Regulation Impact

On April 16, 2013, the U.S. Commerce and State Departments published final regulations impacting U.S. export controls of defense articles and of commercial articles with a military application while protecting U.S. national security. These rules become effective on October 15, 2013, and culminate nearly four years of Obama administration effort to modernize U.S. export controls through the President’s Export Control Reform (ECR) initiative.

These regulations directly impact manufacturers, designers, and exporters of aircraft, gas turbine engines, and other associated parts and equipment. Although the administration still has much work to finish the ECR initiative and some uncertainties remain on further changes, all aerospace manufacturing and design companies should spend the coming months reviewing these new regulations to see if their items and services are reclassified.

Need for Export Control Reform
President Obama launched an administration-wide review of the export control system in August 2009. In response, then-Secretaries – Secretary of State Hillary Clinton, Secretary of Defense Robert Gates, and Secretary of Commerce Gary Locke – determined that ECR was essential for three main reasons, including that ECR would:

• Increase interoperability of U.S. military forces with allied countries, which could only happen by encouraging those allies to buy more U.S. goods;
• Strengthen the U.S. industrial base by reducing incentives for foreign manufacturers to design out and avoid U.S.-origin content and services; and
• Allow government officials to focus resources on transactions posing the greatest national security concern.

Currently, the Commerce Department’s Bureau of Industry and Security (BIS) regulates exports of “dual-use” items – items with both civilian and military applications – under the Export Administration Regulations (EAR). The State Department’s Directorate of Defense Trade Controls (DDTC) regulates exports of military items under the International Traffic in Arms Regulations (ITAR).

Under the EAR, export licenses are needed only on a case-by-case basis depending on the technology, end-user, and country of ultimate destination involved. Under the ITAR, however, export licenses are needed to export or re-export worldwide with some very limited, and often not very useful, exceptions. Import licenses are needed in certain situations too.

The EAR’s Commerce Control List (CCL) is a detailed, objective list of items subject to the BIS licensing regime, with each item on the CCL assigned an Export Control Classification Number (ECCN). A company in any given field usually can review potentially applicable ECCNs to determine if its products are EAR-controlled or not. In contrast, the ITAR’s U.S. Munitions List (USML), in most instances, is entirely non-specific, and provides no objective criteria for such self-assessments. U.S. manufacturers are at risk because the USML is so vague.

U.S. industry leaders have noted the current system remains locked in the 1960s Cold War mentality and has not undergone a significant update since the early 1990s. The ECR initiative is designed to fix some of the difficulties that industry has complained about for years. In testimony before the House Foreign Affairs Committee Hearing on ECR on April 24, 2013, Acting Assistant Secretary, Bureau of Political Military Affairs, Tom Kelly, acknowledged that the current system “is cumbersome, complex, and incorrectly controls too many items as though they were ‘crown jewels’ technologies.” Kelly further stated that, “what that has meant is that an inordinate amount of agencies’ resources – both in terms of licensing and compliance activities – has been expended on nuts and bolts as well as our REAL ‘crown jewels’ technologies.”
 

Left: Larry Ward, Partner – Corporate Group, Dorsey & Whitney LLP Right: Nelson Dong, Partner – Corporate Group, Chair of the National Security Law Practice, & Co-Chair of the Asia-Pacific Practice, Dorsey & Whitney LLP

Communications Satellite Industry
Throughout the 1990s, a major New York-based aerospace supplier held about an 85% worldwide market share for several widely used communications satellite components. In 1999, Congress shifted the export controls on those components from Commerce Department jurisdiction to the State Department. As a result, those components were subject to the same restrictive licensing regime as fighter aircraft or tanks. Thus, suppliers of these components needed DDTC export licenses to export them, including to the then-booming market in Europe, when previously those suppliers rarely needed BIS export licenses. Further, if European customers wanted to re-export those components to a collaborator in another European country or wanted to re-export satellites with those components built into them, they had to obtain another DDTC license. Today, that New York supplier’s worldwide market share has dropped to about 15% because foreign customers want ITAR-free parts to avoid such restrictions.

Beyond the supplier’s worldwide market share falling so starkly, the supplier’s unit prices to NASA and the Defense Department were driven up because those agencies then had to bear 100% of the expensive R&D needed for those parts. Both U.S. industry and government agencies ultimately suffered when these components were treated as if they were fighter jets.

The ‘Specially Designed’ Problem
This New York supplier is not the only company – and the satellite industry is not the only industry – impacted by such results under the current export control regime. Under the current regime, if a company “specially designs or modifies” any item, part, or component for defense or military purposes, then it becomes ITAR-controlled. U.S. exporters have long struggled to understand what is “specially designed or modified,” but the term is generally regarded to mean any change, however minor, to an item’s form, fit, or function. A company that wants to export a specially designed or modified item then needs to apply for DDTC licenses. Even if the company has no intention to export the item, it must file an annual DDTC registration, currently costing a minimum of $2,250, simply because it manufactures the item.

Taken to the extreme, this means that a Boeing supplier of a 1/4" flat washer for commercial aircraft would see the washer become subject to the ITAR if it were simply changed to a 3/8" dimension for a defense or military project. Under the ITAR, that supplier would need to be DDTC-registered even if it never intends to export the 3/8" washer. The supplier also must ensure that any of its foreign national employees, even those in the United States, will not have access to the 3/8" washer blueprints or specifications unless the company obtains a DDTC license. To comply with these rules, the supplier almost certainly would need a new export control policy and internal training program. Rather quickly, what was once $2,250 to register with the DDTC becomes ever more expensive for that supplier.

