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The challenges of the U.S. and EU divergence on Iranian sanctions

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29 March 2016

With a great political drum roll, 16th January this year was marked as the day that a large number of the international sanctions against Iran were lifted. Businesses have, for some time, geared up for activity in Iran but most waited for the so-called Implementation Day before firing the starting pistol.

In an era of challenging fiscal conditions, low oil and other commodity prices, and stagnant growth for many economies, the emergence of a new and largely untapped market is enticing. However, for many multinationals with a connection to the U.S. or with some form of external debt, seizing the opportunities presented by Iran will continue to be difficult, if not impossible. Similarly, even if permissible, the practicalities of actually doing business in Iran in a way which minimises compliance risks may knock some investors off their stride.

So what can you actually do in Iran? The answer is somewhat mixed. For most non-U.S. businesses, the door to Iran is clearly open, provided that they can convince their banks, investors and insurers to join them and eliminate U.S. secondary sanctions risk. For others, there is very little they can do while the remaining sanctions are still in place.

How did we get here?

Iran has been the subject of sanctions (whether UN, EU and/or U.S.) since the Iranian hostage crisis in 1979. The restrictions significantly escalated from 2010. A primary concern of the international community has been that Iran’s nuclear technology should not be used for proliferation of nuclear weapons. Following concerns that Iran was not fulfilling its international obligations, the UN, EU, U.S. and other countries responded with the imposition of stringent, comprehensive sanctions.

In November 2013, a landmark interim deal to settle nuclear concerns was reached between the U.S., UK, France, China, Russia and Germany (the P5+1 or E3+3) and Iran (the Joint Plan of Action or JPOA). Later, in July 2015, and after some delay, came the Joint Comprehensive Plan of Action (JCPOA). This set out the roadmap to a more permanent lifting of sanctions. The JCPOA is designed to see the international community reassured, on an ongoing basis, as to the peaceful nature of Iran’s nuclear capability and, in return, for Iran to receive significant sanctions relief.

The JCPOA sets out a series of milestones to be met by Iran which will then result in the lifting of certain UN, U.S. and EU sanctions. The so-called Implementation Day was the first point at which a significant number of restrictions were lifted. The Implementation Day was declared following confirmation from the IAEA that Iran had fulfilled its obligations under the JCPOA, which included removing the core of its Arak heavy-water nuclear reactor. There remain extensive U.S. restrictions in place and some EU sanctions. It’s envisaged that the remaining EU sanctions will be lifted over the remaining course of the JCPOA, again, subject to Iran meeting certain milestones.

The U.S. nexus

If you are a U.S. company, the position remains largely unchanged and you are not likely to be able to enter Iran in any way. There are a few restricted exceptions. In addition to the limited authorisations in place before Implementation Day, there are several new limited authorisations. Activity may be possible where your non-U.S. subsidiary is authorised by a U.S. general license (General License H) to engage in the specific activity in question. Another possibility is if you wish to sell commercial aircraft or aircraft parts to Iran and have obtained a specific license from OFAC, or import certain Iranian-origin goods.

What about those businesses with a presence in the U.S. but which are headquartered in Europe or Asia, or even those with no presence in the U.S.? As a first step, you will need to establish whether you, or the proposed activities, are within the reach of the U.S. sanctions regime. There are a number of examples:

  • You are part of a transaction which is designed to evade U.S. sanctions, or which could cause a U.S. person to violate sanctions.
  • Your U.S. person employees or U.S. operations support or facilitate activities by your non-U.S. operations that are prohibited under U.S. sanctions. That U.S. person could be, for example, a U.S. subsidiary, or an employee of a non-U.S. group company who holds a U.S. passport. The history of U.S. enforcement against U.S. branches and subsidiaries of European entities for this offence means that there is a high level of concern over how to interpret this aspect of the U.S. sanctions regime. Careful consideration will need to be given to ensure that no U.S. persons have any direct or indirect connection with the Iranian business in order to protect such persons from direct liability, and their employers from potential indirect liability and/or reputational harm.
  • Your activity may fall within the scope of U.S. ‘secondary’ sanctions applicable to non-U.S. companies if, for example, you have entered into a significant transaction with certain U.S. sanctions targets (including the Iranian Revolutionary Guard Corps), or traded in graphite, aluminium or steel with Iran. This could amount to “sanctionable activity” under U.S. law, and may, among other things, result in your access to the U.S. financial markets being restricted.

Whilst there is no simple description of what a U.S. nexus could be, the net is wide and considerations will include whether you have:

  •  U.S. subsidiaries, branches or offices;
  •  U.S. citizen or permanent resident employees;
  •  U.S. counterparties or financiers;
  •  dealings in U.S.-origin goods or services;
  •  activities conducted in or through the U.S.; or
  •  denominated the transaction in USD.

Even if your business does have a U.S. nexus, your non-U.S. employees and operations may, in certain circumstances, still be able to transact with Iran. Many businesses are actively pursuing opportunities on this basis. Careful consideration needs to be given to the appropriate corporate and treasury structure to be used for any proposed business.

As a basic starting point, you will need to ensure the complete segregation of all your U.S. operations and employees. The ongoing monitoring of such segregation and the ring-fencing of the Iranian operations or businesses will be critical to ensuring long-term compliance. Multinationals will need to consider whether the opportunity in Iran is worth the inevitable cost of isolating its U.S. operations and carefully monitoring transactions for ongoing compliance.

