Export Due Diligence for Expansion Into Chemical Markets Abroad

I. Introduction

Companies that fail to obtain required government authorizations before exporting chemicals and related products and technologies can face fines of $250,000 per violation or even the loss of export privileges under the U.S. export control system. Such penalties can quickly undermine financial gains expected from international expansion and possibly even prevent it. In addition, not accounting for relevant licensing requirements and application processing times can cause unexpected delays in deliveries to customers or in getting materials, production equipment and technologies to overseas partners.

With proper planning, however, international companies can build into their expansion efforts strategies to obtain appropriate authorizations and thereby avoid substantial penalties and delays. Such strategies are particularly important for companies in the chemical industry that either (1) are or will begin exporting goods, equipment, or services or making technology available abroad or (2) plan to acquire other companies in the United States or abroad that are engaged in those activities. Building export control procedures into daily operations and into reviews of corporate acquisitions is key to reducing the likelihood of incurring or inheriting substantial monetary penalties and shipment delays.

II. U.S. Export Controls Relevant to Daily Operations in the Chemical Industry

All exports of goods, equipment and technologies are subject to one of the various sets of U.S. export control regulations. Only those exports that the government has deemed to be sensitive for foreign policy or national security reasons, however, might be prohibited without a government license. The two sets of U.S. export control regulations that are most likely to cause compliance issues for the chemical industry are the U.S. Commerce Department’s Export Administration Regulations ¹15 C.F.R. Parts 730 through 774. (EAR) and the U.S. State Department’s International Traffic in Arms Regulations ²22 C.F.R. Parts 120 through 130. (ITAR).

As further explained below, the Export Administration Regulations generally apply to the export of all items that could be used for a purpose that threatens national security or is inconsistent with a foreign policy, regardless of their actual intended use. The International Traffic in Arms Regulations generally apply to items that are specifically designed or modified for a military or space application. Many common chemicals and related products are subject to the EAR for, as noted, their capacity to be used as, or in the manufacture of, chemical or biological weapons. Many chemicals that are explosives or propellants or are otherwise known as chemical agents are subject to the ITAR. Examples of EAR and ITAR chemicals and related products are noted below.

A. Export Administration Regulations

The Commerce Department’s Bureau of Industry and Security (“BIS”) implements and enforces the EAR. ³http://www.bis.doc.gov. Within BIS, the Chemical and Biological Controls Division has responsibility for controls on chemical-related exports.

The Export Administration Regulations apply to exports from the United States of goods, equipment, software and technology. ⁴15 C.F.R. §§734.2 (b)(2)-(3) and 734.3. They also regulate reexports of those items ⁵Id. §§734.2 (b)(4)-(5). and exports of items made in and exported from other countries if they contain more than de minimis controlled U.S.-origin content. ⁶Id. §734.3 (a). More information on these issues is provided below.

Several types of items are expressly exempt from EAR coverage, including items that are subject to the jurisdiction of the State Department, Department of Energy, or Nuclear Regulatory Commission. ⁷Id. § 734.3 (b)(1). Information that qualifies as being publicly available is also exempt. ⁸Id. § 734.3 (b)(3). The publicly available information carve-out is of particular significance to universities and to companies that develop their technology in collaboration with universities.

1. Core Concepts

For the purposes of the Export Administration Regulations, an “export” is an “actual shipment or transmission of items out of the United States.” ⁹Id. § 734.2 (b)(1). The rules, therefore, impose restrictions on the actual movement of tangible items out of the United States, as well as electronic transmission of chemical-related technology and software out of the country, such as to affiliated manufacturing facilities. A “reexport” is an “actual shipment or transmission … from one foreign country to another.” ¹⁰Id. § 734.2 (b)(4). Consequently, the sharing of U.S.-origin technology between foreign plants or the sharing of equipment between foreign plants might also not be permissible without a government license.

When the Export Administration Regulations use the term “actual” in the definitions of export and reexport, however, they do not actually mean it. Those definitions are supplemented by the somewhat peculiar concept of the “Deemed Export Rule,” which also applies to reexports. That rule generally provides that sharing technology with a non-U.S. national who is not a Green Card holder or permanent resident in the country where the sharing occurs is deemed to be an export to the individual’s home country. ¹¹Id. § 734.2 (b). This means that providing foreign nationals who are not Green Card holders access to certain technology regarding chemicals and related products is sometimes prohibited without a government license. This rule poses significant issues for chemical industry employers of personnel such as scientists and engineers, even if the employer is not actually involved in international business. The I-129 form for certain visas also imposes this requirement through a certification as to whether the sponsored employee will have access to controlled technology.

The Export Administration Regulations also restrict shipments and transmissions from foreign countries even if the item being sent is not 100 percent of U.S. origin. The de minimis rules provide that, if an item made outside the United States contains more than 10 percent or 25 percent restricted content (the applicable percentage depends on the destination), the item becomes subject to the EAR. ¹²Id. § 734.4, Part 734 Supp. 2. This rule requires foreign chemical manufacturers and processors to be aware of whether they are using U.S.-origin chemicals and technologies in their own operations and whether a U.S. license would be required to export the items they manufacture outside the United States.

The Export Administration Regulations require a license before an export or reexport can proceed in three circumstances: (1) the applicable Commerce Control List (“CCL”) classification of the good or technology or the Commerce embargo rules indicate the item involved is controlled for the intended destination, (2) the end-user is on one of the U.S. government’s prohibited lists or (3) the end-use is prohibited. ¹³Id. §736.2 (a). These situations are addressed further below.

