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US Secondary Sanctions and Navigating the EU Blocking Regulation

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United Kingdom

To date, the EU blocking Regulation, designed to counteract the extra-territoriality of US sanctions against Iran and Cuba has been considered a toothless tool and has not yet been substantively considered in the English courts.

Businesses continue to grapple with the issue of complying with EU law but potentially exposing themselves to US secondary sanctions, or complying with US law and potentially violating the EU Blocking Regulation. Questions still exist about how the UK and European courts will interpret the provisions of the EU Blocking Regulation but cases before the Italian, German and Dutch courts have now offered some initial guidance.

The Cases

Case 1, Italian Court: An Italian company controlled by partners in Iran was notified by its bank that their banking services would be terminated due to US sanctions concerns. The court ordered an injunction to prevent the bank from terminating its services, as do so would be a breach of the EU Blocking Regulation.

Case 2, Italian Court: An Italian company had a supply contract with an Iranian company that became subject to US sanctions. Payment by the Iranian company was subsequently frozen by the Italian company's bank. The Italian court ordered the release of funds under the EU Blocking Regulation given that the US designation was ineffective in the EU, and the Iranian bank was not subject to any sanctions in the EU.

Case 3, German Court: An interim injunction was granted based on the EU Blocking Regulation requiring a telecoms company to provide services to an EU-based branch of an Iranian bank, which had been targeted by the re-imposition of US Iran sanctions.

The telecoms company had terminated the contract for telecoms services with immediate effect and without notice. It argued that it did not need to give notice; due to the re-imposition of US sanctions against Iran, the bank's access to SWIFT had been cut off and the telecoms company said it was entitled to assume that the bank would no longer be able to meet its obligations under the contract and pay for services. The telecoms company also said it was concerned about acting contrary to US sanctions.

The bank argued that the immediate termination of services had caused significant damage, as it was unable to carry out its business without internet and telephone services. It said that it had always met its payment obligations, that such obligations were satisfied via its German business account, which had sufficient coverage, and that transfers could be made without reliance on SWIFT.

The court agreed with the bank that the telecoms provider had not given sufficient justification for the termination of the contract. Termination would only be effective if there was an important reason, and if the continuation of the contract was unacceptable for the terminating party taking into account all the circumstances and weighing up the interests of both parties. The court granted an interim injunction for the restoration of the telecoms services based on the EU Blocking Regulation. However, the court did hold that insolvency could justify termination without notice – so if there had been a real risk that the bank was going insolvent due to the re-imposition of sanctions, the termination may have been justified.

Case 4, German Court: This was a case on near identical facts, where again an injunction was granted on the basis of the EU Blocking Regulation, requiring a company to restore telecoms services to an Iranian bank.

The telecoms company had terminated the contract for telecoms services with no notice. The Iranian bank was subject to the re-imposed US sanctions and no longer had access to SWIFT. The telecoms company therefore argued that it was entitled to assume the bank would no longer be able to fulfil its contractual obligations and pay for services, due to the significant economic difficulties that would be caused by the lack of access to SWIFT. It was also concerned by US sanctions, given that the company was part of a group that generated 50% of its sales in the US. The telecoms provider claimed it could terminate under the contractual terms for good cause, that the EU Blocking Regulation did not preclude termination and that there were sufficient other competitors that the bank could turn to for telecoms services.

The bank said that the termination had caused damage as it has interrupted email and payment transactions as well as the security system for the building. It said that its payments under the contract were not in arrears and that payment could still be made despite the termination of its SWIFT access. The bank had significant funds with the German Federal Bank and offered to make a payment on account for the next 2 years of the contract.

The court agreed with the bank and granted the injunction to restore internet and fixed line telephone services. The telecoms company had not put forward an important reason for termination. The alleged economic difficulties were not adequately explained by the US sanctions. The bank's licence was at risk without a functioning communication infrastructure, it had showed that it had sufficient funds available to make payments and that it was unable to find another provider in the short term.

The bank made a separate injunction application to restore 3 mobile phone contracts, which the telecoms provider had also terminated. The bank said the mobile phones were used by 3 senior decision-makers of the bank and that 24-hour access to these individuals was required.

The telecoms provider had again terminated the contracts due to the re-imposition of US sanctions against Iran and the assumption that the bank could no longer fulfil its contractual obligations. It said that due to US secondary sanctions, German banks for the most part do not accept payments from Iranian companies and financial institutions and that the company could not be expected to accept the threat of economic disadvantage on the US market where it generates half the group's turnover. It was therefore entitled to terminate the contract for good cause.

The court agreed with the telecoms provider and refused to restore the mobile phones. It distinguished the previous injunction as in that instance the termination of internet connections had an immediate and existential impact on the operation of the bank and no substitute was available in the short term. In this case, only three mobile phones were effected and there were a number of alternative providers so the accessibility of the bank's decision-makers outside of office hours could be guaranteed without the bank having to rely on the services of the telecom provider in question.

Case 5, German Court: The court refused to grant an injunction under the EU Blocking Regulation, which would have prevented the savings account of an international logistics company being closed due to the bank's concerns over US sanctions against Iran. The bank's terms and conditions allowed it to terminate an account for a valid reason. The court held that the valid reason was compliance with US secondary sanctions, as the bank had shown that its correspondent banks may refuse to co-operate with it due to secondary sanctions.