All aerospace manufacturing and design companies should spend the coming months reviewing new regulations to see if their items and services are reclassified.

A High-Level View of ECR
One key ECR element is to revise the USML so that it is a “positive” list of controlled items like the CCL, and in that way, a company should be able to review the revised USML to determine quickly if any given product is USML-controlled or not. For the most part, items that remain on the USML after ECR will be those that the government believes are the nation’s “crown jewel” military technologies. Aerospace manufacturing and design firms with items remaining on the USML will need to register with the DDTC annually and to obtain DDTC licenses for exports.

The EAR and the ITAR will contain updated and clearer definitions of “specially designed.” These definitions will focus on an item’s properties that achieve or exceed certain controlled performance levels, characteristics, or functions. More importantly for industry, these definitions will decontrol items that are subject to the EAR based on a classification ruling from the DDTC; that have the same form, fit, and function as an item not on the USML; or, that were developed for commercial or dual-use purposes. These definitions also categorically exclude all fasteners, washers, spacers, insulators, grommets, busing, springs, wires, or solders.

Most items that are moved from the USML to the CCL under ECR will be moved to a newly created “600 series” of ECCNs. Items listed in subparagraphs a. through x. of a given 600-series ECCN will be regulated most stringently by the BIS and, in many instances, suppliers will be required to get a BIS license for exports. Conversely, items listed in subparagraph y. of a given 600-series ECCN will be regulated least stringently, and currently suppliers will need a BIS license only for exports to one of the so-called T-5 countries (Cuba, Iran, North Korea, Sudan, or Syria).

The BIS has also published a new license exception: Strategic Trade Authorization (STA). STA includes two country groups – one of highly trusted allies and one of somewhat less-trusted but generally safe allies. Suppliers of certain items controlled in subparagraphs a. through x. of a 600 series ECCN will be able to use STA to export items to those countries without any BIS export license. However, to use STA, exporters must keep certain records and confirm in writing that foreign customers will abide by certain “down-stream” obligations. Aerospace manufacturing and design companies will have to decide for themselves if these compliance obligations outweigh the BIS licensing process, which can take weeks or months.

Regulations directly impact manufacturers, designers, and exporters of aircraft, gas turbine engines, and other associated parts and equipment.

Rules and Their Impact
Under the April 16 rules, the State Department provides revisions to USML Category VIII (Aircraft and Related Articles) and creates a new USML Category XIX (Gas Turbine Engines and Associated Equipment). The Commerce Department provides parallel revisions to the 600 series of CCL Category 9 (Aerospace and Propulsion). Under revised USML Category VIII, 13 specific types of aircraft are to be covered, including, for example, fighters; fixed-wing attack aircraft; specified trainers; military unmanned aerial vehicles; military intelligence, surveillance, and reconnaissance aircraft; aircraft capable of being refueled in flight; and target drones. Under Category XIX, certain gas turbine engines are covered based on their thrust capacity or other characteristics and certain engines are specified by name.

USML Category VIII(h) will control all parts, components, accessories, attachments, and equipment specially designed for the B-1B, B-2, F-15SE, F/A-18 E/F/G, F-22, F-35, and F-117 aircraft and other specific parts, components, accessories, attachments, and equipment for all USML-controlled aircraft. Similarly, USML Category XIX(f) will control certain parts specially designed for specified engines.

New ECCNs listed in EAR Category 9 will control items that “fall off” the USML. Among other things, ECCNs under subparagraphs a. through w. will control aircraft specially designed for military use but not enumerated in USML Category VIII; specified ground equipment; life-support systems and safety equipment; non-USML drone control equipment; and radar altimeters. ECCNs under subparagraph y. will control aircraft tires; audio selector panels; filters and filter assemblies for hydraulic, oil, and fuel systems; galleys; lavatories; life rafts; cockpit mirrors; passenger seats; underwater beacons; lead-acid and nickel-cadmium batteries; and other items.

Recently, the DDTC has completed proposed revisions to USML Category XV (Spacecraft Systems and Related Articles) and the BIS has completed the proposed creation of several new ECCNs within CCL Category 9 (Aerospace and Propulsion). As this article went to press, these DDTC and BIS proposals were awaiting official publication in the Federal Register and by the time of publication, those proposals might be published and accessible to the public for comment on the agency websites.

Change and Adjustment
Both government and industry personnel will need to adjust to these profound, unprecedented changes in the U.S. export control system as ECR steadily unfolds during 2013 and 2014. Implementation of the April 16, 2013, rules this October likely will demonstrate if the administration has achieved the lofty goals it set when ECR began. It is unlikely that such major shifts will go as smoothly as everyone would hope, but they are nonetheless exactly the kinds of changes that industry has urged upon the government for many years. Aerospace manufacturing and design companies will need to give adequate time and space for these reform measures to take their full effect. All aerospace manufacturing and design companies should invest the resources in the coming months to update their compliance programs and communicate changes through appropriate internal training in order to avoid any violations of the EAR or the ITAR.

Dorsey & Whitney LLP
Seattle, Wash.
www.dorsey.com