2. Chemicals on the Commerce Control List

a) In General

The CCL is a list of items that cannot be exported or reexported to certain countries without a government license. It is part of the EAR and consists of 10 categories of types of items:

• Category 0 –  Nuclear materials, facilities and equipment

• Category 1 –  Special materials and related equipment, chemicals, “microorganisms,” and “toxins”

• Category 2 –  Systems, equipment, and components

• Category 3 –  Electronics

• Category 4 –  Computers

• Category 5 –  Part 1 – Telecommunications
  Part 2 – Information security

• Category 6 –  Sensors and lasers

• Category 7 –  Navigation and avionics

• Category 8 –  Marine

• Category 9 –  Aerospace and propulsion ¹⁴Id. § 738.2.

CCL Categories 1 and 2 are particularly relevant to the chemical industry, and they are addressed further below.

Each of the 10 CCL categories is divided further into Export Control Classification Numbers (ECCNs), which are essentially alphanumeric codes associated with descriptions of various items. ¹⁵See http://www.bis.doc.gov/licensing/exportingbasics.htm. For example, one particularly relevant ECCN in Category 1 describes numerous chemicals and has a heading that reads: “1C350 Chemicals that may be used as precursors for toxic chemicals.” The ECCN is the alphanumeric code 1C350, and the remainder of the heading describes the types of items that ECCN covers. The specific items covered appear in the ECCN’s entry under the subheading “List of Items Controlled.” ECCN 1C350 also includes several notes that indicate the types of items that are excluded from the ECCN’s scope and guidance on how to interpret this ECCN. This is common. Also, if an ECCN describes an item that will be exported, the notations in the “Reason for Control” subheading must then be studied. ¹⁶Id. §738.4 (a).

One reason for control for ECCN 1C350 states, “CB applies to entire entry [-] CB Column 2.” The code CB is defined in the EAR as meaning the “[p]roliferation of chemical and biological weapons.” ¹⁷Id. §742.2. Other reasons for control are described in Part 742 as well. The “Column 2” wording is a reference to the Commerce Country Chart, which an exporter must consult next unless the ECCN instructs otherwise. ¹⁸Id. §738.4 (a).

The Commerce Country Chart is a matrix listing the countries of the world in the left-hand column and reasons why exports might require a license in the top row. ¹⁹Id. § 738.3. If there is an “X” in the cell where the row for a given country and the column for an ECCN’s reason for control meet, a license is required before items described by that ECCN can be exported to that country. ²⁰Id. §738.4 (a). Even if one reason for control noted in an ECCN does not apply to an intended destination, a license would be required if any other reason for control noted for the ECCN would apply. ²¹Id. §738.4 (a).

If an item is subject to the EAR but is not listed on the CCL, that item is referred to by the code “EAR99.” ²²Id. § 732.3 (b)(3). EAR99 items can be exported and reexported under the EAR to any destination without a license, provided the destination is not embargoed (such as Iran, Syria, etc.) and the end-user and end-use prohibitions noted below do not apply. ²³Id. § 736.2 (b).

Part 746 of the EAR identifies the scope of the embargoes the United States implements through the EAR. ²⁴Id. §746.1 The U.S. Treasury Department also administers embargoes through its Office of Foreign Assets Control (OFAC). ²⁵See, e.g., 31 C.F.R. Parts 510 (North Korea), 515 (Cuba), 535 (Iran), 537 (Burma) and 538 (Sudan), among others. OFAC’s embargoes are typically broader than those under the EAR and are not addressed here.

b) Chemicals and Related Items on the CCL

The chemical industry is one of the more likely industries to be affected by the requirements under the EAR. Two of the 10 categories of items controlled on the CCL (Categories 1 and 2) pertain to chemicals and related materials, equipment, and technologies. Many of the chemicals on the Commerce Control List are also listed in Schedules 2 and 3 to the Chemical Weapons Convention, and several of these chemicals are somewhat common.

The following are a few examples of chemicals that are controlled on the CCL and cannot be exported or reexported to many countries without a license:

• Hydrogen cyanide ²⁶15 C.F.R. Part 774, Supp. 1 ECCN 1C354 b.1.c. – A valuable precursor for a variety of chemical compounds such as polymers and pharmaceuticals. Hydrogen cyanide is also a blood agent listed under Schedule 3 of the CWC and is the gas of choice for capital punishment executions via the gas chamber.

• Phosgene ²⁷Id. ECCN 1C355 b.1.a. – Used to synthesize precursors for polyurethane and polycarbonate manufacturing. Phosgene is listed under Schedule 3 of the CWC because the gas can cause pulmonary damage and was used as a chemical warfare agent in World War I.

• Phosphorus oxychloride ²⁸Id. ECCN 1C350 c.3. – Used to manufacture certain esters used as flame retardants and plasticisers; also used in the semiconductor industry and in laboratories as a dehydrating agent. Several phosphorus compounds are listed under Schedule 3 of the CWC because they can also be used as precursors for manufacturing organophosphorus nerve agents such as sarin.

• Sulfur dichloride ²⁹Id. ECCN 1C350 c.7. – Used to manufacture sulfur dyes, insecticides, synthetic rubbers, as a catalyst for vegetable oils, and to harden soft woods. It is listed under Schedule 3 of the CWC because it is a precursor for the manufacture of sulfur mustard (a.k.a. mustard gas), a blister agent used in World War I.

• 2-Chloroethanol ³⁰Id. ECCN 1C350 d.2. – Used as a precursor for ethylene oxide, which is a widely used industrial feedstock chemical. Although it is not listed in the CWC, it can also be used as a precursor for sulfur mustard.

