Global Trade & Sanctions Law

Ukraine Freedom Support Act

The enactment of the Ukraine Freedom Support Act of 2014 starts the timeline for the following new extraterritorial sanctions:

• Sanctions on Rosoboronexport (effective January 17, 2015) – The President is required to impose three or more sanctions from the list of options below. Rosoboronexport is the sole state broker and exporter/importer of Russian defense products. Despite the President’s stated intent not to use the sanctions authorized under the act, it is not clear how he will be able to avoid the requirement of this mandatory provision.
• Arms-Related Activities in Syria, Ukraine, Georgia and Moldova (effective February 1, 2015) – The President is required to impose three or more sanctions from the list of options below against Russian and Russian-owned or controlled parties who are determined to produce, transfer or broker sales of defense articles to these countries without the support of their internationally recognized governments or who provide support for these activities. Although nominally mandatory, the determination with regard to parties is discretionary, giving the President flexibility to apply this provision.
• Investment in Crude Oil Projects (effective February 1, 2015) – The President is authorized to impose three or more sanctions from the list of options below on foreign persons that are determined to have knowingly made a significant investment in a “special Russian crude oil project,” which includes Russian deepwater, arctic offshore, and shale formation projects “intended to extract crude oil.” The U.S. Treasury and Commerce Departments have interpreted similar language to include gas projects that may produce oil.
• Foreign Financial Institutions (effective June 16, 2015) – Sanctions may be imposed on foreign financial institutions that knowingly (a) engage in significant transactions with parties sanctioned under this statute, or (b) facilitate significant financial transactions on behalf of Russian Specially Designated Nationals (SDNs) designated under Ukraine-related sanctions. The sanctions authorized for such activities are prohibitions or restrictions on opening or maintaining correspondent and payable-through accounts in the United States.

Read more: U.S. Sanctions Legislation Targets Russia While EU and U.S. Expand Crimea Sanctions

Stephan E. Becker, Pillsbury partner, will co-present on the topic of “U.S. Sanctions Relating to the Unrest in Ukraine: Compliance Challenges,” on Thursday, October 9 at 1:00pm.

The United States began by imposing sanctions on persons and entities associated with the unrest in the Ukraine, but the sanctions have been expanded to target broader segments of the Russian economy with the adoption of new sectoral sanctions.

During this PLI webinar, the following topics will be discussed:

• The scope of the U.S. sanctions administered by the Treasury and Commerce Departments
• The implementation of sectoral sanctions on the Russian financial, defense and oil& gas sectors
• Recent expansions of the sanctions and potential future changes

For more information and to register, please visit the event page.

The United States recently expanded sanctions and export controls against the Russian defense sector. These designations and export control steps have implications for defense contractors, parts suppliers and brokers.

The Office of Foreign Assets Control (OFAC) recently expanded the list of Specially Designated Nationals (SDNs) to include entities in the Russian defense sector and also expanded its sectoral sanctions, which previously applied to the financial and energy sectors, to include the Russian defense sector. The U.S. Department of Commerce, Bureau of Industry and Security (BIS) also expanded export controls applicable to Russia’s defense industry.

Sanctions Designations
On September 12, 2014, OFAC added five new entities as SDNs in the Russian defense sector including:

• Almaz-Antey Air Defense Concern Main System Design Bureau
• JSC, Tikhomirov Scientific Research Institute of Instrument Design
• JSC, Kalinin Machine Plant
• JSC, Mytishchinski Mashinostroitelny Zavod, OAO
• Dolgoprundy Research Production Enterprise, OAO

The Russian defense entities that were previously designated as SDNs in July 2014 include:

• Almaz-Antey Corp.
• Federal State Unitary Enterprise State Research and Production Enterprise Bazalt
• JSC Concern Sozvezdie
• JSC MIC NPO Mashinostroyenia
• Kalashnikov Concern
• KBP Instrument Design Bureau
• Radio-Electronic Technologies
• Uralvagonzavod
• United Shipbuilding Corp.

All transactions involving the property or interests in property of these SDNs held by U.S. persons or in the United States are prohibited. This prohibition includes transactions in U.S. dollars that clear through the United States whether or not U.S. persons are involved. The sanctions apply to any company owned 50 percent or more by one of these companies. If equipment was ordered or purchased but money is still owed, shipment of the items may be blocked. OFAC guidance should be sought before proceeding.

Sectoral Sanctions
OFAC also issued Directive 3 pursuant to Executive Order 13662 restricting transactions with specified defense entities involving new debt with a maturity of more than 30 days. New debt is defined as bonds, loans, extensions of credit, loan guarantees, letters of credit, drafts, bankers’ acceptances, discount notes or bills, or commercial paper, issued after the date that the person was listed under the Directive. Financing and providing services in support of the debt are also prohibited. Currently, Rostec is the only entity that has been listed under Directive 3. However, the prohibitions in Directive 3 also apply to any company owned 50 percent or more by Rostec, which is a large conglomerate with numerous subsidiaries and ownership stakes in Russian defense industry companies. OFAC has indicated that providing Rostec and its subsidiaries with deferred purchase agreements extending payment terms of longer than 30 days would constitute a prohibited extension of credit. This prohibition will be of particular importance to suppliers and other parties that provide goods or services to the Rostec family of companies.

Export Controls
BIS expanded the Entity List to impose export control restrictions on the SDNs added by OFAC as described above. The BIS Entity List already covered the nine SDNs previously designated by OFAC in the defense sector. Transactions with these entities involving any item subject to the Export Administration Regulations (EAR) require a license that is subject to a policy of denial. This restriction applies to reexports of items that are subject to the EAR even if a U.S. person is not involved in the transaction.

BIS also prohibited the export of certain items to Russia without a license when the exporter knows that the item is intended for a “military end use” or “military end user” in Russia. This prohibition extends to Russia the “military end use/end user” rule that previously applied only to China. The ECCN list covered by this rule is contained in EAR Part 744, Supplement No. 2. License applications for these items will be reviewed on a case-by-case basis, but will be subject to denial if the items would make a material contribution to Russia’s military capabilities. Items not listed in Supplement No. 2 are not subject to these restrictions even if destined for use by a military end user, though would be subject to the above SDN and Entities List prohibitions if destined for one of those companies.

In response to the continuing situation in eastern Ukraine and Crimea, the European Union (EU) has adopted further significant sanctions against Russia. On 6 August 2014, Russia responded.

The EU is continuing to intensify sanctions against Russia in response to the rising tensions in eastern Ukraine and Crimea. A number of key restrictive measures came into force on 1 August 2014, contained in Council Regulation (EU) No 833/2014 of 31 July 2014 (“Council Regulation”).

Financial Sanctions

New sectoral sanctions prohibit EU nationals and companies entering into contracts after 1 August 2014 to buy or sell a range of specified financial instruments (with a maturity exceeding 90 days) issued by the following major state owned Russian banks – Bank for Development and Foreign Economic Affairs (“VEB”), Gazprombank, Russian Agricultural Bank (Rosselkhozbank), Sberbank and VTB Bank OAO. This prohibition extends to their non-EU subsidiaries owned over 50 percent and those acting on their behalf. Services related to the issuing of such financial instruments, e.g. brokering, also are prohibited.

Other Restrictions

Further sanctions measures adopted by the EU include:

(i) an arms embargo (which includes a ban on the purchase, import or transport of military goods from Russia);

(ii) an export ban on dual-use goods for military end users; and

(iii) measures to curtail access to certain equipment and technologies, particularly in the oil exploration and production sector.

These measures have followed other recent sanctions aimed at Russia. In particular, EU Regulation 825/2014 on 30 July 2014 already had placed a ban on providing loans or other credit in a wide range of sectors in Crimea and Sevastopol.

To date, the EU also has frozen the assets of, and banned travel for, many individuals, including certain Russian and Ukrainian officials, who are deemed responsible for destabilizing the situation in eastern Ukraine. The EU also has frozen the assets of a number of entities in Russia and the Ukraine, making it an offence to deal in assets belonging to listed entities.

Russia Retaliates

In response, on 6 August 2014, Russia imposed a one-year import ban on certain agricultural and food products originating from countries that have introduced sanctions against Russia (or acceded to such sanctions). Furthermore, the Russian government is considering banning transit flights across its territory for EU and US airlines.

This past week’s activities represent the first significant expansion of EU sanctions beyond a limited asset freeze list. Companies should actively assess whether they face exposure in Europe or otherwise in their business interests in Russia and/or the Ukraine.

The United States, European Union and Canada each took steps recently to expand sanctions against Russia, including the targeting of major defense companies and the addition of export controls. These designations and export control steps have implications for defense contractors and brokers.

The Office of Foreign Assets Control (“OFAC”) listed the following Russian defense-sector companies as Specially Designated Nationals (“SDNs”) effective July 16, 2014:

• Almaz-Antey Corp.
• Federal State Unitary Enterprise State Research and Production Enterprise Bazalt
• JSC Concern Sozvezdie
• JSC MIC NPO Mashinostroyenia
• Kalashnikov Concern
• KBP Instrument Design Bureau
• Radio-Electronic Technologies
• Uralvagonzavod.

In addition, on July 29, 2014, OFAC designated the United Shipbuilding Corporation, which designs and repairs both military and commercial ships in Russia.

New transactions with these Russian companies by U.S. companies, citizens or permanent residents or persons in the United States are prohibited. As a consequence, transactions in dollars in which funds transfers clear through the U.S. banking system are subject to blocking as well. In addition, the sanctions apply to any company owned 50 percent or more by one of these manufacturers.

These designations, however, do not apply to equipment previously manufactured by these companies and already purchased and fully paid for. Such equipment is not blocked and may be possessed and used by persons subject to U.S. jurisdiction. Further, the sanctions do not prohibit new sales or lease transactions for such equipment in the secondary market. For example, according to OFAC guidance, if a U.S. person owns 100 AK-47 rifles originally manufactured by Kalashnikov Concern and purchased outright before July 16, 2014, these rifles may be re-sold in the secondary market so long as the sanctioned Russian companies or other SDNs are not part of the transaction.

If equipment has been ordered or acquired from one of these Russian companies, but money is still owed, the items may be blocked. Depending on the transaction, the sanctioned companies may continue to have an interest in the equipment. OFAC has recommended that any purchaser in such a situation seek guidance on whether the U.S. government would consider the items to be blocked.

In addition to the OFAC SDN designations, these nine companies have been added to the U.S. Bureau of Industry and Security (“BIS”) Entity List. Any export or re-export to these companies of goods, software or technology subject to the Export Administration Regulations (“EAR”) is now prohibited without a license, with a presumption that any such license request will be denied. Jurisdiction is based on U.S. content. Non-U.S. persons acting outside of the United States are subject to the prohibition if exporting or re-exporting to these companies items that are subject to the EAR.

The U.S. State Department’s Directorate of Defense Trade Controls (“DDTC”) has not yet issued a new policy statement concerning these companies. Exports of defense articles and defense services to Russia, however, are subject to a policy of denial. Brokering requests related to the resale of previously purchased defense articles from defense sector companies may be approved, although companies are advised to contact DDTC for guidance.

Actions in Other Jurisdictions
To date, the European Union (“EU”) has designated only one entity within the arms and materiel industry, Almaz-Antey Corp. The EU, however, has placed restrictions on exports of dual-use goods and technology that could be intended for a military end use/end user in Russia. The sale, supply, transfer or export directly or indirectly to a person in Russia or for use in Russia is prohibited. Further, the EU has prohibited technical assistance and financing/financial assistance relating to items on the Common Military List or dual-use goods that could be used for a military end use or end user, as well as the provision to, manufacture or maintenance for, or use of such items by a Russian person or in Russia. Pre-existing contract obligations, however, may be authorized.

Canada has designated eight of the same entities that the U.S. designated for operating in the arms and materiel industry. Property of the designated entities that is within Canada or the possession of a Canadian person is now blocked.

Sanctions and export controls continue to evolve in response to events in Ukraine and Russia. The defense manufacturing and materiel sector in Russia likely will continue to be a target of sanctions by the U.S. and other western governments.

The United States, Canada and the European Union have designated a number of additional officials and companies as the unrest continues in eastern Ukraine. The United States also imposed sanctions on the head of Russian energy giant Rosneft and announced new export controls on shipments to Russia. Although sector-wide sanctions or broader measures against the Russian banking or energy industries have not yet been imposed, such measures remain under active consideration and further destabilization or Russian military action could trigger additional steps in the near future.

The United States (April 28, 2014), Canada (April 28, May 4, and May 12, 2014) and European Union (“EU”) (April 29 and May 12, 2014) have imposed additional sanctions designations, continuing to target selected individuals and entities. As yet, no country has implemented broader embargoes against Russia or its industry sectors. Normal business, banking and travel continue to be permitted, except for transactions involving the designated individuals and entities.

The U.S., Canada and EU have made the following new designations:

U.S. Sanctions

• Six additional Russian government officials.
• Igor Sechin – President and Chairman of the Management Board for Rosneft, Russia’s leading petroleum company.  Rosneft, however, is not subject to sanctions since Sechin does not own more than 50 percent of Rosneft.
• Seventeen other entities owned or controlled by Bank Rossiya, Gennady Timchenko or the Rotenberg brothers who have been previously targeted by U.S. sanctions.  The entities are in the financial/banking, construction, transportation/logistics and consumer products sectors.
• OFAC added a new Russian bank, Tempbank, to its Specially Designated Nationals List on May 8.  This action was taken under the Syrian Sanctions Regulations.

Canada Sanctions

• Twenty-one individuals – All but two of the individuals were previously named by other jurisdictions; the two new individuals are both Russian political figures.
• Eighteen entities – Two Russian banks (RosEnergoBank and ExpoBank) that have not been named by any other jurisdiction and sixteen additional entities that had already been designated by the United States.

EU Sanctions

• Fifteen individuals, consisting of nine Russian political figures, including the Chief of the General Staff of the Armed Forces of the Russian Federation and six persons involved in the Crimean separatist movement or new Crimean government.
• Thirteen additional individuals, including of Russian government and military officials and Ukrainian separatist leaders, and two companies (PSJC Chernomorneftegaz and Feodosia) whose assets were appropriated by the Crimean authorities.

Additional U.S. Actions
The U.S. Commerce Department’s Bureau of Industry and Security (“BIS”) had announced in March that it was suspending processing of new licenses for exports to Russia. On April 28, 2014, BIS updated the policy, stating that it will deny pending license applications for exports or re-exports of high technology items that could be used to support Russia’s military capabilities and will revoke any existing licenses meeting those criteria. BIS, however, announced that it would consider license applications not meeting those criteria on a case-by-case basis, allowing the processing of some applications to resume. The State Department has posted a similar notice regarding licenses under the International Traffic in Arms Regulations (“ITAR”) for export or retransfer of military equipment, software, technology and services.

BIS also added 13 Russian companies to its Entity List. Any export or re-export to these companies of goods, software or technology subject to U.S. jurisdiction under the Export Administration Regulations are now prohibited without a license, with a presumption that any such license request will be denied.

On May 8, 2014 the Department of Treasury’s Office of Foreign Assets Control (“OFAC”) published the Ukraine-Related Sanctions Regulations at 31 C.F.R. Part 589 implementing Executive Orders 13660, 13661 and 13662. These regulations codify the prohibitions outlined in the Executive Orders, as well as certain interpretations such as guidance on the prohibitions applicable to entities owned 50 percent or more by a designated individual or entity

Next Steps
Although the most recent steps are incremental, the U.S. Administration has indicated that additional sanctions against the Russian energy, banking and other sectors remain on the table and the United States is negotiating with the EU on the scope of these broader sanctions. At a Senate Foreign Relations Committee hearing on May 8, 2014, a number of senators voiced frustration with the Administration’s approach, and 21 Republican senators have introduced legislation requiring the imposition of broad sanctions oneconomic sectors, while Administration representatives advocated a surgical approach using a “scalpel” to cut across parts of sectors. Events surrounding the planned separatist vote in eastern Ukraine that took place on May 11, 2014 and the planned Ukraine-wide elections on May 25 could trigger the imposition of broader sanctions, which would likely have a more significant impact than the sanctions designations that have been made to date.

The Obama Administration has threatened to impose additional sanctions on Russia in response to the Ukraine crisis but so far has only blocked the assets of 32 individuals and one bank. Additionally, with little fanfare, the two primary U.S. agencies responsible for issuing export licenses announced that they have stopped processing applications for licenses to export or re-export products and technology to Russia. The United Kingdom is suspending existing licenses and will not process license applications to export to Russia products and services that are destined for military use in the Ukraine.

United States Export License Policy
The Commerce Department’s Bureau of Industry and Security (BIS) administers the Export Administration Regulations (EAR), which apply to exports of commercial and dual-use products, software and technology. BIS posted a notice on its website on March 26 stating that it has not been issuing licenses for the export or re-export of items to Russia since March 1, just days after the initial armed invasion of Crimea. During fiscal year 2013, BIS approved 1,832 license applications for export/re-export to Russia of U.S. origin items.

The State Department’s Directorate of Defense Trade Controls (DDTC) administers the International Traffic in Arms Regulations, which govern exports of military equipment, software, technology and services. DDTC posted a notice on its website on March 27 similarly announcing that it has placed a hold on issuing licenses for exports to Russia.

The actions have been taken independently of the sanctions imposed by the United States on individuals and entities considered to be associated with President Putin following Russia’s annexation of Crimea. Neither agency has amended its regulations. Rather, they are exercising their existing broad discretion over licensing decisions. Consequently, their announcements have no effect on the export of items not requiring a license, or those qualifying for license exceptions or exemptions. There is also no effect on exporting items under licenses that have previously been approved by either agency. At this point, companies may continue to ship these items to Russia.

United Kingdom Export License Policy
On March 18, the United Kingdom announced that it was suspending existing licenses and processing license applications “for direct export to Russia for military and dual use items destined for units of the Russian armed forces or other state agencies which could be or are being deployed against Ukraine.” This suspension also applies to licenses for exports to third countries of items to be incorporated into equipment destined for use by Russia against the Ukraine.

Modest Impact and Mixed Signals
The suspension of license processing for Russia will, of course, have an immediate impact on companies with pending applications and those that regularly require export licenses for operations in Russia. For example, applications for technical assistance agreements for space launch services will be on indefinite hold and the volatility of the situation in Ukraine makes it impossible to predict when that policy may be revised.

Within the larger policy context, however, these actions are not likely to have an important impact on diplomacy. Most U.S. trade with Russia does not require export licenses, and while the United Kingdom and Russia earlier this year had discussed expanding their defense trade cooperation, they had not yet signed an agreement before the Ukraine crisis exploded.

Meanwhile, other countries are sending mixed signals regarding defense and high technology trade. Although the German government cancelled a Rheinmetall contract to deliver a combat simulator to Russia, Siemens’ CEO promised continued cooperation in a meeting with President Putin last week. France is still scheduled to deliver two aircraft carriers to Russia, and even the United States has not taken steps to suspend or cancel the delivery to the Afghan defense forces of Russian Mi-17 helicopters purchased from Rosoboronexport.

As the Ukraine crisis continues, it is possible that the U.S. and allied country governments will strengthen their technology and defense trade sanctions, perhaps expanding them to include other products or technology that do not now require licenses but might be seen as sensitive. Companies trading in agricultural or low technology commercial items, however, are unlikely to be affected by export restrictions unless a total trade embargo is imposed on Russia, which currently is not a policy option on the horizon.

Sanctions escalated at a rapid pace last week as western powers responded to the crisis in Ukraine and Russian’s annexation of Crimea. The United States, European Union (EU), Canada and Australia have implemented sanctions. The approaches and specific sanctions lists of these four jurisdictions overlap but have certain key differences. Following are the current contours of these sanctions (through March 23, 2014).

Sanctions Implemented to Date

United States – Has named 32 specially designated nationals (“SDNs”) under three new Executive Orders, including 31 individuals and one bank. Transactions with these SDNs are prohibited and their property is blocked, with no exception made for agreements or joint ventures established prior to the sanctions. The United States also has instituted travel and visa bans for certain Russian and Ukrainian officials. Executive Orders 13660 (March 6, 2014), 13661 (March 16, 2014), and 13662 (March 20, 2014) have set up a framework to sanction persons disrupting democracy in the Ukraine, Russian government officials, entities operating in the arms and related materiel sector in Russia, and persons operating in particular economic sectors within Russia to be identified based on Executive Order 13662 (which may include the financial services, energy, metals and mining, engineering and defense industries).

EU – Has frozen the assets of and banned travel for several Russian and Ukrainian officials under Council Regulations 208/2014 (March 5, 2014) and 269/2014 (March 17, 2014) and Implementing Regulation 284/2014 (March 21, 2014). Unlike the United States, the EU makes exceptions under certain conditions for payments due under contracts/obligations and certain arbitral decisions arising prior to the designation of the individual, for certain judicial/legal awards, and for funds determined to be for basic needs, legal fees or service charges for frozen accounts.

Canada – Has frozen the assets and banned travel to certain Russian and Ukrainian officials under two sets of regulations for Ukraine — Freezing Assets of Corrupt Foreign Officials (Ukraine) Regulations (SOR/2014-44) (March 5, 2014) and Special Economic Measures (Ukraine) Regulations (SOR/2014-60) (March 17, 2014) and its amending regulations, as well as one set of regulations for Russia — Special Economic Measures (Russia) Regulations (SOR/2014-58) (March 17, 2014). Canada allows some transfers with designated individuals, such as: those due under contracts entered into prior to the individual being designated, pension payments; transactions related to a diplomatic mission or an organization with diplomatic status; transactions necessary for a Canadian to obtain accounts, funds or investments held by a designated person; those for legal services; and for loan repayments where the loan was entered into prior to the individual being designated.

Australia – Has announced that sanctions and travel bans will be imposed on a list of individuals in response to Russian actions in Crimea. The specific parties are still under consideration and no updates have been made to the Australia sanctions webpage to date.

All four jurisdictions are expected to consider additional sanctions, including designations of Russian companies and/or financial institutions, targeting the assets of Russian oligarchs and restricting sensitive export sectors.

Adapting to Further Escalation of Sanctions
It still is permissible to do business with and in Ukraine and Russia. The sanctions issued to date focus on specific individuals and one entity (Bank Rossiya) that has been sanctioned by both the United States and Canada. Entities that are majority-owned by these individuals and entities are covered by the sanctions as well. However, broader embargoes including prohibitions on financial transactions and investment bans are being actively considered and could be imposed without advance notice.

The extreme uncertainty of the current environment should prompt companies in the U.S., EU, Canada and Australia not only to screen and block transactions with the individuals and entities that have been named to date, but also to assess their exposure to transactions or investments involving Russia and Ukraine and to take steps to minimize such exposure wherever possible. U.S. and EU regulators are assessing their financial institutions’ exposure to former Ukrainian officials, Russia oligarchs and their investment holdings, and other Russian entities. It is likely that additional sanctions will be imposed. Transactions involving Russian counterparties should be monitored carefully to evaluate whether the individual or entity is in the sphere that is most likely to be targeted (particularly those closely associated with President Putin) and transactions should be limited to the shortest term possible.

Russia has responded to the U.S. and western sanctions in kind, banning travel into Russia for nine high profile U.S. government officials. While these sanctions have little economic impact, statements by the Russian government indicate that additional counter-sanctions targeting U.S. and EU business interests are possible, and perhaps even likely.