Successful M&A Deals Involving Non-U.S. Entities Require Close Attention to U.S. Sanctions and Export Controls Compliance

U.S. economic sanctions and export controls have broad extraterritorial reach. The Office of Foreign Assets Control (“OFAC”) and the Bureau of Industry and Security (“BIS”) regularly impose significant monetary penalties and other sanctions on non-U.S. entities for violations. OFAC can also designate non-U.S. entities on sanctions lists and exclude them from participating in U.S. trade or finance.

An entity that acquires another, regardless of nationality, can be held liable for the acquired entity’s pre- and post-acquisition violations. OFAC makes the following observations in its guidance document “A Framework for OFAC Compliance Commitments.” (See Document 1 at page 4, emphasis added.)

“Mergers and Acquisitions (M&A): As noted above, proper risk assessments should include and encompass a variety of factors and data points for each organization. One of the multitude of areas organizations should include in their risk assessments—which, in recent years, appears to have presented numerous challenges with respect to OFAC sanctions—are mergers and acquisitions. Compliance functions should also be integrated into the merger, acquisition, and integration process. Whether in an advisory capacity or as a participant, the organization engages in appropriate due diligence to ensure that sanctions-related issues are identified, escalated to the relevant senior levels, addressed prior to the conclusion of any transaction, and incorporated into the organization’s risk assessment process. After an M&A transaction is completed, the organization’s Audit and Testing function will be critical to identifying any additional sanctions-related issues.”

We are currently in an aggressive environment as regards U.S. enforcement of its economic sanctions and export controls. It is essential that participants in mergers and acquisitions involving non-U.S. parties pay close attention to due diligence and to contractual representations, warranties and covenants on U.S. economic sanctions and export controls. Failing to do so would carry a significant risk of sanctions being imposed on one or more of the parties to the transaction, as well as negative commercial and reputational consequences and a possible significant reduction in the deal’s value proposition. These risks can arise from pre- or post-transaction violations by one of the parties. Risks can also arise from post-transaction activity that would not have been a violation before the acquisition but becomes prohibited if the M&A results in a non-U.S. entity with no previous U.S. ownership becoming controlled by a U.S. entity after the transaction. Without the active involvement of U.S. sanctions and export controls experts, these complexities would probably be missed and the resulting risks not considered.

In a September 2020 case, OFAC entered into a settlement agreement with Keysight Technologies Inc., a U.S. entity, as successor to Anite Finland OY, a Finnish entity. (See Document 2.)

• Keysight acquired Anite in August 2015. Keysight’s pre-acquisition due diligence and risk assessments had identified that Anite did business with Iran before the acquisition.
• After the acquisition, Keysight and Anite took steps to discontinue Anite’s Iran business.
• Despite Keysight’s efforts, Anite’s management continued sales to Iran by altering commercial documents and taking other deliberate steps to conceal that business. Anite’s sales to Iran included equipment incorporating 10% or more controlled U.S.-origin content. Anite had no license from any U.S. authority for those sales. The sales therefore violated both BIS export controls and OFAC’s Iran sanctions.
• Anite was still a Keysight subsidiary when the violations occurred, but it was later merged into Keysight and ceased to exist as a legal entity. Keysight, as successor entity, agreed to pay USD 473,157 to settle its civil liability for Anite’s violations.

In a February 2019 enforcement case, OFAC imposed a civil penalty of USD 5,512,564 on AppliChem GmbH, a German entity, for violating U.S. economic sanctions against Cuba.

• On January 1, 2012, Illinois Tool Works, Inc. (“ITW”), a U.S. entity, acquired AppliChem. Under OFAC’s Cuban Assets Control Regulations (“CACR”), the acquisition made AppliChem subject to U.S. sanctions restrictions on Cuba as a non-U.S. entity owned or controlled by a U.S. entity.
• In its pre-acquisition due diligence, ITW found that AppliChem did business with countries subject to U.S. sanctions, including Cuba. ITW informed AppliChem that it would have to cease all business with Cuba after the acquisition.
• However, AppliChem staff devised a complex scheme to continue the Cuba sales and conceal them from ITW. ITW eventually discovered AppliChem’s violations and disclosed them to OFAC.
• In this case, OFAC imposed the USD 5 million penalty not on the U.S. parent company but on the German subsidiary that made the Cuba sales that had become prohibited as a result of the acquisition by ITW.
• OFAC noted in its release that the case “demonstrates the importance of (i) implementing risk-based controls, such as periodic audits, to ensure that subsidiaries comply with their obligations under OFAC sanctions regulations” and of “(ii) conducting follow-up due diligence on acquisitions of foreign entities with historical dealings with sanctioned persons and jurisdictions.”

