In response to Russia/Ukraine conflict, and Belarus’ ensuing support for Russia, the United States and global allies have imposed sweeping sanctions and export control restrictions on both Russia and Belarus. These actions are discussed extensively in our prior publications.
The sanctions and export controls restrictions especially target Russia and have had a significant impact on the Russian economy. Virtually every industry is impacted, and Russia’s financial institutions, businesses and prominent individuals are being targeted by ever-widening sanctions and export control restrictions imposed by the United States and global allies. As the situation evolves, further restrictions remain possible.
As a result of these restrictions, there is an increased risk for the international business community to inadvertently violate sanctions and export controls through indirect business activities. Such risks are particularly present in supply chains involving countries that continue to openly trade with Russia, such as China. Below, we provide an overview of supply chain risks and recommended steps businesses may take to mitigate such risks.
Growing Supply Chain Risks
In response to the Russia-Ukraine conflict, the U.S. government has imposed stringent export control restrictions that have resulted in significant changes to the U.S. Export Administration Regulations (EAR) as applied to Russia and Belarus. Accordingly, U.S. and non-U.S. companies exporting, reexporting or transferring (in-country) items subject to the EAR to, or within, Russia and Belarus risk liability.
For example, the U.S. Department of Commerce’s Bureau of Industry and Security (BIS) created two new foreign direct product (FDP) rules targeting non-U.S. made products that are exported to Russia or Belarus. While the traditional “national security” FDP rule applies to non-U.S. made products that are the direct product of U.S. technology or software controlled for national security (NS) reasons (or a major component of a plant that is the direct product of NS-controlled technology or software), the new FDP rule for Russia and Belarus applies to non-U.S. made products (except EAR99 items) that are the direct product of U.S. technology or software in any Export Control Classification Number (ECCN) on the Commerce Control List (CCL)—or a major component of a plant that is the direct product of such technology or software. BIS also created an even more expanded application of the traditional FDP rule targeting Russian and Belarusian “military end-users,” which applies to non-U.S. made items that are designated as EAR99 items subject to limited exceptions. Of importance, license requirements for the two new FDP rules do not apply to exports or reexports from certain excluded countries, which include Japan. However, that exclusion only applies because Japan imposes similar restrictions on products made in Japan with U.S. technology or software that would be exported to Russia or Belarus.
Overall, these export control restrictions have prevented Russian and Belarussian companies from accessing U.S. hardware, software and technology. There has also been an increased risk of non-U.S. made items now requiring a license for export to Russia or Belarus due to the expanded FDP rules. As such, Russia has turned to countries like China for alternative sources of goods and technology. As Russia in particular continues to look elsewhere, it is important for international companies to reassess their supply chains and mitigate the risk of items ending up in Russia or Belarus in violation of U.S. export controls and sanctions. This is especially important for companies who source from or manufacture in countries who are not imposing sanctions similar to Western allied nations.
Civil violations of the EAR are subject to strict liability. In other words, penalties can be imposed without regard to the intent, knowledge or degree of care in attempting to comply with laws and regulations. Administrative monetary penalties can reach up to $328,121 per violation or twice the value of the transaction, whichever is greater. (Note that this amount is for 2022 and subject to inflation adjustment annually.)
Criminal penalties, which involve a willful violation of the EAR, can include up to 20 years of imprisonment and up to $1 million in fines per violation, or both. Violators may also be subject to the denial of their export privileges.
Practical Recommendations: Red Flags and Know Your Customer Guidance
Export control and sanctions regulators expect companies to conduct thorough risk-based due diligence prior to dealing with counterparties. This is standard industry practice, but it is especially important now with the sprawling export controls and sanctions restrictions in place for Russia and Belarus. Thus, companies should ensure they are conducting proper due diligence on all third parties involved in their supply chains—e.g., customers, suppliers, vendors, commercial partners, contractors and employees—to address and mitigate risks.
As recommended by BIS in its Export Compliance Guidelines, companies should set up a screening process as part of their due diligence process and ensure they are paying attention to any red flags that arise in a transaction. “Red flags” constitute abnormal circumstances in a transaction that indicate an export may be destined for an inappropriate end-use, end-user or destination. Examples of red flags include the following:
- The customer or purchasing agent is reluctant to offer information about themselves;
- The product’s capabilities do not fit the buyer’s line of business;
- The product ordered is incompatible with the technical level of the country to which the product is being shipped;
- The customer is unfamiliar with the product’s performance characteristics but still wants the product;
- The customer provides, or due diligence reveals, conflicting information;
- The customer has little or no business background;
- When questioned, the buyer is evasive or unclear about whether the purchased product is for domestic use, export or reexport; or
- The customer is willing to pay in cash for an expensive item when the terms of the sale call for financing.
When red flags are raised, companies should exercise additional due diligence to further inquire about the suspicious circumstances and confirm that the end-use, end-user or ultimate country of destination in the proposed transaction are appropriate.
BIS specifically warns against “self-blinding” (i.e., purposefully cutting off the flow of information that comes to a company in the normal course of business). In such instances, companies have an affirmative duty to inquire, verify or otherwise “go behind” the customer’s representations. If the problem persists after the inquiry, then a company should not proceed with the transaction.
If a company becomes aware of a violation of the EAR after the transaction occurs, BIS encourages the submission of a Voluntary Self Disclosure (VSD). Submitting a VSD is considered a mitigating factor, and, according to BIS, is an excellent indicator of a party’s intent to comply with U.S. export control requirements.
Checklist to Mitigate Russia-Related Supply Chain Risks
Please consider the checklist below as practical guidance when conducting business to mitigate risks stemming from inadvertent violations of export controls restrictions involving Russia and Belarus:
- Continue to closely monitor sanctions and export control developments related to Russia and Belarus.
- Know and screen all entities in your supply chain.
- Are there red flags indicating your items may be going to Russian or Belarussian end-users?
- Is the customer unwilling to provide information about the end-user or end-use of the product?
- Are the product’s capabilities incompatible with the buyer’s line of business?
- Is the shipping route abnormal for the product and destination?
- Is the customer not providing clear information to your questions?
- Consider obtaining signed certifications from third parties ensuring compliance with relevant sanctions and export controls against Russia and Belarus (and U.S. sanctions and export controls in general).
- If you become aware of a violation, do not ignore.
- Do not self-blind!
Our attorneys and consultants are available to assist in addressing questions regarding the impact of the information provided above. Our Ukraine crisis team, which includes attorneys qualified under Russian law, is closely following all developments in response to the conflict in Ukraine and is well-positioned to assist and advise companies.