Jessica Gladstone, International Counsel at Debevoise & Plimpton LLP, and a member of the firm’s global team advising on sanctions issues, discusses the impact of US and EU sanctions on international business.
The commercial effects of politics
Recent political developments in Crimea have had serious commercial consequences for many working in or with partners in the region. Not only has the political disruption had a direct impact on business in the region but so too has the international response, by means of the introduction of sanctions, by foreign governments.
At least four distinct sanctions regimes have been introduced as a result of the developments in Crimea: the United States, European Union, Canada and Australia have all introduced restrictive measures of varying degrees, each with their own specific requirements and designated persons. Some non-EU countries, including Montenegro, Iceland, Albania, Norway, and Ukraine, have committed to conform their national policies to the EU position also. And the position is far from settled. Still more nations may impose economic sanctions, and those regimes already in place may change in scope, in response to the political developments, at any moment.
As a result, and as ever, the patchwork and piecemeal nature of the multiple and distinct sanctions regimes that have been introduced mean that businesses must be vigilant and aware of the ever-changing restrictions, the obligations imposed on them, and the impact on their business.
The sanctions regimes
Although the major regimes are similar in general terms – both the US and EU regimes impose asset freezes and travel bans to varying degrees – the scope and the intricacies of the US and EU sanctions regimes differ, as do the lists of designated persons for each regime. This information is highly date-sensitive, but an overview of the present situation is set out below.
The European Union’s restrictive measures in respect of Crimea-related sanctions consist of two regimes, with differing objectives, working in parallel. The first targets individuals associated with the former Ukrainian government said to be “responsible for the misappropriation of Ukrainian State funds and persons responsible for human rights violations in Ukraine” (Council Regulation 208/2014 of 5 March 2014) and the second targets political figures from Crimea and Russia, and members of the Russian military said to be responsible “for actions which undermine or threaten the territorial integrity, sovereignty and independence of Ukraine” (Council Regulation 269/2014 of 17 March 2014). As of 12 May 2014, the second regime has been expanded by Council Regulation 476/2014 to permit the designation of:
• natural persons (and natural or legal persons, entities or bodies associated with them) responsible for actively supporting or implementing actions or policies which: (i) undermine the territorial integrity, sovereignty and independence of Ukraine; (ii) undermine the stability or security in Ukraine; or (iii) which obstruct the work of international organisations in Ukraine; or
• legal persons, entities or bodies in Crimea or Sevastopol whose ownership has been transferred contrary to Ukrainian law, as well as legal persons, entities or bodies which have benefited from such a transfer.
Both regimes impose an asset freeze and the second regime also imposes a travel ban. Currently 22 individuals are listed pursuant to the first regime (4 of whom were most recently added on 15 April 2014), and 61 are listed pursuant to the second (15 of whom were added on 28 April 2014; and a further 13 on 12 May 2014). On 12 May 2014, for the first time, 2 entities were also designated by the EU under the second regime. These are energy companies which the EU has identified as entities in Crimea “whose ownership has been transferred contrary to Ukrainian law”.
The asset freeze prohibits EU persons, which includes persons within the EU as well as EU nationals anywhere in the world, from dealing in funds or economic resources that belong to or are controlled or held by the listed individuals. Moreover, EU persons are also prohibited from making funds or economic resources available to the listed individuals, whether directly or indirectly. It is an offence to contravene or circumvent any of the prohibitions and it is also an offence to enable or facilitate their contravention. The travel ban requires all member states to prevent entry into, or transit through, their territory.
The EU has indicated that the sanctions may be expanded further, with the European Council asking the Commission and the Members States in March 2014 to prepare possible targeted measures in addition. This was confirmed in Council Conclusions on Ukraine on 14 April 2014 and again on 12 May 2014, when the President of the European Council also issued a statement announcing that the “EU has agreed that further steps by Russia to destabilise the situation in Ukraine would lead to additional far reaching consequences for relations in a broad range of economic areas. Preparatory work on this is underway.”
The UK, as well as implementing the EU regulations, has also revised some of its trade restrictions. All licences and applications issued by the UK for direct export to Russia of military or dual-use items destined for units of the Russian armed forces and or other State agencies have been suspended. Moreover, all licences for export to third countries of such goods intended for re-export to Russia have also been suspended.
The United States’ regime also introduces an asset freeze and a travel ban. President Obama issued three Executive Orders in March 2014, and in addition the US Congress enacted a new statute (Public Law 113-95) which became law on 3 April 2014. Each authorise the US Treasury Secretary to “block” the property of listed individuals or entities. The first Executive Order is targeted mostly at officials of the Yanukovych government of Ukraine; the second is targeted mostly at Russian officials that the US considers to be involved in the events in Crimea. As yet, no one has been designated under the third executive order or the 3 April statute. However, by virtue of these measures (see in particular Section 1(a)(i) of the third Executive Order), the Treasury Secretary is authorised to extend these designations, including to companies operating in certain sectors of the Russian economy, such as financial services, energy, metals and mining, engineering and defense and related materiel.
