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The Effects of COVID-19 on Sanctions and Export Controls

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The Effects of COVID-19 on Sanctions and Export Controls

The global outbreak of the novel COVID-19 virus and resulting pandemic have disrupted nearly all fields of commerce throughout the world. While the situation continues to develop and has had broader implications, the effect both on U.S. and EU sanctions and export control policies is notable. We summarize below some of the changes to U.S. sanctions and export controls that have occurred in recent weeks in response to the pandemic. We also present the European response to this crisis with respect to export control regulations. Because the situation is dynamic, compliance professionals should continue to monitor further developments closely.

The U.S. Response to COVID-19

Favorable Licensing for COVID-19 Related Goods and Services for the Time Being

For the time being, many items related to the coronavirus response are subject to general authorization and otherwise favorable review standards. Already the U.S. government has issued general licenses to facilitate the provision of humanitarian goods to Iran, where the virus has had a devastating impact. Specifically, on February 27, 2020, the U.S. Department of the Treasury, Office of Foreign Assets Control (“OFAC”) – the U.S. agency responsible for administering and enforcing most U.S. sanctions – issued General License 8. That general license authorizes payments and related transactions involving the Central Bank of Iran for exports of food, medicine, and medical devices. The general license builds upon several existing authorizations, which are summarized in a new Frequently Asked Question issued on March 6, 2020, and broadly permits certain donations and other humanitarian aid to Iran, so long as the recipients are not the Government of Iran, Specially Designated Nationals, or otherwise prohibited parties.

To date, there have been no similar general licenses issued by the U.S. Department of Commerce, Bureau of Industry and Security (“BIS”), which is the U.S. agency responsible for dual-use export controls on goods and technology. For the time being, we anticipate that license requests for COVID-19 related items that would require authorization from BIS will generally be reviewed favorably by the agency, consistent with the policy underlying OFAC’s General License 8. In particular, on February 7, 2020, BIS issued guidance specifying that the COVID-19 virus is classified as EAR99, meaning that samples of the virus subject to the EAR (by, for example, being present in the United States) generally may be exported, re-exported, or transferred to most countries without a destination-based license. This is notable because the related virus from the SARS outbreak in 2003 is classified under ECCN 1C351.a.46, which is subject to more stringent licensing requirements. The current classification of the COVID-19 virus as EAR99 could, therefore, more easily facilitate international research on treatments and vaccines for the virus.

However, as the crisis continues to unfold, if certain essential resources become globally scarce – such as respirators and certain medicines – it is possible that BIS could control such items under its existing powers applicable to goods in “short supply,” which are described in Part 754 of the Export Administration Regulations. In the immediate aftermath of the outbreak, a number of countries around the world instituted unilateral trade controls on medical equipment and other supplies needed to respond to the pandemic.  Indeed, according to one report, as of March 21, 2020, at least 54 governments had instituted such controls. In addition, following restrictions by some individual member states, the EU instituted a license requirement for the export of personal protective equipment. Other counties – including Russia, Turkey, and India – have imposed similar restrictions or outright bans on export. The White House is also reportedly drafting a “Buy American” executive order intended to bring pharmaceutical and medical supply manufacturing back to the United States, but has been met with opposition within the administration.  In addition, on April 3, 2020, the White House used the Defense Production Act to block U.S.-based 3M from exporting surgical face masks abroad, signaling perhaps a more aggressive approach towards controls on items used to contain the outbreak.

Timing Delays

With the metropolitan Washington, D.C. area and other major cities throughout the United States subject to shelter-in-place orders, all but essential government employees have moved their work from their normal physical locations to home.  Inefficiencies, distractions, and family needs could delay and expand the review timelines of license applications and other requests for authorization. If a large number of the personnel responsible for license reviews or their immediate family members become ill, delays could be extended even further.

In addition, even for exports or re-exports that are authorized, finding available shippers and freight forwarders may prove challenging, with many non-essential shipments being delayed to free up supply-chain resources necessary to effectively respond to the pandemic. Shippers, such as FedEx, have reduced their capacity in response to the slowing economy, and have suspended their service guarantees in anticipation of delays.

