The following article is from China Business Law Journal May 2023 issue.
In an increasingly complex global market where sanctions are becoming more norm than exception, Chinese companies should take note of all available options to fight back. Judith Xu, chief compliance officer and legal director at Junzheng Logistics, and Vicky Wang, a Shanghai-based partner at Wintell & Co, plot the battle lines
ECONOMIC SANCTIONS have become a common tool used by countries to pursue their foreign policies and national security goals. The Russia-Ukraine conflict is a prime example of this trend, as major Western powers including the EU, US and UK have imposed a broad scope of sanction measures against Russia.
These sanctions primarily apply to their own entities, companies, nationals, ships and aircraft, as well as commercial activities conducted within the nexus involving the above. The specific measures of sanctions differ between countries and regions, but can be generally categorised as follows:
- Listing specific individuals, entities, vessels and aircraft in the sanction list. For example, Vladimir Putin, Russian oligarchs and Russian banks have been included into the US specially designated nationals and blocked persons list (SDN List);
- Prohibiting or restricting the import and export of goods in key sectors and industries, such as energy and/or military-related industries, as well as for products from the contested LNR region;
- Restrictions on financing and access of capital market, such as the SWIFT ban, and the prohibition of investments, close correspondents or payable-through accounts (PTAs); and
- Other restrictions such as border control, and ban on provision of accounting and consulting services.
According to Castellum.ai, a database tracking global sanctions, Russia became the most sanctioned country in the world in March 2022, surpassing Iran and North Korea. Not only have the sanctions had a significant impact on Russia’s economy, particularly in the oil and gas sector, they have also caused widespread tensions in the global market.
As it happens, Chinese companies often have strong economic and trade ties with the primary targets of US sanctions, such as Russia and Iran.
According to the latest data released by the General Administration of Customs of China on 13 January 2023, the trade volume between China and Russia in 2022 increased by 34.3% to a record high of RMB1.28 trillion (USD190.3 billion). In 2022, China exported goods worth USD76.1 billion to Russia, an increase of 12.8% compared to 2021; while the value of goods exported from Russia to China increased by 43.4% to USD114.1 billion.
In recent years, the US has intensified sanctions and penalties against non-US companies for business transactions and activities with entities subject to US sanctions, giving full play to the long-arm effects of those measures. On the other hand, the integration of the global economy makes it inevitable for Chinese companies to be tied to US interests. This has resulted in Chinese companies being easily identified as violating US economic restrictions, laws and regulations, thereby falling prey to its network of sanctions.
THE OFAC AND SDN LIST
Sun Tzu wrote in The Art of War: “If you know the enemy and know yourself, you need not fear the result of a hundred battles.” In this sense, it is crucial for Chinese companies to grasp the mechanism and implications of these major sanction measures before they can take necessary measures to mitigate the risks and avoid potential violations.
The Office of Foreign Assets Control (OFAC) of the US Department of the Treasury administers and enforces economic and trade sanctions based on US foreign policies and national security goals. The OFAC also plays a critical role in administering licensing programmes that allow certain transactions to proceed in spite of sanctions. One of the most important and widely known sanction lists managed by the OFAC is the SDN list, which includes individuals, companies and organisations deemed to be a threat to US national security or foreign policy.
When making a designation to the SDN list, the OFAC relies on information from various sources such as US government agencies, foreign governments, UN expert panels, and open-source reporting. Thorough investigations are usually conducted that include a review of all available information, the findings and conclusions of which are documented in a formal evidentiary memorandum outlining the evidence supporting the determination that a person meets one or more criteria specified by the sanctions authority. Before the OFAC makes a final determination, proposed listing actions are reviewed by the Departments of the Treasury, Justice, State and other US agencies as necessary.
Designation on the SDN List can result in severe legal consequences, which mainly include:
- All property and interests in property of designated individuals or entities in the US, or that subsequently come within the US, or that come within the possession or control of US persons are blocked;
- Any transaction or dealing by US persons, or within the US, in blocked properties or interests in them is prohibited, including but not limited to the making or receiving of any contribution of funds, goods or services to, or for the benefit of, designated individuals or entities;
- Any transaction by any US person, or within the US, that evades or avoids, or has the purpose of evading or avoiding, or attempts to violate, any of the prohibitions, is prohibited. Any conspiracy formed to violate any of the prohibitions is also prohibited; and
- Civil and criminal penalties may be assessed for violations.
A special “50% rule” has been adopted by the OFAC for the identification of blocked persons. According to this rule, any entity owned in the aggregate, directly or indirectly, 50% or more by one or more blocked persons is itself considered a blocked person. The property and interests in property of such an entity are blocked regardless of whether the entity itself is listed in the annex to an executive order or otherwise placed on the OFAC’s SDN List.
Accordingly, a US person generally may not engage in any transactions with such an entity unless authorised by the OFAC. In certain OFAC sanctions programmes (e.g., Cuba and Iran), there is a broader category of entities with property and interests in property that are blocked.
In this regard, US persons are advised to act with caution when considering a transaction with a non-blocked entity in which one or more blocked persons has a significant ownership interest that is less than 50%, or in which one or more blocked persons may control by means other than a majority ownership interest. Such entities may be the subject of future designation or enforcement action by the OFAC. Furthermore, a US person may not procure goods, services or technology from, or engage in transactions with, a blocked person directly or indirectly.
It is also interesting to note that the OFAC defines US persons in a quite broad context. Pursuant to Code of Federal Regulations of US section 560.314, the term US person refers to:
“Any United States citizen, permanent resident alien, entity organised under the laws of the United States or any jurisdiction within the United States (including foreign branches), or any person in the United States.”
