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International Trade Regulatory Considerations in Legal Auditing and Due Diligence

Increased concern about national security has led the U.S. government to more aggressively enforce regulations governing imports, exports, and related areas. This enforcement has resulted in record fines and damaging publicity for leading U.S. and international companies. At the same time, efforts to negotiate a growing number of free trade agreements are creating new opportunities and risks for companies worldwide.

Compliance with regulations governing international trade should be a necessary component of internal legal auditing programs, even for those businesses that engage in limited import and export trade. International trade considerations also can be an important facet of due diligence reviews in acquisitions and other transactions.

The rules governing international trade are complex and sometimes counterintuitive. For example, although export control requirements generally apply to military items and high technology "dual use" goods, even commonplace items like hammers and nails are controlled to certain parties and destinations. While specific issues under these rules should be discussed with counsel, a basic ability to "spot" international trade issues in the legal audit and due diligence contexts can benefit companies in significant ways, such as:

  • avoiding or limiting potentially severe criminal and civil liability for violations of key import and export laws.
  • preventing the "purchase" of trade-related regulatory liability in an acquisition or other transaction.
  • avoiding the substantial negative publicity that can accompany violations, particularly of those laws that forbid trading with countries and persons who pose national security risks.
  • identifying competitive risks and opportunities presented by the continued rapid change in international trade rules.

Set forth below are brief summaries of the primary U.S. legal regimes governing international trade, along with some preliminary questions and examples that may help identify potential issues under these rules.

Import Requirements

The U.S. customs law imposes substantial responsibilities on persons or firms that are the "importer of record" of goods, including the obligations to make accurate customs declarations and to otherwise exercise "reasonable care" in the customs context. Violations of these requirements can, depending on the circumstances, result in substantial criminal and civil penalties, including the possible seizure of the imported goods.

Basic inquiries in the customs context might include the following:

  • Does your company have in place procedures to assure the exercise of "reasonable care" in the customs context, including internal procedures and, where appropriate, the advice and assistance of brokers and advisors on customs law issues?
  • How does your company determine the valuation of imported goods for customs purposes? If the normal "transaction value" test is appropriate, how do you assure that this value includes the value of required additions, such as assists, royalties, and commissions?
  • What procedures do you have in place to determine the proper classification of imported goods?
  • How does your company assure that imported goods (including repackaged imported goods) are marked to indicate their correct country of origin?
  • What procedures do you have in place to assure that your imports comply with customs-related requirements of other agencies, including the FCC, FDA, USDA, and the CPSC?
  • Is your company's imported merchandise subject to quota/visa requirements or countervailing duty or antidumping duty orders?
  • Does your system of import recordkeeping comply with the requirements of U.S. customs law?

Trade Agreements

Multilateral trade agreements, such as the North American Free Trade Agreement ("NAFTA"), and various trade preference programs, such as the Generalized System of Preferences ("GSP"), provide duty-free or reduced duty treatment for eligible goods as well as other advantages for goods and services from participating countries. Receipt of these benefits are, however, contingent on a variety of requirements, including highly specific rules of origin. The ongoing negotiation of new trade agreements, including the agreement to establish Free Trade Area of the Americas ("FTAA") in the Western Hemisphere and the Central American Free Trade Agreement ("CAFTA"), also will present new opportunities and risks for many companies.

Basic inquiries in the trade agreements context might include the following:

  • If your company imports goods that receive preferential tariffs under a trade agreement or preference program, do the goods meet the requirements of the agreement or program? For example, if the imported goods benefit from NAFTA tariff treatment, can you demonstrate that they are NAFTA-originating?
  • If your company exports goods that receive such preferential tariffs, do the goods meet the relevant requirements? For example, if your company represents that manufactured goods are of U.S. origin for NAFTA purposes, have you thoroughly analyzed the applicable NAFTA origin rules?
  • Does your company import, export, use, or compete with goods or services that may be subject to liberalized tariff or other treatment under emerging trade agreements like the FTAA or CAFTA? Has your company analyzed the opportunities and risks posed to its current business by such substantial changes in trading rules?

