Following our earlier bulletin, on October 31, 2017, the US Department of State and Department of Treasury’s Office of Foreign Assets Control (“OFAC”) posted comprehensive guidance related to the Countering America’s Adversaries Through Sanctions Act of 2017 (“CAATSA”). The new guidance addresses multiple provisions of CAATSA, mainly the provisions concerning secondary sanctions targeting Russia. The new guidance significantly limits and clarifies the scope of these secondary sanctions.
As detailed in our prior alert, on August 2, 2017, President Trump signed CAATSA into law. The legislation provided several new categories of primary and secondary sanctions relating to Russia, Iran and North Korea.
In relation to Russia sanctions under CAATSA, OFAC issued FAQs regarding Section 223(a), Section 226, Section 228, Section 233, and the newly amended Sectoral Sanctions Initiative Directive 4.
Section 223(a) defines the scope of persons who may be designated under section 1(a) of Executive Order 13662 to include any state-owned entities “operating in the [Russian] railway, shipping, or metals or mining sector[s].” In its guidance, OFAC states that it does not intend at present to impose any sanctions on such entities given its discretion, and notes that it intends to “maintain unity with partners on sanctions.” The guidance, however, notes that OFAC may, as a matter of legal authority, impose sanctions in any sector of the Russian economy.
Section 226 amends the Ukraine Freedom Support Act (“UFSA”) to impose mandatory sanctions, subject to waiver authority, on foreign financial institutions who have (i) facilitated “significant financial transactions” with certain Russia-related Specially Designated Nationals (“SDN”) or (ii) engaged in one or more “significant transaction[s]” with Russian defense and intelligence-sector entities. The guidance clarifies that transactions with persons subject to current sectoral sanctions pursuant to Executive Order 13662 (“SSI Entities”) will not be sanctionable under Section 226.
In addition, the guidance notes that to determine whether a transaction meets the “significance” threshold, OFAC will consider the totality of the facts and circumstances, including the following factors: (i) the size, number, and frequency of the transaction(s); (ii) the nature of the transaction(s); (iii) the level of awareness of management and whether the transaction(s) are part of a pattern of conduct; (iv) the nexus between the transaction(s) and a blocked person; (v) the impact of the transaction(s) on statutory objectives; (vi) whether the transaction(s) involve deceptive practices; and (vii) such other factors as are relevant on a case-by-case basis.
However, consistent with past guidance, OFAC has interpreted the term “facilitation” and “financial transactions” broadly. Foreign financial institutions thus need to be extremely careful in dealing with any SDN designated under the Russia-related sanctions Executive Orders.
OFAC’s guidance concerning Section 228 addresses a significant ambiguity in the text of CAATSA. Section 228 introduced mandatory secondary sanctions against persons who have knowingly facilitated “significant transaction(s), including significant deceptive or structured transactions”, “on behalf of” any person currently included on Russia-related sanctions lists or any child, spouse, parent, or sibling of such persons. This provision, on its face, seemed to create ambiguity regarding whether transactions with non-SDN entities designated under the SSI Executive Orders (which are not generally blocked but are instead subject to narrow restrictions on debt and equity transactions) and in relation to unconventional oil projects, would be covered by the provision. Such an interpretation would have led to an anomalous result, in which transactions which are permissible for US persons under the SSI regulations would have exposed non-US persons to a risk of secondary sanctions. As was widely expected, OFAC has clarified that this is not the case in general, and that transactions which would be permissible for US persons because they are allowed by the SSI restrictions will not serve as a basis for secondary sanctions against non-US persons.
The guidance further notes that a transaction in which only SSI Entities are involved must also involve deceptive practices (i.e., attempts to obscure or conceal the actual parties or true nature of the transaction(s), or to evade sanctions) to potentially be considered significant, for secondary sanctions purposes, under Section 228. This means that most general commercial transactions with SSI Entities will not be secondarily sanctionable, but if they involve prohibited transactions for US persons, such as certain capital market transactions and transactions for non-conventional oil projects, it will be critical to avoid any indicia of an intent to conceal the nature of the relevant transaction.
Section 233 requires the President to impose secondary sanctions on any person determined by the President to have, with “actual knowledge,” made an investment exceeding certain thresholds which “directly and significantly contribute” to Russia’s ability to privatize state assets and which “unjustly benefits” Russian government “officials” or their “close associates or family members.”
