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EU Blocking Regulation, US sanctions and contractual termination – when sanctions and business collide

News / / London

In a recent ruling, the European Court of Justice (“ECJ”) was asked to consider the interpretation of Article 5 of EC Regulation No. 2771/96 of 22 November 1996 (commonly referred to as the “Blocking Regulation”) in relation to the termination, by a German telecoms company, of a contract with a bank subject to US sanctions. 

The background facts

Bank Melli Iran (“Melli”) is an Iranian bank owned by the Iranian state. Telekom Deutschland GmbH (“Telekom”) is a subsidiary of Deutsche Telekom AG, a German company with half of its turnover derived from the US.  

Melli has a branch in Germany and concluded a framework contract with Telekom that saw Telekom provide Melli with several telecommunication services for which Melli paid within the prescribed time. The services provided by Telekom were found by the German Regional Court to be essential for Melli’s internal/external communication within Germany and without them, Melli’s German sites could not participate in commercial relationships.

In 2018, the United States withdrew from the Joint Comprehensive Plan of Action, a nuclear deal agreement reached in 2015 by Iran on the one hand and the UK, US, China, France, Germany and Russia on the other hand and subsequently endorsed by UN Security Council Resolution. Therefore, from 5 November 2018, the US re-imposed secondary sanctions against Iran (those purporting to apply to non-US persons). This re-imposition of sanctions affected persons covered by the OFAC Specially Designated Nationals list (“SDN List”), on which Melli was listed.

In November 2018, Telekom notified Melli of the termination of all contracts between them with immediate effect and did the same in respect of four other Iranian linked companies included on the US SDN list. 

The German Regional Court decision

Melli brought an action before the Regional Court in Hamburg seeking an order that Telekom leave the contractual telephone and internet connections active. 

The Court found that Telekom were required to perform the contracts at issue until the period for ordinary termination had expired, but not thereafter. It was further found that the ordinary termination by Telekom of those contracts was consistent with Article 5 of the Blocking Regulation.

Paragraph 1 of Article 5 of the Blocking Regulation provided as follows:

“No person referred to in Article 11 shall comply, 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 the laws specified in the Annex or from actions based thereon or resulting therefrom.”

Article 11 included EU residents and nationals and legal persons incorporated in the EU (such as Telekom) and the Annex referred to in Article 5 included reference to the Iran Freedom and Counter-Proliferation Act of 2012, pursuant to which US sanctions were re-imposed.

Following the Regional Court’s ruling, Melli appealed to the Higher Regional Court, submitting that the termination by Telekom was solely done in order to comply with the secondary sanctions adopted by the US and therefore infringed Article 5 of the Blocking Regulation.

The Higher Regional Court decision

The Higher Regional Court found that the first paragraph of Article 5 was not applicable and in so doing further noted that:

1. The existence of secondary sanctions alone was sufficient for the first paragraph of Article 5 to apply;

2. The termination of contracts does not infringe the first paragraph of Article 5 where it is motivated by purely economic reasons that do not have any specific connection with the sanctions imposed by third countries. Accordingly, Telekom was exceptionally required to give its reasons for the termination of the contracts and if necessary, prove that the decision was not taken out of fear of repercussions for Telekom in the US.

3. A termination of a contract which was in breach of Article 5 was devoid of legal effect and, under German law, any infringement of the restrictions was an administrative offence punishable by a fine up to EUR 500,000. Taking into account that the group business (of which Telekom was part) derived half its turnover from US business, it was contrary to the principle of proportionality (set out in Article 9 to the Blocking Regulation) to fine Telekom and require them to perform the contracts where the Blocking Regulation did not have the direct aim of protecting Melli’s interests.

4. According to the preamble, the Blocking Regulation aims to protect economic operators in the EU. The Court did not consider that the ability to recover damages under Article 6 of the Blocking Regulation, nor the possibility to obtain authorisation to comply with the sanctions was sufficient compensation for the risk of economic loss. The Court queried whether, where there is a risk of substantial economic loss in the US, the general prohibition in the Blocking Regulation was consistent with the freedom to conduct business under the EU Charter.

Accordingly, the German Court decided to stay the proceedings and refer various questions, set out below, to the European Court of Justice (“ECJ”) for a preliminary ruling.

The European Court of Justice decision

The ECJ held as follows:

1. Does Article 5 of the Blocking Regulation only apply where the US issues an order against an EU economic operator or does it suffice that the action of the EU economic operator seeks to comply with secondary sanctions?

Taking into account the wording, content and objective of legislation, the ECJ found that Article 5 must be interpreted as prohibiting persons in Article 11 from complying with the extra-territorial sanction, even in the absence of an order directing compliance by the administrative or judicial authorities of the third countries that adopted those laws (in this case, the US). In doing so, it rejected the argument that this interpretation was incompatible with the objective of the Blocking Regulation, to protect the interests of EU persons and those within the EU, including their freedom to conduct business.  The latter is a fundamental freedom enshrined in the EU Charter which has previously been held to cover the freedom to exercise economic or commercial activity, freedom of contract and free competition.

