The Challenge Iran Sanctions Pose for EU Operators

On Nov. 5, the United States will reimpose previously suspended economic sanctions targeting Iran, many of which have extraterritorial effect and will apply to European companies. The European Union has responded by expanding an existing “blocking statute” to cover U.S. sanctions against Iran, purportedly to protect EU companies from the effect of U.S. sanctions and to allow them to continue to transact with Iran.

The interaction between the U.S. and EU sanctions regimes will create a number of novel legal issues and compliance challenges for European companies, especially those European companies with ties to the United States. In some cases, European companies may be forced to choose between complying with U.S. sanctions and the EU blocking statute.

Background

In May 2018, President Donald Trump announced the United States’ withdrawal from the Joint Comprehensive Plan of Action, or JCPOA. In August, the United States reimposed a series of Iranian sanctions. On Nov. 5, a second tranche of suspended U.S. sanctions will come back into force. Through these changes, the United States has: (1) tightened its primary sanctions regime, which applies to U.S. persons and foreign entities owned or controlled by U.S. persons and (2) reinstated secondary sanctions, which can be imposed on foreign persons otherwise outside of U.S. jurisdiction.

These changes will have minimal impact on American citizens and U.S. companies because they generally have not been permitted to do business with Iran for decades. However, these developments have important implications for many European companies. For the last several years, European subsidiaries of U.S. persons, or U.S.-owned EU operators — including European portfolio companies of U.S.-based private equity sponsors — were permitted to do business with Iran pursuant to General License H, provided certain conditions were met. Likewise, other European companies could transact with most Iranian counterparties without risking being targeted by U.S. secondary sanctions. The United States has revoked General License H, and all of the previously suspended U.S. secondary sanctions will return on Nov. 5.

The EU has responded to the United States’ actions by revamping Council Regulation (EC) No. 2271/96, which was drafted in response to U.S. sanctions against Cuba in the mid-1990s. The blocking statute is designed “to protect[] EU Operators engaging in lawful international trade and/or movement of capital as well as related commerce activities with third countries in accordance with EU law.”[1] The blocking statute applies to EU nationals, non-EU nationals resident in an EU member state and corporate entities organized under the laws of an EU member states — collectively, “EU operators.” The recent amendments to the blocking statute include U.S. statutes and regulations that set forth the United States’ primary sanctions targeting Iran and authorize the U.S. president to impose secondary sanctions on individuals and entities that do business with Iran — collectively, the “Iran legislation.”[2]

The revised blocking statute became effective on Aug. 6, 2018, and:

• Prohibits EU operators from complying with any “requirement or prohibition” in the Iran legislation;
• Mandates that EU member states will not recognize or enforce any court order or administrative agency decision resulting from the Iran legislation;
• Imposes an affirmative reporting obligation on the EU operators when their “economic and/or financial interests ... are affected, directly or indirectly,” by the Iran legislation; and
• Vests EU operators with a private right of action to recover damages and legal costs caused by the application of the Iran legislation or “by actions based thereon or resulting therefrom.” 

Key Questions

The interaction between the reinstated U.S. sanctions and the EU blocking statute presents a number of compliance challenges for EU operators, especially those with U.S. connections.

Does the Blocking Statute Cover Secondary Sanctions?

The blocking statute states that no EU operators “shall comply, whether directly or through a subsidiary or other intermediary person, actively or by deliberate omission, with any requirement or prohibition” of the Iran legislation. Apart from the Iranian Transactions and Sanctions Regulations, or ITSR, discussed below, none of the Iran legislation “requires” EU operators to take any actions or “prohibits” EU operators from transacting with Iran. Rather, those laws authorize the president to impose secondary sanctions on EU operators that engage in certain types of transactions involving Iran. As a result, it is not clear whether EU operators would breach the blocking statute by terminating or declining to pursue Iran-related business that could result in the imposition of secondary sanctions.