• Triethanolamine ³¹Id. ECCN 1C350 c.9. – Used as an emulsifier and surfactant in many industrial and consumer products. It is listed under Schedule 3 of the CWC because it is a precursor for nitrogen mustard, a blister agent that was widely stockpiled during World War II.

• Botulinum toxins ³²Id. ECCN 1C351 d.3. – More commonly known as “Botox,” type A botulinum toxin is used in medical and cosmetic applications. These potent neurotoxins are the most toxic substances known, and can cause the foodborne illness botulism.

Several dozen other chemicals are also on the CCL and cannot be widely exported without a license. The CCL also covers several specialized compounds, composites, and related products such as certain components made from fluorinated compounds ³³See, e.g., id. ECCNs 1A001 a., 1A001 b., 1A001 c., 1C350 d.1., non-fluorinated polymeric substances ³⁴See, e.g., id. ECCNs 1C008 a, 1C008 b., 1C008 a.1., 1C998 a. , unprocessed fluorinated compounds ³⁵See, e.g., id. ECCNs 1C009 a., 1C009 b., 1C009 c., composites consisting of an organic, metal or carbon matrix ³⁶See, e.g., id. ECCNs 1A002 a., 1A002 b., manufactures of non-fusible aromatic polyimides ³⁷See, e.g., id. ECCNs 1A003 a., 1A003 b. , ceramic base materials ³⁸See, e.g., id. ECCNs 1C007 a., 1C007 c., 1C007 d. and fibrous or filamentary materials ³⁹See, e.g., id. ECCNs 1C010 a., 1C010 b., 1C010 c., 1C010 d., in addition to other materials, including organisms and metals.

A wide variety of equipment that is used to develop, manufacture, or process the foregoing types of items is also controlled on the CCL. Examples of such items that cannot be widely exported without a license include certain agitators ⁴⁰See, e.g., id. ECCNs 2B350 a., 2B350 b., fittings ⁴¹See, e.g., id. ECCNs 2A292 a., 2A292 b., heat exchangers ⁴²See, e.g., id. ECCNs 0B001 b.5., 0B001 d.5., 2A290 a., 2B350 d., pipes ⁴³See, e.g., id. ECCNs 2A292 a., 2A292 b. , pumps ⁴⁴See, e.g., id. ECCNs 0B001 c.9., 0B002 e.2., 0B004 b.2.c., 1B230, 2A291 d., 2A293, 2B350 i., valves ⁴⁵See, e.g., id. ECCNs 0B001 b.1., 0B001 d.6., 2A226, 2A292 a., 2A292 b., 2B350 g., reaction vessels ⁴⁶See, e.g., id. ECCNs 2B350 a.1, 2B350 a.2, 2B350 a.3. and storage tanks ⁴⁷See, e.g., id. ECCNs 2B350 c.1, 2B350 c.2, 2B350 c.3..

Technology that is related to the development, production or use of controlled chemicals and related items often also cannot be exported or shared with foreign-national employees who are not permanent residents without first obtaining a U.S. government license.

3. End-User Restrictions

While the most common reason a transaction might require a license under the EAR is its CCL classification and intended destination, a transaction might also not be permitted if it would involve an entity or individual on one of the prohibited lists that the Commerce Department or Treasury Department maintains. ⁴⁸The lists and a description of each are available at http://www.bis.doc.gov/complianceandenforcement/liststocheck.htm. The most relevant Commerce Department lists are the Denied Persons List and the Entity List. ⁴⁹15 C.F.R. Part 744 provides the bases for adding an entity or individual to one of the Commerce Department’s prohibited party lists. These lists identify entities and individuals that have lost their export privileges or have been identified by BIS as having engaged in some activity that threatens U.S. national security or foreign policy. The Treasury Department’s Office of Foreign Assets Control is also relevant because it administers a list of Specially Designated Nationals (SDNs) ⁵⁰See http://www.treasury.gov/resource-center/sanctions/SDN-List/Pages/default.aspx. that U.S. companies cannot do business with under the EAR or OFAC regulations.

These restrictions are particularly applicable to the chemical industry, because the types of entities and individuals that cause the U.S. government concern are also often interested in chemicals and related products.

4. End-Use Restrictions

The Export Administration Regulations also identify a number of end uses for which exports and reexports cannot be made without a license. ⁵¹15 C.F.R. Part 744. Examples include activities relating to nuclear proliferation ⁵²Id. § 744.2. and the development of chemical or biological weapons. ⁵³Id. §744.4.

The end-use license requirements typically arise only when the exporter or reexporter has knowledge of an intended prohibited end use. Companies often deal with these requirements, in part, by obtaining end-use certifications from customers in other sensitive industries. Regardless of a company’s approach, however, it is critical that indications of possible prohibited end uses not be ignored, because the Export Administration Regulations permit BIS to infer knowledge from deliberate ignorance and other conduct. ⁵⁴Id. § 772.1 (Def. of “Knowledge”).

5. License Exceptions

Even if it appears that a license is required, several license exceptions in the EAR might override that requirement. ⁵⁵Id. Part 740. Each license exception has detailed eligibility requirements, and needs to be studied carefully. Examples of the types of exports that might be covered by an exception include exports for the repair or replacement of previously exported items ⁵⁶Id. § 740.10., exports for certain government programs ⁵⁷Id. § 740.11. and exports of certain trade tools. ⁵⁸Id. § 740.9 (a)(2)(i). The U.S. government has also recently issued a new exception called “Strategic Trade Authorization” (STA), which permits many restricted exports and reexports to countries that are of lesser concern. ⁵⁹Id. § 740.20.