2. If it suffices that the action of an EU economic operator seeks to comply with secondary sanctions, does the first paragraph of Article 5 preclude the interpretation of national law as meaning that a party giving notice of termination may terminate a continuing contractual obligation with an OFAC SDN list party (and thus announce a termination owing to a wish to comply with the US sanctions), without having to show and prove in civil proceedings that the reason for termination was not a wish to comply with those sanctions?

In considering this question, the ECJ first had to consider whether Article 5 could be relied upon in civil proceedings. They determined that it could be in circumstances where it is for the national courts to ensure the full effectiveness of the Blocking Regulation and compliance with the prohibition in Article 5 by means of civil proceedings instituted by a person against another person to whom that prohibition is addressed.

However, while enforcement of the Blocking Regulation was entrusted to the Member States, that competence did not alter the scope of the prohibitions in the Blocking Regulation which lay down clear, precise and unconditional requirements, the full effectiveness of which the national courts were obliged to ensure. On this, the ECJ noted that the reason for the prohibition under Article 5 is that persons could in the exercise of their activities, including by their decision to terminate contracts, give extraterritorial effect to the laws specified in the Annex, which the Blocking Regulation seeks specifically to counteract.

The ECJ found that it was not clear from Article 5 nor other provisions of the Blocking Regulation that a person was required to provide reasons for the termination of a commercial contract with a person included on the SDN list. Accordingly, Article 5 does not preclude a national law under which a person subject to the Blocking Regulation may terminate contracts with a person on the US OFAC SDN list without providing a reason for the termination.

However, in order to ensure that Article 5 is fully effective, the Court held that where, in civil proceedings relating to the alleged infringement of the requirements in Article 5, all the evidence available to the national court tends to indicate (prima facie) that by terminating the contracts a person complied with the laws specified in the Blocking Regulation Annex (i.e. the US sanctions) it was for that person to establish to the requisite legal standard that their conduct did not seek to comply with those laws.

3. Must an ordinary termination in breach of the first paragraph of Article 5 be regarded as ineffective or can the Regulation be satisfied through other penalties e.g. a fine?

4. If ordinary termination is ineffective, having regard to the EU Charter and the possibility of granting an exemption under the second paragraph of Article 5, does that apply even where maintaining the business relationship with the listed SDN would expose the EU operator to considerable economic losses in the US market?

The third and fourth questions were considered together.

The ECJ noted the following principles:

  1. The Blocking Regulation must be interpreted in light of fundamental rights whose observance the Court ensures and which are set out in the EU Charter;
  2. Article 9 of the Regulation provided that sanctions for infringement must be effective, proportional and dissuasive;
  3. While Member States retain the power to choose the penalties that seem to them appropriate, they must exercise their powers in accordance with EU law and its general principles, of which fundamental rights and freedom form part;
  4. The severity of sanctions must be commensurate with the seriousness of the infringements for which they are imposed, in particular, by ensuring they have a genuinely deterrent effect, while respecting the general principle of proportionality. 

If it were to be established that Telekom’s ordinary termination was in breach of Article 5 then, pursuant to the German civil code, that termination would be considered null and void. While this annulment was a limitation on the freedom to conduct business under Article 16 to the EU Charter, that freedom is not an absolute prerogative and must be viewed in relation to its function in society and balanced with other interests protected by the EU and the rights and freedoms of others.   

The ECJ ultimately considered that it was for the national court to assess whether the exposure to sanctions by the US on Telekom’s activity outside of the EU was liable to entail disproportionate effects for Telekom, having regard to the objectives of the Blocking Regulation to protect the established legal order and the interest of the EU in general, including the objective of free movement of capital between EU countries and third countries. This assessment required the national court striking a balance between the two, taking into account the need to protect the established legal order in the EU which would be served by compliance with Article 5 and the probability that the person concerned may be exposed to economic loss, as well as the extent of that loss, if a commercial relationship with a relevant SDN could not be terminated.

In assessing proportionality, it is a relevant consideration that a party, in this case Telekom, had  not applied to the EU Commission for derogation from the prohibitions laid down in Article 5 and therefore deprived themselves of avoiding limitations on their freedom to conduct business that would result from an annulment of the termination of contracts with Melli.   

Comment

The difficulty of walking the tightrope between competing sanctions regimes is well illustrated by this decision. For those operating in the global marketplace, it is a dilemma with a long history, with the EU Blocking Regulation having been effected over 25 years ago albeit now expanded to cover more recent extra-territorial developments in the US sanctions landscape.

The ECJ ruling is welcome in that it identifies the scope for a balancing exercise to be undertaken.  However, where that balancing exercise falls to the courts of the various EU Member States there is inevitably scope for divergence and significant uncertainty as to the outcome.

Any party faced with issues relating to sanctions and particularly the Blocking Regulation should carefully consider and explore the potential options available to them and risks associated with the same. Importantly, there is a route to authorisation under the Blocking Regulation which was not pursued by Telekom and this may provide some assistance for EU persons faced with a similar scenario.

Sanctions continue to play a major part in international politics and business and the consequence of breaching the same can be serious. If there is any concern about a potential sanctions issue, then appropriate legal advice should be sought at an early stage.    

Please contact the authors if you have any query about this article or any other sanctions-related query.

Fionna Gavin

Fionna Gavin Partner

James Rose

James Rose Managing Associate

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