The amendment to the EU blocking statute came into force on Aug. 6, 2018, which was the same day that the United States reimposed its first tranche of Iranian sanctions. Furthermore, EU Commission guidance noted that the amendment was “triggered by” the United States’ decision to reimpose U.S. secondary sanctions targeting Iran.[3] The timing of the amendment, along with the relevant guidance, suggests that the EU intended to capture the U.S. secondary sanctions, although the operative language of the blocking statute leaves open the possibility that those laws are not covered.

Does the Blocking Statute Prohibit EU Companies That Are Owned or Controlled by a U.S. Person From Complying with the U.S. Primary Sanctions?

Unlike the secondary sanctions, the U.S. primary sanctions contain prohibitions that clearly do apply to some EU operators. Most notably, the ITSR prohibit U.S.-owned EU operators from engaging in most commercial transactions with Iran. Various U.S.-owned EU operators — such as EU subsidiaries of U.S. companies and EU portfolio companies owned by U.S.-based private equity sponsors — are required to comply with the ITSR.

Nevertheless, the blocking statute might not cover the ITSR in its entirety. The blocking statute prohibits EU operators from complying with the requirements or prohibitions of the laws and regulations specified in the blocking statute’s annex, which includes the ITSR. Curiously, the annex summarizes only two ITSR provisions related to reexports of goods, technology or services to Iran. The annex does not describe the ITSR provisions that require U.S.-owned EU operators to comply with the primary sanctions to the same extent as U.S. persons. The absence of such a summary leaves open the possibility that the blocking statute applies only to the ITSR’s re-export provisions.[4]

How Will EU Operators Weigh the Risks Associated with the U.S. Sanctions and the EU Blocking Statute?

If the blocking statute does prohibit EU operators from complying with all U.S. primary sanctions and from engaging in transactions that could result in the imposition of U.S. secondary sanctions, EU operators doing business with Iran may only be able to comply with one of the two regimes. The EU operators could comply with the EU blocking statute and risk being penalized for violating U.S. sanctions. Alternatively, they could comply with the U.S. sanctions and bear the consequences of running afoul of the EU blocking statute. Neither option would be appealing.

EU companies might be able to navigate through the apparent conflicts between the U.S. and EU regimes. Guidance from the EU Commission makes it clear that EU operators “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.”[5] This guidance leaves open the possibility that EU companies could avoid liability under the blocking statute if their management can articulate a plausible business-related explanation for not doing business in Iran that does not relate solely to the relevant U.S. sanctions.

If EU operators are genuinely caught between both regimes, they will have to weigh the potential consequences of violating the EU blocking statute and not abiding by relevant U.S. sanctions before selecting a path forward. Historically, the United States has aggressively enforced its primary sanctions regime, but has been less active in imposing secondary sanctions on non-U.S. companies for transacting business with Iran. By contrast, the EU blocking statute has seen almost no enforcement activity during the past two decades. Although some EU member states have not even enacted domestic legislation to create penalties for breaching the blocking statute, others have done so. In fact, violators of the blocking statute face criminal penalties in some countries — e.g., United Kingdom, Ireland and the Netherlands.

Will EU Operators Utilize the Blocking Statute to Bring Claims Against Third Parties?

The blocking statute authorizes EU operators to “recover any damages, including legal costs, caused to that person by the application of the laws specified in the annex or by actions based thereon or resulting therefrom.” Even if EU member states do not bring enforcement actions against EU operators for violating the blocking statute, third parties could utilize this private right of action to bring claims against those parties.

A number of parties could utilize the blocking statute to bring claims. For instance, if an EU-based bank cut off financing to an EU company because the EU company used the proceeds to purchase Iranian-origin goods or services, the EU company might have a viable claim against the bank. Similarly, if an EU company that had sold products to Iranian counterparties elected to terminate that business and laid off employees in response to the lower production levels, the terminated EU employees potentially could sue for damages and legal costs. If private parties prevail in such litigation, government authorities might feel political pressure to bring enforcement actions against the EU operator found to have violated the EU blocking statute.

Will the EU Take Any Other Steps to Promote Trade with Iran?

