On May 24, 2011, the U.S. State Department imposed sanctions on seven companies under the Iran Sanctions Act. These sanctions represent a marked increase in the State Department's enforcement of the Act, which was expanded in 2010 to target companies in the maritime industry that provide goods or services that assist Iran in obtaining refined petroleum products. This alert summarizes the impact of these designations from both a legal and practical risk-management perspective.

Political Backdrop

Implementation of CISIDA. In July 2010, Congress passed the Comprehensive Iran Sanctions, Accountability, and Divestment Act of 2010 (CISADA). One of the major effects of CISADA was an expansion of the Iran Sanctions Act to require the State Department to investigate non-U.S. entities that engaged in activity that supported Iran's ability to refine or import refined petroleum products. If the State Department finds the non-U.S. entity engaged in sanctionable activity, the State Department is required to impose at least three of nine sanctions, which range in severity, from a statutory list.

The Obama Administration was unenthusiastic at best regarding CISADA, as CISADA's unilateral, extraterritorial sanctions run counter to the Obama Administration's goals of seeking multilateral sanctions. Furthermore, congressionally-mandated investigations and sanctions impinge on executive discretion. Hence, notwithstanding the strong statutory language, there was a real question as to how vigorously these extraterritorial provisions would be enforced. However, in recent months, the Administration has come under increasing pressure from certain members of Congress to enforce CISADA, with a number of sanctions bills proposed, including the Iran Threat Reduction Act of 2011, introduced in the House of Representatives in mid-May 2011, with 74 co-sponsors. Therefore, congressional pressure may have played some role in the timing of this State Department action.

State Department Enforcement. Unlike most sanctions programs which are regulated and enforced by the U.S. Department of Treasury Office of Foreign Assets Controls (OFAC), the particular sanctions relating to Iran's refined petroleum industry fall primarily under the State Department's jurisdiction. Prior to the May 24, 2011 action, the State Department had only designated two entities under CISADA: Bearusneft, a state-owned Belarusian energy company, and NaftIran Intertrade Company. And unlike OFAC, the State Department was publically fairly close-lipped about how it was interpreting CISADA and what investigations might be underway. However, the State Department had periodically announced companies that were voluntarily ceasing or winding down activity in Iran relating to the energy sector, and apparently did engage in private dialogue with certain companies.

Specific Sanctions Imposed on Designated Entities

Because the State Department was required to choose at least three sanctions from a statutory list, the legal effect of the sanctions on each of the entities is quite different. While the State Department has not provided the actual orders, based on its press releases, the sanctions appear to be as follows:

Petrochemical Commercial Company aka PCCI (Jersey); Royal Oyster Group (UAE); and Speedy Ship aka Sepahan Oil Company or SPD (UAE/Iran); and Associated Shipbrokering (Monaco)

The sanctions imposed on these entities are substantial, and the entities have been designated on the OFAC Specially Designated Nationals (SDN) list. The specific sanctions:

  • Bar these entities from conducting foreign currency exchanges through the U.S. financial system.
  • Prohibit U.S. financial institutions from engaging in transactions with these entities.
  • Require U.S. persons to block assets of these entities in the United States.

Tanker Pacific (Singapore) and Ofer Brothers Group (Israel)

These entities have not been designated as SDNs and OFAC issued specific guidance to that effect. Further, the sanctions, as a legal matter, are quite limited in scope, barring these entities from:

  • Obtaining loans or credits over $10 million from U.S. financial institutions in any 12-month period.
  • Being the beneficiary of any financing or loan guarantee financing from the Export-Import Bank of the United States.
  • Obtaining any controlled U.S.-origin goods that would require an export license.

Petroleos de Venezuela (PDVSA)

This entity has not been designated as an SDN; the State Department press release indicates that the sanctions do not prohibit the export of crude oil to the U.S. and do not apply to PDVSA subsidiaries. The latter point was critical as CITCO is a PDVSA subsidiary. The sanctions do prohibit PDVSA from:

  • Competing for U.S. government procurement contracts.
  • Being the beneficiary of any financing or loan guarantee financing from the Export-Import Bank of the United States.
  • Obtaining any controlled U.S.-origin goods that would require an export license.

