This article by counsel Brendan Hanifin and associate Emerson Siegle was published by Law360 on September 22, 2017.

On Sept. 21, 2017, President Donald Trump issued an executive order, "Imposing Additional Sanctions with Respect to North Korea." The executive order, which accords the U.S. Treasury Department’s Office of Foreign Assets Control broad authority to impose sanctions against individuals and entities that conduct or facilitate business with North Korea, represents a significant escalation of U.S. sanctions targeting North Korea.1 In addition, the executive order presents new compliance considerations for companies that conduct business with North Korean trading partners, including China, India and Russia.

Overview of Recent Developments

Since President Trump’s inauguration, North Korea and the international community have been engaged in a series of provocations and retaliatory actions. Beginning in February and continuing through mid-2017, North Korea test-fired several ballistic missiles, including missiles fired over the Sea of Japan. On June 19, University of Virginia student Otto Warmbier died shortly after his release from an 18-month term of imprisonment in North Korea, apparently due to severe brain damage suffered during his incarceration.

On Aug. 2, President Trump signed the Countering America’s Adversaries Through Sanctions Act, which provided for new sanctions targeting North Korea, Iran, and Russia. Among other steps, the act (1) prohibits the exportation of precious metals, aviation fuel, and other goods to North Korea; (2) imposes sanctions targeting the North Korean shipping industry; and (3) authorizes sanctions against persons who employ certain North Korean laborers. Three days later, the United Nations Security Council (“UNSC”) voted unanimously to impose new sanctions on North Korea, banning key North Korean exports such as coal, iron, lead and seafood.

On Aug. 29, North Korea launched an intercontinental ballistic missile over the Japanese island of Hokkaido. Less than one week later, North Korea claimed that it had successfully tested a hydrogen bomb. The UNSC responded to these acts of aggression on Sept. 11 by imposing additional sanctions that, among other things, banned exports of North Korean textiles and placed a cap on oil importation. More stringent measures — including an oil embargo — reportedly were eliminated from a draft of the resolution to secure support from China and Russia for the U.S.-led resolution.2 On Sept. 15, North Korea launched a second ballistic missile over Japan.

The Executive Order

The executive order imposes or authorizes four categories of sanctions.

First, the executive order authorizes OFAC to impose sanctions against any person (i.e., individual or entity) who (1) operates in specified North Korean industries; (2) owns, controls or operates any North Korean port; (3) has engaged in at least one significant import from, or export to, North Korea; (4) is a citizen of, or organized under the laws of, North Korea; (5) has materially assisted, sponsored, or supported any person blocked pursuant to the executive order; or (6) is owned or controlled by, or has acted on behalf of, any other person blocked pursuant to the executive order. Persons designated under the executive order will be added to OFAC’s Specially Designated Nationals And Blocked Persons (“SDN”) List. U.S. Persons are prohibited from engaging in virtually all transactions with individuals or entities on the SDN List, as well as entities majority-owned by blocked persons.3

Second, the executive order prohibits any aircraft that has landed in North Korea, or vessel that has called on a port in North Korea, within the past 180 days — or that has engaged in a ship-to-ship transfer with such a vessel — from entering the United States. General License 10, published simultaneously with the executive order, provides an exception for emergency landings and vessels in distress.

Third, the executive order blocks all funds that originate from, are destined for, or pass through a foreign bank account that OFAC determines to be owned or controlled by a North Korean person (or to have been used to transfer funds in which any North Korean person has an interest).

Fourth, the executive order authorizes OFAC to impose sanctions on any foreign financial institution that either knowingly conducts or facilitates (1) any significant transaction with certain North Korea-related blocked persons; or (2) any significant transaction in connection with trade with North Korea. Such sanctions may be as limited as restrictions on correspondent or payable-through accounts, or as robust as full blocking sanctions. While the executive order does not define the term “significant transaction,” the Iranian Transactions and Sanctions Regulations provide that OFAC shall determine whether a transaction is significant based on the “totality of the facts and circumstances,” including the size, nature, and impact of the transaction, as well as the culpability of the entity involved. 31 C.F.R. § 561.404.

Compliance Considerations

Although intended to increase pressure on the North Korean regime, the primary targets of the executive order are non-North Korean individuals and entities that conduct business with the reclusive country. As described by President Trump, the executive order aims to “cut off sources of revenue that fund North Korea’s efforts to develop the deadliest weapons known to humankind” and to pressure non-U.S. persons to make “a clear choice: do business with the United States or facilitate trade with the lawless regime in North Korea.”4

While most U.S. companies (and companies with U.S. operations) have no interest in conducting business with North Korea, many U.S. companies have relationships with counterparties in China, India, and Russia, all of which are among North Korea’s largest trading partners. In light of the executive order, such companies may wish to reconsider how they assess sanctions risk when contracting with counterparties that conduct — or may conduct — business with North Korea.