The EU, China, Russia and Iran are considering establishing a special purpose vehicle, or SPV, to “facilitate payments related to Iran’s exports (including oil) and imports, which will assist and reassure economic operators pursuing legitimate business with Iran.”[6] While the details are unclear, the SPV apparently will facilitate transactions and payments between Iran and the EU, China and Russia without involving the wider international finance system.[7]

Significant questions remain regarding whether the EU, China, Russia and Iran will move forward with the SPV. An international payment or barter system would be complex, and various countries would need to contribute significant financial resources to get the system up and running. In addition, the country that hosts the SPV could face penalties imposed by the United States, especially given the negative public remarks made by senior Trump administration officials regarding the proposed system.[8]

Even if the SPV comes online, EU operators might not derive significant benefits from it. In theory, the SPV would make it easier to transact with Iran, but reality may prove more complicated. The model for the SPV was a Soviet-era barter system; international trade has grown more complex over the last few decades. In addition, the SPV might not provide EU operators with sufficient protection from U.S. sanctions. Although the opaque nature of the SPV could make it more difficult to establish business ties with Iran, the U.S. government likely would be able to identify many EU operators engaged in substantial business with Iran through other means.

Conclusion

The recent changes to the U.S.-Iranian sanctions regime and the EU’s blocking statute raise a host of complex legal questions and compliance challenges for EU operators. Dealing with Iran has never been simple, but come Nov. 5, it will be more complicated than ever before.

Michael S. Casey, Marcus Thompson and Zachary S. Brez are all partners at Kirkland & Ellis LLP.

The opinions expressed are those of the author(s) and do not necessarily reflect the views of the firm, its clients, or Portfolio Media Inc. or any of its or their respective affiliates. This article is for general information purposes and is not intended to be and should not be taken as legal advice.

[1] Guidance Note, Questions and Answers: adoption of update of the Blocking Statute, Official Journal of the European Union, 2018/C 277 I/03, (Aug. 7, 2018), available at: https://eur-lex.europa.eu/legal-content/EN/TXT/?uri=uriserv:OJ.CI.2018.277.01.0004.01.ENG&toc=OJ:C:2018:277I:TOC.

[2] The Iran legislation listed in the blocking statute annex is: the Iran Sanctions Act of 1996, the Iran Freedom and Counter-Proliferation Act of 2012, the National Defense Authorization Act for Fiscal Year 2012, the Iran Threat Reduction and Syria Human Rights Act of 2012 and the Iranian Transactions and Sanctions Regulations.

[3] Guidance Note, Questions and Answers: adoption of update of the Blocking Statute, Official Journal of the European Union, 2018/C 277 I/03, (Aug. 7, 2018), available at: https://eur-lex.europa.eu/legal-content/EN/TXT/?uri=uriserv:OJ.CI.2018.277.01.0004.01.ENG&toc=OJ:C:2018:277I:TOC.

[4] A note to the annex states that the ITSR and other instruments described in the annex “are summarized only for information purposes,” which could be read to suggest that the EU blocking statute covers the ITSR in its entirely.

[5] Guidance Note, Questions and Answers: adoption of update of the Blocking Statute, Official Journal of the European Union, 2018/C 277 I/03, (Aug. 7, 2018), available at: https://eur-lex.europa.eu/legal-content/EN/TXT/?uri=uriserv:OJ.CI.2018.277.01.0004.01.ENG&toc=OJ:C:2018:277I:TOC.

[6] Joint Ministerial Statement, paragraph 10, available at: https://eeas.europa.eu/headquarters/headquarters homepage/51036/implementation-joint-comprehensive-plan-action-joint-ministerial-statement_en.

[7] EU Plan to sidestep Iran sanctions: How will it work?, Deutsche Welle, (Sept. 26, 2018), available at: https://www.dw.com/en/eu-plan-to-sidestep-iran-sanctions-how-will-it-work/a-45647007.

[8] EU Scrambles to defy US Iran sanctions, Financial Times (Oct. 28, 2018), available at: https://www.ft.com/content/0cb5534c-daac-11e8-9f04-38d397e6661c.