On October 9, 2012, President Obama signed Executive Order 13628 “Authorizing the Implementation of Certain Sanctions Set Forth in the Iran Threat Reduction and Syria Human Rights Act of 2012 and Additional Sanctions with Respect to Iran” (the Order). This is the first in a series of steps required to implement the Iran Threat Reduction and Syria Human Rights Act (the “ITRA,” “ITRSHRA,” or “ITRASHRA” ranging from political correctness to accuracy), which was enacted on August 10, 2012.

The Order largely repeats relevant portions of the ITRA and directs numerous agencies (primarily State and Treasury) to implement various provisions of the statute. In so doing, it perpetuates much of the uncertainty in the ITRA and raises more questions than it answers. That being said, the Administration is beginning to clarify certain critical aspects of the law, particularly those regarding section 218 of the act albeit in a manner that offers cold comfort in most cases. From the perspective of US and foreign industry working to comply with, and counsel trying to make sense of, the latest wave of sanctions against Iran, there’s a little bit of good, a hefty dose of bad, and a whole lot of ugly.

Below we highlight several of the key aspects of the Order (as elaborated upon in guidance from the US Treasury Department Office of Foreign Assets Control).

  • Owned or Controlled Foreign Affiliates of US Companies Prohibited from Transactions Involving Iran. Most significant to US-based multinational corporations, section 4 of the Order implements section 218 of the ITRA to prohibit owned or controlled foreign affiliates of US persons from engaging in knowing violations of the Iranian Transactions Regulations (31 CFR Part 560), Executive Order 13599, section 5 of Executive Order 13622, or section 12 of the Order. According to the OFAC guidance on this prohibition, “Section 4 of the Order prohibits an entity owned or controlled by a US person and established or maintained outside the United States (a “foreign subsidiary”) from knowingly engaging in any transaction, directly or indirectly, with the Government of Iran or any person subject to the jurisdiction of the Government of Iran, if that transaction would be prohibited by certain Executive Orders prohibiting trade and other dealings with, and investment in, Iran and blocking the Government of Iran and Iranian financial institutions, or any regulation issued pursuant to the foregoing, if the transaction were engaged in by a United States person or in the United States.” (Emphasis added.)

In analyzing whether a foreign affiliate’s conduct is now prohibited, one should ask:  “Could a US person engage in this transaction without violating one or more of the sanctions against Iran?” If no, then the foreign subsidiary may not do it either.

Well, how do you tell whether a foreign affiliate is owned or controlled by a US person? That’s a harder question to answer. ITRA section 218(a)(2) itself defines the term ‘‘own or control’’ with respect to an entity, as:

  1. hold[ing] more than 50 percent of the equity interest by vote or value in the entity;
  2. hold[ing] a majority of seats on the board of directors of the entity; or
  3. otherwise control[ling] the actions, policies, or personnel decisions of the entity.

Neither the ITRA nor the Order defines what is meant by “otherwise controlling the actions, policies or personnel decisions of the entity.” Decades of dealing with this concept under the Cuban Assets Control Regulations does offer insight into how OFAC treats the concept of control.

Though control must be analyzed on a fact-specific basis and other significant indicia of control should be considered (e.g., veto rights), we believe the multi-factor test in section 760.1(c) of the US Export Administration Regulations for determining when a foreign subsidiary or affiliate of a US domestic concern is deemed to be owned or controlled-in-fact by the US domestic concern for purposes of the Commerce Department’s antiboycott laws provides a useful framework, at least with respect to those elements of ownership or control not specifically addressed by ITRA section 218(a)(2). Subject to rebuttal by competent evidence, section 760.1(c) of the EAR provides that a foreign affiliate is presumed to be controlled in fact when:

