Conducting a Legal Compliance Review for Import and Export Activity in the Context of a Potential Merger or Acquisition

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March 2, 2004

            A successful completion of any merger or acquisition of a company engaged in importing and/or exporting, must of necessity include a due diligence review of compliance in these areas.  In today’s global economy many companies are heavily engaged in import and export activities. As anyone familiar with these activities can attest, an undiscovered problem in the import or export area can result in the imposition of substantial civil and even criminal penalties.  Many of these problems can be discovered in the course of conducting an appropriate legal compliance review.   Once identified the prospective buyer has the ability to adjust or modify the deal in a number of ways that can minimize or shield itself from liability.  For example, the buyer can decide to avoid the deal entirely, adjust the purchase price, withhold or escrow part of the purchase price pending resolution of the problems identified, or require that the seller provide appropriate warranty or indemnity language that will shield the buyer from liability.

             How does one go about conducting such a review?    In our practice we have found that the utilization of detailed questionnaires and interviews of key import/export personnel is most productive and cost efficient.  The more information we are given about the import/export activities of a company the better we are able to prepare a questionnaire that will zero in on the information that will reveal the level of compliance of the company in these areas.   A certain amount of document review is usually required, but unlike other due diligence undertakings,   it is rare that a lengthy and labor intensive document review is necessary.   Once this examination is completed senior management is provided with a privileged and confidential report of our findings. 

             What are the areas that should be addressed in a legal compliance review?  The most important area to begin with is the overall corporate customs policy and administration that is in place in the company.  A clear red flag, of course, is the absence of such a policy and the lack of involvement of the management of the company in the import/export functions.  A good corporate policy will set out clear delegation of authority from a senior executive down to the hands-on personnel who will be responsible for the company’s import/export compliance on a daily basis.  It is very important to identify where the import/export compliance function is located within the company.  That is to say, do they have the ear of management when necessary.  Such a review should also focus on the ‘atmosphere of compliance’ in the company; i.e., is it based entirely on risk analysis – what are the chances of getting caught – or is there an overriding corporate culture to do things right?  It is also critical to determine the relationship between the import/export department and the internal audit function of the company.   

             A legal compliance review also needs to focus on the specific filings that are mandatory for each import and export.  For example, every importation into the United States becomes the subject of a Customs entry.  There are a number of declarations that must be made to complete the entry.  Each of these declarations can result in additional duty assessments and penalties if they are improperly made.  For example, in every case, an importer must declare a correct Customs value and tariff classification.  Each of these determinations can be difficult and complex and there are many rules and precedents that must be followed.  Often an importation is eligible for special duty reduction programs, which if claimed by the importer on the Customs entry, requires that the importer possess, or be in a position to obtain, sourcing, manufacturing or other data to support the claim.  Among the duty reduction programs that an importer can avail itself of is the North American Free Trade Agreement (NAFTA), American Goods Returned, Generalized System of Preferences (GSP) and the Caribbean Basin Trade Partnership Agreement (CBTPA).  The U.S. is continuously negotiating additional bilateral or sector agreements, each of which will have different requirements for eligibility. 

             In addition a legal compliance review will determine whether any of the products imported by the prospective acquisition is subject to antidumping, countervailing or other non-tariff trade barriers, and if so whether there are adequate controls in place to ensure that, either the additional duties are being properly deposited, or if appropriate, that the company is actively engaged in trying to mitigate its exposure to such assessments. 

             A legal compliance review should also include a review of the company’s history with the Bureau of Customs and Border Protection, its performance in past audits, disclosure of violations to Customs, as well as any investigations or penalty assessments.  The review should also evaluate the efforts undertaken by the company to prevent a recurrence of the problems resulting in such governmental actions.

             On the export side, while accurate export documentation is important, and must be reviewed, it is also critical to determine what type of export controls are applicable to the company’s products and whether the company has an effective export compliance program in place that is adequately staffed and supported by management.  There are several agencies that have the authority to prevent a company from doing business overseas if serious or repeat export violations occur.  These agencies include the Department of State, the Bureau of Industry and Security and the Office of Foreign Assets Control.

             Finally, a legal compliance review should assess the adequacy of the company’s record retention program for imports and exports and relationships with third party service providers, such as Customs brokers. 

             Like any other due diligence review that is done before concluding a merger or acquisition, a legal compliance review of a company’s import/export functions will ensure that no unpleasant surprises surface later when the buyer is not in a position to protect its interests and investment.