Practical Implications of Designations

The imposition of any sanctions on an entity by the U.S. government can, in addition to legal exposure, have practical implications for both U.S. and non-U.S. companies.

The entities designated as SDNs (i.e., PCCI, Royal Oyster Group, Speedy Ship, and Associated Shipbrokers) are essentially frozen out of the U.S. financial system. Once an entity is designated as an SDN or otherwise blacklisted by the United States, there is a cascade of negative effects:

  • Insurers may terminate or deny coverages relating to these entities.
  • Electronic payments to or from these entities in U.S. dollars are blocked, and given the wide use of the dollar in shipping, this can significantly effect the ability of the designated entity to carry on business.
  • Business partners, because they are required by law or simply as a matter of risk management, may cease or curtail business with these entities, putting financial stress on them.

The sanctions imposed on Pacific Tanker, the Ofer Brothers Group and PDVSA are fairly narrow in scope, and do not bar most types of transactions with these entities. Nevertheless, many companies, either for lack of sophisticated guidance or as a matter of risk management, treat all sanctioned entities similarly. Hence, there are certain risks in doing business with these entities. In particular:

  • Following passage of CISADA and EU sanctions against certain Iranian entities, many P&I clubs and other insurance providers in the marine industry substantially broadened their "sanctions" clauses. Therefore, depending on how these clauses are written and interpreted, there is a risk regarding coverages.
  • It should not be assumed that U.S. agencies work in concert, and there is always the possibility that these designations could cause delays by local port officials when entering U.S. ports.
  • Routine transactions may be delayed or impaired as third parties seek legal advice on these issues.

Other Actions Regarding CISADA

Almost certainly in coordination with the imposition of sanctions on these seven entities, the U.S. government issued other information and directives:

  • On May 23, 2011, the President issued Executive Order 13574 providing some clarification on the scope of some of these sanctions and delegating certain authority to the Secretary of the Treasury. This was likely necessary in order to coordinate blocking of assets of the designated entities.
  • The State Department published several guidance documents on May 23, 2011, including a "Guidelines About the Provision of Goods and Services, Including Insurance, to Entities That Ship Refined Petroleum to Iran." These guidelines, which had been circulated informally months before but never publically posted, provide examples of activities that could be sanctionable under CISADA, including:
    • Chartering of a ship to another company that uses the ship to supply petroleum resources to Iran.
    • Brokering the sale of refined petroleum products to Iran.
  • The State Department on May 24, 2011 issued a fact sheet outlining its success in persuading certain non-U.S. companies from activities in the Iran energy sector and other "voluntary" action by non-U.S. entities, for example:
    • Lloyds of London no longer offers insurance or reinsurance of petroleum shipments to Iran.
    • NYK Line Ltd. decided to withdraw from trade with Iran.
  • OFAC in connection with the designations of these entities added certain entities to their SDN list and posted guidance as to other entities.

Recommended Action

Companies in the maritime industry need to quickly evaluate their business relationships with the recently-named entities, both for legal obligations and as a matter of risk management. This requires careful legal review, as breaking contractual arrangements in the absence of a clear breach could have significant financial consequences. On the other hand, there are ways that a company can protect itself against some business risks in continued dealings with these entities, such as additional assurances, confirmation of coverages, or protective measures to shift liability for cost delays caused by the imposition of sanctions onto the sanctioned entity.

When CISADA was passed last year, a common question was whether and how vigorously the State Department would actually enforce the extraterritorial provisions of the law, given the lack of enforcement under the Iran Sanctions Act over the years. Based on their analysis of this question, non-U.S. companies in the maritime industry took varying approaches with respect to the refined petroleum trade with Iran. These recent designations change this analysis considerably. And while the sanctions imposed on certain entities may appear relatively minor as a legal matter, the cost to these companies in terms of negative publicity and loss of business should not be underestimated. Hence, non-U.S. maritime companies should reevaluate their policies and business relationships in the Iran-related petroleum trade.