Success in the technology sector depends upon the development and timely deployment of innovative products. The extent to which export controls may impact such success can be easily overlooked. Not identifying applicable export controls can put the sale of new and existing products to export markets at significant risk. In addition, failure to comply with applicable export laws can adversely affect potential investments in, or acquisitions of, companies whose export markets constitute a significant component of their business. As a result, the identification and administration of export control issues should be a top priority for Canadian technology companies.
Principle of Export Controls
Compliance with export controls may at times involve complex questions. However, the basic principle behind these controls is not complex. Simply put, it is illegal in Canada – just as it is in many other countries, including the United States – to export certain products, including certain technology products (hardware or software, old or new), without applying for and obtaining a government-issued permit to do so.
In Canada, the export of an export-controlled good without the requisite export permit is a violation of the Export and Imports Permit Act (the "EIPA") and may attract severe penalties. A business found to be in violation of the EIPA may be subject to fines in an amount that is in the discretion of the court and/or imprisonment. Violations of the EIPA may also create delays in a company’s ability to obtain new export permits or obtain renewals of existing permits. Canadian exporters may also be subject to US export laws (discussed below), where civil penalties for violations are reported to now be as high as US$ 250,000 per offending export transaction.
The Canadian Export Regime
Unless certain exceptions apply, items listed on the Export Control List ("ECL") including "dual-use goods" (i.e., goods and technology that may be used in both commercial and military applications) and/or destined to areas listed on the Area Control List ("ACL") require a permit from the Minister of International Trade for export.
There are two kinds of export permits: General Export Permits ("GEP") and Individual Export Permits ("IEP"). GEPs allow for the pre-authorized export or import of certain eligible goods to/from certain eligible countries, by a simplified process. If an exporter cannot rely on an existing GEP, the exporter must apply for an IEP. Applications for such permits may be done online if the business is registered with the online export permit system of Foreign Affairs and International Trade Canada. IEPs are generally provided to allow a one-time export of a given product to a given destination. However, in certain circumstances, exporters may benefit from a broad-based multi-destination IEP to cover estimated future export sales to multiple destinations over the course of a given period (typically two years). Numerous conditions can apply to broad-based multi-destination IEPs, including: that the permit does not authorize exports to certain "non-open" countries; due diligence requirements regarding end use of the product as well as the end users; and the reporting of export sales to the Export and Import Controls Bureau (the "EICB") at Foreign Affairs and International Trade Canada.
In addition to export permit requirements administered by the Foreign Affairs and International Trade Canada, certain items may also be subject to additional export controls by other government departments and agencies, for example, the Canadian Nuclear Safety Commission. Special requirements also apply to certain defence articles (termed "controlled goods" – not to be confused with "export-controlled goods") including, for example, certain munitions, strategic goods and missile related equipment and technology. An exporter of controlled goods (and anyone who deals with controlled goods) must be registered with the Controlled Goods Program ("CGP"), administered by the Controlled Goods Directorate at Public Works and Government Services Canada. Depending on the products it makes, a business in the technology sector may be subject to both the "export-controlled goods" regimes as well as the "controlled goods" regime in Canada. The export of goods from Canada also generally requires the filing of an export declaration and any applicable export permit data with the Canada Border Services Agency.
Exports to the United States
Canada and the United States have agreed, on a bilateral and reciprocal basis, that they will not require export permits for most export-controlled goods that originate in their respective territories and that are destined for end-use in the territory of the other. Accordingly, no export permit is required under Canadian law for the sale to the United States of most export-controlled goods that would otherwise require a permit if destined for any other export market. There are, however, important exceptions to this reciprocal understanding. For example, certain items on Canada’s Export Control List in Groups 2 through 7 (e.g., munitions, items related to nuclear, biological and chemical non-proliferation, other military and strategic goods and missile technology) require an IEP. In addition, products that are simply transhipped through the United States for final destination in other export markets require an export permit applicable to the country of final destination.
