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Iran sanctions and the EU Blocking Regulation: Navigating legal conflict

​The European Union promised a strong response to the withdrawal of the U.S. from the Iran deal, as announced by President Trump on 8 May 2018. To this end, it has taken a key step by amending the EU Blocking Regulation. This bulletin considers a number of the practical and legal issues that have subsequently arisen for non U.S. businesses caught between the requirements of the Blocking Regulations on the one hand and the newly re-imposed U.S. secondary targeting Iran on the other.

The core purpose of the updated Blocking Regulation is to ensure that EU based businesses can take investment decisions in relation to Iran freely and, in particular, in such a way that they are not coerced into complying with certain of the U.S.’s recently re-imposed “secondary sanctions” which EU law does not recognise as having applicability. To this end, the Blocking Regulation creates a number of requirements, one of which prohibits EU persons from complying with such re-imposed U.S. sanctions. However, the threat of this requirement in and of itself is unlikely to be enough to protect EU businesses from the risk of enforcement by the U.S. authorities for breaching these U.S. sanctions, creating an obvious dilemma for EU businesses and particularly those with links to Iran.

More widely, ensuring that EU businesses continue to do business with Iran is believed by many commentators to be an important element in incentivising the Iranians to keep to their commitments under the JCPOA. We await to see what else will be done by the EU and the JCPOA’s other remaining signatories to save the deal (if anything), and to enable Iran to continue to participate in the global economy.

U.S. extraterritorial reach

At first glance, you may wonder why U.S. sanctions on Iran should matter to EU businesses, or indeed any other non U.S. businesses, operating exclusively outside of the U.S.. The reason is that a number of the U.S.’s sanctions have wide extraterritorial reach. More fully, the U.S. seeks to apply certain of its sanctions to non U.S. persons and entities acting outside of the U.S. in various situations. These extraterritorial sanctions are often referred to as U.S. “secondary sanctions”.

A number of U.S. secondary sanctions have been, and are being re-imposed, which target Iranian related activities as a consequence of the U.S.’s departure from the JCPOA. These sanctions are being re introduced in two phases, with some having come back into force on 7 August 2018 and others set to come into force on 5 November 2018. A wide range of activities are targeted, including: (i) having dealings with persons on the so called “SDN List” (ie asset freeze targets); (ii) conducting or facilitating significant transactions for the purchase or sale of Iranian rials or of contracts whose value are based on the exchange rate of the Iranian rial; or (iii) conducting or facilitating significant transactions for the purchase, sale, marketing, or transport of petroleum, petroleum products, or petrochemical products from Iran.

Even where the sorts of activities targeted by the U.S. secondary sanctions are undertaken by non U.S. persons operating outside of the U.S., such persons can be targeted with a range of measures. The exact measures that can be imposed in any given case are dependent on the underlying secondary sanctions that have been engaged, but they can include being: (i) added to the SDN List; (ii) restricted from obtaining financing provided by U.S. financial institutions; and (iii) denied U.S. export and re export privileges.

The EU response

The Blocking Regulation was originally introduced by the EU in 1996 in response to the extraterritorial reach of certain sanctions imposed by the U.S. in relation to Cuba in the 1990s. It has now been updated to include several of the U.S. extraterritorial sanctions in relation to Iran that have been, or will be, re-imposed subsequent to the U.S.’s exit from the Iran deal.

The Blocking Regulation prohibits any EU person or entity from complying with certain of the re-imposed U.S. extraterritorial sanctions. An associated licensing derogation is also provided for. That said, it will only be possible for EU persons to obtain such a licence where it can be demonstrated that “serious damage” would arise for either the applicant and/or the EU where the applicant is not allowed to comply with the targeted U.S. laws. This licensing mechanism is not believed to have been widely used historically, and its potential availability to EU persons is, therefore, uncertain.

The Blocking Regulation also provides protection to EU persons and entities by containing:
− an assurance that any U.S. court judgment or administrative determination against an EU person or entity giving effect to the U.S. sanctions listed in its annex will not be enforced in an EU court; and
− a right for any EU person or entity suffering damage as a result of a person complying with the listed U.S. sanctions to recover those damages from that person.

