United States: Successor Liability Ruling Leads to $1.76 Million Settlement in Export Control Case

In the mergers and acquisition context, undiscovered export control violations can be the source of serious liabilities, which can arise years after the transaction. Although the civil and criminal fines for such violation can be quite high, the additional penalties for export violations can have a profoundly negative impact. Companies found to have violated the U.S. export controls may be barred from exporting and from government contracting. As a recent ruling in a case arising from an acquisition shows, these liabilities will follow acquired assets, even when the purchaser believes it has left the target’s liabilities behind.

Employing a "substantial continuity" theory of successor liability, the Bureau of Industry and Security (BIS), the federal agency that enforces export controls, in 2004 imposed liability on a purchaser of assets for export control violations committed by the seller of the assets. A BIS administrative law judge (ALJ) rejected the purchaser’s arguments that they could not be held liable for pre-acquisition export violations of the seller, even though under one agreement the buyer had expressly left such liabilities behind with the seller. The purchaser ultimately agreed to a $1.76 million payment to settle allegations that both pre- and post-acquisition transactions violated the Export Administration Regulations (EAR).

The ALJ’s ruling in Sigma-Aldrich Business Holdings clearly established that successor liability exists under the EAR. It also provides a basis for imposing such liability based on the acquisition of assets alone, even when the seller remains a going concern. More broadly, BIS’s pursuit of the corporate parents, when it had a relatively easy case against the operating company, demonstrates that purchasing entities must focus on export compliance issues both during and immediately following an acquisition of another entity or its assets.

In April 1997, three Sigma Aldrich entities acquired certain assets and property of, and partnership shares in, Research Biochemicals Limited Partnership (RBLP). Specifically, Sigma-Aldrich Research Biochemicals, Inc. (Research) acquired RBLP’s assets, property, and liabilities. Research agreed to perform under RBLP’s existing contracts and fulfill existing orders. At the same time, Sigma-Aldrich Corporation (Corp) and Sigma-Aldrich Business Holdings (Holdings) acquired 1 percent and 99 percent, respectively, of the partnership units in RBLP. Corp and Holdings paid $18 million for these units. The ALJ found no evidence of any consideration paid by Research for the assets and property of RBLP.

BIS alleged that, prior to the acquisition, RBLP had made numerous unlicensed exports of biological toxins and the illegal exports continued after the acquisition. In all, the charges included 268 allegations of unlicensed exports and 50 related charges of making false statements and failing to retain records required by the EAR. Although only Research acquired RBLP’s assets and liabilities, while Corp and Holding acquired only partnership units, BIS sought to hold all three entities liable for the pre-acquisition violations.

The Sigma-Aldrich entities raised three arguments against successor liability, all of which were rejected by the ALJ. Specifically, Sigma-Aldrich argued that:

1. Liability could not be imposed on any Sigma-Aldrich entity because there is no statutory provision for successor liability under the EAR;
2. Even if a statutory basis for successor liability existed, such liability could not be imposed where the seller remained a viable enforcement target; and
3. Liability could not be imposed on Corp and Research because they had acquired only partnership units and not assets or liabilities.

First, on the overarching question of whether successor liability could be imposed at all, the ALJ relied on a provision in the underlying statute imposing liability on any "person" that commits a violation, as interpreted under the federal rules of statutory construction. The ALJ noted that under the federal rules of statutory construction, "person" includes corporations, companies, and partnerships, and that "company" includes successors. From these definitions, the ALJ concluded that Congress must have intended "persons" as used in IEEPA to include corporations and their successors.

Second, the ALJ relied on a provision of the EAR that allows BIS to apply enforcement orders (such as a denial of the privilege to export goods from the U.S.) to the corporate affiliates of the company that committed the violation. Such orders prohibit persons and entities from participating in export transactions, typically as a penalty for prior violations. The cited provision allows BIS to extend such orders to corporate siblings, offspring, and parents to prevent the denied party from routing export transactions through its corporate relatives. As this is expressly a remedial authority that allows BIS to enforce denial orders, its relevance to the successor liability analysis would appear marginal at best. Nevertheless, the fundamental ruling that the EAR generally permits successor liability is likely to withstand future challenges and should be considered established.

