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Liability for breaches of sanctions: financiers, lessors and charterers beware, OFAC settles claims against Apollo and Eagle Bulk

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10 February 2020

Two recent settlements in the United States have highlighted the risks for parties involved in aviation and shipping of incurring liabilities for a breach of sanctions.  

A US aircraft engine lessor and a US-based shipping company have each settled their potential liability for breaches of US sanctions: the first, triggered by a sublessee’s provision of engines to a sanctioned entity, despite terms in the lessor’s lease prohibiting such conduct; and the second, triggered by a subsidiary carrying cargo which a buyer had bought from a sanctioned party.  In this briefing we explain how a lessor or ship-owner can find itself in hot water for others’ conduct and what it can do to help protect itself from having to pay significant sums to settle claims related to such conduct, through active monitoring and compliance certificates.

Introduction 

The US Office of Foreign Assets Control (OFAC) has agreed to a settlement of US$210,600 with Apollo Aviation Group LLC (Apollo), a US aircraft engine lessor, for 12 apparent violations of US sanctions targeting Sudan (US Sudan Sanctions).  OFAC has also agreed a settlement of US$1,125,000 with Eagle Shipping International (USA) LLC (Eagle Shipping) for 36 apparent violations of now-repealed US sanctions targeting Burma (US Burma Sanctions).  

What exactly happened in the Apollo case?

Starting in July 2013, Apollo leased three aircraft engines to a UAE entity (Company 1).  The lease documentation prohibited Company 1 from operating in, or transferring the engines to, any country targeted by US or UN sanctions.  Company 1, in turn, subleased the engines to a Ukrainian airline (Company 2), which installed the engines on aircraft that Company 2 then wet-leased to Sudan Air.  A wet-lease is a transaction under which a lessor provides an aircraft to a lessee, while retaining responsibility for operational matters such as crew, maintenance, insurance and licensing.  At the time, Sudan was targeted by comprehensive, country-wide sanctions, and Sudan Air was targeted by blocking (i.e. asset-freezing) sanctions.

In May 2015, two of the leases expired and the engines were returned to Apollo.  Apollo reviewed the engine records and discovered that the engines had been installed on aircraft wet-leased to Sudan Air and used in Sudan, and that the third engine was still in service on an aircraft wet-leased to Sudan Air.  Apollo recalled the third engine and voluntarily reported the events regarding all three engines to OFAC. 

Based on the value of the engines and their related leases, the maximum fine OFAC could have imposed was US$3,000,000. However, OFAC calculated a base penalty of US$360,000 based on Apollo’s voluntary disclosure and OFAC’s determination that the apparent violations constituted a “non-egregious” case (i.e. not a flagrant violation in OFAC’s view). In determining the final settlement amount of US$210,600, OFAC considered a number of aggravating and mitigating factors. 

Aggravating factors included the following: (i) Apollo was a large, sophisticated international player in the aviation industry; (ii) Apollo failed to carry out any ongoing monitoring on the use of its engines; and (iii) Sudan Air was on OFAC’s List of Specially Designated Nationals and Blocked Persons (SDN List, and those listed thereon, SDNs) and therefore targeted by blocking sanctions.

Mitigating factors included the following: (i) Apollo’s lack of knowledge of wrong-doing until after the fact; and (ii) the remedial measures that Apollo took afterwards, such as enhancing employee training on US sanctions and obtaining US law export compliance certificates from lessees and sublessees.

What exactly happened in the Eagle Shipping case?

In 2011 Eagle Shipping’s subsidiary Eagle Bulk Pte Ltd (Eagle Bulk) entered into a charter with a Singaporean Company to carry sand from Burma to Singapore.  When the cargo was loaded, the shipping documents revealed that the seller was Myawaddy Trading Limited (Myawaddy), at the time an SDN under US Burma Sanctions.  Eagle Bulk raised concerns with the Singaporean Company and was presented with some amended shipping documents naming a different seller.  However, other shipping documents suggested Myawaddy was still the true seller.  Eagle Bulk told the ship’s captain to sign the new shipping documents, but the captain refused to sign those documents that identified Myawaddy as seller.  The captain contacted Eagle Bulk which then revoked the captain’s authority to sign the shipping documents.  However in the meantime, local Burmese officials took the ship’s crews’ passports and refused to clear the ship for departure.

Eagle Bulk applied for an OFAC licence to carry the cargo to Singapore because there was now evidence that an SDN was party to the shipping documents.  OFAC did not issue the licence.  Concerned for the crew’s safety, Eagle Bulk signed the shipping documents and sailed to Singapore with the cargo.

