More than ever before, financial institutions are concerned about exposure to government enforcement actions, particularly in connection with trade sanctions regulations. These concerns have led to increasingly robust compliance language in credit agreements with their corporate borrowers. This article describes some of the enforcement trends that are combining to raise the threat-level for banks and identifies some of the concerns of borrowers regarding the cascading effects on the standard language of contracts governing access to corporate credit.
Representations and warranties, and covenants concerning general compliance with laws have long been a staple of credit agreements between corporate borrowers and financial institutions. More and more, these general provisions are followed by specific and detailed provisions addressing compliance with U.S. and non-U.S. laws and regulations governing sanctions and other trade restrictions, anti-terrorism, anti-bribery and anti-money laundering (AML). The addition of specific reference to some or all of these laws and regulations, combined with the absence of much wiggle room for compliance, stems from several developments that have raised the risks to financial institutions and incentivized them to shift some of that risk to their borrowers. In turn, borrowers have become increasingly concerned about their ability to assume such risk.
The most important driver for financial institutions is likely the significant number of high-dollar sanctions-related enforcement actions directed at banks by the U.S. Department of Justice (“DOJ”) in recent years. Most of the matters involve violations of regulations, promulgated and administered by Treasury’s Office of Foreign Assets Control (“OFAC”), that prohibit transactions between the U.S. financial system and Iran. Eight of the world’s largest banks have acknowledged violating these regulations (or similar regulations involving countries such as Cuba and Sudan) and paid fines ranging from $33 million to $8.9 billion since 2009. Some of these settlements involved parallel enforcement actions by the New York State Department of Financial Services, which along with counterparts such as the California Department of Business Oversight have become sanctions and AML enforcers to reckon with.
Although most of the enforcement activity has focused on foreign financial institutions, these cases have focused domestic lenders’ attention on compliance with OFAC regulations. At the same time, for several reasons, those regulations are growing increasingly complex.
Unpacking the OFAC Dynamic
First and foremost, the perceived success of international sanctions in forcing Iran to the negotiating table has demonstrated the utility of sanctions to policy makers. As a result, sanctions are a more popular foreign policy tool. Sanctions have been a key part of the West’s response to Russia’s activities in Ukraine. In particular, the sanctions imposed by the U.S. against Russian individuals and businesses have implicated several Russian energy companies and financial institutions that did significant international business, increasing the likelihood that an international transaction could run afoul of OFAC’s regulations.
While U.S. sanctions against Russia have been growing tighter, there are several sets of sanctions that appear to be going in the opposite direction. Pursuant to the P5+1 Joint Plan of Action with Iran (“JPA”) announced in November 2013, the U.S. temporarily suspended its Iran sanctions in a very limited number of areas. These temporary suspensions are focused almost exclusively on secondary sanctions targeting the conduct of non-U.S. persons and entities, leaving the sanctions essentially unaltered with respect to U.S. persons and entities owned or controlled by U.S. persons. Moreover, the suspension of sanctions will not be extended if the parties are unable to reach agreement on Iran’s nuclear program. Some sanctions imposed by the EU and other members of the international community have also been suspended.
If the agreement reached with Iran over its nuclear program in July 2015 is adopted by the Congress (as now appears likely), it will result in significant changes to U.S. sanctions. However, the U.S. has expressed that its concerns with Iran’s support of terrorism justify continued imposition of a significant sanctions program against Iran, indicating that at least some U.S. sanctions against Iran will remain in place.
On another front, in December 2014, President Obama announced that the U.S. would begin normalizing diplomatic relations with Cuba and called for a lifting of the comprehensive sanctions targeting Cuba. Since then, his administration has announced new measures permitting additional travel, trade and financial transactions with Cuba. However, the changes so far are modest, as the lifting of the embargo will require congressional approval.
The sanctions relating to Iran and Cuba are similar in that, with respect to each, there appears to be substantial easing on the horizon, but we are not there yet. Because these countries have been closed to U.S. business for some time, there are likely U.S. businesses that are poised to jump in as soon as changes come. And that raises the possibility that some might jump the gun, violating sanctions in the course of their attempts to lay the groundwork for a post-sanctions era.
In the past, for most companies the breadth of sanctions against these two countries translated to a single, straightforward principle: absolute prohibition. Now if the red light turns to yellow, opportunities for sanctions violations may increase.