EU persons affected by the application of the U.S. laws targeted by the Blocking Regulation must further report the same to the European Commission

The future of the regime created by the Blocking Regulation is also uncertain. The European Commission has stated that it intends to give extra teeth to its response to the re-imposition of U.S. sanctions on Iran, and it remains to be seen what this will lead to in practice. In particular, the prospect of substantive amendments to the main body of the Blocking Regulation cannot be ruled out.

Conflict of laws

The consequence of the U.S.’s re-imposition of secondary sanctions targeting Iran and the EU’s subsequent updating of the Blocking Regulation is that the respective laws are now directly conflicted. On the one hand, non compliance with the U.S.’s secondary sanctions can result in EU businesses being targeted with U.S. sanctions should they offend the same. On the other hand, it is now an offence for EU businesses under the Blocking Regulation to comply with the very same secondary sanctions.

Many EU businesses, both financial institutions and corporates, have historically sought to comply with both EU and U.S. regimes as a matter of course (often as a natural consequence of requirements within their financing documentation), and for them the conflict is a live issue of immediate concern. These businesses are now faced with a difficult choice as to how to proceed – particularly in any transactions that have an Iranian nexus.

For these EU businesses, there is no simple or obvious answer. Possible approaches could involve: (i) looking to obtain an authorisation from the European Commission to enable simultaneous compliance with both the Blocking Regulation and the targeted U.S. secondary sanctions; (ii) establishing a technical alignment with what is required by the targeted U.S. secondary sanctions without actually seeking to comply with the same; or (iii) approaching each scenario on a case by case basis. There are pros and cons with each of these approaches. We briefly explore these further below.

Licensing route
 
As noted above, the Blocking Regulation provides for a licensing derogation that allows for EU persons to be authorized to comply fully or partially with the targeted U.S. secondary sanctions to the extent that their non compliance with the same would seriously damage their interests or those of the European Community.
 
Obtaining such licenses could be difficult. The term “seriously damage” is not defined in the Blocking Regulation, although associated EU guidance confirms that not every nuisance or damage suffered by EU operators will entitle them to obtain such a license. Similarly, a set of criteria has been developed by the European Commission to use when determining license applications, which appears to set a high bar. This makes sense in context. If the bar was not set high, there would be a risk that the licensing route would undermine the overriding objectives of the Blocking Regulation.
 
The key advantage of this route is that, assuming that a license is actually obtained, a technical compliance could follow with both the Blocking Regulation and the targeted U.S. secondary sanctions. That said, there is no guarantee that any given applicant will actually obtain a license (in whole or in part) at the point they make their application. Further, the application could alert the relevant authorities in and of itself of a desire on the part of the applicant to conduct its business in a manner that would otherwise be illegal. Lastly, even if the license were to be granted, the same may not be a complete defence to third parties bringing civil claims for damages against the license holder pursuant to the Blocking Regulations’ wider provisions as described above.
 
Alignment route
 
The Blocking Regulation does not restrict EU businesses from choosing to start, continue or cease business operations with an Iranian nexus for reasons beyond sanctions. This particular point is confirmed in guidance from the European Commission, which observes that EU businesses are free to choose whether to start working, continue, or cease business operations in Iran, and whether to engage or not in an economic sector on the basis of their assessment of the economic situation.
 
In other words, EU businesses could opt to reject any particular transactions with an Iranian link on wider grounds not related to the U.S. secondary sanctions targeted by the Blocking Regulation. By way of example, and, in a banking context, examples could include: (a) credit risk related concerns; (b) concerns relating to money laundering related issues; (c) concerns over bribery or human rights related issues; and/or (d) a need to comply with legislation (including U.S. legislation) other than the U.S. secondary sanctions targeted by the Blocking Regulation. Making decisions for reasons such as these should not offend the Blocking Regulations’ requirements, but should nevertheless simultaneously provide a technical alignment with the requirements of the U.S. secondary sanctions that target Iran.
 