Existing Business and Relationships

Unlike certain previous announcements of new or expanded sanctions, the executive order did not append an initial list of designated individuals or entities. However, for companies that conduct business with known North Korean trading partners, there is an immediate risk that existing counterparties may soon be designated (i.e., sanctioned) by OFAC. As a general matter, SDN designations take effect within 24 hours. As neither the executive order nor the accompanying general license or FAQs provide for a wind-down period with respect to existing contracts and business arrangements, if a counterparty should be designated as a blocked person, a U.S. company would need to either (1) withdraw from the relationship immediately; or (2) request a license from OFAC to wind down the relationship.

In many — if not most — cases, companies concerned about compliance with U.S. sanctions will not know whether their counterparties or banking partners in China, India, Russia or other countries conduct business with North Korea. Many investors conduct robust sanctions-focused due diligence of prospective investment targets; however, the same level of diligence frequently is not conducted with regard to contractual or banking partners. While the overall likelihood of a counterparty or banking partner conducting or facilitating business with North Korea is relatively remote (given the size of North Korea’s economy), certain regions (e.g., northeast China) and industries (e.g., mining, textiles) may present a higher risk.

Various news outlets reported on Sept. 21 that the People’s Bank of China, China’s national bank, has instructed Chinese financial institutions “to stop providing financial services to new North Korean customers and to wind down loans with existing customers.”5 If effectively implemented, this directive could substantially mitigate the going-forward risk presented by relationships with Chinese financial institutions. In the past, however, China has not demonstrated a willingness to implement sanctions targeting North Korea. As the executive order authorizes OFAC to sanction foreign financial institutions that conduct or facilitate business with North Korean clients, companies should proceed with caution when dealing with Chinese financial institutions (at least until China demonstrates a commitment to enforce the directive).

Future Business and Relationships

Looking forward, companies that conduct business in countries or industries that present a relatively higher risk of intersection with the executive order may consider taking proactive steps to mitigate sanctions — as well as commercial and reputational — risk.

  • Due Diligence: The best and most effective way to avoid conducting business with an individual or entity who trades with North Korea — and therefore mitigate the risk of conducting business with a potential, future sanctions target — is to conduct pre-engagement due diligence. As in the anti-corruption context, effective due diligence should be risk-based (but, at minimum, should include restricted party screening). The appropriate scope of due diligence is necessarily transaction-specific, with relevant factors including, among others, the location, industry, and reputation of the prospective counterparty. Because information regarding North Korean business ties may not be readily available in English-language media, companies may consider conducting local-language media searches and/or engaging in-country reputational vendors, depending upon the level of risk presented by the prospective engagement.
  • Contractual Protections: In addition to pre-engagement due diligence, companies concerned about their prospective counterparties’ historical or future dealings with North Korea may seek contractual protections. Appropriate contractual protections may include (1) representations that the counterparty has not — and will not — conduct any business with or in North Korea (or other countries or territories subject to comprehensive U.S. sanctions);6 and (2) exit rights in the event that the relationship becomes contrary to applicable sanctions.

The Future of Extraterritorial Enforcement

The executive order is the latest in a series of actions demonstrating that current OFAC leadership embraces an expansive view of the agency’s extraterritorial reach. As a general matter, entities organized outside of the United States that are neither owned nor controlled by U.S. persons are not required to comply with U.S. economic sanctions (subject to limited exceptions). However, in recent enforcement actions, OFAC has adopted aggressive positions regarding jurisdiction and extraterritoriality.

The executive order authorizes OFAC to impose sanctions against non-U.S. entities for conduct that is wholly unrelated to the United States. While OFAC regularly designates non-U.S. individuals and entities for conduct considered adverse to U.S. national security interests (e.g., terrorism, narcotics trafficking), it is unusual for OFAC to target non-U.S. individuals or entities based on otherwise lawful dealings with a specific country, absent an ownership or control nexus to the United States.7 As such, the executive order may be viewed as a test of the practical limitations of OFAC’s extraterritorial jurisdiction and may signal additional expansive (and novel) assertions of extraterritorial jurisdiction by OFAC in the future.

Conclusion

The executive order represents a significant expansion of U.S. sanctions targeting North Korea, in that the order grants OFAC increased authority to sanction individuals and entities — including those in major international markets such as China, India and Russia — that do business with North Korea. While it is unclear how aggressively OFAC will exercise this new authority, U.S. companies (and companies with U.S. operations) would be well-served to account for potential new sanctions designations when assessing current and future business relationships in higher-risk countries.