A recent federal appeals court decision addresses a familiar issue for many companies: When can a U.S. exporter be liable for a product that is re-exported to a sanctioned country, such as Iran? This update summarizes the opinion of the U.S. Court of Appeals for the District of Columbia Circuit in Epsilon Electronics Inc. v. United States Dep’t of Treasury (Epsilon), and offers practical advice to U.S. exporters on how to avoid potential liability resulting from transactions with distributors in light of Epsilon.
Summary of Epsilon Opinion
The Epsilon case concerned the decision of the Office of Foreign Assets Control, U.S. Department of Treasury (OFAC), to impose a $4.1 million penalty on Epsilon, a U.S. exporter of electronics. The transactions at issue concerned Epsilon exports of electronic products to a United Arab Emirates (UAE) distributor, which OFAC believed were later re-exported to Iran.
In charging Epsilon with 39 violations of the Iranian Transactions and Sanctions Regulations (ITSR), OFAC invoked the ITSR prohibition on sending items to a non-sanctioned third country if the U.S. exporter knew or had reason to know that the goods are intended for re-export to Iran. OFAC relied upon evidence showing that the distributor in question sold items exclusively to Iran, and that Epsilon was aware of this distributor’s practice.
The Epsilon opinion is a rare instance of a U.S. Court of Appeals opining on OFAC’s regulations and an OFAC enforcement action. The Epsilon opinion holds that:
U.S. exporters can be liable even if the items in question did not go to Iran. A U.S. exporter may be liable for an export violation under the ITSR even if the third-country recipient did not actually re-export the items to Iran. The relevant inquiry is what the U.S. exporter knew, or had reason to know, concerning the distributor’s activities. OFAC does not need to prove that the items in question were actually re-exported to Iran.
OFAC must evaluate evidence indicating the sales went to non-Iranian locations. According to Epsilon, OFAC unlawfully failed to explain why evidence suggesting that the distributor was reselling the merchandise in the UAE market, rather than the Iranian market, was not credible. On this basis, the Court of Appeals for the D.C. Circuit remanded OFAC’s finding of violations for five transactions where evidence suggested those transactions were for the UAE market. In contrast, the opinion affirmed OFAC’s findings of ITSR violations for 34 transactions where evidence showed that the distributor sold such items exclusively to the Iranian market.
The general inventory exception does not trump evidence imputing knowledge to a U.S. exporter of resales to Iran. The ITSR provide what Epsilon argued was a safe harbor if the third-country distributor put the items from the United States into general inventory. The court disagreed. Where a U.S. exporter sells to a third-country distributor and has reason to know that the product is intended for resale to Iran, this is a violation of the ITSR notwithstanding that the products might go into a distributor’s general inventory. Thus, the general inventory exception does not necessarily negate evidence placing the U.S. exporter on notice that the goods ultimately might be destined for Iran. Historically, many believed that, if a third-country distributor places goods into general inventory, this precluded a U.S. exporter from having knowledge required to establish an ITSR violation. At OFAC’s urging, the Epsilon opinion rejected this position.
The Epsilon court affirmed several aggressive positions taken by OFAC concerning the scope of the ITSR. These interpretations are not obvious from reading the ITSR. But standard tools for interpreting regulatory text can be risky in the sanctions setting because: (1) the underlying statutes broadly delegate authority to the executive branch; (2) courts rarely disagree with an agency’s interpretation of its own regulations; and (3) deference to the executive branch is even greater in the national security context. These legal realities suggest a conservative reading of OFAC sanctions regulations.
Practical Advice for U.S. Exporters
U.S. exporters often have limited visibility into what distributors will do with goods, software or technology after they are exported from the United States. Certain actions can mitigate the risk of a U.S. exporter’s product being diverted to a prohibited destination.
Add diversion prohibitions to contracts and obtain certifications of compliance with these prohibitions. U.S. exporters should insist that distributors agree not to divert the U.S. goods to sanctioned locations and then follow up by obtaining regular certifications of compliance from the distributor confirming that no improper product diversion has occurred.
Ask distributors to explain how they prevent product diversion. U.S. exporters should ask their distributors what actions they take to prevent diversion of items to sanctioned destinations. The answers to such questions can identify risk and even red flags that warrant follow-up by the U.S. exporter. Moreover, documenting those interactions can protect against later OFAC action by showing the U.S. exporter was diligent in vetting its distributors or resellers. In Epsilon, the U.S. exporter pointed to email correspondence indicating that it believed the reseller was involved in the UAE market, not the Iranian market. The court faulted OFAC for failing to fully consider this evidence.
Review publicly available sources about distributors. U.S. exporters sometimes can gain insight into their distributor’s markets by reviewing public filings, the distributor’s website and news articles. In Epsilon, the UAE reseller’s website made clear that it provided items to the Iranian market. Enforcement authorities regularly urge U.S. exporters to conduct sufficient due diligence to avoid unnecessary risk. They also will adjust penalties based on the robustness of the U.S. distributor’s due diligence efforts.
Examine carefully all export information provided by the distributor. For significant transactions, U.S. exporters should examine carefully the export documentation from the distributor. Such examination may reveal a reference to a prohibited destination or end user in the documentation, or raise a question that merits follow-up by the U.S. exporter.
These efforts should form part of a comprehensive effort to mitigate risk and educate employees to identify potential export compliance problems.