 

M&A participants who ignore these precautions take on a significant risk of serious negative consequences under U.S. economic sanctions and export controls. Non-U.S. entities may assume that M&A transactions with other non-U.S. entities are not subject to U.S. sanctions and export controls. They are. Both OFAC and BIS frequently take action against non-U.S. entities for violations. 

It is essential that non-U.S. parties to cross-border transactions, or to transactions in which one or both parties engage in international business, carry out due diligence on U.S. sanctions and export controls, include in the transaction documents representations and covenants that address U.S. sanctions and export controls risk, and also ensure ongoing monitoring and recurring audits to avoid situations such as those in the Keysight and AppliChem cases. Close cooperation between the M&A and Compliance teams is essential.

It is essential that the M&A and Compliance teams have a consistent plan and work together to make sure U.S. economic sanctions and export controls are not overlooked just because none of the parties to the transaction is a U.S. party. The following pre-transaction, transaction and post-transaction steps are essential.

• Board and senior management direction.
  • Require consideration of U.S. sanctions and export controls in every transaction involving non-U.S. entities or cross-border deals.
  • Require robust representations and warranties on compliance with U.S. sanctions and export controls, together with audit rights and indemnities, in the documentation of every deal.
  • Ensure that post-closing integration planning for the two entities includes immediate compliance controls and monitoring.
• Pre-signing due diligence.
  • Mapping exposure to U.S. economic sanctions. Identify potentially sensitive dealings with sanctioned jurisdictions, restricted parties or sanctioned sectors.
  • Review and assessment of product and technology classifications for U.S. export control purposes. Determine whether the products or technologies are subject to U.S. dual-use or defense export controls.
  • Restricted party screening. Review screening processes and identify any gaps.
  • Assess potentially high-risk counterparties and intermediaries, including distributors and agents, especially in high-risk markets.
  • Identify risks arising from technology transfers. Identify cross-border technology flows and data access.
  • Internal controls assessment. Assessment and gap analysis of existing U.S. economic sanctions and export controls compliance procedures.
• Transaction documents. The Share Purchase Agreement (“SPA”) or other agreement is usually heavily negotiated and depends on the specific facts and circumstances of each deal. The due diligence findings shape the scope and coverage of its provisions. Typical provisions to consider for maximum protection against risks under U.S. economic sanctions and export controls are set out below.
  • Representations on compliance with U.S. economic sanctions and export controls.
    • The parties, and their officers, directors and employees, are not sanctioned.
    • The parties comply with U.S. sanctions and export controls.
    • There are no dealings with sanctioned countries, parties or sectors.
    • The parties do not engage in sanctionable activities under U.S. secondary sanctions.
    • All products and technologies are properly classified under U.S. export controls.
    • The required U.S. export control licenses have been obtained.
  • Schedule of non-compliance.
  • Compliance covenants
    • Before closing, the parties must cease any activity that could amount to a violation of U.S. sanctions or export controls by any of the parties.
    • The parties must not engage in sanctionable activities under secondary sanctions.
    • The parties undertake to cooperate in implementing compliance measures, including access to personnel, records and systems.
  • Audit and access rights.
  • Indemnities for non-compliance.
    • The parties undertake to indemnify each other for losses, penalties, fines, investigation costs and remediation expenses arising from the other party’s non-compliance with U.S. sanctions or export controls.
  • Exit rights in the event of illegality under U.S. sanctions or export controls, for example, if one of the parties is designated.
  • Compliance-linked closing conditions, for example, voluntary self-disclosures before closing.
• Post-closing compliance integration.
  • Immediate restricted party screening.
  • Removal of problematic counterparties or intermediaries.
  • Review and update of compliance procedures and employee training.
  • Data and technology segregation and access controls where U.S. export controls require them.
  • Ongoing auditing and testing of the compliance function.

Mergers and acquisitions involving non-U.S. entities are not free of risk under U.S. economic sanctions or export controls. For these deals to succeed, the M&A, compliance and management teams must work in tandem to ensure risks are properly addressed. The involvement of U.S. sanctions and export controls experts is essential.

Referenced documents

• Document 1. A Framework for OFAC Compliance Commitments: https://ofac.treasury.gov/media/16331/download?inline
• Document 2. Keysight OFAC settlement agreement: https://ofac.treasury.gov/media/48171/download?inline
• Document 3. OFAC AppliChem case: https://ofac.treasury.gov/media/7556/download?inline