Defense Cos. Face Hazards In New Push For Foreign Sales

By Dietrich Knauth

Law360, New York (April 21, 2014, 7:03 PM EDT) — While many U.S. defense companies are hoping that foreign military sales can help them weather a prolonged slump in military sales at home, cross-border sales hold several risks for the unwary, including heavy fines and criminal penalties for violating export controls and anti-bribery laws.

The U.S. government has encouraged its defense industry to expand weapons sales to allies, both through its Foreign Military Sales program, in which U.S. contractors fulfill weapons sales brokered and controlled by the U.S. government, and the Foreign Military Financing program, in which foreign countries subsidized by U.S. funding buy directly from American contractors. Both offer opportunities for defense companies feeling the squeeze of budget reductions at home, but both carry risks, experts said.

“This is truly one of the hot issues in federal procurement nowadays,” said Andrew Irwin of Steptoe & Johnson LLP, speaking at the American Bar Association’s annual Federal Procurement Institute. “With declining federal spending, I think every large and small contractor is thinking to themselves, ‘How do I maintain or replenish my revenue in markets outside of the United States, and how do I do it in a manner that’s smart, that doesn’t get me in trouble and really grows my business?’”

With all the contracting regulations U.S. companies must manage, doing work for the U.S. government is tough enough, but expanding defense work adds a whole overlay of new responsibilities, Irwin said.

“When a company gets involved in this sort of business, it’s not simply about understanding procurement anymore. It’s not, ‘How do we perform a U.S. government contract?'” Irwin said. “It’s, ‘What are all the things that can go wrong or that we need to be mindful of when we work abroad?'”

But the opportunities are there as well — in 2012, FMS were $70 billion, a sharp increase in just a few years. Before 2006, FMS was only about $10 billion a year, Irwin said. Most of that funding goes to traditional export markets like the Gulf Arab states, Southeast Asia, India and Israel.

“The amount of money that’s being pumped into global, primarily arms, markets is really staggering,” Irwin said.

Direct commercial sales under the Foreign Military Financing program offer some advantages over the Foreign Military Sales program but carry different risks, according to Marques Peterson of McKenna Long & Aldridge LLP. FMF provides grants for the acquisition of U.S. defense equipment, services and training, and nations participating in the program include major export markets like Israel, Egypt, Greece and Turkey.

“The reason that direct commercial sales is something that’s a hot item and something that’s going to continue to expand in the next couple years is that there’s a perceived notion that you have greater flexibility,” Peterson said. “You don’t have the U.S. government playing catcher in the middle between the foreign government purchaser and the U.S. contractor, so you can negotiate directly.”

But FMF-funded sales come with unique restrictions, notably the requirement that the funds be used only for U.S.-made products. Since U.S. companies can’t use FMF funds for foreign subcontractors, brokers, procurement agents or foreign-made supplies, contractors really need to know their supply chain and ensure that all costs are allowable before selling under the FMF program, Peterson said.

Other legal challenges faced by defense exporters include the Foreign Corrupt Practices Act, International Trafficking in Arms Regulations, U.S. economic sanctions and anti-boycott regulations.

Export laws are undergoing a massive shift, in which many items are being transferred from the State Department’s restrictive Munitions List to the Commerce Department Commerce Control List. The switchover, while generally welcomed by U.S. exporters, will require manufacturers and suppliers to carefully determine how their products fit into the new regulatory regime and will require many to familiarize themselves with the Commerce Department’s licensing policies, attorneys said.

U.S. anti-boycott regulations are another part of export law that exporters must remain aware of, Irwin said. The Arab League’s boycott of Israel — supported by Iraq, Kuwait, Lebanon, Libya, Qatar and the United Arab Emirates — means that defense companies must be on the lookout for boilerplate contract language about complying with “all local laws” or risk running afoul of U.S. anti-boycott rules, Irwin said.

Bribery remains a risk in many defense export markets, and contractors must be wary of the Foreign Corrupt Practices Act’s expansive definitions of “foreign officials” and the types of gifts and payments that can be seen as corrupt.

Companies should also be careful to ensure that their recordkeeping is up to snuff, according to Jessica Tillipman, assistant dean of government contracts law at George Washington University Law School. While the FCPA penalizes outright bribery, it also has “books and records” requirements that are far more likely to trip up an exporter, she said.

“Companies really need to be wary of the books and records provision, because that’s where the government often sees companies slip up,” Tillipman said.

Because the FCPA penalizes bribes even when they are not directly authorized, rigorous due diligence is essential when dealing with foreign officials and third-party agents in a foreign country, she said.

“When you’re going into a new country and establishing yourself or even trying to broaden your business base, every single time there is a government interaction, no matter how minimal, there is a potential for FCPA liability or even liability under some of the similar statutes in other countries,” Tillipman said. “The reasons why a particular third-party agent may be so attractive to a company — their government connections, their familiarity with an area, their expertise in an area, their connections otherwise — are the same reasons why they’re the biggest risks.”

A common way for companies to get into trouble with FCPA enforcers is to hire a local agent and tell them to do “whatever you need to get it done” — a directive that can be read to including bribery if a company doesn’t explicitly disallow it, Tillipman said.

Companies should also be wary of the sometimes-expansive definition of “government official” under the FCPA, Irwin said.

“In the aerospace and defense world, or engineering and construction world, public sector officials are usually fairly obvious,” Irwin said. “But imagine if you’re a health care company and you’re selling to China and everyone who you want to demonstrate a product to is a doctor in a state-run hospital, then they may actually be foreign officials for the purposes of the FCPA.”

Fortunately, the DOJ is fairly clear about what it expects from companies and has published a guidebook on anti-bribery enforcement, Tillipman said.

Bribery offenses will not only trigger the FCPA, but other nations’ anti-corruption laws as well, which are increasingly used for extraterritorial enforcement. Brazil, which is seen as one potentially growing market for U.S. exporters, recently enacted its own anti-bribery law, which exporters should be wary of, according to Ricardo P. Levy of Pinheiro Neto Advogados.

Enforcement of that law could be very hectic, since any local government can bring enforcement action, unlike in the United States where the U.S. Securities and Exchange Commission and U.S. Department of Justice take the lead, Levy said.

“Each one of them will have jurisdiction to prosecute cases,” Levy said. “On the one hand, this makes it easier to enforce; on the other hand, it can be a nightmare, in terms of lack of harmonization.”

The Brazilian law also allows municipalities to keep money they recover, which could encourage a sort of localized blackmail, Levy said. Defense contracts and other federal procurements tend to be more professional and transparent, but contractors should be especially wary of contracting locally, he said.

“This money goes to the same procuring entity, the same authority which is handling the case and condemning the company, so there is a clear conflict of interest there,” Levy said.

Published by Law360

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