Yesterday, August 2, 2017, President Trump signed into law H.R. 3364, the “Countering America’s Adversaries Through Sanctions Act”. The general press is covering this story by writing about Russia’s initial retaliation taking the form of cutting the staff authorized at the U.S. embassy in Moscow and the seizure of certain U.S. diplomatic property within Russia. When it comes to international traders, the impact on dealing with Russia, but also Iran and North Korea, takes the form of enhanced compliance efforts.
The new law will provide more in the way of direct and indirect sanctions. A direct sanction arises because the person (or company/entity) is listed by one of the relevant U.S. agencies on the appropriate blocked persons list. A secondary sanction arises because a blocked person (individual or entity) owns or has a controlling ownership in a company not otherwise listed as blocked. Of course, additional headaches exist when there is U.S. content in the good being sold, so the impact is on both exports and imports.
Those already seeking to do business with Russia or Iran will not find anything unusual in these new sanctions. The existing sanctions regimes regarding those two countries change only to the extent of those on whom the sanctions may be imposed. The potentially big change comes with regard to North Korea. It is commonly understood that much of the economic support which North Korea receives internationally comes from relationships fostered with the government of China, driven, in large measure, by their common border. Bearing in mind the extensive amount of trade going on between U.S. and Chinese companies, in the face of this new law, American companies would be wise to undertake much more due diligence in their dealings with their Chinese buyers and sellers than has been the case in the past.
The enforcement agency for U.S. economic sanctions is the Office of Foreign Assets Control or OFAC. In August 2014, OFAC issued “Revised Guidance on Entities Owned by Persons Whose Property and Interests in Property are Blocked”. See https://www.treasury.gov/resourcecenter/sanctions/Documents/licensing_guidance.pdf. The document is one page in length, but when read in conjunction with OFAC’s Frequently Asked Questions, the information helps clarify the degree of complexity which can arise. See https://www.treasury.gov/resourcecenter/faqs/Sanctions/Pages/faq_general.aspx#basic.
Most of the pages in the new law detail limitations put on the President by Congress to minimize the likelihood that sanctions on Russia, in particular, will be eased unilaterally by Presidential action. However, what this new law means for international traders is that, in a relatively short period of time, new lists of blocked parties may be issued, and, of course, those lists are already frequently updated. Some of the reports in the new law are demanded within 90 days of enactment and others at 180 days and others even later. Beside listing persons (individuals and companies ) as blocked, denial of visas, penalties and seizure of assets is authorized. When it comes to North Korea, the use of forced labor to make goods is specifically called out. Of course, those familiar with the Trade Facilitation and Trade Enforcement Act of 2016 recall its enhanced measures for dealing with assertions of goods made by forced labor. Nevertheless, the prohibition on importation of goods made by forced labor has been on the books since 1930!
The latest round of sanctions now demands that American companies seek many more details from their Chinese buyers and sellers. The key is clearly understanding both who owns the party with whom you are dealing, but also who are that party’s customers/suppliers and whether any of those persons are blocked or any blocked person holds an ownership interest in the vendor (direct or indirect) with whom you are dealing. To make the needed determination, OFAC draws a distinction between entities which are “owned” by a blocked party, and those which are only “controlled” by a blocked party. Either way, OFAC’s guidance makes clear that if you are dealing, even remotely, with blocked parties, appropriate due diligence is mandated.
The basic position of OFAC is if a blocked person does not own 50% of more of the entity, that entity is not considered blocked. However, American traders should be careful they are not dealing with a blocked person representing a non-blocked person. One cannot deal with a blocked person, until authorized to do so by OFAC by way of a license being granted.
OFAC also aggregates ownership stakes, meaning if you have two blocked persons whose combined ownership interest is 50% of more, the entity which they own is also considered blocked. If the blocked person has an ownership interest in an entity through another entity or entities, then you again get into indirect ownership considerations, and also illustrates the impact of secondary sanctions.