OFAC has now provided a broad interpretation to the terms “investment,” “facilitation” and “unjust benefits.” In particular, “investment” includes a transaction that constitutes a commitment or contribution of funds or other assets or a loan or other extension of credit to an enterprise, and therefore a broad range of debt transactions are covered. “Unjust benefits” are interpreted to include activities such as public corruption that result in any direct or indirect advantage, value, or gain, whether the benefit is tangible or intangible, by officials of the Government of the Russian Federation, or their close associates or family members. Such public corruption could include, among other things, the misuse of Russian public assets or the misuse of public authority – this potentially necessitates robust anti-corruption due diligence for any transaction that may fall under the broad range of “investment” under Section 233.
OFAC also amended and reissued Directive 4 under Executive Order 13622 in accordance with Section 223(d) of CAATSA, which requires modifications to the applicable scope of Directive 4 to cover “new” deepwater, Arctic offshore, and shale oil projects, whether located in Russia or elsewhere, if Russian entities subject to Directive 4 have either a “controlling” interest or an ownership interest in excess of 33 percent. The guidance notes that amendments to Directive 4 do not change the applicability of OFAC’s 50 percent rule in the Directive 4 context. To constitute a “new” project, the project has to be initiated on or after January 29, 2018; a project is “initiated” when a government or its related entity formally grants exploration, development, or production rights to any party.
In relation to Iran, OFAC has now designated Iran’s Islamic Revolutionary Guard Corps (IRGC) pursuant to Section 105 of CAATSA for terrorism-related sanctions. Assets of foreign persons that are officials, agents, or affiliates of the IRGC are blocked. As the IRGC was previously designated under other sanctions program, the impact of the new designation will be limited to further prohibitions for transactions involving IRGC and its affiliates that were authorized under other programs, such as personal communications, humanitarian donations, information or informational materials and travel.
Department of State Guidance
New Department of State guidance concerns Sections 225 and 232 of CAATSA.
Section 225 amends the UFSA to authorize the mandatory imposition of secondary sanctions against any persons who have made a “significant investment” in a Russian non-conventional (e.g. deepwater, offshore or shale) project related to the extraction of crude oil. “Investment” could include arrangements where goods or services are provided in exchange for equity in an enterprise or rights to a share of the revenue or profits of an enterprise.
In determining whether an investment is “significant” for the purposes of the UFSA, the Department of State will consider the totality of the facts and circumstances surrounding the investment and weigh various factors on a case-by-case basis. The factors considered in the determination may include, but are not limited to, the significance of the transactions to US national security and foreign policy interests, in particular where the transaction has a significant adverse impact on such interest; the nature and magnitude of the investment, including the size of the investment relative to the project’s overall capitalization; and the relation and significance of the investment to the Russian energy sector. For the purposes of Section 225, an investment is not significant if US persons would not require specific licenses from the OFAC to make or participate in it. This interpretation aligns Section 225 with the scope of OFAC’s newly amended Directive 4.
Section 232 authorizes secondary sanctions on any person who has “knowingly” made an investment exceeding $1,000,000 in fair market value, or exceeding $5,000,000 in aggregate fair market value over a 12-month period, in the export-pipeline infrastructure of Russia. The investment must either “directly and significantly contribute to the enhancement” of Russia’s ability to construct such pipelines, or must consist of “goods, services, technology, information, or support” that could “directly and significantly facilitate the maintenance or expansion of the construction, modernization, or repair of energy pipelines” by Russia.
The new guidance, as anticipated, highlighted that sanctions under Section 232 will be implemented so as not to harm the energy security of European allies of the United States. For the purposes of Section 232, the focus of implementation would be on energy export pipelines that (1) originate in the Russian Federation, and (2) transport hydrocarbons across an international land or maritime border for delivery to another country. Pipelines that originate outside the Russian Federation and transit through the territory of the Russian Federation would not be the focus of implementation.
In addition, the guidance provides an express safe harbor for pipeline projects “initiated” on or before August 2, 2017, effectively grandfathering such projects such that contracts, including new contracts, related to such grandfathered projects will not attract US secondary sanctions. A project will be deemed to be “initiated” when a contract for the project is signed.
Conclusions and Outlook
Overall, the various guidance issued suggests a balanced approach towards the use of Russia-related secondary sanctions authorized under CAATSA. In several areas, the guidance provides important clarifications which should reduce secondary sanctions concerns for many companies conducting Russia-related business that is compliant with CAATSA as interpreted by the relevant agencies. However, given the complexity of the guidance and the breadth of CAATSA’s provisions, it will remain critical to examine sanctions compliance issues carefully when any transaction has a nexus to countries or entities sanctioned under CAATSA.
Herbert Smith Freehills continues to monitor developments related to CAATSA and stands ready to assist businesses seeking sanctions-related advice.