under current legal standards, however, successor liability could be imposed for failure to comply with U.S. export laws and regulations. These regulations include, but are not limited to, the Export Administration Regulations, which are implemented by the U.S. Commerce Department, Bureau of Industry and Security.

Generally, it is established law that successor liability is not imposed on a purchase of assets unless one of four exceptions applies: (1) The purchasing corporation expressly or impliedly agrees to assume the liability; (2) The transaction amounts to a de facto consolidation or merger; (3) The buyer is merely a continuation of the seller; or (4) The transaction was fraudulently entered into in order to escape liability.

With respect to violations of U.S. export control laws, a broad interpretation of the third exception is applied. To determine if successor liability should be applied under this exception, which is known as “substantial continuity,” certain factors are examined by the regulators.

These include retention of the same personnel, continued operations at the same location under the same business name, production of the same products, maintenance of the same assets and general business operations and holding the company out to the public as a continuation of the previous corporation.

Regulators seek to ensure that past illegal practices do not continue and violators are held accountable for their actions. For legal and policy reasons, the seller, if dissolved and devoid of significant assets, would generally not be pursued as a viable responsible target for violation penalties. If the seller is not pursued, the regulators might seek a party to be responsible for the violations. That party may be your company.

Corporate Due Diligence and
U.S. Exports Controls

If your company were found responsible for the acquired company’s failure to comply with U.S. export laws, the consequences may be severe. Monetary penalties could potentially be in the hundreds of thousands of dollars or more. The acquired company may lose the privilege to engage in international commerce. Bad publicity may also ensue. The cost of investigating and correcting the problem may also be substantial.

To better protect your company for inadvertently acquiring export control related liabilities, you should consider requesting information with respect to the status of compliance with U.S. export controls at the target company. Having the opportunity to assess the target company’s compliance with U.S. export controls will likely reduce the risk that the acquisition may result in the inadvertent assumption of regulatory liabilities.

So, what do you need to look for? U.S. export controls are concerned with whom U.S. companies conduct business, what U.S. origin technology or product is being exported and the potential destination and how the company conducts international business. Applicable legal requirements may be imposed by several agencies, including the Departments of Commerce, State and Treasury. Understanding the regulatory requirements that apply to the target company should probably be the same step in the due diligence exercise.

The U.S. government maintains a number of lists of individuals and companies with whom U.S. parties are prohibited or restricted from conducting business without U.S. government authorization. As part of the due diligence exercise, your company should obtain assurances that the target company has not engaged in transactions with a prohibited party.

Depending on the target company’s products or technology, a license may be required to export or re-export the product or technology. To assess if a license is required, the export jurisdiction/classification and the end destination of the product or technology needs to be determined. Licensing requirements may also apply to the transfer of technology to foreign nationals, i.e., visa holders within the U.S. or to or for certain end-users. If a license is required for the export of the product or technology, you should also assess if the target company has obtained the required authorization and complied with the terms of the applicable license.

U.S. export controls are also concerned with how a company conducts business. If the target company conducts business in member countries of the Arab League country, you will need to assess compliance with anti-boycott regulations. These regulations prohibit U.S. companies from complying with requests to participate in boycotts of countries friendly to the U.S. This particular issue generally arises in letters of credit, purchase orders or contracts that request a U.S. company to support the Arab League’s boycott of Israel. Compliance with the anti-boycott laws should also be considered as part of your due diligence efforts.

U.S. export control laws may be counterintuitive. While this article provides a brief description of main areas of concern, there are additional requirements that are not discussed here. A comprehensive due diligence review would consider not just the requirements referenced above, but all applicable areas of export controls.

To ensure compliance with U.S. export controls, companies should develop an export compliance program that addresses all areas of concern. Your due diligence checklist should be drafted to request information that allows you to evaluate the target company’s export compliance program. If the target company is engaged in international business and does not have a compliance program or has never heard of U.S. export controls, you may consider that a red flag; a red flag that may result in the acquisition of potential liabilities by your company.

Lizbeth Rodriguez-Johnson is an Export Controls/Trade Sanctions attorney at Holland & Hart. She can be reached at [email protected] or (303) 295-8399.