Update on Russia-Ukraine Sanctions: With Fourth Expansion of Sanctions, Compliance Safeguards Should be a Priority

On April 28, 2014, the United States and the European Union (EU) announced a fourth expansion of sanctions in response to events in southern and eastern Ukraine.  The United States extended "blocking" sanctions to an additional 7 Russian individuals and 17 Russian companies.  The United States also announced its intention to begin revoking export licenses for transfer of advanced technology items to Russia.  The EU expanded blocking sanctions to another 15 Russian and Ukrainian individuals.  Other jurisdictions such as Canada and Japan are also enlarging sanctions against Russia.

Apart from sanctions against Russian and Ukrainian individuals (66 by the United States and 45 by the EU) and against 19 companies by the United States, U.S. and EU trade and investment with Russia generally remain unrestricted.  Many have observed that the sanctions prohibit only a tiny fraction of business involving Russia.  But uncertainties about U.S. and EU authorities' application of existing sanctions and the likelihood of further expansion of sanctions present acute challenges for multinational companies, particularly given substantial legal penalties and reputational damage from sanctions violations. 

In this fluid and uncertain environment, at least three steps are advisable as multinationals make decisions about whether to maintain or extend Russian business interests.  First, companies should be as well informed as possible about facts relevant to sanctions compliance, such as ownership profiles of Russian counterparties, and about existing and anticipated sanctions prohibitions.  Second, companies should insist on far-reaching contractual and other written protections to reduce potential sanctions liability.  Finally, companies should have well developed plans to extricate themselves from Russian business arrangements as needed depending on sanctions developments.

Expanded Sanctions

U.S. Sanctions:  United States sanctions relating to Russia have taken three principal forms.  First, under executive orders promulgated in March 2014, the U.S. Treasury Department's Office of Foreign Assets Control (OFAC) has "blocked" 45 Russian and Ukrainian individuals and 19 companies, including several Russian banks and energy sector companies. Most recent designations involve politicians and businesspeople close to President Vladimir Putin, including most notably Mr. Igor Sechin, the head of Rosneft, the largest state-owned oil company, and Mr. Sergei Chemezov, CEO of the Russian state-holding company Rostec.  When OFAC designates persons as being blocked, they appear on OFAC's List of Specially Designated Nationals (SDN List).

The "blocking" measures freeze designated individuals' and entities' assets located in the United States or otherwise held by U.S. persons and generally forbid U.S. persons to engage in transactions in which these sanctioned persons/entities have a direct or indirect interest.  Apart from the designees themselves, blocking prohibitions extend to companies that are 50%-or-more owned by designated individuals and entities.

That a designated person might control a company by means other than ownership would not, in and of itself, cause the company to be treated like a blocked entity.  Thus, assets of Rosneft and Rostec are not automatically blocked even though their CEOs, Mr. Sechin and Mr. Chemezov, have become sanctioned persons.  Depending on the circumstances, however, application of blocking measures against senior managers could effectively prevent transactions with their companies since those transactions could be deemed indirect dealings with the blocked managers.

Second, the United States has intensified export controls relating to Russia.  At the outset of March 2014, U.S. export control regulators stopped processing applications for licenses to export or re-export items to Russia.  In addition, the U.S. Commerce Department, which administers controls on commercial "dual use" items, has added 13 Russian companies to its "Entity List," placing them off limits for transfers of items that are subject to the Commerce Department's export controls.  As a result, even non-U.S. persons are forbidden to transfer such items from abroad to these sanctioned companies.  Finally, the Commerce Department has announced that it plans to revoke licenses for some exports and re-exports of advanced technology equipment, software and technology to Russia.

Third, individuals who are blocked by OFAC generally are not permitted to enter the United States.

EU Sanctions:  The Council of the EU has added 15 individuals to the list of sanctioned Russian and Ukrainian persons, bringing the total count of sanctioned persons to 48.  Each member state of the EU may enact domestic measures in relation to matters such as offenses and penalties for breach. At this time, the EU's list includes only individuals, and there is some overlap with the U.S. designations. At the same time, companies owned or controlled by listed persons should already be considered frozen by the EU sanctions.

The EU sanctions block all funds and economic resources belonging to or owned, held or controlled by the listed persons and ban entry to the EU by such persons. Unlike the U.S. sanctions, the EU sanctions explicitly include control of a company by listed persons as a basis for treating that company as likewise being blocked. Each EU member state can adopt different interpretative rules regarding when a listed person controls a company (in the UK, e.g., a case-by-case approach is used).

The EU has not, as of today, announced any EU-wide restrictions on export licenses to Russia. However, since March 18, 2014, the UK has suspended licences for direct exports to Russia as well as for exports to third countries where there is a clear risk that items would be incorporated into equipment for export to Russia.