Further, ongoing regulatory objectives may be put on pause or delayed. In particular, the Export Control Reform Act of 2018 directed BIS (in conjunction with the Departments of Defense, Energy, State, and other agencies as appropriate) to define the terms “emerging technologies” and “foundational technologies,” and to impose controls on such technologies that are “essential to the national security of the United States.” In late 2018, BIS issued an Advance Notice of Proposed Rulemaking to solicit comments on the criteria that should be considered in defining “emerging technology,” and recently – in January 2020 – issued an interim rule with the first restrictions applicable to artificial intelligence software. A proposed definition for “emerging technology” had been expected by the end of 2019, but it is likely that the COVID-19 crisis will result in further delay of additional rulemaking on this issue.

Enforcement Remains Steady

Nevertheless, enforcement activity – at least throughout the early part of the crisis – has continued. For example, during the week of March 16, 2020 alone, OFAC took three separate enforcement actions to designate nearly twenty parties involved in exporting Iranian petroleum products. Similarly, on March 26, 2020, U.S. Department of Justice announced that a federal grand jury had indicted Venezuelan President Nicolás Maduro on drug trafficking and money-laundering charges, even as courts across the country began to close and suspend proceedings in response to the crisis.  The devastating effect that the virus has had thus far in Iran in particular has drawn international pressure for the U.S. to lift sanctions targeting that country and others, with one of the most prominent calls coming on March 31, 2020, from the UN Special Rapporteur on the Right to Food. However, Treasury Secretary Steven Mnuchin vowed, “The Trump administration will continue to target and isolate those who support the Iranian regime.”

It is therefore imperative that companies remain vigilant in their compliance efforts, even while juggling a myriad of unprecedented and difficult challenges. In particular, employees working from home should exercise care, especially when utilizing technical data subject to export controls, to avoid inadvertent “deemed” exports to unauthorized persons. Compliance officers should also stress that companies’ compliance procedures – such as screening and third-party due diligence – remain in effect throughout the crisis.

The EU’s Response to COVID-19

In response to the crisis, EU Member States have aimed to protect the supply of goods and technologies within the medical and healthcare sector at the country level, while at the same time regulating EU exports to third countries at the European level.

The EU’s Limitations on Export Restrictions Between Its Member States

According to Article 168 of the Treaty on the Functioning of the EU (“TFEU”), public health falls within the jurisdiction of Member States themselves. Member States are therefore, in principle, free to organize and supply their healthcare systems as they see fit.

However, EU action can, by its own terms, “supplement” and “support” these national policies. As such, Article 4 of the TFEU and Article 168 of the TFEU provide for shared jurisdiction between the EU and Member States on common security and public health issues. This shared jurisdiction includes such issues as disease prevention, combating major health scourges, and combating serious cross-border threats to health. Nevertheless, it should be noted that the EU’s ability to legislate and adopt legally binding texts on these matters is limited to those that do not require legislative or regulatory harmonization of Member States’ national laws.

For their part, Member States have the obligation to respect the fundamental principle of the free movement of goods within the single EU market, as provided for in Articles 26 and 28 to 37 of the TFEU, and barriers to the trade of goods may only be re-established in certain circumstances, such as the protection of public health.

In this vein, since the beginning of the health crisis in Europe, several countries, including France and Germany, have taken national measures introducing requisitions of personal protective equipment (“PPE”) – which includes equipment such as masks, protective goggles and visors, face shields, oral-nasal protective equipment and protective clothing – and restrictions on the export of this PPE. For example, France seized all stocks of anti-projection and FFP2 type surgical masks from national producers and distributors, and then extended this requisition to other types of surgical masks. These national requisitions have de facto restricted all exports of masks outside French and German territories.

To respond to this seeming retreat within national boundaries, and in order to ensure the free movement of goods between Member States, the EU has reacted twofold: to provide a coordinated response to the health crisis and ensure unhindered access to medical supplies within the EU.

First, on March 13, 2020, the European Commission reminded the French and German governments, without naming them directly, that “[i]t is essential to act together to secure production, stocking, availability and rational use of medical protective equipment and medicines in the EU, openly and transparently, rather than taking unilateral measures that restrict the free movement of essential healthcare goods.”  In so doing, Brussels therefore called upon the crucial importance of solidarity between Member States during the current health crisis.

