International sanctions affect a wide range of individuals, from specific companies and their beneficiaries to entire sectors of the economy of certain countries. To be correct to build work with counterparties and not be exposed to danger, it is necessary to understand the existing sanctioning mechanisms and possible protection tools against unscrupulous counterparties. For example, carrying out transactions in US dollars or the presence of court cases of a non-resident in the territory of the United States are among the signs of a connection with the United States. The presence of such a connection with the USA enables OFAC to apply sanctions to a legal entity registered even in Ukraine.
US Sanctions and Signs of US Connection for Non-Residents
The most influential and widespread US sanctions are those imposed by the US Department of the Treasury’s Office of Foreign Assets Control (OFAC). These sanctions are so effective because of the actual extension to an unlimited number of persons in any jurisdictions and a well-developed and prescribed mechanism of responsibility for their violation. OFAC’s sanctions include a fine of up to $300,000 or an amount not exceeding twice the amount of the transaction entered into in violation of the sanctions. Criminal liability in the form of imprisonment for a term of up to 20 years or a fine of up to one million US dollars.
OFAC sanctions apply to a resident of another country if:
- he is subject to primary OFAC sanctions – targeted, sectoral sanctions, or is a resident of a country or region subject to comprehensive sanctions;
- secondary sanctions have been applied to him for cooperation with persons subject to primary sanctions,
- a non-resident has some level of connection to the US. Signs of connection with the USA can be:
- the presence of vertically related persons registered in the USA – holding, subsidiary, ultimate beneficiary,
- carrying out financial transactions with counterparties from the USA,
- carrying out financial transactions related to goods and services of American origin,
- carrying out financial transactions in US dollars,
- legal proceedings involving a non-resident on the territory of the United States.
- a non-resident provides assistance or facilitates transactions with sanctioned persons.
It is also necessary to take into account that Ukrainian legislation contains mechanisms for the implementation of international sanctions. For example, the imposition of UN or EU sanctions may lead to the imposition of personal special economic sanctions at the level of Ukraine or the application of certain prohibitive mechanisms of industry legislation at the level of Ukraine (for example, a ban on legal entities of the aggressor country to participate in public procurement or privatization).
Sanctions are applied not only to the persons directly indicated in the sanctions lists. Companies associated with them also pose a danger. Ownership and control criteria are used to identify such individuals who are subject to sanctions and who are not on the sanctions lists.
In the case of US sanctions, ownership and control are defined as follows:
- 50% or more of the shares or other corporate rights are owned by a sub-sanctioned person or several sub-sanctioned persons. If two persons subject to sanctions each own 25% of the capital of a company not specified in the sanctions lists, the company is automatically considered subject to sanctions,
- the 50% rule is applied in cascade: if the person “X” owns 50% of the company “A”, and the company “A” owns 50% of the company “B”, then the company “A” is automatically subject to sanctions, since it is owned by the sub-sanctioned person “X” , and company “B” is automatically subject to sanctions, since 50% of its capital belongs to company “A”.
CONTROL: is not currently expressly provided for, however, given OFAC’s broad interpretation of the provisions of US sanctions law, we do not rule out that OFAC will eventually implement relevant criteria. This scenario is especially likely if this loophole is found to lead to a significant circumvention of sanctions.
US International Sanctions (OFAC): What non-residents should pay attention to
Ukraine is at the epicenter of the sanctions tornado: it initiates the introduction of sanctions and imposes them independently. How not to accidentally get caught in the whirlwind of sanctions, the destructive power of which is hard to overestimate for business?
- Check counterparties for inclusion in sanctioned lists and delisting from sanctioned lists. The full cycle of the sanction audit should also include a check on the national level sanction lists.
Risks are concentrated precisely in the base of existing and potential counterparties. Above all, it is necessary to pay attention to sanction compliance, a full-fledged, systematic and regular check of counterparties.
A sub-sanctioned counterparty is:
refusal to service bank accounts,
inability to work with American and European counterparties,
application of secondary sanctions,
financial and criminal liability.
How to recognize risks in time and minimize the consequences of cooperation with sanctioned persons
The demand for the development of ethics and compliance departments is steadily growing in proportion to the risks. Within the simplest version of compliance control, it is worth paying attention to:
verification and up-to-date maintenance of the ownership structure of counterparties,
verification of the application of targeted sanctions against the management of the counterparty and its beneficiary,
verification of historical changes in the counterparty’s ownership structure,
checking the structure of payments.
In addition, now more than ever, the problem of losing control over assets located in temporarily occupied territories is becoming urgent. It is necessary to pay attention to the proper recording of the fact of loss of control over property in the temporarily occupied territory:
“If your company owns assets that are located in temporarily occupied territories and over which control has been lost, it is necessary to properly record such facts. For example, to apply to law enforcement agencies with a statement about the commission of a criminal offense. This minimizes the risk of any secondary sanctions being applied to you due to the fact that your property may be used by representatives of the aggressor country.”