Next, having found that the underlying statute permitted the imposition of liability on successor entities, the ALJ turned to the question of whether the Sigma- Aldrich entities could be liable for RBLP’s violations. In doing so, the ALJ first identified the standard that would be applied in determining whether successors could be liable for violations of the EAR.

The ALJ’s opinion purports to rely on "the traditional rules of successor liability." The ALJ acknowledged that "asset purchasers are not liable as successors" unless one of four exceptions applies. The four exceptions cited are where: (1) the purchaser expressly or impliedly assumes the liability; (2) the purchase constitutes a de facto merger; (3) the purchasing entity constitutes a "mere continuation" of the selling entity; and (4) the transaction was fraudulently conducted to avoid liability.

The opinion acknowledges that, strictly applied, none of the four established exceptions would apply to allow successor liability in the context of an asset purchase. Accordingly, the ALJ turned to a broader variation of the "mere continuation" exception. Under the "substantial continuity" exception employed by the ALJ, "a literal ‘purchase’ of assets is not required to establish successor liability so long as there is some form of a ‘transfer’ of assets." The ALJ identified the five factors to be considered under this analysis as whether the successor: (1) retains the same employees, management, and production facilities; (2) produces the same products; (3) retains the same business name; (4) has the same assets and operations; and (5) holds itself out a continuation of the previous entity. The stated rationale for applying this theory is to prevent corporate wrongdoers from "using corporate formalities to escape liability."

The opinion also notes that the substantial continuity analysis requires the successor to have knowledge of the potential liability. The ALJ found that knowledge can be inferred from the same factors that would support a finding of substantial continuity: retaining the same employees, supervisory personnel, products, and production facilities. This analysis effectively eliminates any meaningful knowledge requirement.

The ALJ also addressed the purchaser’s contention that they could not be held liable because the predecessor entity that committed the violations remained a viable target for prosecution. The ALJ offered several rationales for rejecting that claim. First, the ALJ found that successor liability could attach regardless of the nature of the entity. The opinion also notes that responsible parties can be held jointly and severally liable. Finally, it found that successor liability may be imposed for policy reasons. Specifically, such liability is appropriate to protect the public interest and prevent corporations from evading the purpose of the regulations through corporate structuring formalities.

In undertaking the policy analysis, the ALJ specifically relied on the national security and anti-terrorism purposes of the export regulations. By invoking these purposes, the ALJ probably insulated the opinion from judicial reversal. The courts have been notoriously reluctant to overturn agency decisions that are based on national security considerations. Moreover, because all export controls are intended to serve national security and foreign policy purposes, the ALJ's rationale would seem to justify imposing successor liability under almost any circumstance, a conclusion that is supported by the balance of the decision in the case.

Rather than relying on the express assumption of liability by Research, the ALJ’s opinion finds that Research is a substantial continuation of RBLP’s business, and would be liable for RBLPs’ violations. It then goes on to analyze Corp and Holding’s potential liability. The opinion acknowledges that under the purchase agreement, only partnership units were transferred and that the agreement makes no mention of either assets or liabilities. It then concedes that, given these facts, neither Corp nor Holdings would ordinarily be considered successors in interest even under the substantial continuation theory.

Nevertheless, the ALJ refused to grant summary judgment for those two respondents, finding that a question of fact existed as to whether they had in fact acquired the assets of RBLP, at least for some period of time. In so finding, the ALJ looked to the details of the transaction, Noting that the consideration was paid only for the partnership units, the ALJ questioned whether "RBLP gratuitously transferred its assets and business to [Research], or whether RBLP’s assets and liabilities were first acquired by [Corp and Holdings]." In short, the ALJ ignored the transactional documents and the structure of the transaction, as well as sworn testimony, in order to hold the purchasers in the case.

In seeking to attach liability to Sigma-Aldrich, the government sent a clear message. It expects sophisticated buyers in the mergers and acquisitions context to work and deal with export control issues. If the buyer fails to find the problem, and the violations continue, the buyer will be called to account not only for the post-acquisition violations, but for those occurring prior to the transaction.

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