6. License Applications

If a transaction cannot proceed without a license, a license application must be submitted to BIS using its online system, called SNAP-R. ⁶⁰Id. § 748.7 (b). SNAP-R requires a free registration and certification for both the company making the application and the individual who will be administering the company’s SNAP-R account. ⁶¹Id. § 748.7 (b).

License applications can cover multiple items being sent to a given recipient and typically require identification of the end-user, end-use, ECCN, quantity, and fair market value. ⁶²Id. Part 748, Supp. 1. Many license applications also require additional information specific to the type of application. This is the case for applications covering chemicals. The additional information required can include facts about the grade, form, concentration, mixtures, or ingredients involved, the applicable Chemical Abstract Service Registry numbers and an end-user certificate. ⁶³Id. Part 748, Supp. 2. Additional support documents, such as ultimate consignee statements or import certifications, might be required depending upon the reason why a license is required and the intended destination. ⁶⁴Id. §§ 748.9, 748.10, 748.11.

7. Classification Requests and Advisory Opinion Requests

Companies that are uncertain about whether or how an item is described on the CCL can request that BIS provide an official classification of that item. ⁶⁵Id. § 748.3 (b). This entails providing BIS detailed information about the item at issue. It is generally in the requesting company’s best interest to have done its own classification analysis and suggest to BIS the logic for what the outcome should be. The request should also identify any interpretation issues that might be involved and how they should be resolved. BIS does not make its classifications public, but many companies choose to do so. BIS has started a listing online of such companies. ⁶⁶http://www.bis.doc.gov/commodityclassificationpage.htm. This list is particularly useful for companies that export another company’s products, such as networking equipment and production machinery.

BIS will also issue formal advisory opinions on legal interpretations of the EAR. ⁶⁷15 C.F.R. § 748.3 (c). Requests for advisory opinions are made by letter and should present the legal issue and the requesting company’s analysis for what it believes is the correct outcome. BIS makes redacted versions of certain advisory opinions available on its website. ⁶⁸http://www.bis.doc.gov/policiesandregulations/advisoryopinions.htm. Of particular interest to chemical and related industries is the guidance BIS offers in particular advisory opinions regarding (1) when certain pumps and valves are not controlled even though they have characteristics that are relevant to chemical weapon processing ⁶⁹http://www.bis.doc.gov/policiesandregulations/advisoryopinions/webcims_20430_outgoing_letter.pdf. and (2) when technology for carbon fiber and organic resin items cannot be exported without a license ⁷⁰http://www.bis.doc.gov/policiesandregulations/advisoryopinions/dec27_2010.pdf. .

8. Other Requirements

The Export Administration Regulations impose requirements regarding export-related documents that a company must keep. ⁷¹15 C.F.R. Part 762. The regulations also impose a number of administrative requirements for covered shipments. The most relevant of these is a requirement to file an Automated Export System entry with U.S. Customs for exports requiring a license ⁷²Id. §758.1. and to include a destination control statement on invoices for shipments of non-EAR99 items. ⁷³Id. § 758.6.

9. Penalties and Voluntary Self-Disclosures

The possible penalties for violating the EAR are very steep. For civil violations, the monetary penalties can be $250,000 or twice the value of the transaction for each violation. ⁷⁴50 U.S.C.A. §1705 (b); 15 C.F.R. §764.3 (a)(1). In addition, a company can lose its export privileges and be subject to outside audits. ⁷⁵15 C.F.R. §764.3 (a)(2).

For criminal violations, the penalty can be $1 million or twice the benefit received from the transaction for each violation plus possible jail time of 20 years. ⁷⁶18 U.S.C.A. §3571; 50 U.S.C.A. §1705 (c); 15 C.F.R. §764.3 (b).

Companies that discover a violation often face difficult choices. Depending on the situation and their own appetite for risk (not only of the violation being detected but also of the possible penalties resulting from the disclosure), companies often use the EAR’s voluntary self-disclosure process. ⁷⁷15 C.F.R. § 764.5. A principal benefit of voluntary self-disclosures is that BIS has stated its policy is to begin settlement negotiations at half the total possible monetary penalty if a voluntary self-disclosure is submitted. ⁷⁸http://www.bis.doc.gov/complianceandenforcement/factsheet11012007.pdf. Preparing such disclosures, however, can involve substantial resources, such as for reviewing what has occurred and why and ensuring the company knows the full extent of any related issues.

10. EAR Chemical Industry Export Control Enforcement Cases

Over the years, BIS has brought cases against numerous companies that export chemicals and related items. The most common fact pattern for these enforcement cases seems to involve the export of triethanolamine, either as a standalone chemical ⁷⁹E.g. Case ID No. E2070, Nalco Company, available at http://efoia.bis.doc.gov/exportcontrolviolations/e2070.pdf. or in other forms, such as a mixture for various applications including lubrication and cooling of cutting machines. ⁸⁰E.g. Case ID No. E2085, Buehler Limited, available at http://efoia.bis.doc.gov/exportcontrolviolations/e2085.pdf. These cases have settled for penalties in the range of tens of thousands to millions of dollars.

Examples of penalties and basic facts involved in other EAR enforcement cases are as follows:

• $2.5 million – Flowserve Corp. – Exported pumps, valves and related components to several countries ⁸¹Case ID Nos. E2228 through E2233, and E2235 through E2238, available at http://efoia.bis.doc.gov/exportcontrolviolations/tocexportviolations.htm.