The assets of a person who is “blocked” by the US sanctions regime must be frozen if they are in the United States or in the possession of a “US person”—a term that includes US nationals, permanent residents and companies (including their foreign branches). For example, foreign branches of US banks are required to freeze assets located in foreign countries, including Russia. Non-US banks are required to freeze assets held at their US branches, but are not required to freeze assets worldwide merely because they have a US branch. Blocking also effectively prohibits US companies, individual US nationals and persons in the US from engaging in any kind of transaction with a blocked individual or entity. Additionally, under a longstanding interpretation by OFAC, the property of a company is blocked automatically if a blocked individual or entity owns 50% or more of the company’s equity.
Following the Geneva Statement on Ukraine on 17 April 2014 by representatives of the EU, US, Ukraine and Russia, where the parties agreed upon “initial concrete steps to de-escalate tensions and restore security for all citizens”, the US has warned that if the terms of the deal are not adhered to, stronger economic sanctions may follow.
With the addition of new designations on 28 April 2014, there are currently 45 individuals and 19 entities listed under US sanctions authorized in response to events in Ukraine.
In response to the imposition of these restrictive measures, Russia has adopted its own countermeasures. While it has not imposed any asset freezes or broader measures, it has introduced a visa ban on 9 US government officials, and it has intimated that it will take further steps if necessary.
Russia has also adopted regulatory measures in response to the sanctions. For example, on 5 May 2013, President Putin enacted regulations on international payment systems operating in Russia, following the decision by Visa and MasterCard to stop providing financial transaction services to clients of Rossiya Bank, Sobinbank and SMP Bank, after the banks were designated under US sanctions. The regulations require international payment systems to establish their processing centre in Russia, to maintain their provision of services to Russian clients, and to provide Russia’s central bank with a security deposit amounting to the average value of two days’ worth of transactions, from which a daily fee of 10% of the deposit may be deducted for failure to comply.
If broader sanctions are taken against Russia, Western companies operating in Russia are concerned not only about the potential impact this may have on their ability to continue business, but also about the possible retaliation that may follow.
The possible effects of the various sanctions regimes reach into many aspects of commercial life, and are too extensive to enumerate exhaustively. However, it is useful to categorise and consider examples of some of the potential effects that may be felt by companies doing business in the region.
First and foremost, as with the imposition of any new sanctions legislation or the expansion of existing sanctions legislation, immediate attention is required on the business compliance front. The compliance function in any company that is required to comply with the sanctions laws should check whether customers, depositors, vendors or other counterparties are the target of sanctions. Companies that use automatic screening software to detect sanctioned parties should be sure that they are receiving timely updates of the databases that the software uses to check for sanctioned entities. Those in charge of any contemplated or pending transaction involving Russian or Ukrainian individuals or entities should recheck the counterparties against the sanctions lists each time the lists are updated.
Following this initial screening process companies are likely to have a myriad of questions and specialist legal advice should be sought in relation to these. These are critical issues not least because the criminal penalties and potential fines that may result from a breach of sanctions – particularly from the US authorities – have been seen extend to hundreds of millions of dollars; and the reputational and business consequences of breaches can be equally severe, if not more so. In each specific case, the answers to such issues will turn on an analysis of the sanctions regimes that apply in the particular circumstances, and the legal and factual framework between the parties.
Questions will commonly arise in terms of (i) evaluating contractual obligations – e.g. in determining whether performance is possible/required under existing contracts (and drafting sanctions clauses to protect against uncertainty in new contracts); (ii) enforcing contracts (is a contract illegal or frustrated where a contract counterparty is sanctioned as a blocked person?; does this constitute force majeure, or “material adverse change”?); (iii) understanding any potential implications for shareholders in a sanctioned entity; (iv) assessing the practicalities and timing of compliance, such as whether there will be a grace period for performance of existing contracts with a sanctioned company or individual; (v) determining how affiliates or other companies with connections to designated people should be treated; (vi) determining how joint ventures to which designated people are a part should be treated, and handling the practical implications for the other parties; (vii) dealing with complex corporate transactions, where e.g. a contract has multiple counterparties, some of whom are blocked and some of whom are not; (viii) protecting rights of creditors (for instance where a borrower under a USD loan becomes designated); and (ix) litigating or arbitrating with a designated entity, or enforcing judgments and awards against them.
From a business perspective, the potential implications of the current situation are equally complex, as companies try to predict the future, evaluate the risks to existing investments in the region, anticipate potential issues with making future sales in the region, and assess the market conditions for attracting or making potential new investments, and for securing loans and other financing. In considering new financing or investment in an affected region, even where sanctions are not immediately or directly relevant, the political environment can have a marked impact on the calculation of risk/reward, and accordingly on the opportunities available.
The effect of the political situation on companies operating in Crimea is particularly acute. Crimea is now fully under Russian control but still claimed by Ukraine, leaving a potential dispute as to which laws apply, and complicating the practicalities and the politics for companies seeking to do business as normal.
As tensions in the region continue to rise, the sanctions matrix may become still more complicated. Companies must get on top of, and remain on top of, this fast-changing area of law, as the financial, criminal and reputational consequences of non-compliance are too great to risk.
Jessica Gladstone is International Counsel at Debevoise & Plimpton LLP, and a member of the firm’s global team advising on sanctions issues. Her practice focuses on international arbitration and litigation, and public international law.