  1. The domestic concern beneficially owns or controls (whether directly or indirectly) more than 50 percent of the outstanding voting securities of the foreign subsidiary or affiliate;
  2. The domestic concern beneficially owns or controls (whether directly or indirectly) 25 percent or more of the voting securities of the foreign subsidiary or   affiliate, if no other person owns or controls (whether directly or indirectly) an equal or larger percentage;
  3. The foreign subsidiary or affiliate is operated by the domestic concern pursuant to the provisions of an exclusive management contract;
  4. A majority of the members of the board of directors of the foreign subsidiary or affiliate are also members of the comparable governing body of the domestic concern;
  5. The domestic concern has authority to appoint the majority of the members of the board of directors of the foreign subsidiary or affiliate; or
  6. The domestic concern has authority to appoint the chief operating officer of the foreign subsidiary or affiliate.
  • Broad Definition of Persons Subject to Jurisdiction of Iran. Section 13(g) of the order defines “subject to the jurisdiction of the Government of Iran” as “a person organized under the laws of Iran or any jurisdiction within Iran, ordinarily resident in Iran, or in Iran, or owned or controlled by any of the foregoing.” This means, among other things, that owned or controlled foreign affiliates of US companies are prohibited from engaging in any unauthorized transactions involving Iranian companies and their owned or controlled foreign affiliates regardless of where they are operating. Further, individuals ordinarily resident in Iran are targeted as are any entities they own or control, even outside of Iran.

Note that these prohibitions apply regardless of whether the entities in question are designated on OFAC’s List of Specially Designated Nationals & Blocked Persons. Another way to look at this is that all Iranian entities and their controlled affiliates incorporated outside Iran, as well as those individuals “ordinarily resident” in Iran (which is not defined) and the entities they own or control, are effectively treated as something approaching (but not quite reaching) SDN status.

While this definition appears even more like the Cuba sanctions, the actions are prohibited only to the extent they would be prohibited as to a US person. US persons generally are not prohibited from doing business with third-country companies even when those companies are owned or controlled by Iranian companies. Some additional nexus to Iran or the Government of Iran must exist, such as SDN involvement or a reason to believe the transaction furthers the export, reexport or transfer of goods, technology or services to Iran. As a technical legal matter, therefore, this new definition of “subject to the jurisdiction of the Government of Iran” might not be as broad as it first appears. As a practical matter, however, it will likely have a chilling effect well outside Iranian borders, particularly with financial institutions fearful of becoming the next headline in a $100 million-plus enforcement action.

  • Parent Penalized for the Acts of its Foreign Subsidiaries. Section 4(b) of the Order provides that civil penalties “may be assessed against the United States person that owns or controls the entity that engaged in the prohibited transaction.” OFAC elaborates that such penalties “shall be applied to the US parent company to the same extent that they would apply to a US person for the same conduct.” This means that each violation of the Iran sanctions a foreign subsidiary commits may subject its parent to a civil penalty of up to $250,000 or twice the value of the transaction per violation.

Presumably in an attempt to make the ITRA less vulnerable to challenge as being impermissibly extraterritorial, Congress stopped short of deeming owned or controlled foreign affiliates of US companies to be US persons (unlike the Trading with the Enemy Act). Rather, the ITRA may be read to split prescriptive jurisdiction and enforcement jurisdiction: it prohibits wholly foreign conduct but only expressly penalizes the US parent. In so doing, did Congress unwittingly complicate controlled foreign affiliates’ ability to assert a force majeure defense to a breach of contract claim? We think not because the subsidiary is directly prohibited from performing even if only indirectly penalized, but a foreign tribunal or arbitral panel might disagree.

  • Exemptions, General Licenses, and Favorable Licensing Policies Apply to Foreign Subsidiaries. According to the OFAC guidance on section 4 of the Order, “To the extent a transaction is exempt from the prohibitions of the Iranian Transactions Regulations, EO 13599, section 5 of EO 13622, or Section 12 of the Order, or is authorized by a general license issued pursuant to these authorities if engaged in by a US person, it would not be prohibited for a foreign subsidiary (as defined above) to engage in the transaction, provided that it satisfies all the conditions and requirements of the exemption or general license. Similarly, if the transaction is one for which a US person might apply for a specific license — for example, the exportation of medical devices to Iran — a foreign subsidiary or its US parent may apply for a specific license for the foreign subsidiary to engage in the transaction.”

As before, in analyzing whether a foreign affiliate’s conduct is exempt, ask: “Would the exemption or authorization allow a US person to engage in this transaction?” If yes, then the foreign subsidiary would not be prohibited or could apply for a license. OFAC’s interpretation should be particularly helpful in the context of informational materials, intellectual property protection transactions, travel-related transactions, and sales of food, medicine, agricultural commodities, and medical devices.

