International Trade & Compliance - April 2013

by Orrick, Herrington & Sutcliffe LLP
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The U.S. State and Commerce Departments have published amendments to the International Traffic in Arms Regulations (“ITAR”) and Export Administration Regulations (“EAR”) as a major step in implementing changes to export controls as part of the Obama Administration’s Export Control Reform Initiative. The thrust of the initiative is to move items that the President has determined no longer warrant control on the U.S. Munitions List to a new section of the Commerce Control List. The Commerce Control List has traditionally been reserved for civil or dual-use items that are eligible for more flexible treatment under the EAR. The regulations are in final form and are to become effective October 15, 2013.

The only specific items addressed by these initial amendments are for military aircraft, certain aircraft engines and related items. In addition to structural changes to the Commerce Control List, the amendments substantially change treatment of parts and components by creating an elaborate and unnatural provision governing the term “specially designed.” This provision will determine the export licensing treatment of most parts and components.

A key goal of the export control reform initiative is streamlining and simplifying requirements that are notoriously cumbersome and far-reaching. While some obvious progress has been made in the April 16 amendments, it is notable that the regulations and accompanying material are voluminous and complex. In any event, this is the most substantial and integrated U.S. export control reform effort in decades. So far, it is being undertaken wholly by administrative initiative without any new authorizing legislation.

Background

The United States and other nations impose license requirements—“controls”—on exports, reexports and, in some circumstances, in-country transfers of certain types of goods, services, software and technical information for national security and foreign policy reasons. In part, U.S. export controls implement international arrangements. But some U.S. export controls are imposed unilaterally.

The State Department’s Directorate of Defense Trade Controls (“DDTC”) administers the ITAR. The ITAR cover items on the U.S. Munitions List, which is part of the ITAR. The ITAR can be particularly challenging and difficult to reconcile with normal commercial business practices.

The Commerce Department’s Bureau of Industry and Security (“BIS”) administers the EAR. The EAR also rely on a list of export controlled items, the Commerce Control List. But the EAR have a residual scope in that they can impose license requirements on transfers of any item that is not regulated solely by another U.S. export control regime.

Since the mid-2000s even senior U.S. defense officials have begun to acknowledge that U.S. export controls can work at cross purposes with the national security interests that they are supposed to advance. The White House announced an initiative to reform U.S. export controls in August 2009. The initiative is intended to protect and enhance U.S. security interests while focusing export controls on items that merit control and eliminating unnecessary controls. Foremost export control issues tend to concern China, overwhelmingly the leading market for exports that are subject to relatively restrictive controls.

The amendments that affect aircraft and aircraft engines are part of a series of amendments to address all categories of the U.S. Munitions List. Proposed regulations to move items from the U.S. Munitions List to the Commerce Control List have been published for twelve of the twenty-one U.S. Munitions List categories. Final regulations have now been published for Categories VIII and XIX of the U.S. Munitions List (military aircraft and turbine engines).

Treatment of Parts and Components

A critical focus of plans to move items between the control lists is parts and components of systems on the U.S. Munitions List. The United States imposes extensive military export controls (ITAR controls) on parts and components of military systems. For the most part, the ITAR express these controls in very general terms—parts and components that are “specifically designed or modified” for items identified on the U.S. Munitions List. Compliance with ITAR parts and components controls can be particularly difficult because U.S. officials have often construed the terms “specifically designed” or “specially designed” in a sweeping and at times arbitrary manner, and have applied those terms in open-ended, “catch-all” categories of parts and components.

In addition to moving many parts and components from the U.S. Munitions List to the Commerce Control List, the Obama Administration has stressed its intention to reduce, in both lists, the number of residual “catch-all” controls covering items that are specially designed or modified to serve in or with listed items.

“Specially Designed” Provision

In the Commerce Control List, “catch-all” controls also generally cover items that are “specially designed” for items expressly enumerated on the Commerce Control List. Apart from reducing the number of “catch-all” controls, the Obama Administration committed to clarify the term “specially designed” and begin using that term in both the Commerce Control List and the U.S. Munitions List.

Instead of a definition, the April 16 ITAR and EAR amendments establish a mechanism or series of criteria and exceptions that, when applied to a particular part or component, will determine whether the part or component qualifies as “specially designed.” It is a complicated mechanism that, in large part, bears no connection to the plain meaning of the words “specially designed.”

The amendments’ treatment of “specially designed” is bifurcated. For end items, the provision is reasonably straightforward and intuitive. It captures items that have properties that are “peculiarly responsible” for achieving or exceeding the performance levels, characteristics or functions set forth in the control list and that render the end item in which a component is incorporated subject to control. For parts, components, accessories, attachments and software, however, the “specially designed” provision has a “catch-and-release” structure. Most such items are at least initially covered simply by virtue of their use in or with a controlled item. One must then assess a series of exceptions to determine if the parts, components, accessories, attachments or software are “released” from the initial sweeping coverage of the “specially designed” provision.

As with the export control reform initiative as a whole, the “specially designed” provision raises at least as many questions as it answers. It is expected that U.S. officials will issue additional guidance on how to apply the new approach to “specially designed.”

The Administration has indicated that it will complete many additional rulemakings this year as part of the Export Control Reform Initiative. In the Administration’s plan, these rulemakings are to be followed by legislation that will provide a clear statutory foundation for the EAR—something that has generally been missing since 1994—as well as consolidate in a single agency the export control functions that are currently spread across several government departments and agencies.

The Orrick International Trade & Compliance Group is deeply involved in export control matters. For more information about these developments, please contact Harry L. Clark at (202) 339-8499 or hclark@orrick.com, W. Clark McFadden II at (202) 339-8479 or cmcfadden@orrick.com, or your Orrick relationship lawyer.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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