European court tests US sanctions rules

The CJEU has interpreted the EU Blocking Regulation for first time, as Christopher Hill, Nigel Brook and Patrick Murphy, Clyde & Co, report, and given business a little more clarity on how the rules might work

The Court of Justice of the European Union’s (CJEU) judgment in Bank Melli Iran v Telekom Deutschland GmBH (handed down on 21 December 2021), provided the first interpretation from the court of article five of the EU Blocking Regulation, which prohibits EU persons from acting in compliance with certain sanctions imposed by the US on Iran and Cuba.

In 2018, the US withdrew from the Joint Comprehensive Plan of Action and reimposed certain sanctions on Iran with effect from 5 November 2018. Shortly thereafter, Telekom Deutschland GmbH (Telekom) cancelled its contracts with the German branch of Bank Melli Iran (Bank Melli), an Iranian bank owned by the Iran government, for the provision of telephone and internet services.

Telekom cancelled the contract on the basis of paragraph 134 of the Bürgerliches Gesetzbuch (German Civil Code), which provides: “Any legal act contrary to a statutory prohibition shall be void except as otherwise provided by law.”

Bank Melli disputed Telekom’s termination of its services and commenced proceedings in the Hamburg courts, requesting specific performance of the cancelled contracts.

One of the arguments made by Bank Melli was that the sole reason for termination was Telekom’s wish to comply with US secondary sanctions, in contravention of article five of the EU Blocking Regulation.

Article five prohibits EU persons from “comply[ing], whether directly or through a subsidiary or other intermediary person, actively or by deliberate omission, with any requirement or prohibition, including requests of foreign courts, based on or resulting, directly or indirectly, from [specified US sanctions] or from actions based thereon or resulting therefrom”, unless authorised by the European Commission.

The Hamburg court subsequently sought a preliminary ruling from the CJEU regarding the interpretation of article five and its application to the dispute between Bank Melli and Telekom.

In May 2021, an advocate-general (AG) of the CJEU provided an opinion on the questions referred. The court’s ruling differs from the positions expressed by the AG in some material respects.

The first question considered whether article five applies in the absence of an order directing compliance issued by US administrative or judicial authorities. The CJEU considered that it does. Article five was broadly drafted and confirmed that it prohibited EU persons from complying with the requirements or prohibitions laid down in the laws specified in the EU Blocking Regulation’s annex, even in the absence of an order directing compliance issued by a US administrative or judicial authority.

The CJEU recognised that certain of the US sanctions laws specified in the EU Blocking Regulation’s annex were capable of achieving their intended objective through the threat of potential legal consequences (ie US secondary sanctions). Therefore, the EU Blocking Regulation would not be able to achieve its intended effect if its application was limited to compliance with the orders of US administrative or judicial authorities.

The second question addressed whether an EU operator can terminate a contract with a person designated under US sanctions (SDNs) without providing reasons for termination.

Answering in the affirmative, the CJEU confirmed that the EU Blocking Regulation does not prohibit EU persons from terminating contracts with SDNs without providing reasons. Therefore, if a contractual party is permitted by national law to terminate a contract without providing reasons, they can do so without contravening article five.

However, the CJEU went on to state that a counterparty may challenge the termination of a contract in civil proceedings on the basis that such termination was in contravention of article five. In this scenario, the burden of proof would fall on the terminating party to demonstrate, to the requisite legal standard, that they did not act in prohibited compliance with the US sanctions specified in the EU Blocking Regulation’s annex.

The CJEU did not express an opinion on the kinds of evidence that could demonstrate that an EU operator did not act in prohibited compliance with US sanctions. In this regard, the AG commented in his opinion that “there are many companies and individuals who would have ethical qualms and reservations about doing business [with Iran]”, and that any “sincere” decision to terminate a contract on this basis would need to be demonstrated (such as engagement in a “coherent and systematic corporate social-responsibility policy”).

However, it seems that such broader questions as to the relevant evidence and requisite standard of proof have been left to national courts for now.

This question of whether the termination of a contract in contravention of article five is ineffective, and would such termination be ineffective where it would expose the EU operator to substantial economic loss, was important for the Telekom Deutschland group as it generated about 50% of its turnover in the US market.

The court concluded that a contravention of article five could lead to the annulment of a contractual termination, provided that such annulment did not lead to “disproportionate effects” for the EU operator concerned.

In terms of what could amount to “disproportionate effects”, the CJEU left this matter to be decided by national courts. They instructed national courts to balance the objectives of the EU Blocking Regulation against the probability that the EU operator in question would be exposed to severe economic losses if it was unable to terminate its contractual relationship.

The CJEU emphasised that it would be relevant for national courts to consider whether the EU operator in question had sought to apply to the European Commission for authorisation to comply with US sanctions targeted by the EU Blocking Regulation, suggesting that a failure to do so could weigh against the EU operator in an assessment of “disproportionate effects”.

The court’s judgment helpfully clarifies a number of important points for EU persons around the interpretation of article five, though it also leaves other important questions unaddressed.

The judgment confirms that commercial decisions taken by EU persons in response to US sanctions risks may be subject to scrutiny in litigation. Such decisions may be reversed by EU member-state courts. The court did not state which types of conduct might amount to prohibited compliance with US sanctions. In particular, it did not comment on whether an EU operator’s reliance on contractual risk allocation provisions (which may not necessarily provide for termination of contracts) could amount to such prohibited compliance. It seems that this matter will likely be decided by EU member state courts, according to the particular facts of each case and applicable law.

An EU operator’s appetite for business with persons targeted by specified US sanctions may be influenced by several factors. The court’s judgment leaves open for contracts to be terminated without contravening article five, provided that the reason(s) for doing so are clearly and demonstrably based on grounds other than compliance with such US sanctions. Given the risk that such termination could be challenged in civil litigation, EU persons should ensure that their reasons for termination of contracts with a nexus to sanctioned counterparties or jurisdictions are clearly documented and evidenced.

The court acknowledged that penalties and remedies for a contravention of article five are not harmonised across EU member states. Therefore, it could be the case that the courts of some EU member states may order payment of damages, rather than specific performance.

It also remains to be seen how US sanctions enforcement authorities might react to a scenario in which an EU court has ordered specific performance of a contract that would expose an EU company to US sanctions.

Finally, the UK has retained the EU Blocking Regulation in UK law following its withdrawal from the EU (with the necessary amendments to place it on a UK law footing). While courts in the UK are not required to follow the court’s judgment, they may find the court’s reasoning to be persuasive.

What next?

At the beginning of 2021, the European Commission announced that it would consider potential amendments and/or revisions to the EU Blocking Regulation with a view to streamlining its application by reducing compliance costs for EU citizens and businesses.

A public consultation closed in November 2021 and the nature and extent of any amendments or proposed replacement is forthcoming. It is anticipated that any amendments arising from this evaluation and impact assessment will be adopted in Q2 2022.

It remains to be seen whether any such amendments can address the current uncertainties and compliance risks faced by EU persons and businesses.

Contributed by Christopher Hill, Nigel Brook and Patrick Murphy, with additional input from Qi Jiang, senior associate, all at Clyde & Co

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