• $1.5 million – Protea Chemicals – Resold sodium cyanide and potassium cyanide in South Africa ⁸²http://www.bis.doc.gov/news/2005/prochem.htm

• $225,000 – Quest Technologies – Exported chlorine and sulfur dioxide gas sensors to various Middle Eastern and Asian countries ⁸³http://www.bis.doc.gov/news/archive2001/questfined225k.htm

• $200,000 – Essex Group Inc. – Exported aromatic polyamide-imide solution to China ⁸⁴Case ID No. E2225, Essex Group, Inc., available at http://efoia.bis.doc.gov/exportcontrolviolations/e2225.pdf.

• $60,000 – Andes Chemical Corp. – Exported sodium bifluoride to Jamaica ⁸⁵Case ID No. E2049, Andes Chemical Corporation, available at http://efoia.bis.doc.gov/exportcontrolviolations/e2049.pdf.

• $365,000 (suspended for a year provided no further violations occur) – New England Trading Global Inc. – Exported sodium cyanide and potassium cyanide to Israel ⁸⁶Case ID No. E2184, New England Trading Global, Inc., available at http://efoia.bis.doc.gov/exportcontrolviolations/e2184.pdf.

• Loss of export privileges for 20 years – Elecmat Inc. – Conspired to export various chemicals and electronic components to Taiwan ⁸⁷Case ID No. E2039, Elecmat, Inc., available at http://efoia.bis.doc.gov/exportcontrolviolations/e2093.pdf.

Cases arising out of violations of the EAR can very easily result in significant penalties. For companies that have not been aware of the licensing requirements applicable to their business, large numbers of prohibited transactions can accumulate over the years before someone within the company becomes aware of the restrictions or the government initiates an enforcement case. At that point, the theoretical penalties are typically in the millions of dollars.

Significant factors affecting the likely settlement amount include whether the company has a robust compliance program, the company’s culpability, its sophistication, how cooperative it is in BIS’s investigation, and how effective its corrective actions are. ⁸⁸15 C.F.R. Supp. 1 Part 766 §III.B. These are key issues to keep in mind whenever a company is reviewing its own compliance or that of a company to be acquired.

B. International Traffic in Arms Regulations

U.S. companies in the chemical industry that specifically design or modify chemicals or related products, equipment, or technology for a military or space application are generally subject to the State Department’s International Traffic in Arms Regulations. ⁸⁹22 C.F.R. Parts 120 to 130. The Directorate of Defense Trade Controls (DDTC) administers and enforces the ITAR from within the State Department. ⁹⁰http://www.pmddtc.state.gov Division III within the DDTC Office of Defense Trade Controls Licensing typically has responsibility for chemical-related items. ⁹¹http://www.pmddtc.state.gov/about/key_personnel.html

It is important to note that the scope of the ITAR is not limited to items one might intuitively consider to be military in nature. The restrictions under the ITAR are very broad and can apply to any company working with a customer whose business relates even tangentially to a military or space application. For example, even though the bulk of the chemical-related products covered under the ITAR are explosives, propellants, chemical agents, or similar items, other types of relevant products like aerospace coatings can be covered as well.

There is a much greater likelihood under the ITAR than under the EAR that a chemical product or technology cannot be exported or reexported without a license. This is because all ITAR-controlled exports require a license unless one of the few exemptions apply. ⁹²22 C.F.R. §123.1 (a). It is also important to note that those rules impose many more restrictions on the export and sharing of technology and the provision of services than under the EAR. ⁹³Id. §§124.1, 124.3-.4, 124.7-.11. In addition, the core concepts noted above regarding when a transaction involves an export and deemed exports generally apply to the ITAR as well. ⁹⁴Id. §120.17 (Def. of “Export”). The de minimis rule under the EAR does not, however, apply to the ITAR, as noted below. ⁹⁵Id.

1. Defense Articles, Defense Services and License Requirements

The key issue under the ITAR is whether the tangible item at issue in a transaction, for example a chemical or piece of equipment, is a “defense article.” A defense article is any item listed on the ITAR’s U.S. Munitions List (USML) ⁹⁶Id. §120.6., which consists of 21 categories of diverse items. ⁹⁷Id. §121.1 Each USML category lists specific types of tangible items that are controlled. Technical data directly related to a tangible item that is subject to the ITAR are also considered defense articles. ⁹⁸Id. §§120.6, 120.10.

Two categories on the USML pertain specifically to items relevant to the chemical industry. Category V covers “Explosives and Energetic Materials, Propellants, Incendiary Agents and Their Constituents.” Category XIV covers “Toxicological Agents, Including Chemical Agents, Biological Agents, and Associated Equipment.” These categories include specific chemicals as well as numerous types of equipment relating to those chemicals, such as equipment for testing chemical agents, sample collection and processing, and individual and collective protection. Other categories can also be relevant. For example, Category XIII covers “Auxiliary Military Equipment” and includes “special paints” for concealment or deception and related items. “Special paints” can also be captured in a number of other USML categories, because they are considered an accessory or attachment for various controlled items in those other categories. ⁹⁹Id. § 121.8 (c).

It is also worth noting that the U.S. government is currently considering substantial changes to the ITAR that would make several chemicals subject to the EAR’s restrictions rather than being subject to the ITAR. ¹⁰⁰See, e.g., 77 Fed. Reg. 25,932 (May 2, 2012).