Re-Export of US-Origin Goods
Many Canadian technology companies acquire technology from US suppliers that is re-exported by the Canadian company, either on a stand-alone basis or incorporated into the Canadian company’s products. In such cases, the Canadian exporter must determine not only the application of Canadian export laws but must also consider the impact of US export laws regarding the re-export of the US-origin goods. The issues arising from the export from Canada of US-origin goods or Canadian goods containing US-origin components are often complex and typically require input from both US and Canadian legal counsel.
US Export Controls
Canadian technology companies often have subsidiaries, affiliates and/or offices located in the United States. In such cases it is important to be aware of potential obligations, restrictions and/or liabilities arising under US export control laws. This is the case not only for exports by the US subsidiaries or affiliates to unrelated customers abroad but also with respect to intercompany transfers of controlled goods. In the latter case, as "export" is broadly defined under US export control law to include, among other things, the release to a foreign national of technology or software subject to export regulations (e.g., from an American to a Canadian when both are in Canada or in the United States or elsewhere), it is easy to overlook transactions that may be subject to US export controls. Under certain circumstances, a company need not be the "exporter of record" to be considered the "exporter" under US law.
As in Canada, additional regulations apply to the manufacture and export of defence articles. In the United States, such goods are regulated by the International Traffic in Arms Regulations ("ITAR").
Internal Controls for Compliance with Export Permit Requirements
It is not enough to simply obtain an export permit. Companies must also ensure that they comply with the terms of the export permit and, in the case of time and/or value limited permits, that they keep track of the permit expiration date and total sales value so that a renewal can be applied for on a timely basis. In addition, new products will generally not be covered by existing permits and must be reviewed in a timely matter in order to determine what export controls may apply to their export.
It is important, therefore, for companies to implement sound internal compliance measures, including educating employees about the importance of export control compliance, designating individuals who are responsible for export compliance matters, and ensuring that new products are automatically reviewed for export-controlled status. Such internal controls will result in greater business certainty as full compliance with export controls will facilitate the application process for future export permits and/or export permit renewals.
Merger & Acquisitions/Investment Due Diligence
Export control compliance is important not only to companies whose products are subject to export controls. It is just as important for companies and investors that are considering the acquisition of, or investments in, Canadian or foreign companies who may be subject to such controls. Prior to consummating such an acquisition or investment, proper due diligence regarding the target company’s export activities should be conducted. For example, the purchaser or investor will want to assure itself that the target company has not exported or imported in violation of the EIPA and any other applicable export control laws (including those of the United States), and that it has obtained all necessary export permits.
Simply asking the target company if it has obtained all necessary export permits will usually not be sufficient as non-compliance is often a result of the target company not being aware of its obligations under applicable export laws. Proper due diligence includes determining what procedures the target company has implemented in order to assess its export control obligations. A lack of such procedures is a clear signal that further investigation is required. Where non-compliance issues are identified, the purchaser or investor will have to evaluate the risks resulting from such non-compliance and decide whether it wishes to accept such risk, insist that the non-compliance is rectified prior to closing, or negotiate an appropriate reduction in purchase price or valuation and/or indemnification for any losses arising from such non-compliance.
In the course of advising clients, we have discovered that some clients are under the mistaken belief that customs brokers will handle export control issues on behalf of the company. A customs broker typically deals only with payment of duties and taxes when exporting/importing physical goods. Customs brokers generally do not assist companies in obtaining export permits, and typically are wholly uninvolved in, and therefore unaware of, exports of non-physical products such as software by companies in the high technology sector.
A failure to understand and comply with applicable export controls can have a devastating effect on a technology company. As a result, every company should have at least one person whose responsibility it is to ensure that the company is in compliance with applicable export control laws and remains so. Where questions arise regarding the applicability or interpretation of export control laws, or where non-compliance has been discovered by the company, consultation with a lawyer who is experienced in the area of export control is highly recommended. As with many other issues that businesses must address, upfront investments in time and effort to ensure the proper management of export control issues pays dividends in the form of avoiding the potentially significant costs of compliance that will otherwise be incurred down the line. This is especially the case for companies in the technology sector whose export markets constitute a significant component of their business. Where success depends upon the development and timely export of innovative products, export control issues is a top priority that may be easily addressed.