The bank had sent a termination notice to the logistics company, saying that the savings account would be closed due to the re-imposition of US sanctions against the company and the risk of secondary sanctions and OFAC taking enforcement action against the company for acting contrary to US sanctions. The bank argued that processing payments for the company posed a threat of secondary sanctions, which would endanger: (a) its business relationships with its correspondent banks; and (b) the American and African payments branches of its business. The contractual terms provided that the bank could terminate if there was a valid reason, but would take due account of the legitimate concerns of the customer, and in particular concerns about terminating at an inopportune time. The bank had given notice and the company had the opportunity to open new accounts with other banks, and had not sufficiently demonstrated its efforts to do so.

The logistics company argued that termination was made at an inopportune time and did not take into account their legitimate interests since it had not been possible to open a new bank account with similar services and terms. The company sought the continuation of its account until it succeeded in opening an equivalent account on reasonable terms. Iranian banks in Hamburg would in principle be prepared to open an account but would not be able to process certain payments. One bank had offered to open an account but the fees for doing so were so extortionate and the company would not be provided with any bank or credit card. The company said the termination of the account violated the EU Blocking Regulation and it was unclear what measures the US could impose against the Bank when the US sanctions were of no effect in the EU.

The court held that the termination was lawful. The re-imposition of US secondary sanctions was a valid reason for termination. The bank had shown that its correspondent banks, necessary for the operation of its US dollar business, may refuse to work with it in order to avoid the risk of becoming subject to sanctions themselves. The bank had taken into account the legitimate interests of the customer and did not have to accept the risk of secondary sanctions and being cut off from its American and African payment business so that the company could continue its business.

The court held that there was no violation of the EU Blocking Regulation. Whilst the EU Blocking Regulation prohibits persons from complying with extraterritorial US sanctions against Iran that does not mean that it obliges EU businesses to continue trading with Iranian entities, particularly when to do so would be contrary to their commercial interests. The court relied on guidance published by the EU Commission which states, "EU operators are free to conduct their business as they see fit in accordance with EU law and national applicable laws. This means that they are free to choose whether to start working, continue, or cease business operations in Iran or Cuba, and whether to engage or not in an economic sector on the basis of their assessment of the economic situation. The purpose of the Blocking Stature is exactly to ensure that such business decisions remain free…" The bank had relied on its contractual terms and terminated for a valid reason, being US secondary sanctions and the risk that US correspondent banks (necessary for the banks functions) may cease to carry out business with the bank.

Case 6, Dutch Court: A distribution agreement was restored on the basis that the termination of the agreement due to US secondary sanctions concerns may have been a breach of the EU Blocking Regulation.

A Dutch company, Exact Software, had entered into a distribution agreement with PAM International, a company based in the Dutch Caribbean island of CuraƧao. PAM then distributed software supplied by Exact to companies in Cuba. Exact terminated the distribution agreement with immediate effect, on the basis that following the conclusion of its acquisition by a US investment company, US sanctions would legally oblige it to terminate the agreement and the circumstances amounted to force majeure.

The court held that the termination was unlawful and ordered Exact to restore its services to PAM. The risk of exposure to US sanctions for Exact and its shareholders fell entirely within their own sphere of risk and did not constitute force majeure. The fact that Exact and its shareholders may be exposed to criminal and financial liability risks because of US secondary sanctions for continuing the agreement did not change the position; they had to bear the risk. Mere exposure to the risk of US sanctions did not constitute a valid ground for terminating a contract. Exact had chosen to terminate the contract; the position may have been different if performance of the contract had become practically unfeasible because of US sanctions (as the German bank had demonstrated in case 5 above). Dutch authorities are now investigating Exact for a breach of the EU Blocking Regulation.

Implications

These cases highlight that the application of the EU Blocking Regulation will depend upon the individual facts of each case, and may be applied inconsistently across the EU member states. It seems that there is a careful balancing line between favouring the interests of EU companies that wish to continue Iran or Cuba related business versus giving latitude to EU businesses who wish to terminate transactions where there are commercial interests at stake as a result of US secondary sanctions risks.

The Dutch and Italian courts have taken a more strict interpretation of the EU Blocking Regulation, reversing actions that have been taken because of US secondary sanctions concerns and emphasising that making decisions purely based on US secondary sanctions concerns breaches the EU Blocking Regulation. The German courts have taken a more practical approach, placing significant consideration on the commercial consequences of US sanctions on the companies concerned.

These cases highlight the importance of having appropriate sanctions clauses in your contracts and carefully considering the reasons behind the termination of a contract. As the US continues to diverge from the EU in its sanctions strategy (such as in the case of Russia) businesses should consider reviewing their existing contracts and future proofing their contracts to cater for the changing sanctions landscape. Careful consideration should be given to contractual termination provisions to ensure they are fit for purpose and, if appropriate, cater for termination arising out of the imposition of new sanctions or US secondary sanctions risks. In a passing comment made in a UK case last year, the court did comment that a party, who validly invokes a sanctions clause in a contract to refuse performance of its obligations, would not be considered to be in breach of the EU Blocking Regulation. Reliance on a sanctions clause would simply be classed as reliance on the terms of a contract rather than classed as complying with US sanctions in breach of the EU Blocking Regulation. Whilst this comment is non-binding, it does highlight the protection that contractual sanctions clauses could offer.

When terminating contracts, businesses should act with care when documenting the reasons for that termination, ensuring decisions related to Iranian and Cuban business are taken for clear commercial reasons. The above cases show that, without more (and without a valid contractual ground for termination), a mere risk of exposure to US secondary sanctions may not provide valid grounds for terminating a contract. Of course, the option remains for companies to seek an authorisation from the EU Commission to comply with US sanctions, if non-compliance would cause serious damage to the interests of the company. This could be particularly relevant for EU companies with US parent companies or US subsidiaries.

If you have any questions or concerns about the issues highlighted above or would like to discuss any general sanctions related issue please contact us.

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