As noted, a license is required to export or reexport a defense article to any country, unless an exemption applies. ¹⁰¹22 C.F.R. § 123.1. Temporary exports and imports also require a license. ¹⁰²Id. §§123.4, 123.5. Permanent imports might require a license but are subject to the jurisdiction of the Bureau of Alcohol, Tobacco, Firearms and Explosives. ¹⁰³Id. § 123.2.

In contrast to EAR, there is no de minimis provision for foreign-made items incorporating ITAR-controlled items. Such foreign-made items become subject to the ITAR.

As noted in the explanation of the EAR, items subject to the ITAR are expressly excluded from the scope of the EAR. This means that the ITAR’s jurisdiction trumps the EAR.

A license is also required for a U.S. company to provide essentially any type of assistance to a non-U.S. company with respect to a defense article. ¹⁰⁴22 C.F.R. §§120.9, 124.1. (including assistance in the design, development, engineering, manufacture, production, assembly, testing, repair, maintenance, modification, operation, demilitarization, destruction, processing or use of defense articles). For example, even where a U.S. company is selling or exporting a chemical or piece of equipment that does not require an export license under the ITAR or EAR, the U.S. company can still perform a restricted defense service by providing many types of assistance with respect to the integration of that item into a defense article or into the development or production process for a defense article.

2. Registration

Unlike the EAR, U.S. companies that manufacture or export defense articles or provide defense services must register with DDTC and pay a registration fee. ¹⁰⁵Id. Part 122. Brokers of ITAR items must also register with DDTC and comply with certain other requirements. ¹⁰⁶Id. § 129.3.

3. Types of Licenses

The ITAR licensing system is more complex than under the EAR, in part because there are more types of licenses under the ITAR. The most common ITAR licenses for exporting chemicals or related equipment or technical data are referred to as a DSP-5 (permanent export), DSP-61 (temporary import) and DSP-73 (temporary export). ¹⁰⁷http://www.pmddtc.state.gov/licensing/forms.html. The basic information requirements for these license applications include invoices or similar documents and a description of the item’s intended end use. ¹⁰⁸See, e.g., http://www.pmddtc.state.gov/DTRADE/documents/DTrade_DSP_5_Instructions.pdf (Guidelines for completing the DSP-5). The information requirements are not particularly complicated, but the actual license applications can be quite cumbersome, requiring attention to whether the appropriate information is included in the correct block on the given form.

The provision of a restricted defense service requires one of three types of licenses. A Technical Assistance Agreement (TAA) authorizes a U.S. company to provide almost any type of assistance (such as design support, troubleshooting, marketing discussions, etc.) other than services relating to the manufacture or distribution of defense articles. ¹⁰⁹Id. § 120.22. A Manufacturing License Agreement (MLA) is required to provide a non-U.S. company the right to manufacture or know-how for the manufacture of a defense article. ¹¹⁰Id. § 120.21. A Warehouse Distribution Agreement (WDA) is required for a non-U.S. company to store and distribute a U.S. company’s defense articles. ¹¹¹Id. § 120.23.

Each of the three types of agreements authorizing a defense service resemble standard commercial agreements in many respects, but they must be drafted separately from any such agreements. ¹¹²See Guidelines for Preparing Electronic Agreements (Revision 3.0), available at: http://www.pmddtc.state.gov/licensing/documents/Guidelines%20for%20Preparing%20Electronic%20Agreements%20Revision%203%20(2).pdf. DDTC provides standard templates applicants should follow, and they include several verbatim provisions required under the ITAR. ¹¹³Id.

ITAR license applications must be submitted through DTrade, which is DDTC’s online filing system. ¹¹⁴http://www.pmddtc.state.gov/DTRADE/index.html.

There are a few exemptions for defense article exports and the provision of defense services. The most common exemption is probably the “Canadian Exemption.” It generally permits defense article exports to Canada without a license, provided the end user is the Canadian government or a company registered under a particular Canadian law, and the defense article to be exported is not one of several sensitive types identified in the ITAR. ¹¹⁵77 Fed. Reg. 16592 (Mar. 21, 2012), available at http://www.pmddtc.state.gov/FR/2012/
77FR16592.pdf. Defense Services can be provided under the Canadian Exemption without a license, but the scope of information that can be shared is limited, and certain written certifications are required. ¹¹⁶Id. Although the Canadian exemption is of significant benefit to the chemical industry, it does not apply to many chemical agent-related items. ¹¹⁷Id.

4. Commodity Jurisdiction Determinations

The wording of the ITAR is often extremely vague and broad. As a result, many companies are not certain whether they are subject to the ITAR. One common solution for these companies is to obtain a Commodity Jurisdiction Determination, which is an official DDTC ruling as to whether an item is subject to the ITAR. ¹¹⁸22 C.F.R. §§ 120.3, 120.4; http://www.pmddtc.state.gov/commodity_jurisdiction/index.html. DDTC now makes a summary of its determinations available online. ¹¹⁹http://www.pmddtc.state.gov/commodity_jurisdiction/determination.html. As with classification requests under the EAR, a Commodity Jurisdiction submission should state the desired outcome and applicable reasoning.

5. Other Requirements

There are a number of other requirements under the ITAR that pertain to recordkeeping ¹²⁰22 C.F.R. § 122.5. and the actual shipment of ITAR items. Among the more common shipment requirements are the requirement to include a destination control statement on the bill of lading and invoice, ¹²¹Id. § 123.9 (b). file an export record in the Automated Export System, ¹²²Id. § 123.22 (a). mark technical data, and keep a record of when exemptions are used. ¹²³Id. §§123.26, 125.6.