Contractual mechanisms for the protection of contractual mechanisms at various stages of the agreement
Contracts can provide for the following points:
- providing guarantees by the counterparty regarding the lack of cooperation or any ties with sanctioned persons,
- the counterparty’s liability for breach of such guarantees, for example, in the amount that would cover your costs in connection with sanction proceedings and for the payment of sanction fines;
- the right of your company to unilaterally terminate the contract if such violations are detected.
Sanction due diligence of the seller and the target company before investment deals
Before concluding investment agreements, we recommend checking the following risks:
- the application of sanctions against each company, manager and any other person from the entire corporate structure of the seller and the target company;
- the presence of risky transactions from the point of view of sanctions compliance among already executed agreements – the presence of complex payment schemes, supply of goods, transactions on the territory of countries subject to complex sanctions;
- unrelated persons provide surety for significant financial obligations of the target company;
- structuring of payments for already concluded, but not yet executed agreements.
Sanctions cloaking and circumvention: an overview of international practice and typical mechanisms
Continuation of contracts concluded before inclusion in the sanctions list
Thanks to this loophole, during 2014-2020, companies from France, Germany, Italy and other EU countries supplied Russian defense enterprises with weapons and their components worth approximately 350 million euros.
EU Council Decision No. 2014/512/CFSP provided for an embargo on the supply of military goods. However, this decision contained an exception regarding the implementation of agreements concluded before August 1, 2014. That is, if the agreement was concluded before the above-mentioned deadline, but then the parties decided to make changes to it, then in fact such actions did not violate the requirements of the above-mentioned decision of the Council of the EU.
Use of an intermediary buyer
According to EU Council Decision No. 692/2014, EU residents do not have the right to export energy sector goods to the territory of Crimea. In 2015 and 2016, the Siemens concern supplied electric turbines to a Russian company for use at a power plant in the Krasnodar region. However, after receiving the turbines, they were transferred to another Russian company and used to repair the Balaklava and Tavriy TPPs in the temporarily occupied Crimea.
Dual purpose goods
Decision of the Council of the EU No. 833/2014 prohibited the export of dual-use goods if the final recipient of such goods is the enterprises of the Russian defense complex or if such goods will be used for military purposes. However, this decision allowed the export of such goods if they were to be used for non-military purposes.
EU residents concluded contracts with intermediary companies, which indicated that they were not enterprises of the Russian defense complex and would not use them for military purposes. After receiving such goods, these intermediary companies resold such goods to Russian enterprises that produced weapons.
Changing the type of activity
Decision of the Council of the EU No. 833/2014 also provides for a ban on the export of technologies and equipment intended for the development of oil or shale deposits, including in the Arctic.
Until 2014, the Norwegian company Statoil cooperated with Rosnefta on the development of just such fields. After the introduction of sanctions, Statoil changed the scope of its services to the development of unconventional limestone deposits. Statoil continued to export the same technologies and goods to Rosneft, but formally did not violate the decision of the Council of the EU, since it was not carrying out a type of activity subject to sanctions.
What can be done if the counterparty is on the list of sanctions after concluding the contract
Exemption from sanctions
It is necessary to check the decision of the relevant body on the introduction of sanctions on the subject of prohibited transactions and any exclusions. For example, the presence of a humanitarian element or exceptions to the implementation of contracts concluded before the introduction of sanctions, etc.
Availability of a general or special license
OFAC regularly issues new and renews existing general licenses that allow an unlimited number of individuals to engage in certain types of transactions with sanctioned entities. If this is provided for by the relevant sanctioning mechanisms, you can apply to the local regulator with the requirement to provide a special license to carry out a specific transaction.
Local legislation contains a “no claims clause”
For example, according to the decision of the EU Council No. 45/2014, the relevant sanctioned persons cannot submit any claims for compensation, collection of fines, compensation for damages, etc., in connection with any non-performance by the other party of the contract, if such non-performance arose due to fulfillment of relevant sanction requirements.
Termination of the contract
Check the provisions of the contract and the legislation according to which the contract was concluded, and if possible, apply to the court with a demand to terminate the contract. For example, in Ukraine, in such a case, the party to which sanctions are not applied could apply to the court and refer to a significant change in the circumstances that the parties were guided by when concluding the relevant contract.
If termination of the contract is impossible for any reason, we advise you to check the provisions of the applicable law and the contract regarding (1) force majeure circumstances, (2) the procedure for notification of their occurrence, (3) the list of obligations that may not be fulfilled in due to force majeure circumstances, and (4) during which period such obligations may not be fulfilled.