To make its point, OFAC includes some examples in its FAQs:
Example 1: Blocked Person X owns 50 percent of Entity A, and Entity A owns 50 percent of Entity B. Entity B is considered to be blocked. This is so because Blocked Person X owns, indirectly, 50% of Entity B. In addition, Blocked Person X’s 50 percent ownership of Entity A makes Entity A a blocked person. Entity A’s 50 percent ownership of Entity B in turn makes Entity B a blocked person.
Example 2: Blocked Person X owns 50 percent of Entity A and 50 percent of Entity B. Entities A and B each own 25 percent of Entity C. Entity C is considered to be blocked. This is so because, through its 50 percent ownership of Entity A, Blocked Person X is considered to indirectly own 25 percent of Entity C; and through its 50 percent ownership of Entity B, Blocked Person X is considered to indirectly own another 25 percent of Entity C. When Blocked Person X’s indirect ownership of Entity C through Entity A and Entity B is totaled, it equals 50 percent. Entity C is also considered to be blocked due to the 50 percent aggregate ownership by Entities A and B, which are themselves blocked entities due to Blocked Person X’s 50 percent ownership of each.
Example 3: Blocked Person X owns 50 percent of Entity A and 10 percent of Entity B. Entity A also owns 40 percent of Entity B. Entity B is considered to be blocked. This is so because, through its 50 percent ownership of Entity A, Blocked Person X is considered to indirectly own 40 percent of Entity B. When added to Blocked Person X’s direct 10 percent ownership of Entity B, Blocked Person X’s total ownership (direct and indirect) of Entity B is 50 percent. Entity B is also blocked due to the 50 percent aggregate ownership by Blocked Person X and Entity A, which are themselves both blocked persons.
Example 4: Blocked Person X owns 50 percent of Entity A and 25 percent of Entity B. Entities A and B each own 25 percent of Entity C. Entity C is not considered to be blocked. This is so because, even though Blocked Person X is considered to indirectly own 25 percent of Entity C through its 50 percent ownership of Entity A, Entity B is not 50 percent or more owned by Blocked Person X, and therefore Blocked Person X is not considered to indirectly own any of Entity C through its part ownership of Entity B. Blocked Person X’s total ownership (direct and indirect) of Entity C therefore does not equal or exceed 50 percent. Entity A is itself a blocked person, but its ownership of Entity C also does not equal or exceed 50 percent.
Example 5: Blocked Person X owns 25 percent of Entity A and 25 percent of Entity B. Entities A and B each own 50 percent of Entity C. Entity C is not considered to be blocked. This is so because Blocked Person X’s 25 percent ownership of each of Entity A and Entity B falls short of 50 percent. Accordingly, neither Entity A nor Entity B is blocked and Blocked Person X is not considered to indirectly own any of Entity C through its part ownership of Entities A or B.
The outcome, of course, could change if one learns the blocked person (or a downstream entity) has previously sold its interest in the person with whom you are conducting business and the remaining ownership interest is less than 50%. However, that divestiture must take place entirely outside of U.S. jurisdiction and not involve any U.S. person. Nonetheless, one would be wise to question any remaining ownership interest to make sure the information being provided is accurate and complete, and the change in ownership is neither a sham transaction nor presented so as to evade the U.S. sanctions.
To summarize, there are direct sanctions which arise when the person (individual or company) with whom you are intending to do business is listed by the U.S. government as a blocked person. That determination can be made by appropriate screening and applies whether one is buying or selling goods or services. Sticking to the China supplier example, the more difficult challenge is the secondary sanctions context, i.e., to identify whether your intended Chinese supplier is sourcing any product (parts or finished goods) from or any product is sold to North Korea and figuring that out requires many more questions to be asked and the responses to be properly evaluated before a final decision is made whether the transaction can go forward and be compliant!
The bottom line is if you are dealing with a buyer or seller that has any blocked person involved in any way, it is critical to carefully and fully vet the transaction, before determining the deal can be concluded. Of course, retaining the documentation which establishes the manner in which due diligence was conducted is also critical.