6. Penalties and Voluntary Disclosures

The possible civil penalties for violating the ITAR are $500,000 per violation, audit requirements and loss of export privileges. ¹²⁴22 U.S.C.A. §§2778, 2779a, 2780; 22 C.F.R. §§127.7, 127.10. The criminal penalties are $1 million or twice the gain or loss from the violation and a suspension of export privileges, plus, for individuals, twenty years in jail. ¹²⁵18 U.S.C.A. §3571; 22 U.S.C.A. §2778 (c); 22 C.F.R. §§127.3, 127.7.

As with the EAR, should a violation occur, the ITAR provide for a voluntary disclosure process that frequently offers companies the opportunity to receive more favorable treatment than would be the case if DDTC learned of the violation on its own. ¹²⁶22 C.F.R. § 127.12. The requirements as to the information that needs to be submitted are fairly similar to those under the EAR. It should also be noted, however, that, if a violation involves one of the Section 126.1 countries for which there is a general licensing policy of denial, a disclosure might be mandatory. ¹²⁷Id. § 126.1 (e).

III. Export Control Due Diligence Needed in Chemical Industry Acquisitions

The substantial penalties exporters can incur for export control violations should persuade any buyer in the chemical industry to want to know whether a seller with international business has been in compliance with those controls. If a buyer does not perform adequate export control due diligence on a seller, the anticipated financial benefit from the acquisition and even the ability to continue the seller’s business can be disrupted indefinitely. These adverse consequences of noncompliance could arise regardless of the corporate form that will remain after the acquisition and whether the buyer should be considered to have successor liability. Even if the buyer does not become liable for a seller’s noncompliance, it is still a problem for the buyer if the newly acquired business cannot provide the value the buyer expected.

The purpose of export control due diligence is not to audit the seller, but to conduct an adequate review of a seller’s business practices. This review should give the buyer a sufficient sense of whether the seller is likely to have any past export compliance issues. If there have been such issues, the due diligence should also give the buyer a sense of the magnitude of penalties that might follow were the government to bring an enforcement case.

These assessments permit a buyer to decide whether any issues are so severe that it should walk away from the deal or that it should adjust the purchase price (or increase holdbacks) to account for anticipated penalties. Buyers will, of course, have varying comfort levels, which will guide the level of detail required through the due diligence process. In addition, sellers should undertake the same due diligence that a buyer would so that the seller can avoid possibly losing a deal or accepting a significant reduction in the sales price.

A. The Export Control Compliance Program

The first and most telling factor a buyer should evaluate is whether a seller with international chemical business has a robust export control compliance program. Such programs should include a policy statement reflecting corporate commitment at the highest levels of management and procedures for complying with export control requirements. The extent and complexity of the procedures should reflect the nature of the company’s chemical-related business and the types of export control issues that business could raise. The existence of an export control compliance program and its content reveals whether the company understands those issues, whether it has implemented appropriate procedures, and whether it can readily demonstrate to the buyer how it has complied with relevant export controls.

There is no single format or substantive content required for a compliance program. The basic outline of a program should highlight the regulatory requirements relevant to the business and the procedures the seller has implemented based on its size, operations, and risk of noncompliance. But the lack of a compliance program should signal to a buyer that it will need to spend extra time on export control due diligence. Depending upon the types of chemicals and related products and technologies a seller sends abroad, the absence of a robust compliance program could be of significant concern to the buyer about the seller’s potential liability.

B. Relevant Substantive Issues for Review

The chemical-related export control issues to be reviewed and the amount of time and detail required for the review will depend upon each seller’s circumstances. There are a few core export control issues, however, that need to be reviewed. They are of the greatest significance and will suggest the level of detail that is required from the due diligence and what follow-on inquiries are needed.

The core issues for export control due diligence are whether a seller has effective procedures to (1) identify the export control classifications and related license requirements for its products, equipment, and technology and ensure required licenses are obtained, (2) prevent shipments to entities and individuals on a government’s prohibited lists, and (3) ensure shipments are not made for prohibited purposes.

These issues and related procedures should also be addressed in the compliance program. If they are not, there is a greater likelihood that the buyer will have to do more work to understand the company’s operations and identify information relevant to whether the seller has export compliance issues.

The level of detail and number of due diligence inquiries needed to evaluate the core export control due diligence issues will vary, but, at the very least, the buyer will need to cover the following topics:

1. Understand the seller’s products

This is somewhat obvious overall, but it has a particular importance for export control due diligence. A buyer needs to know the technical characteristics of the products, equipment, technology, and services the seller might have sent overseas to customers, subsidiaries, joint ventures, etc. so that the buyer can then determine whether those items are described on any relevant export control list.

A seller will often also use its understanding of the buyer’s products to make an initial assessment of the likelihood that there will be export control compliance issues.

2. Identify possible export control classifications

Buyers need to try to confirm, or at least narrow down, the possible export control classifications according to the CCL or USML. If the seller has a good compliance program, this aspect might will be fairly straightforward. It can be quite difficult otherwise, depending upon the variety and complexity of the buyer’s products, equipment, and technology. If those items are classified as other than EAR99, knowing where past shipments and transfers have gone is particularly important.

If the seller does not have an established compliance program, it is often necessary, or at least very helpful, to have the assistance of the seller’s technical personnel while trying to determine relevant CCL or USML classifications. Those personnel, however, are frequently not available because they have not been informed about the possible sale or for a variety of other reasons.