In addition, it appears that foreign subsidiaries would not be prohibited from relying upon the so-called “general inventory exception,” which is the inverse of the prohibition of section 560.204 of the Iranian Transactions Regulations. We caution, however, that the US Government has of late construed this quite narrowly in the context of related-party transactions, in part due to the presumption of collective knowledge across affiliates and the nature of just-in-time sourcing as well as the (over)broad application of the facilitation prohibition. Moreover, because the foreign subsidiary is effectively treated as stepping into the shoes of its US parent for purposes of the sanctions, it is clear that the “general inventory” exception would not apply when we are talking about the foreign subsidiary’s unaffiliated general inventory as opposed to the inventory of its customer.

Nonetheless, in cases where a foreign subsidiary undertakes reasonable, good faith due diligence supported with appropriate contractual representations and warranties, a foreign subsidiary’s continued supply to unaffiliated third-country companies that engage in non-predominant sales to Iran still would not be prohibited unless:

a) Such goods, technology, or services are intended specifically for supply, transshipment, or reexportation, directly or indirectly, to Iran or the Government of Iran; or

(b) Such goods, technology, or services are intended specifically for use in the production of, for commingling with, or for incorporation into goods, technology, or services to be directly or indirectly supplied, transshipped, or reexported exclusively or predominantly to Iran or the Government of Iran [and now any person subject to the jurisdiction of the Government of Iran]. See 31 CFR   560.204 (emphasis added).

Ultimately reliance on this doctrine turns on the foreign subsidiary’s “knowledge,” which section 13(d) or the Order defines “with respect to conduct, a circumstance, or a result [to] mean that a person has actual knowledge, or should have known, of the conduct, the circumstance, or the result.” (In case you were wondering, this is the “good.”)

  • Specific Licenses’ Coverage of Subsidiary Depends on the Terms. OFAC explains, “Whether a US parent company’s specific license covers transactions by its foreign subsidiary that are otherwise prohibited by section 4 of the Order will depend on the terms of that license and the scope of the authorized activities.” TSRA AGMED licenses frequently did cover the actions of foreign subsidiaries in addition to the US parent company. Foreign subsidiaries may now apply for licenses in their own right, although such license applications should still include their US parent company to ensure that any facilitation of the licensed transactions by the US parent would also be covered. One can only hope that OFAC will be able to cope with the flood of license applications that might be headed its way.
  • No Contract Sanctity or Wind-Down Period for Transactions Involving Iran. Though perhaps not surprising given the text of the ITRA, section 4(d) of the Order provides that the prohibitions on foreign subsidiaries apply without regard to any prior contractual commitments. Further, the Order and OFAC’s guidance avoid creating any express wind-down period for foreign subsidiaries of US companies to terminate their operations involving Iran. To avoid the possibility of civil penalties being imposed on the US parent for subsidiaries’ activities that continue after October 9, 2012, the only safe harbor the Order recognizes is for the US parent to cease doing business with or divesting its interest in its foreign affiliate no later than February 6, 2013.

The request from industry to clarify that a foreign subsidiary’s termination of its business involving Iran should be sufficient to avoid parent company liability apparently did not make its way into the text of the Order. We would like to think that, in exercising its enforcement discretion, OFAC would be unlikely to penalize parent companies whose subsidiaries made good faith efforts to terminate all prohibited transactions as soon as possible after October 9, 2012, but no later than February 6, 2012. Strictly speaking, however, potential civil liability existed from the issuance of the Order on October 9, 2012. The longer the delay, the higher the risks – unless the parent company avails itself of the divestment provision. Companies unable to terminate their business with Iran in short order may wish to consider applying for an advisory opinion that they are allowed to wind down during this period or, in the alternative, a specific license from OFAC authorizing the wind-down.

Now that we’ve given you a taste of the good and the bad, we are in the final stages of preparing a rather lengthy chart that attempts to deconstruct the extensive set of US sanctions against Iran. In so doing, it struck us just how ugly these sanctions measures are. What makes this sanctions program fall into the “ugly” category is not the severe penalties, the extraterritorial effect, and vicarious liability (that’s the “bad”). Rather, it’s the sheer number, complexity, and interrelationship of these measures. While we hope the chart will be a useful tool in highlighting the key Iran sanctions measures, we do not intend it to be comprehensive. It nonetheless illustrates just how byzantine these laws have become, requiring careful legal analysis to ensure compliance in the face of significant regulatory uncertainty.