Eagle Bulk then applied for a further OFAC licence to ship additional cargoes of sand.  While the application was pending, Eagle Bulk resumed shipments.  When the licence was refused, the then COO of Eagle Bulk failed to communicate this to others within the organisation and the shipments continued. 

Eagle Bulk was reorganised in Chapter 11 bankruptcy proceedings in 2014.  New management self-reported the violations to OFAC.  In this case, the maximum fine OFAC could have imposed was US$9,000,000.  The apparent violations were an “egregious” case (i.e. flagrant) in OFAC’s view, but due to the self-disclosure, the maximum civil penalty applicable was $4,500,000.  In determining the final settlement amount of US$1,125,000, OFAC considered a number of aggravating and mitigating factors. 

Aggravating factors included the following: (i) Eagle Bulk’s reckless disregard for US sanctions; (ii) the involvement of a senior officer of Eagle Shipping in approving the transactions; (iii) the sanctions violations provided significant economic benefit to Burma’s military regime; and (iv) Eagle Bulk’s position as a commercially sophisticated global shipping company. 

Mitigating factors included the following: (i) Eagle Bulk’s lack of prior violations; (ii) under its new management Eagle Bulk had co-operated and dealt with the investigation properly; and (iii) the remedial measures that Eagle Bulk took afterwards to improve compliance.

What are the US sanctions? 

In Apollo’s case, at the time that Company 2 wet-leased the engines, Sudan was targeted by comprehensive, country-wide sanctions.  These comprehensive sanctions prohibited almost all transactions, whether direct or indirect, between US persons, or anyone with a US nexus, and Sudan or persons located or organised in Sudan.  In particular, the US sanctions with respect to Sudan prohibited the exportation or re-exportation, directly or indirectly, of goods, technology or services from the United States or by US persons to Sudan.

Sudan Air also was targeted by blocking sanctions.  Blocking sanctions prohibit transactions by US persons and in the United States that involve SDNs, directly or indirectly.

The US Burma sanctions, on the other hand, did not impose a comprehensive, country-wide prohibition against dealing with Burma, but Myawaddy was an SDN at the time the sand was shipped.  Accordingly, transactions by US persons and from, through, or within the United States (including transfers through the US financial system) in Myawaddy’s property and property interests was prohibited.

Are there similar UK or EU sanctions?

The EU and UK’s sanctions regimes contain similar restrictions to the US blocking sanctions imposed on Sudan Air.  The EU and UK can, and have, imposed asset freezes on numerous entities and individuals under their country-specific sanctions regimes.  These restrictions prohibit EU and UK individuals and entities from making funds or economic resources available, directly or indirectly, to or for the benefit of any asset freeze targets.  Currently, the relevant EU and UK regulations only impose asset freezes on four Sudanese individuals.  At the time that Company 2 wet-leased the engines, Sudan Air was not subject to an asset freeze under EU or UK sanctions.

There is a key difference between the EU and UK’s asset freeze restrictions and the US blocking sanctions.  US sanctions are subject to the principle of strict liability.  However, a breach of EU or UK asset freeze restrictions will only occur if someone knows, or has reasonable cause to suspect, that they are making funds or economic resources available, directly or indirectly, to or for the benefit of an asset freeze target.  If Apollo was subject to EU or UK sanctions (and Sudan Air was targeted by an EU or UK asset freeze), it would be likely to argue that it had not breached EU or UK sanctions as (i) it had no knowledge that the aircraft were being wet-leased to an asset freeze target and (ii) it did not have reasonable cause to suspect the same as its lease agreement with Company 1 contained a provision prohibiting the lessee from maintaining, operating, flying or transferring the engines to any countries subject to United Nations sanctions (although we note that the provision did not appear to refer to EU or UK sanctions so it is unclear how successful this particular argument would be in practice).

Who might be affected by similar OFAC enforcement actions?

As well as aircraft and engine transactions, shipping transactions are also vulnerable to potential violations of sanctions through the actions of sublessees and charterers (a time or voyage charter is similar to a wet-lease).  In the Eagle Bulk case it was the charterer who bought the sand from an SDN and then the bill of lading and other shipping documents introduced an SDN into the vessel charter between Eagle Bulk and the Singaporean company.

Primary US sanctions govern transactions by US persons or that occur from, through or within the United States.  US persons (i.e. citizens, permanent residents, entities organised under the laws of the United States (including non-US branches) and persons in the United States) wherever located are subject to the regulations and prohibitions of US sanctions.