Should an EU business want to rely on this route, however, it would have to take care that it did not, if terminating or ending any Iranian business, do so on any grounds that could be inferred as being related to seeking compliance with the U.S.’s targeted secondary sanctions. This could prove to be particularly difficult for those EU businesses that have historically traded with Iran but are now looking to stop Iranian related activities at this point. Such businesses’ decision making processes could potentially come under close scrutiny, and care would have to be taken to demonstrate that the conclusions reached by such processes were not, in fact, based upon a simple desire to comply with the U.S. secondary sanctions targeted by the Blocking Regulation.
 
Case by case basis approach
 
Alternatively, EU operators may decide to consider these issues on a case by case basis as Iran related proposals arise. It is worth noting that the U.S. secondary sanctions do not prohibit EU persons from undertaking any/all activities with Iran – merely those activities that are targeted by the relevant U.S. secondary sanctions as listed within the Blocking Regulation.
 
From a Blocking Regulation perspective, and to the extent that it is concluded in any given case that none of the U.S. laws that are targeted by the Blocking Regulation actually have obvious applicability to the activities being contemplated, the Blocking Regulation should have only limited direct relevance to such activities. In other words, a decision to undertake the Iranian related activities (or not undertake them, as the case may be) would not be materially based on a desire or otherwise to comply with the U.S. laws targeted by the Blocking Regulation (ie as the same would not be engaged).
 
The disadvantage of this approach, of course, is that were an EU person to conclude that the relevant activities that it was contemplating engaging in were targeted by the relevant U.S. secondary sanctions but not otherwise restricted pursuant to the EU’s own sanctions regime or any other applicable EU laws, it would potentially find itself in an awkward position i.e., as to abandon or stop such activities could result in accusations being made that such abandonment was brought about as a consequence of seeking compliance with the targeted U.S. secondary sanctions in a manner that was prohibited by the Blocking Regulation.
 
Enforcement
 
The Blocking Regulation itself does not impose any penalties for the breach of its requirements. However, pursuant to its provisions, EU Member States are under an obligation to impose sanctions which are “effective, proportional and dissuasive” where a breach arises. That said, it is widely understood that the Blocking Regulation has not been heavily enforced to date. No jurisprudence is believed to exist at the EU level, and only one enforcement action is heavily reported, being an Austrian case which dates to 2007.
 
From a U.S. perspective, one of the key sanctions regulators, OFAC, has historically engaged with non U.S. persons in question before imposing secondary sanctions on them, and offered them an opportunity to cease their sanctionable activities before targeting them with any sanctions. It is also worth noting that secondary sanctions are not, therefore, imposed very often. That is not to say this may not change, particularly given the current political focus on Iran.
 
The one potential exception, however, is designation as an SDN. OFAC has historically viewed its designation authority to be very broad, and it can target non U.S. persons quickly and without notice. OFAC designates SDNs on a continual basis, and so the risk in this regard is believed to be higher. This notwithstanding, it is difficult to isolate the basis for individual designations, thus making it equally difficult to say with certainty how frequently OFAC employs this authority against persons engaged in some measure of sanctionable activity as regulated through the secondary sanctions.
 
In any event, the U.S. authorities have historically not seen the Blocking Regulation (and, in particular, the excuse of illegality it provides to EU operators) as being a defence to the undertaking of activities that are targeted by U.S. sanctions.
 
In the current environment, EU businesses with links to Iran should keep a close watch on this issue moving forward, and adapt their approach accordingly.
 
Conclusions
 
The U.S.’s decision to withdraw from the JCPOA has caused political ructions with global implications. Many businesses are now feeling its indirect effects. In various scenarios, it may simply not be possible for European corporates to ensure technical compliance with both the U.S.’s secondary sanctions regime and its countermeasure as created by the Blocking Regulation. Navigating the complexity and risks associated with this conflicting legal landscape will no doubt be challenging for some time to come.
 
Further information
 
This article is part of the Allen & Overy Legal & Regulatory Risk Note, a quarterly publication.  For more information please contact Karen Birch – karen.birch@allenovery.com, or tel +44 20 3088 3710.
 

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