Where do the banks stand?

Even if you can implement a compliant corporate structure for your Iranian business, you will need to give consideration, at the outset, as to whether you are permitted to trade with Iran under any external finance covenants and whether your existing relationship banks are in a position to support you in day-to-day transactions with Iran.

For understandable reasons, lenders have, for many years, included broad restrictions against dealing with Iran in their lending documents. Aside from representations, we typically find covenants to the effect that borrowers (and their affiliates) are not permitted to engage with any ‘restricted party’. This term (usually defined) will include any person or entity located, or organised, in a country subject to territory-wide sanctions. In most instances, Iran (amongst others such as Cuba and North Korea) will be specifically mentioned as such a country.

Not only does this type of restriction prevent you from trading with an entity subject to an asset freeze, it also prohibits any trade with Iranian individuals and entities whilst comprehensive sanctions remain in place. Clearly, as the U.S. primary sanctions against Iran remain largely intact, there is a good argument that this type of restriction would still bite even though the EU sanctions have largely been lifted.

For U.S. lenders, these types of restrictions continue to be justified. They remain subject to U.S. primary sanctions and would, therefore, generally be in breach of sanctions if their funds were used to trade with Iran. While foreign subsidiaries of U.S. banks might in certain circumstances be able to provide financing for Iranian businesses under General License H, and U.S. banks would be permitted to change their policies to permit this, U.S. banks remain extremely wary of facilitation liability and other compliance risks, and it remains to be seen whether they will go ahead with any policy changes. For the moment, in general, they have not changed their position on Iran.

For EU banks, the position (at law) is clearer but it may, in practice, be more of an internal policy position that leads them to push back on borrowers looking to enter Iran (especially those banks with a substantial U.S. presence).
As a result, these potential restrictions need to be considered at an early stage. Corporates may need to speak with their banks to secure consent to proceed with business in Iran and seek an amendment or waiver to the sanctions provisions of existing loan agreements. This is unlikely to be a quick process. Most internal policies of the major banks still impose a blanket prohibition on supporting trade with Iran. It will take time (and pressure from clients) to update these policies to reflect the new reality to the extent any such changes are permitted by law.

Similarly, establishing correspondent relationships with Iranian banks is proving to be a slow and challenging process for many western institutions. Differences in, for instance, know-your-customer checks and antimoney laundering procedures are proving a significant stumbling block in practice. Corporates may need to speak to a range of banks before being able to identify one that is readily able to support them transacting business in Iran on a day-to-day basis. At present, many western banks remain either prohibited from transacting, or reluctant to transact, with Iranian counterparties or handle funds emanating from Iran in any currency.

Even before banks can get comfortable with a correspondent banking relationship, they will need to have considered the U.S. nexus and U.S. secondary sanctions question. Transacting in USD will, in reality, not be possible. Given the links that most financial institutions have with the U.S. financial system, they continue to be extremely cautious about tripping over U.S. primary and secondary sanctions. Again, the U.S. stance on sanctions relief may set the global default for many institutions.

Grandfathering, wind-down periods and snap-back

Aside from the practicalities of doing business in Iran, one of the other major uncertainties is the risk of the snap-back of sanctions in the event there is a dispute in connection with the JCPOA. This can be triggered by the parties to the JCPOA commencing a dispute process and ultimately failing to settle the issue (in which case the matter would go back to the UN Security Council).

The JCPOA states that the re-imposed sanctions would not apply with retroactive effect to contracts signed between any party and Iran or Iranian individuals/entities, provided that the activities contemplated under and execution of such contracts are consistent with the JCPOA and the previous and current UN Security Council resolutions.
Greater clarity is needed here. The length of a wind-down period, if any, that will be available on snap-back is unknown, though the prospect of such a period is discussed in both U.S. and EU guidance. As contracts are drawn up, this is a critical area for businesses to consider and for the European Commission, amongst others, to provide greater clarity.

What now?

For non-U.S. businesses, establishing (or re-establishing) business activities in Iran is a real possibility. To proceed safely, you will need to address any banking, investor or insurance concerns arising from your contemplated activities. In addition, your compliance controls must be up to the task of assessing potential counterparties, ensuring that you don’t trip U.S. secondary sanctions, and insulating your U.S. personnel or businesses operations from sanctions risk. Finally, you will need to master the day-to-day practicalities of doing business in Iran.

For non-U.S. subsidiaries of U.S. businesses, a decision can be taken as to whether General License H should be utilised. U.S. parents will need to assess this possibility carefully in light of the strict prohibitions still in place for U.S. persons.

Finally, U.S. persons must remain on the sidelines for the time being as long as the existing prohibitions remain in place (other than in relation to the limited areas for which activity may be covered by a license).
Looking ahead, the risk of snap-back must be kept in mind. Anyone entering into business relationships in Iran must consider whether, and the extent to which, you can reasonably retain flexibility to extricate yourself in the event that sanctions snap back.

Added to the uncertainty posed by snap-back risk are doubts about the future direction of U.S. sanctions. This is currently at issue in the U.S. presidential election. Many believe that a President Hillary Clinton would largely continue the path being laid by President Obama. But how would U.S. sanctions look under a President Sanders or a President Trump?

The opportunities created by a more open Iran may be significant but it is going to take time, and some patience, before we see any meaningful activity.