Blocking Regulation: The first step towards solving the conflict of laws between EU and US sanctions

Hogan Lovells

[co-author: Iris C. Z. Karaman]

The Court of Justice of the EU has interpreted for the first time the Blocking Regulation. The ruling confirms that it is possible to terminate contracts with a US designated person without providing reasons. However, in civil proceedings it is for the EU party to prove that, when it sought to terminate a contract, it did not seek to comply with US sanctions in the absence of an authorisation by the European Commission. The Blocking Regulation does not preclude the annulment of the termination of a contract, provided the annulment does not have disproportionate economic losses for the EU person concerned. EU companies will keep facing challenges to comply with the US sanctions on Cuba or Iran whilst being prohibited from doing so under the Blocking Regulation and should consider appropriate ways to maintain evidence about the motivations behind termination of contracts with SDNs.

Introduction

On 21 December 2021, the Grand Chamber of the Court of Justice of the EU (“Court”) rendered its judgment in case C-124/20, on a request by the Higher Regional Court of Hamburg (“referring court”) for a preliminary ruling on the interpretation of the EU Blocking Regulation, made in proceedings between Bank Melli Iran (“BMI”) and Telekom Deutschland GmbH (“Telekom”). Under the preliminary ruling procedure, national courts of Member States can refer a question on the interpretation or application of EU law to the Court. The Court is competent to provide an answer to the questions asked, but not to rule on the underlying dispute before the referring court.

Legal Background

The Blocking Regulation was adopted in 1996 and aims to protect EU parties from the extra-territorial application of non-EU countries’ laws, listed in an Annex thereto (“Listed Laws”). Listed Laws include certain US sanctions measures on Iran. Article 5 of the EU Blocking Regulation (“Article 5”) prohibits EU persons from, among others, complying, directly or through a subsidiary or other intermediary, actively or by deliberate omission, with Listed Laws, unless authorised by the European Commission (“Commission”).

Following the reinstatement of US sanctions on Iran, the EU amended the Blocking Regulation in August 2018 to include certain US sanctions legislation on Iran under the Listed Laws. Among other restrictions, those sanctions targeted dealings with parties listed on the Specially Designated Nationals and Blocked Persons List (“SDNs”) maintained by the US Office of Foreign Assets Control (“OFAC”), even if the activity had no US nexus – the so-called “secondary sanctions”. Under secondary US sanctions, any non-US entity that is not owned or controlled by a US person could face exposure under Iran-related sanctions legislation for engaging in a “significant” transaction with any Iranian party listed as an SDN, even if the activity has no US nexus.

The Underlying Dispute

BMI is an Iranian State-owned bank with a branch office in Germany. It has concluded several telecommunication services contracts with Telekom, a subsidiary of Deutsche Telekom AG, established in Germany. Under various contracts, Telekom provided BMI with several telecommunications services which are essential to the internal and external communication of BMI in Germany. The contracts did not involve the supply of US-origin goods, software and technology, so the US Export Administration Regulations (EAR) did not apply. As we understand, the contracts also did not involve any USD payments or otherwise a US nexus such that would have triggered primary US sanctions.

In November 2018, following BMI’s re-designation as an SDN, Telekom notified BMI that it would terminate all contracts with immediate effect. BMI brought interim proceedings before German Courts. In one of those proceedings, the Regional Hamburg Court ordered Telekom to perform the contracts until the end of the notice periods for ordinary termination, which were due to expire between 25 January 2019 and 7 January 2021. However, Telekom terminated the contracts “as of the earliest possible date”, without providing reasons for the termination. The case escalated to the referring court, with BMI claiming that termination of the contracts was inconsistent with the Blocking Regulation, because Telekom terminated the contracts only in order to comply with US secondary sanctions. Telekom submitted that, under the Blocking Regulation, it had the commercial freedom to terminate its contracts with BMI at any time and for any reasons.

Findings of the CJEU

The referring court asked the following questions to the Court:

  • Does Article 5 apply only where the US issues an administrative or judicial order directly or indirectly against an EU company, or does it suffice that the EU company seeks to comply with US secondary sanctions?

The Court concluded that Article 5 applies if an EU company intends to comply with Listed Laws, even without having received a court or administrative order from the US authorities to do so. This is consistent with the letter and spirit of the Blocking Regulation, which would not be effective in countering the effects of Listed Laws if it only prohibited compliance with judicial or administrative orders.

  • Does Article 5 require that the party giving notice of termination without an authorisation by the Commission needs to show and prove in civil proceedings that the reason for terminating was not a wish to comply with US secondary sanctions?

The Court confirmed that the Blocking Regulation can be relied on in civil proceedings and concluded that EU companies may terminate contracts with SDNs without providing reasons. Article 5 does not prohibit EU parties without an authorisation by the European Commission to terminate contracts with SDNs without providing reasons. Consequently, national law allowing EU parties without any authorisation by the Commission to terminate contracts with Iranian SDNs are not inconsistent with Article 5.

However, under the German Civil Code, the termination of a contract in breach of a statutory prohibition such as the Blocking Regulation would be null and void. Accordingly, it is for the party claiming breach of a statutory prohibition to show that the termination of the contract was a violation of the Blocking Regulation. The Court held that proving this would be very difficult or virtually impossible as evidence is generally not accessible. Therefore, the Court concluded that, in civil proceedings, the burden of proof is reversed: it is for that EU company to prove that it did not seek to comply with Listed Laws.