Steps to Protect Business Interests in Russia

As sanctions continue to expand, multinational companies face increasing challenges presented by sanctions' legal prohibitions and, often more importantly, uncertainties about interpretation of those prohibitions and prospects for additional sanctions.  The Obama Administration has highlighted a new executive order's authorization of sanctions not just against additional individuals and entities but also against Russian business sectors.  Depending on developments in Ukraine, broader embargo measures could emerge, which could intensify sanctions compliance challenges exponentially.

In these circumstances, it is advisable for multinationals to take the following steps:

1. Be as well informed as possible about facts relevant to sanctions compliance and establish effective compliance programs

• Understand the extent to which the multinational's operations must observe sanctions prohibitions:
  • United States sanctions relating to Russia apply to all "U.S. persons" – U.S. citizens and permanent residents, U.S. legal entities, and persons in or acting in the United States.  Non-U.S. subsidiaries of U.S. companies acting wholly outside the United States are not necessarily covered by U.S. sanctions.  As a prophylactic measure, however, it is often advisable for U.S.-based multinationals to treat their entire corporate families as being covered by U.S. sanctions prohibitions.  In any event, all companies should bear in mind that their U.S. person officers, directors and employees are covered by U.S. sanctions prohibitions.
  • United States export controls purport to apply to all persons worldwide who are dealing in items that are of U.S. origin or that are otherwise covered by the regulations.
  • The EU sanctions apply to all EU nationals, entities incorporated in the EU and to persons and other entities in respect of their business in the EU.
• Screen prospective Russian transaction participants:
  • United States persons need to ensure that they avoid transactions that involve, directly or indirectly, not only designated blocked persons (individuals and entities on the SDN List) but also entities that are 50%-or-more owned by designated persons.
  • EU persons need to ensure that they avoid transactions that involve, directly or indirectly, not only designated blocked persons but also entities that are owned or controlled by designated persons.
  • United States and EU persons should also be aware of blocked persons' more attenuated connections to prospective transactions, such as blocked persons' managerial roles in counterparties or prospective counterparties.  Depending on the circumstances, such connections may or may not impede the transactions.
• Conduct due diligence:
  • Determining whether a particular Russian entity is indirectly owned by a sanctioned person is often not straightforward.  Public registries in Russia do not contain all relevant information and holding structures often involve chains of offshore entities.
  • Useful diligence steps commonly include examination of registries and other public sources of information about ownership, management and other attributes of Russian companies.
• Establish or enhance existing internal compliance programs: Compliance programs foster compliance and enable companies to  react quickly to the changing legal environment. 

2.     Insist on far-reaching contractual and other written protections to guard against sanctions liability 

• Review existing and potential contractual and business arrangements with Russian counterparties to ensure that they provide sufficient safeguards in light of the sanctions regime, considering, among other items, the following:  
  • Termination options, events of default, force majeure, payment and dispute resolution provisions.
  • Sanction-specific representations, warranties and covenants protecting the U.S./EU entity.
  • Choice of governing law and dispute resolution forum ensuring speedy, impartial and fair consideration of claims.
  • Certain contractual issues arising in connection with treatment of investment decisions and arrangements made prior to the Crimea sovereignty controversy and the validity/enforceability of such arrangements and in connection with the new status of Crimea as part of Russia, which is not recognized by most other countries. 
• Establish other written protections:
  • Transaction records, including correspondence with prospective counterparties, regarding ownership and other matters that are relevant to sanctions compliance.
  • Comfort letters regarding matters that are relevant to sanctions compliance.

3.     Develop thorough plans to exit Russian business arrangements as needed 

• Make sure that a contract termination option is available and satisfactory to the company(see discussion above).
• Prepare for potential retaliatory sanctions by Russia:So far the Russian response to sanctions has been limited to sanctioning a number of U.S. and other officials. However, as the crisis develops and sanctions expand, other Russian retaliatory measures may emerge.  Companies with significant assets in Russia may need to consider their response to such a contingency.
• Export licenses and equipment inventory: U.S. exporters may be well advised to take inventory of their existing export licenses to Russia and assets exported thereunder to consider how the latest BIS regulatory action may affect them. Consideration should also be given to identification of key Russian employees working with or having access to exported technology and potential decisions on termination or continuation of such employment.
• Consider whether to move more fluid assets out of Russia.
• Determine if the company holds valid political risk insurance that covers expropriation.

Legislation

The U.S. Congress has enacted legislation codifying some U.S. sanctions.  And a variety of proposals are under consideration in the Congress to further reinforce and expand sanctions.