Furthermore, it is fairly easy to unintentionally violate prohibitions on the so-called “facilitation”, broadly defined as all assists and support to prohibited transactions. US persons may not “facilitate” a transaction operated by a non-US person that would be prohibited by sanctions had it been conducted by US persons.
Consider, however, that as the majority of wire transfers in US dollar currency would be cleared through US banks, a US dollar payment to or from an SDN or a sanctioned country may very likely constitute facilitation. As a result, many non-US companies with a US nexus would take the conservative position to treat themselves as if they were US persons. This also leads to scenarios of over-compliance by international giants, compelled to take extreme measures to reduce legal, business and regulatory risks when facing the prospect of unilateral sanctions.
HOW CHINESE COMPANIES CAN RESPOND
Passive acceptance and shutdown of business. When faced with the risk of US economic sanctions, Chinese companies have several options available to them. Unfortunately, the most common among them is passive acceptance, which means that the sanctioned entity simply accepts the sanctions and shuts down their affected business operations.
One of the underlying reasons for this passive acceptance is that Chinese companies often regard US sanctions as a “death penalty”, believing them to be too severe and final, leaving little chance to remedy the situation. Furthermore, Chinese companies quite often have limited or even no knowledge of possible remedies available for consideration. This is a worrying trend because it not only affects the Chinese companies in question, but also has wider ramifications for the national economy.
File petition for delisting and removal. Each year, the OFAC removes hundreds of individuals and entities from the SDN List after thorough review. Delisting and removal may occur due to a change in behaviour, death of an SDN, the cessation of the basis for the designation, or the designation being based on mistaken identity.
On 20 April 2017, the OFAC issued FAQs regarding petitions for removal from the SDN List, further clarifying that the power and integrity of OFAC sanctions derive not only from its ability to designate and add persons to the SDN List, but also from its willingness to remove them from the list as consistent with the law. The ultimate goal of sanctions is not to punish, but to bring about a desirable change in behaviour.
Unfortunately, such delisting petition processes may be difficult and lengthy, involving multiple stages and possible submission of extensive documentation and supporting evidence. In addition, it is necessary to note that the decision to remove an individual or entity from the SDN List rests solely with the OFAC and US authority, and there is no guarantee or safety net that such a petition will be successful. Nevertheless, for those who have been wrongly designated as SDN, filing a petition is an option worth exploring, but one should keep in mind the potential risks and challenges.
Following the triumph of COSCO Shipping Tanker (Dalian), which was deleted from the SDN List in January 2020, Junzheng Logistics stands out as the first successful example of a Chinese private company taking proactive action and using legal rules to defend their legitimate rights in the field of US sanctions. It set a precedent for other Chinese companies facing similar dilemmas.
In March 2020, the US State Department announced sanctions on nine entities and three individuals under the authorisation of Executive Order 13846. Two subsidiaries of Junzheng Logistics were added onto the SDN List. With Junzheng being a global, as well as China’s largest, chemical tanker shipowner, the sanctions against its subsidiaries were bound to have a severe impact on its commercial operations and development in the international market. However, the company did not sit idly, but instead took a proactive approach by filing a delisting petition to the OFAC, which eventually led to the successful removal of both subsidiaries from the SDN List.
This case is a rare example in recent years where a Chinese company obtained the comprehensive lifting of US economic sanctions without paying any fines or being subject to any follow-up conditions. The achievement not only demonstrates the effectiveness of reasonable and active legal action, but also highlights the importance of persistence and determination in the face of adversity.
Challenge the OFAC by initiating a legal proceeding. Another available approach to consider is launching a legal campaign against the OFAC by initiating a court proceeding. Undoubtedly, this is a relatively rare and bold move. As far as public information indicates, no Chinese company has yet taken such action against the OFAC. However, there is a successful case precedent set by ExxonMobil.
On 20 July 2017, the OFAC issued a penalty against ExxonMobil for alleged “reckless disregard” of the Ukraine Related Sanctions Regulations. This was due to the company entering contracts with Russian oil company Rosneft, in May 2014. Within days of the OFAC’s penalty announcement, ExxonMobil filed a complaint in the US District Court for the Northern District of Texas against the Treasury secretary and OFAC director. In this lawsuit, ExxonMobil claimed that the OFAC’s action was “unlawful” under the Administrative Procedures Act and did not give the company “fair notice”, violating the Fifth Amendment to the US Constitution. On 31 December, the District Court ruled in favour of ExxonMobil and vacated the OFAC’s USD2 million penalty against the company.
In another notable case to the opposite effect, the US Court of Appeals for the District of Columbia Circuit recently dismissed the Russian tycoon Oleg Deripaska’s lawsuit challenging sanctions imposed by the OFAC.
Overall, instead of sitting and waiting for the hammer to fall, it’s always better to take the initiative, carefully weigh all available options, evaluate the potential results, and take legal steps.
ESTABLISH A SYSTEM
The world is becoming increasingly interconnected, with businesses and individuals operating across borders more frequently than ever before. While this presents many opportunities, it also creates risks, particularly in relation to international economic sanctions. We strongly encourage Chinese companies engaged in the international market to adopt a sanction compliance and risk management system to monitor and mitigate the relevant risks.
Although the details and requirements vary from one case to another, depending on factors such as company size, business type and parties involved in the transaction, in general a sound international compliance system should, at a minimum, incorporate the following key components: management commitment, risk assessment, internal control, auditing, and training and testing.