  • Is termination of a contact with an SDN in breach of Article 5 ineffective or can other penalties satisfy the purpose of the Blocking Regulation? Is the termination ineffective even where maintaining the contract with the SDN would expose the EU company to considerable losses on the US market?

The Court concluded that the Blocking Regulation does not preclude the annulment of a termination of contracts to comply with Listed Laws without authorization from the Commission, provided that the annulment does not have disproportionate effects.

If the termination of the contracts by Telekom where deemed inconsistent with the Blocking Regulation, the termination would be null and void under German law. However, an annulment of the termination would entail a limitation on Telekom’s freedom to conduct business, which is a fundamental EU right. The Court, taking into account the Charter of Fundamental Rights of the EU, confirmed that the right to conduct business is not absolute and must be weighed against other interests protected by the EU legal order. It concluded that limiting the freedom to conduct business (by annulling the termination of the contracts due to a breach of Article 5) would limit, but not deprive Telekom of the possibility to assert its interests. This is because the annulment is justified only to the extent Telekom effected that termination in order to comply with the Listed Laws.

However, if Telekom demonstrated that the limitation of its freedom to conduct business is disproportionate, the annulment of the termination of the contracts with BMI could not be sustained. In the Court’s view, the limitation of the freedom to conduct business resulting from the possible annulment of the contract’s termination contrary to Article 5 would be in principle necessary in order to counteract the effects of the Listed Laws. However, it is for the referring court to assess whether such limitation is proportionate.

The Court suggested that, when assessing the proportionality of the limitation on the freedom to conduct business, the referring court must strike a balance between the objectives of the Blocking Regulation and the probability that Telekom would be exposed to economic losses and the extent of those losses if it was not able to terminate its contract with an Iranian SDN. In this assessment, the referring court should take into account the fact that Telekom did not apply to the Commission for an authorisation to take actions that would eliminate its exposure to US sanctions, thus depriving itself from the possibility to avoid limiting its freedom to conduct business.

Practical Considerations

Since 2018 when the Blocking Regulation was amended to include additional US sanctions legislation on Iran under Listed Laws, EU Persons have faced significant compliance challenges due to the clear conflict of laws that the Blocking Regulation creates. EU companies that are owned or controlled by US persons must comply with primary US sanctions, which are part of Listed Laws. In addition, EU entities that are not US-owned or controlled face exposure under US secondary sanctions against Iran when engaging in activity with no US nexus because those measures also were added to Listed Laws in 2018. At the same time both types of EU entities are prohibited from complying with those US sanctions under the Blocking Regulation. While various Member States have not adopted national enforcing legislation, the Blocking Regulation is directly applicable in all 27 Member states, and has emerged in various national court proceedings over the past few years.

The recent CJEU judgment sheds some light into the scope of application of the Blocking Regulation although a number of questions remain unanswered. Importantly for companies, the judgement confirms that the Article 5 prohibition applies where an EU person agrees to comply with the Listed laws, for example in private contracts or in its internal sanctions compliance policies. The judgment also acknowledges the challenges EU companies with operations in countries affected by Listed Laws are facing: the proportionality assessment that national courts will have to make when assessing the legality of a contractual termination will have to consider the risk of disproportionate economic losses if restrictive measures were imposed on it by the US government under US secondary sanctions. Failure by EU persons to seek authorization from the Commission to terminate a contract will also be taken into consideration by national courts when conducting this legality assessment.

However, the Court did not provide useful guidance as to how this fine balance should be achieved, which is to be determined by national courts. In practice, this means that EU companies will continue facing the risk of falling foul of the Blocking Regulation unless they are in a position to prove that:

  • Termination of contracts with Iranian SDNs are founded in commercial or other reasons (e.g., anti-corruption) and are not motivated by the threat of US sanctions. Companies should consider the most appropriate way to gather and maintain such evidence; and/or

  • Potential fines or other restrictive measures that could be imposed by the US government under Listed Laws would have a severe and disproportionate effect on the company’s operations. Information communications with the company’s counsel on the level of these penalties and/or legal analyses of the company’s sanctions exposure under Listed Laws could shed light into this point.

Next steps

The Commission is currently preparing a revision of the Blocking Regulation, which was submitted to public consultation in late 2021. At time of writing, it appears that the Commission intends to include additional mechanisms for deterring compliance with the Listed Laws and “streamlining” the application of the Blocking Regulation. A proposal is expected in the second quarter of 2022.

EU stakeholders who have engaged in the public consultation have highlighted the economic reality of sanctions compliance, with some arguing for the exclusion of certain sectors from the prohibition on compliance with the Listed Laws such as the financial sector.

What about the UK?

The UK transposed the Blocking Regulation into domestic law on 1 January 2021 pursuant to The Protecting against the Effects of the Extraterritorial Application of Third Country Legislation Regulations (known as the “Retained Blocking Regulation”). However, due to Brexit, the revision to the Blocking Regulation will not extend to the UK and the UK has not publicly announced an intention to adopt similar changes to the Retained Blocking Regulation. In addition decisions of the Court issued on or after 1 January 2021, including the Court’s BMI ruling, are not binding on the UK, although such decisions can be persuasive when UK courts interpret retained EU law. It remains to be seen whether UK courts will follow or diverge from the principles in the BMI ruling when interpreting the Retained Blocking Regulation.

For an comprehensive overview of the EU, UK and US sanctions landscape, and to monitor the ever developing world of sanctions laws, visit our new Sanctions Navigator, which provides comprehensive information on all key international sanctions regimes, and send updates on major sanctions developments.

[View source.]

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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