Second, the Commission issued new guidelines on border management measures to protect public health and ensure the availability of essential goods and services. The text emphasizes that “[t]he coronavirus crisis has highlighted the challenge of protecting the health of the population whilst avoiding disruptions to the free movement of persons, and the delivery of goods and essential services across Europe.” The EU, through these guidelines, thus reminded its Member States that safeguarding the functioning of the single market is essential to address shortages that would exacerbate the social and economic difficulties Member States are already experiencing.

In response to the Commission’s call, France and Germany decided to withdraw their restrictive measures on transfers of PPE to ensure that “the [PPE] equipment held goes where it is needed, to patients, doctors, hospitals, health care staff, etc.” By way of example, at the end of March, France and Germany each sent more than a million masks and 200,000 protective suits to Italy.

Export restrictions between EU Member States and third countries

The Commission has adopted Regulations (EU) 2020/402 and (EU) 2020/426, requiring PPE exports from the EU to non-EU states to be subject to prior authorization by the competent authorities of the Member States.

This measure is applicable for a period of six weeks starting on March 15, 2020. However, exports to Norway, Iceland, Liechtenstein, and Switzerland, as well as to the Overseas Countries and Territories (i.e., those countries identified in Annex II of the TFEU which are described in Article 198 of the TFEU as “non-European countries and territories which have special relations with Denmark, France, the Netherlands and the United Kingdom”), the Faroe Islands, Andorra, San Marino and Vatican City, will not be subject to these restrictions.

In France, it is the Service des Biens à Double Usage (i.e., the French Dual-Use Goods Agency, the “SBDU,” attached to the Ministry of the Economy), that has been designated by the Commission as the authority for issuing export authorizations for the medical protection goods listed in the Schedule to Regulation 2020/402 of March 13, 2020. The SBDU is authorized to receive applications, organize the administrative process, and make licensing decisions according to the criteria set out in the aforementioned Regulation.

Conclusion

The COVID-19 outbreak presents new and unprecedented challenges. Its effect on the U.S., EU and international approach to sanctions and export controls may be felt for months or even years to come. While the crisis is still in its early stages, compliance professionals should monitor developments daily, ensuring their respective companies are continuing to maintain appropriate risk-based compliance efforts.

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By Ryan Fayhee, Roy (Ruoweng) Liu, Alan G. Kashdan, Olivier Dorgans, Tyler Grove and Camille Mayet at Hughes Hubbard & Reed LLP

compliance

U.S. Regulators Focus on Compliance Efforts in Enforcement Decisions Involving International Companies

Over the past few years, U.S. regulators have made it clear that having comprehensive and effective compliance policies covering trade is a must, regardless of the company size, location or industry. The government’s move to formalize the importance of compliance programs is a clear signal of what it expects and a harbinger of what is to come.

Why Is Trade Compliance Important Regardless of the Company’s Location?

Trade compliance should be the goal of every global company, in particular as a risk mitigation measure and a positive value proposition. A compliance program serves as a security blanket for large financial institutions accustomed to dealing with regulations, small startups with a cloud-based platform, and even companies with no physical presence in the United States. A trade compliance program lays the groundwork for international companies on how to conduct business in or with the United States.

With changing industry regulations, it is critical to keep up to date and have a compliance program that is effective. Failure to have a strong compliance program could result in increased legal exposure, potentially leading to fines and penalties as well as negative publicity associated with an enforcement action. Maintaining an effective trade compliance program could help companies mitigate penalties for potential violations, and is ultimately cost-effective. For example, last year, the U.S. government imposed $1.3 billion in penalties on cargo firms, penalties that could have been mitigated with robust compliance programs.

 Avoiding U.S. Sanctions

Engaging in the complex global supply chain may be a financial win, but it requires formalized diligence procedures to ensure your company does not run afoul of the law. The Department of Treasury’s Office of Foreign Assets Control (OFAC) has released guidance encouraging organizations to employ a risk-based approach to sanctions compliance and focus on five essential components: senior management commitment, risk assessments, internal controls, testing and auditing, and training. To incentivize companies to engage in international transactions, OFAC also provides that in the case of a violation, it will give favorable consideration to companies with effective sanctions compliance programs and that the existence of such a program may mitigate a civil monetary penalty.