If the seller’s technical personnel are not available, a buyer’s own technical personnel can be very helpful and might be able to provide enough information for the classification exercise. Buyers typically have a number of technical personnel involved in an acquisition because they have played a key role in assessing the significance of what the seller makes and how a seller’s product lines fit with the buyer’s business.

3. Know where the seller sends things

Buyers need to inquire about the countries from which the seller ships anything or makes technology transfers and the countries to which it makes such shipments or transfers. Knowing the countries from which these activities originate is essential for a buyer determine, as noted above, whether a seller’s exports required a license. Knowing those countries also helps a buyer know whether it needs to consider compliance with other countries’ export control regimes in addition to the regime under U.S. law.

In addition, the list of countries to which the seller has made shipments or technology transfers shows whether a review of trade with embargoed countries will be necessary. If so, further inquiry is needed into the circumstances of embargoed country activities. These further inquiries would cover, at the very least, the countries from which shipments to embargoed countries were made, the particular affiliates of the seller and personnel that were involved, and what was sent.

A buyer should also know the location of the seller’s facilities around the world and what it does at those facilities, such as manufacturing, engineering, distribution, sales, technical service, etc. This information helps probe the veracity of information provided about a seller’s shipments and technology transfers. In addition, the location of certain types of offices might identify other issues to pursue. For example, an office in purported transshipment points such as the United Arab Emirates increases the possibility that the seller’s business has been tied to embargoed countries.

4. Know the magnitude of shipments and transfers

Buyers need to identify the rough number of shipments and technology transfers a seller has made and whether there have been reexports. This information will give a buyer a sense of the possible magnitude of any compliance issues it has determined are likely to have occurred.

For example, regardless of the export control classification of the products, equipment, and technology at issue, the appropriate due diligence will be far simpler if there were only very few shipments that came from the United States and went only to customers in Europe. Such facts would probably indicate that, even if there are some compliance issues, they are not likely to be noteworthy. In that event, further detailed inquiries might not be appropriate given the circumstances of the deal, such as timing, possible difficulty in getting further information, and other priorities of key personnel.

5. Identify any foreign national issues

If the type of technology a seller uses domestically is likely to be controlled, it is important to review whether the seller employs foreign nationals who are not Green Card holders and whether those employees would have access to the technology. It is also important to review whether anyone overseas has access to that technology through, for example, a computer network. These are examples of access to controlled technology that might not be permissible without a government license.

6. Screen the seller’s customers against the prohibited lists

If the seller does not have a process for screening whether its customers are on a prohibited government list, it is critical that those customers be screened as part of the due diligence. If one or more customers appears on a list and there have been numerous sales to the customer, the potential penalties could accumulate quickly. Also, if the customers involved are key customers, potential violations and future licensing requirements could significantly undermine the value of the business.

Even if the seller does not have a screening process, a batch screen can be done using screening software a buyer might have or by engaging one of the many screening software providers.

If any hits arise through the screening, additional review is required to determine the significance of the hits and whether they indicate compliance issues are likely. A compliance issue does not necessarily arise just because a customer is on a prohibited list, but those screening hits typically do indicate a problem.

7. Review the seller’s industries

Knowing the industries the seller serves will give the buyer a sense of the likelihood that the seller might have made sales for prohibited purposes. For example, if a seller frequently provides coatings or other chemical products to customers in the nuclear industry, there is an elevated risk of compliance issues because of a prohibition against certain unlicensed shipments for certain nuclear industry applications. In that instance, further review of whether the types of sales are likely to have triggered that prohibition would be warranted.

Another issue that arises is that when a seller provides limited or questionable details in response to due diligence questions, a buyer might reasonably have cause for concern about the veracity of that information. Accordingly, a buyer might conclude that it needs to verify the information it has received. The information a seller provides through due diligence typically comes only as informal oral or email responses or through data room documents. Depending upon the concerns the buyer might have in a given area, however, the buyer might conclude that it cannot rely upon the information it received and needs to pursue other means of information collection, such as interviews or onsite inspections.

If a buyer identifies export control compliance issues through due diligence, the next issue to consider is what, if anything, the buyer should do about them. First, some accounting for any compliance issues most likely needs to appear in the purchase agreement. This will most likely be done through schedules that modify the representations and warranties. In addition, the purchase price might be reduced to account for anticipated penalties, and some amount might be placed in escrow to pay such penalties.

The buyer should also consider whether and how it will address past possible violations after the sale, in addition to implementing corrective actions for the business moving forward. Noncompliant aspects of the business need to be stopped, of course. Many buyers also find it worthwhile to file a voluntary disclosure with the relevant government agency, because doing so typically provides certainty and results in lower penalties than would follow a government-initiated investigation. Both parties to a sale should also consider whether and how to phrase provisions in the purchase agreement that account for who controls any buyer-initiated investigation and voluntary disclosure after the sale and whether settlements with the government would be covered by any indemnification clause.

The team handling the export control due diligence also generally handles other international trade due diligence topics, which would typically cover economic sanctions, import compliance, anticorruption laws, and antiboycott laws.

IV. Conclusion

U.S. export controls restrict the international movement of many goods, technologies, and services that are relevant to companies in the chemicals industry. Failure to have adequate export control compliance programs in place can result in significant monetary penalties, onerous audit requirements, and even the inability to export. Companies in the chemical industry that do business internationally should be mindful of relevant export control requirements so that they do not undermine their business goals. In addition, chemical industry buyers acquiring sellers with international business should be sure to conduct export control due diligence on the seller to ensure that they get the full benefit they anticipated from the purchase.