Export Controls

The United States maintains about 20 different export control regimes. Those most likely to affect our clients cover exports of commercial items that have potential military value, "defense articles," related data and related services, and nuclear equipment and data. Depending on its classification, which usually can be ascertained by referring to the applicable set of regulations, an exported item can require a license to a variety of foreign destinations. Licensing can be complex and time consuming, particularly if license processing is delayed because the initial application is incomplete. Following are two examples of situations where the need for an export license could be overlooked:

  • A U.S. company that manufactures commercial lenses is asked to cut one of its lenses to fit a military gun sight. The company farms out the work to its Asian subsidiary and sends the subsidiary the drawing and specifications of the lens that it has received from the prime contractor. The export of the drawing without a license from the State Department is a violation of the International Traffic in Arms Regulations.
  • A manufacturer of specialized integrated circuits hires a new graduate of M.I.T. to work in its research and development facility, securing a visa that permits him to work in place of his previous student visa. The employee is to work with data that would require a license for export to her home country. Sharing those data with the new employee is a "deemed export" that requires an export license from the Department of Commerce.

Penalties for violation of export rates can be severe, including not only fines and prison terms, but also loss of all export privileges for the guilty company, sometimes for a period as long as 20 years.

Trade Embargoes

The United States has maintained a complex and ever-changing system of trade embargoes since World War I, although the current statutory basis for most of the embargo system dates from the late 1970s. Currently embargoed countries include Cuba, Iran, Libya, and Sudan. Formerly sanctioned countries include North Korea (which is under consideration for reimposition of sanctions), Iraq, Yugoslavia, and Vietnam. Burma, Syria, and Angola also are currently subject to less than full embargo sanctions in certain product areas. The Cuban embargo applies to foreign subsidiaries of U.S. companies; the other embargoes apply only to U.S. companies, goods and citizens and residents. This is a complicated and ever-changing area. Consider the following:

  • A U.S. company acquires a Spanish company with significant international earnings. Upon acquisition, the U.S. company learns that a significant portion of the Spanish company's international sales are to Cuba, a favored Spanish trading partner. At the same time, however, sales of the Spanish company's products to Cuba are prohibited because of the U.S. embargo on Cuba, which applies to foreign subsidiaries of U.S. companies.

It is therefore essential that in international acquisition situations, the target's markets and their relation to the U.S. embargo system, be thoroughly understood.

Foreign Payment

U.S. companies have been dealing with criminal sanctions for foreign payments since the passage of the Foreign Corrupt Practices Act ("FCPA") in 1977. Over the last quarter century, responsible U.S. companies have devised sophisticated systems for performing due diligence on prospective agents and consultants and educating their employees on FCPA compliance. Companies in the rest of the industrialized world did not begin to address the issue of overseas payments until 1997, with the promulgation of the OECD Convention on Combating Bribery of Public Officials in International Business Transactions. Consequently, companies making acquisitions of overseas entities, particularly those that have historically been independent or owned by European or other non-U.S. interests, run the risk of acquiring foreign payment problems and the attendant liabilities. A couple of examples illustrate this serious potential problem:

  • An acquired foreign company has a force of more than 100 international sales representatives. Upon acquisition by a U.S. company, all of these representatives must be subject to FCPA due diligence to ensure that the U.S. parent did not "know" that one of these representatives might make an illegal payment.
  • The management of an acquired foreign company grew up professionally in a business culture where payments were a part of international business and overseas bribes were often subtly encouraged by such means as allowing them to be deductible on income tax returns as an ordinary and necessary business expense. Upon acquisition by a U.S. company, these foreign executives will have to be reeducated with respect to FCPA and local compliance standards.

Antiboycott Compliance

The United States maintains two separate–and sometimes inconsistent–regulatory regimes that penalize conduct cooperating with the Arab boycott of Israel. Violation of the Commerce Department's antiboycott regulations can lead to substantial fines and, in serious cases, prison terms or loss of corporate export privileges. Violation of the Treasury Department's rules can lead to loss of a company's foreign tax credit, Subpart F benefits, and FSC benefits for an entire year.


In view of the complexity of these and other international trade-related rules and the serious penalties that can be imposed for violations, a detailed knowledge of these requirements is critical, particularly in the legal audit and due diligence contexts.

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