OFAC is not just issuing guidance, it is increasing its enforcement efforts involving both U.S. and foreign entities. It continues to designate more non-U.S. entities that have helped evade U.S. sanctions. For example, several Chinese shipping companies were found to have violated North Korean sanctions, and as a result, were blocked from doing business in the U.S. or with U.S. parties. In January 2020, Eagle Shipping, a Marshall Islands ship management company with headquarters in Stamford, Connecticut, agreed to pay $1,125,000 to settle its potential civil liability for 36 apparent violations of the Burmese Sanctions Regulations. The violations involved Eagle Shipping’s affiliate in Singapore entering into a chartering agreement with Myawaddy—an entity identified on OFAC’s List of Specially Designated Nationals and Blocked Persons. Eagle filed an application with OFAC requesting a license authorizing it to carry sand cargoes purchased from Myawaddy but continued its dealings while the OFAC application was pending. OFAC ultimately denied the license, but Eagle resumed its dealings with Myawaddy, carrying cargo from Burma to Singapore.

Among the aggravating factors, OFAC considered Eagle’s status as a sophisticated shipping company, which should have had expertise in international trade and global shipping transactions. Among the mitigating factors, OFAC considered Eagle’s efforts to develop and implement a formal sanctions compliance program with specific policies and procedures for compliance screening, transaction checklists, and red-flag identification tools.

Compliance Under Commercial Export Laws

The U.S. Department of Commerce’s Bureau of Industry and Security (BIS), which administers U.S. commercial export control regulations, also has published comprehensive guidance for companies working to develop or shore up compliance materials. In its guidance, BIS identified the following elements as foundational in creating an effective Export Compliance Program (ECP): management commitment, completing regular risk assessments, obtaining proper export authorization, record-keeping, training, compliance audits, addressing export violations and taking corrective actions, and maintaining your ECP. Like OFAC, BIS emphasizes the importance of tailoring your ECP to your organization and business based on size, volume of exports, geographic location, and other relevant factors. Companies that fail to comply with regulations that govern export controls have experienced significant penalties.

The U.S. export control laws govern not only U.S. companies, but also certain export activities of foreign companies dealing with the export of certain products, technology, or services from the United States to a foreign country. For example, most recently, BIS imposed substantial export and reexport restrictions on Huawei, a Chinese company, and its 68 non-U.S. affiliates in connection with Huawei’s violations of U.S. export laws specific to the Iranian Transactions and Sanctions Regulations. As part of that action, BIS restricted any export, re-export, or transfer of U.S.-origin technology, commodity, or software to Huawei and its entities without an export license.

This enforcement action ultimately impacted both the U.S. and non-U.S. businesses, including big and small tech companies, suppliers, importers, shippers, and financial institutions. Separately, in 2017, the U.S. government imposed a $1.2 billion criminal fine against ZTE, a Chinese telecom equipment company, for shipping U.S.-origin telecommunications equipment to Iran and North Korea. These two cases have affected how U.S. and foreign companies view their compliance programs; they also have incentivized the development and implementation of more robust compliance programs, including vetting procedures and sanctions checks that ensure adherence to the U.S. export control regulations.

Recommended Steps for Ensuring Compliance and Mitigating Risk

-The benefits of having a compliance program in place when a mistake happens are significant. When creating your tailored trade compliance policies and procedures, remember the following:

-Compliance programs should include a comprehensive, independent, and objective testing or audit function to ensure that your business is aware of how its programs are performing.

-Programs should be updated regularly in light of constantly changing regulatory and business environments.

-Ensure that your compliance program has comprehensive coverage to track all parties involved in import and export transactions.

-Even products that seem harmless can be used in ways that companies do not intend. As an organization, you are responsible for knowing how your products will be used and for avoiding government-prohibited end uses.

-Watch for red flags on BIS’s published list.

-Watch for “deemed” exports, which are released in the United States of technology or source code to a foreign person. Such a release is deemed to be an export to the foreign person’s most recent country of citizenship or permanent residency, which may require a license or even be prohibited.

Now more than ever, government offices and agencies are providing the industry with guidance on how best to comply with trade regulations. However, this also means that companies can no longer claim ignorance of trade regulations. Today, companies participating in the global marketplace must take proactive preventive measures to ensure compliance, mitigate risk, and minimize potential penalties.

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 Doreen Edelman and Zarema Jaramillo are attorneys at Lowenstein Sandler.