Non-US persons, however, could also be at risk of violating primary US sanctions to the extent that their activities entail transactions occurring from, through or within the United States, including payments through the US financial system.  Most aviation and many shipping transactions are denominated and paid in US Dollars.  This means that payments under these transactions must at some point pass through the US banking system.  This exposes involved parties to potential liability under US sanctions if there is a breach.  Accordingly, simply because a company is not a US person does not mean that it is beyond the reach of US sanctions: a non-US person would be in breach of primary sanctions if it causes a US person to deal in the property of an SDN, for example causing a US financial institution to handle a payment from the SDN.  (US sanctions would reach only the non-US person’s conduct related to the transaction in the United States (the payment), not all the non-US person’s other activities.)

Moreover, certain US export control rules, which are administered by the US Department of Commerce, govern the export and re-export of commercial and dual-use commodities, software and technology from the United States.  Unlike US sanctions, US export control rules govern the item to be exported or re-exported: it is irrelevant whether the exporting party is a US person or a non-US person.  If an item is subject to US export control rules (i.e. is US-origin, is in the United States, or is non-US made but incorporates more than a de minimis amount of US-origin content), then those rules will follow the item wherever it goes in the world. 

Aircraft, engines and parts that are subject to US export control rules remain subject to these restrictions even in the hands of parties without a US presence.  In general, exports and re-exports of items subject to US export controls rules are prohibited to countries and regions targeted by comprehensive, country-wide or territory-wide sanctions (e.g. Cuba, Iran, North Korea, Syria, and the Crimea region of Ukraine).  However, there are certain exceptions for the temporary “sojourn” (i.e. short stopover) of aircraft in these regions, subject to many conditions.  These exceptions were not relevant in Apollo’s case, as it was implicated in the re-exportation of US-origin engines to Sudan aboard the aircraft on which they were installed.  Nevertheless, we refer to these exceptions because they are relevant to aviation leasing companies.

How can a party protect itself from risk?

Apollo’s liability arose because, as OFAC noted, it did not implement compliance measures beyond delivery of the engines (“the point-of-sale”) to function throughout the lease period.  OFAC noted in particular that  Apollo did not periodically monitor the lessee and sublessee’s adherence to the lease provisions requiring compliance with US sanctions.  The US sanctions regime is imposing a greater level of supervision and diligence than parties might have been accustomed to before.  A contractual restriction, wilful ignorance or turning a blind eye will not absolve someone or reduce their potential fine.  While the EU and UK sanctions regimes do not currently impose strict liability in the same way, the risk of both inadvertently becoming subject to US sanctions and of reputational damage are significant.

Robust and clear contractual provisions prohibiting subleasing, wet leasing, sales and re-export to sanctioned countries and individuals are only the starting point.  OFAC also expected Apollo to monitor and ensure its lessee’s and any sublessee’s compliance during the lease term.  To date, many lessors or financiers may have assumed such due diligence was unnecessary so long as they had a clause in their contract making their lessee or customer responsible and so long as they did not know of any breaches.  It is now clear that parties cannot simply rely on compliance wording in the transaction documentation signed at the point of delivery.

There are difficulties in monitoring a sublessee’s compliance as the lessor will not have a direct contract with, or enforceable rights against, the sublessee, unless specific provision is made.  This would involve, at the very least, requiring the lessee to impose proper compliance obligations on its sublessee, getting the lessee to monitor the sublessee’s compliance and to pass evidence of this on to the lessor.  Furthermore, periodic tracking of the leased assets is now technologically easy, aircraft and ship tracking services are readily available.  Lessors could use tracking periodically to corroborate the documentary compliance (the US government and media organisations have used evidence from satellites and tracking services in recent sanctions cases involving cargoes of Iranian oil). 

Lessors and financiers should consider ensuring their lessees and sublessees provide regular compliance certificates dealing with US export and sanctions laws.  In the case in question, Apollo could also have reduced the risk (and hence its fine) by improving its customer due diligence and ensuring its staff were fully trained in its operating policies.

While Eagle Bulk’s former management were party to its breach of sanctions, it had been put in a difficult position commercially: it had agreed to carry the first cargo and the ship was loaded before it became aware of the sanctions issue.  Initial lack of due diligence on its initial chartering of the ship to the Singaporean company was a major factor in the initial violation.

OFAC appears to be targeting what it sees as high risk industries such as shipping and aviation, and although in both these cases the penalties negotiated were somewhat mitigated by the parties’ conduct after discovering the breach of sanctions, the sums agreed were not small. 

Non-Partner Legal Advisers: