How Russia Sanctions Are Affecting Compliance
The wide-ranging sanctions and export controls that the U.S. and its partners have imposed on Russia in recent months pose complex compliance challenges for parties operating across borders, even when there is not a direct or obvious nexus with Russia.
Notably, the U.S. rules include restrictions relating to dealings with sanctioned persons, exports to Russia of a broad range of items, certain services, banknotes, certain imports, and new investment. Furthermore, the annexed Crimea region of Ukraine is subject to a comprehensive U.S. embargo, as are the so-called Donetsk People's Republic, or DNR, and the Luhansk People's Republic, or LNR.
This article provides practical guidance for compliance with such restrictions, which can affect commercial operations, investments, and processing of financial transactions.
Direct Business With Russia
As of this time, Russia is not a subject to a comprehensive embargo, unlike, for example, Cuba or Iran, but the restrictions in place are extensive, and the range of permissible activity has narrowed considerably in recent months.
- Any party engaged in direct business with Russia should confirm that transactions do not involve:
- Any "blocked" individual or entity (including banks);
- Any entity (including banks) subject to financial sanctions that prohibit the transaction;
- Any activity (such as new investment and certain services exports) subject to countrywide sanctions;
- As applicable, any item subject to export controls;
- As applicable, any item restricted for import; and
- Any nexus with Crimea, the DNR or the LNR.
In this context, the following compliance steps are important:
Confirm no countrywide sanctions apply.
The threshold question is whether the category of activity is entirely excluded for Russia. At this time, such countrywide sanctions apply to new investment, importation of Russian energy products, exports and imports of luxury goods, and the exportation of services related to auditing, trust and corporate formation, and management consulting services.
Conduct restricted party screening.
It is important to screen all Russian parties involved in the transaction to confirm whether any are designated on a restricted list or, as applicable, owned 50% or more by such listed parties. This includes all Russian counterparties, end users, banks and government bodies involved in the transaction.
Consider export controls.
To the extent the transaction involves exports, it should be assessed whether the transaction would involve the export of any item subject to the Export Administration Regulations. An item is subject to the EAR if it is located in the United States; of U.S.-origin, wherever located; and of non-U.S.-origin, but incorporating more than a de minimis amount of controlled U.S. content or the direct product of certain U.S. technology or software.
As of this time, all items that are listed on the U.S. Commerce Control List, to the extent subject to the EAR, are controlled for export to Russia, and many designated Russian entities are subject to comprehensive EAR restrictions.
Confirm no nexus with Crimea, the DNR or the LNR.
It is important to conduct diligence to confirm that the business at issue will not involve the Crimea region, the DNR or the LNR, as the flow of goods, services, or capital to or from these regions may be nontransparent.
Indirect Russia Exposure
Engagement with third parties that may have dealings with Russia presents unique challenges. For example, companies that sell their products to third-party distributors face the risk that the distributor could onward sell those products to restricted Russian parties or embargoed regions.
Similarly, companies that supply components to manufacturers face the risk that their products could be incorporated into items sold to Russia, potentially putting the exporter in a position to provide warranty support, software updates and the like for the benefit of persons in Russia.
Companies presented with such third-party risk should consider taking risk-based compliance steps, such as, for example, using contractual terms or side letters restricting provision of the company's goods and services to Russia; informing the third party of any export controls applicable to the company's products; and/or using end-user certificates to ascertain the end users of the company's products.
Operations in Russia
Maintaining operations in Russia, such as through the continued ownership and operation of a Russian subsidiary, presents significant challenges in the current landscape. The following should be noted:
- There is risk that the Russian entity could deal with, or face pressure to deal with, sanctioned Russian parties.
- Practically speaking, it could be difficult for there to be compliant funds flow between the U.S. parent and the Russian subsidiary, or intra-Russia, as many Russian banks are subject to sanctions and cut off from the SWIFT payment messaging system.
- The Russian entity may not have access to goods and services from suppliers based in the United States or an allied country.
- U.S. parties with operations in Russia should assess the contours of the prohibition against new investment in Russia.
- For companies in Russia diligently seeking to comply with U.S. sanctions, such compliance may expose them to liability under local Russian law.
One factor overlaying the above sections is the challenge posed by the extensive number of Russian banks that are subject to sanctions, which makes it difficult to set up a secure channel for funds flow to and from Russia.
First, to the extent any Russian bank is subject to blocking sanctions, generally no transactions involving such bank are permitted.
Second, transactions involving banks subject to less than comprehensive sanctions, while not necessarily off-limits, significantly will complicate any transaction, and are subject to future risk of the bank's designation for comprehensive sanctions.
Third, U.S. banks could be concerned about the compliance implications of the transaction and may reject the funds transfer or freeze it in transit.
Based on these factors, prior to making a payment to a Russian party, it would be prudent for a company to confirm that its bank (and relevant correspondent banks) will process the payment.
General Prohibition 10
Under the EAR, General Prohibition 10 prohibits parties from providing essentially any service in relation to an item that the party knows has been (or is about to be) unlawfully exported in violation of the EAR. Recently, the U.S. Department of Commerce's Bureau of Industry and Security underscored this risk by publishing a list of Russian aircraft exported to Russia in violation of the EAR, and thus off-limits for services. While the aircraft example is the most publicized instance of this, companies should be aware that this restriction applies to any item that they know is connected to an export violation.
Mergers and Acquisitions
Buyers in M&A transactions should diligence any nexus with Russia that the target company has, including with respect to current or historical sales or operations. Buyers should consider whether, as part of the transaction, it should require the company to wind down such activities prior to the closing. As part of this, it is especially important to confirm that the company is not engaged in any ongoing violations, and if so, that such activities are terminated immediately.
Moreover, to address any risk of successor liability following the closing, it is important to assess potential liability the company may face with respect to historical Russia-related activities, not only since the imposition of expansive sanctions and export controls starting in February 2022, but over the last five years, as Russia has been subject to significant restrictions during that time, which is the applicable statute of limitations under both sanctions regulations and the EAR.
Conversely, on the sell side, sellers should review the sales and operations of the company to consider whether there are any Russia-related items to disclose to buyers, including in responses to diligence questions and on disclosure schedules, and whether there were any potential violations of law that would be suitable for a voluntary disclosure to the authorities.
Investment funds should assess their limited partner base to confirm whether any are subject to sanctions. If an investor is sanctioned, it should be considered whether:
- It is necessary to block the investor's funds;
- The investment fund is subject to sanctions;
- The governing documents of the fund or any side letters compel any particular action to be taken with respect to the sanctioned investor;
- It is possible, in compliance with applicable law, to remove the sanctioned investor from the fund or to seek permission from authorities to do so; and/or
- The presence of the sanctioned investor in the fund triggers disclosure under any credit agreements.
Considerations for Non-U.S. Parties
Non-U.S. persons face unique significant compliance challenges with respect to Russia-related business. First, such non-U.S. persons may be subject to sanctions and export control restrictions directly applicable to them in the jurisdictions in which they operate, as many U.S. partners, such as the European Union, the United Kingdom, Canada, Australia and others have imposed their own sanctions and export controls targeting Russia.
Additionally, under certain circumstances the U.S. measures described above could be directly applicable to non-U.S. persons, as follows:
- Any non-U.S. person that "causes" a U.S. person to violate sanctions itself commits a violation of sanctions, such as through the engagement of U.S. suppliers or the use of U.S. dollars in support of restricted activity.
- The EAR apply to all persons worldwide that deal in items subject to the EAR.
- Non-U.S. persons face risk of themselves being designated as sanctioned persons under U.S. secondary sanctions to the extent they engage in activity inconsistent with U.S. policy. Such activities may include providing significant support, goods, or services to a sanctioned person, or certain transactions with strategic Russian sectors, including energy and defense.
The broad range of restrictions targeting Russia presents compliance challenges that cascade throughout the cross-border context. Parties that assess their level of exposure to direct and indirect Russia-related risk, and accordingly adopt a risk-based approach, will be well-positioned to navigate the landscape.
“How Russia Sanctions Are Affecting Compliance,” by Anthony Rapa and Matthew J. Thomas was published in Law360 on May 25, 2022.
Blank Rome partner George T, Boggs contributed to this article.