Banking & financial disputes

Outlook for OFAC Sanctions on Foreign Companies



In recent years, the U.S. has been extremely active in imposing sanctions over a number of different countries including Russia, Iran, and North Korea and also targeting specific companies and individuals. The reasons for these sanctions have been diverse, ranging from terrorism, human rights abuses, and drug trafficking.

Even if the political effectiveness of sanctions in achieving the stated aims of U.S. foreign policy is a matter of some controversy, the popularity of using sanctions is owed in no small part to their remarkable effectiveness in directly affecting the behavior not only of U.S. citizens at whom they are primarily aimed, but also of companies and individuals outside the U.S.

The primary focus of the sanctions is to prohibit U.S. citizens from assisting sanctioned entities, but in practice there is a strong attempt to give sanctions an extraterritorial effect. It takes relatively little to bring foreign companies within the ambit of U.S. sanctions. For example, the involvement of U.S. citizens working for such a company or even the fact that U.S. dollars have been used in a transaction could mean that foreigners are required to disengage from activity with sanctioned individuals or companies.

The threat to foreign companies arises from the risk that should they be in breach of the primary sanctions, the U.S. has the ability to impose secondary sanctions on those foreign companies themselves. This is particularly of concern to banks and other financial institutions that will very often enter into transactions with a U.S. element and may face the possibility of secondary sanctions being imposed, which could result in them having their U.S. banking or other regulatory licenses withdrawn.

The threat of secondary sanctions is in no way lessened by the fact that relatively few secondary sanctions have been imposed by the U.S. sanctions agency—the Office of Foreign Assets Control of the U.S. Treasury Department. For example, the only secondary sanctions brought in respect to the 2017 sanctions imposed on Russian companies and individuals for Russia’s actions against Ukraine have been against the Chinese Ministry of National Defense for purchasing Russian armaments. The way in which the sanctions regulations have been drafted is often opaque. For example, the U.S. sanctions against Russia refer to the need not to provide “material support” or enter into “significant transactions” with the sanctioned entities.

Although OFAC provides some guidance on what the legislation means, it has often proved unwilling or unable to provide definitive answers as to whether parties may be caught by particular transactions. This level of uncertainty is increased by the fact that it is not possible for a non-U.S. party to apply to OFAC for a licence to enter into particular transactions. This all means that it is extremely difficult for a third party to eliminate all risk from a transaction. This often drives companies dealing with sanctioned entities to act with an abundance of caution, thereby increasing the extraterritorial effect of the sanctions.

An example of this long reach of U.S. sanctions is the recent effect on the Nordstream 2 pipeline being built in the Baltic Sea to bring natural gas from Russia to Germany. The U.S. has threated Western companies involved in building the pipeline with sanctions aimed at Russian entities. After non-Russian companies withdrew from the project in the face of U.S. sanctions, the Russian oil company Gazprom confirmed that it would complete the pipeline on its own.

In another example of the lack of certainty over who and what transactions are caught by sanctions, Swedish state broadcaster SVT alleged that Swedbank facilitated transactions of more than $1 million from the business network of Russian billionaire Iskander Mahkmudov to Kalashnikov USA. Normally U.S. sanctions would prevent transfers from the Russian Kalashnikov Concern (sanctioned as part of the Russian defense industry) to its U.S. subsidiary Kalashnikov USA, but these transfers were made from shareholders of Kalashnikov rather than the company itself and were received by individuals associated with Kalashnikov USA.

In response, a representative for Mahkmudov said he had never controlled Kalashnikov Concern and therefore he was not subject to sanctions. Kalashnikov USA further said it was not violating sanctions because it was only assembling guns from parts made in the U.S.

However, the threat remains real because U.S. authorities have in the past shown that they can impose serious penalties on foreign companies. One such case is that of Schlumberger Oilfield Holdings Ltd. Between 2004 and 2010, the French oil well manufacturer’s U.S.-based business provided oilfield services to customers in Iran and Sudan. In doing so, the U.S. authorities determined that it had violated U.S. sanctions against those countries. The company had taken steps to disguise the business dealings, and in 2015 the U.S. authorities imposed a fine of $232 million to emphasize that facilitating trade with sanctioned countries from the U.S. would not be tolerated even if no goods were actually shipped from the U.S.

Commercial Responses

Companies faced with the threat of having U.S. sanctions imposed on them have often responded to the threat by seeking to include in their contracts with potential sanction targets provisions, which expressly provide for dealing with the risk of sanctions being imposed. For example, a bank may include in its lending agreements representations by the borrower which confirm that no sanctions apply to it and that if sanctions are subsequently imposed then this will constitute an event of default of the loan.

However, even so, if sanctions are imposed and a default occurs, it may still be difficult for the bank to eliminate any risk associated with the transactions which are needed for it to disengage from the customer. These potentially risky transactions may even include accepting repayments or releasing security. This is an example of the dilemma which often presents itself to companies dealing with sanctions: whether to take the risk of secondary sanctions being imposed or the alternative risk of being sued by its commercial counterparty for breach of contract.

This issue was highlighted in a recent case in the English courts, Lamesa Investments Ltd v. Cynergy Bank Ltd. However, unusually in that case, it was the borrower rather than the lender who had insisted on a clause that came into play in the context of sanctions. The borrower had inserted a clause in the lending agreement saying that it would not be in default if sums were not paid to the lender “in order to comply with any mandatory provision of law.”

The lender was listed as a blocked entity under U.S. sanctions, and the borrower claimed that it did not have to make repayments under the loan because the U.S. sanctions were a “mandatory provision of law” and that they were provisions of law with which it had to comply (even though neither party was a U.S. company and the agreement was not governed by U.S. law).

Despite these factors and the fact that the clause was drafted in wide and unqualified language, the court agreed that in the context of the negotiations between the parties, it had been understood that U.S. sanctions should be covered by it and confirmed that those sanctions allowed the borrower to refrain from paying sums which would otherwise be due to the lender. However, the court did say that its decision was not to be viewed as giving U.S. foreign policy extraterritorial effect, but more narrowly as interpreting the contractual agreement between the parties.

There is no doubt that sanctions will continue to be used extensively as instruments of foreign policy not only by the U.S. but also by the U.N., the EU (and by the U.K. separately now that it has left the EU). In turn, companies, both those based in the U.S. and elsewhere, will have to closely consider the risks which doing business with sanctioned entities may pose and to take advice on what legal and/or commercial actions they may take to continue business successfully.

This article was originally published by Bloomberg Law in March 2020: https://www.bloomberglaw.com/product/blaw/document/X1AAT1C0000000





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Robin Henry

Partner - Head of Dispute Resolution Services



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