US secondary sanctions: The Court of Justice interprets the EU Blocking Statute
On 21 December 2021, the Court of Justice of the European Union issued a long-awaited judgment on the interpretation of the EU Blocking Statute in C-124/20, Bank Melli. Although the ruling does not dispel all doubts, it does set the direction for interpretation and shows that even imperfect regulations must be applied.
Council Regulation (EC) No 2271/96 of 22 November 1996 protecting against the effects of the extra-territorial application of legislation adopted by a third country, and actions based thereon or resulting therefrom (known as the EU Blocking Statute) was adopted in response to a US sanctions policy aimed at de facto establishing extraterritorial jurisdiction of the United States (we wrote about secondary sanctions in the context of export of dual-use goods). The purpose of the Blocking Statute is to protect the interests of EU member states and natural and legal persons exercising fundamental freedoms of the EU from the effects of sanction laws of third countries (currently it covers US sanctions against Cuba and Iran).
In practice, the Blocking Statute was little used until 2018, when the US withdrew from the Iran nuclear deal (Joint Comprehensive Plan of Action) and reinstated broad sanctions against Iranian entities. In response, the European Commission updated the annex to the Blocking Statute to include the reinstated US secondary sanctions on Iran. It also adopted Implementing Regulation (EU) 2018/1101, setting out the criteria that will be taken into account for granting compliance permits, and issued a guidance note on application of the Blocking Statute.
In the EU, the Blocking Statute invalidates the effects of judgments issued by foreign courts based on the laws of third countries listed in the annex to the regulation (Art. 4), as well as imposes on EU entities an obligation not to comply with orders resulting from those laws (Art. 5, first paragraph). At the same time, the Commission may authorise an EU entity to fully or partially comply with such rules to the extent that non-compliance with the provisions would seriously harm its interests or the interests of the European Union (Art. 5, second paragraph).
To date, EU businesses have taken a fairly conservative approach when dealing with entities subject to US sanctions. Faced with the choice between complying with US secondary sanctions or violating the Blocking Statute, they typically have chosen the former, wishing to avoid the risk of paying a large fine or being placed on the SDN list (Specially Designated Nationals and Blocked Persons List) of the US Department of Treasury Office of Foreign Assets Control (OFAC). An additional argument in favour of this strategy has been that only a few EU countries have introduced criminal and administrative sanctions for non-compliance with the Blocking Statute. (For example, German law provides that a contract termination in violation of Art. 5 of the Blocking Statute is ineffective and constitutes an administrative offence punishable by a fine of up to EUR 500,000. In the Netherlands, violation of Art. 5 of the Blocking Statute is subject to criminal liability.)
However, the question arises whether, following the judgment by the Court of Justice in C‑124/20, Bank Melli Iran v Telekom Deutschland GmbH, EU companies should consider changing their approach and assess whether a potential decision to terminate a business relationship violates the restrictions of the Blocking Statute and, as a result, exposes the company to contractual liability.
Background of the case
The case concerned the termination by Telekom Deutschland GmbH of telecommunications service agreements with Bank Melli Iran. Telekom Deutschland is a subsidiary of Deutsche Telekom, a leading German telecommunications provider. The Deutsche Telekom Group employs more than 270,000 employees worldwide, including 50,000 in the United States, where it generates about 50% of its turnover. Bank Melli is a government-controlled bank in Iran.
Shortly after Bank Melli was placed on the SDN list, Telekom Deutschland informed Bank Melli of termination of all of their binding contracts with immediate effect.
As German law provides for the invalidity of a legal act conflicting with a statutory prohibition, and as Telekom Deutschland terminated the contracts without complying with the ordinary notice periods provided for in those contracts and without authorisation from the Commission, Bank Melli challenged the termination in a German court, claiming that the termination did not comply with Art. 5 of the Blocking Statute.
Faced with this dispute, the regional court in Hamburg asked the Court of Justice to clarify certain aspects of the Blocking Statute.
Court of Justice ruling
The Court of Justice reaffirmed that the Blocking Statute does not prohibit EU entities from terminating contracts with counterparties subject to secondary sanctions without providing reasons for undertaking those steps, if that form of termination of a contract is provided for under national law. On the other hand, the counterparty may challenge the termination in a civil action on the basis that such termination was contrary to Art. 5 of the Blocking Statute.
In such a proceeding, the burden of proof may be reversed, and would fall on the party terminating the agreement. The EU entity would have to demonstrate, to the requisite legal standard, that it did not act to comply with the US sanctions provisions set forth in the annex to the Blocking Statute, and that there were objective reasons for termination of the agreement.
However, the Court of Justice did not reiterate the advocate general’s point that the decision to terminate the contract may simply be part of a responsible business strategy, as an EU business may have concerns about maintaining business relations with countries that pursue dangerous nuclear policies, take actions aimed at destabilising other countries in the region, support terrorist groups, or have discriminatory attitudes towards women and minorities and an undemocratic justice system. In his opinion of 12 May 2021, the advocate general made it explicitly clear that the right of a business not to pursue a business relationship with a given state, based on its own understanding of the values of business ethics, constitutes an essential element of the right to freedom of conscience protected by Art. 10(1) of the Charter of Fundamental Rights of the European Union and the freedom to conduct business under Art. 16 of the charter.
In any event, businesses must be careful. Not only are the reasons for termination important, but so also is the timeframe. For example, it did not escape the advocate general’s attention that Telekom Deutschland sought to terminate its contracts with Bank Melli within two weeks after entry into force of the new US sanctions, and that it behaved similarly with other clients with Iranian ties included on the SDN list and based in Germany.
Moreover, the Court of Justice held that violation of the prohibition against compliance with the US sanctions provisions set out in the Blocking Statute may result in invalidation of the termination of a contract, if such invalidation does not entail disproportionate effects, including economic losses, for the EU business entity.
The Court of Justice left the question of what could be considered “disproportionate effects” to the decision of the national courts. The criteria for evaluating requests for authorisation indicated in Commission Implementing Regulation (EU) 2018/1101 may be helpful in this regard, such as:
- Whether the applicant would face significant economic losses, which could for example threaten its viability or pose a serious risk of bankruptcy
- The existence of an ongoing administrative or judicial investigation against the applicant from the third country which is at the origin of the listed extraterritorial legislation
- The existence of a substantial connecting link with the third country, for example parent companies or subsidiaries
- Whether measures could be reasonably taken by the applicant to avoid or mitigate the damage.
An important factor for this assessment will also be whether the EU operator has applied to the European Commission for approval to comply in whole or in part with the requirements and prohibitions resulting from extraterritorial sanctions.
The ruling by the Court of Justice in Bank Melli will have significant implications for EU entities facing intractable legal and business choices regarding the performance of contracts with entities subject to US secondary sanctions.
However, it appears that if an EU undertaking chooses to comply with EU law and therefore maintain a relationship with a partner subject to secondary sanctions, its economic loss resulting from possible designation as an SDN would not be offset by a claim for restitution under the Blocking Statute. Thus, for businesses with strong commercial ties to the United States, the deterrent effect of US secondary sanctions will continue to be stronger than the potential economic compensation granted under the Blocking Statute.
To protect their position as much as possible, businesses must ensure that any decision to terminate business with US-sanctioned entities is factually justified and part of a coherent business strategy.
Companies operating in jurisdictions covered by the Blocking Statute need to be aware of the interaction between the two systems of prohibitions and seek advice at an early stage to mitigate any risks.
Anna Olejniczak-Michalska, attorney-at-law, Private Client practice, Wardyński & Partners