Libyan Sanctions -- The Beginning of a Regulatory Saga under the U.S., U.N., E.U., and E.U. Member States

International Alert
02.28.11

On February 25, 2011, President Obama signed an Executive Order (the "Order") blocking funds and other property interests of Muammar Qadhafi, his government, and certain members of his family and close associates in response to Qadhafi's use of weapons of war and wanton violence against unarmed civilians. The Order finds there is a risk of misappropriation of Libyan state assets if those assets are not protected. Its clear purpose is to prevent Qadhafi and his regime from taking assets that the U.S. Government believes should be maintained for the benefit of the people of Libya at a later time at which Qadhafi will no longer be in power.

I. Blocked parties under the Executive Order

The Order blocks or provides the authority to block parties in three categories. The first category includes the five individual or natural persons identified in the Order's Annex. The second category, which is described in Section 1(b) of the Order, includes any person that the U.S. Secretary of Treasury, in consultation with the U.S. Secretary of State, concludes falls within one of six defined groups. These groups are senior officials, children of Qadhafi, parties complicit in political repression, parties that assist in such repression, parties owned or controlled by the foregoing, and spouses and dependent children of blocked parties. The third category, which is described in Section 2, includes the Government of Libya and, for example, all instrumentalities of the Government of Libya.

Previous executive orders have not been clear as to whether they are self-implementing or must, before the language is effective, be implemented by the U.S. Department of Treasury, Office of Foreign Assets Control ("OFAC") in regulations that identify specific names of parties the Secretary of the Treasury found to have met the criteria of the orders.

Based on the language of those orders, including the one at issue involving Libya, we believe that the orders are effective immediately without further determinations by the Secretary of Treasury. This raises several issues regarding a U.S. party's compliance obligations. First, a corporation with business in Libya is not in a position to know if a party "materially assisted" in the "human rights abuses related to political repression in Libya." Moreover, a company may not know in every instance whether a person is a senior official of the Government of Libya (note that the term "senior" official is not defined in the Order).

Second, the Order leaves open the question of whether a U.S. party must make an affirmative inquiry. OFAC has not issued explicit guidance on this issue. In our judgment, "best practices" under U.S. export control and embargo laws require a company to consider the information that it receives in the normal course of business. If that information contains a red flag, then the company is required to make an affirmative inquiry to help make the type of determinations under the Order or future implementing regulations. Shades of gray in the Order will leave some doubt regarding the type of any required compliance strategy. However, those shades of gray may be mitigated by establishing and implementing reasonable, documented processes. Because each company may face different facts and risks based on its business, it should shape unique, risk-based compliance strategies.

II. Parties Controlled by Blocked Parties are Themselves Blocked

One of the key principles of U.S.-imposed sanctions is that a party controlled by a blocked party is itself blocked. Over the last 30 years, OFAC has informally advised that control includes various factors that support a finding of de facto control, such as:

  1. The authority to name a majority of the members of a board of directors;
     
  2. Senior officials of the blocked party serving as a majority of the board of directors of another party, which is potentially blocked;
     
  3. A management contract under which the blocked party (for example the Government of Libya) has the power to conduct the day-to-day business of the potentially controlled party (such as business that is separately incorporated but is managed by the Government of Libya or an instrumentality of the Government of Libya);
     
  4. Fifty percent or more of the equity in a closely held corporation; and
     
  5. A small but predominant percentage of the equity in a corporation, such as 20%, when all the remaining shares of a publicly traded corporation are widely distributed.

On February 14, 2008, OFAC issued general advice on the scope of parties whose property interests are blocked because the party is controlled by another, explicitly sanctioned party. While the document is not the picture of clarity, most OFAC practitioners interpret the advice to confirm blocking orders extend to the funds and other property interests of corporations in which another designated (published) party holds 50% or more of the voting equity of any party whose name or other description is not published by OFAC.

In any event, the determination of control likely will continue to require a factual analysis of factors other than a percentage of equity shares and voting power. In the context of a protective blocking program, such as the Order, the key issue regarding control is whether the explicitly blocked party has the right or power, in practice or in law, to move assets from another company in a way that is contrary to the purpose of the Order. Under the Order, if the Qadhafi regime has the practical or legal authority to redirect funds or assets of a given party to itself, OFAC will almost surely view that given party to be controlled by an explicitly blocked party under Sections 1 and 2. The same is true if that power is held by any of the natural persons identified in the Annex to the Order.

III. Obligations of U.S. Financial Institutions to Block the Property Interests of Blocked Persons

Blocking orders, such as the Order, have a profound impact on U.S. financial institutions and their off-shore branches, which are required under such orders to freeze funds that come within their control, report those funds to OFAC, and await instructions from the agency. In the modern global banking system, many banking transactions are administered by U.S. money center banks without any knowledge of the non-U.S. account holder in a non-U.S. bank.

These requirements to block assets that flow through the United States are based upon territorial jurisdiction. The requirement for branch offices to block funds that come within their control is based upon citizenship jurisdiction. Under OFAC principles, a branch is different than a subsidiary. While the off-shore branch of a U.S. corporation is a U.S. person, a controlled subsidiary is not.

As a practical matter, a non-U.S. subsidiary still faces compliance challenges. It has risks of liability theories in the context of "causing" a U.S. person to violate the rules, conspiracy, and aiding and abetting (which is discussed in further detail below).

On February 25, 2011, OFAC issued General License No. 1 to authorize all transactions with financial institutions owned or controlled by the Government of Libya that are organized under the laws of a country other than Libya. The scope of General License No. 1 raises significant issues regarding its scope. In any event, the order should not be interpreted as allowing U.S. persons to circumvent the blocking order by depositing funds in those banks and having those funds transferred to a blocked party such as the Government of Libya or Qadhafi.

IV. Causing Violations by Non-U.S. Persons and Stripping Information from Bank Instructions

Over the last few years, U.S. authorities have indicted two major non-U.S. banks for stripping information from wire transfers of funds to or through U.S. financial institutions. These two cases related to the Iranian Transactions Regulations and resulted in criminal fines of hundreds of millions of dollars. In many other enforcement actions, U.S. enforcement authorities have charged non-U.S. persons with "causing" a violation of the reexport control and sanctions rules of the United States. As noted above, other theories of liability include aiding and abetting and conspiracy. For these reasons, it is simply misleading to conclude that the Order applies only to U.S. persons.

It is important that all instructions to banks be complete and accurate. Any instruction may not obscure the nature of the transactions, including the source of funds and the subsequent destination or recipient of the funds.

If a blocked party does not have a property interest in the funds, the Order does not apply to the transfer. However, even if a blocked party does have a property interest in the funds, no obligation to block the funds exists if no U.S. person participates in the transfer or receives the funds, unless the non-U.S. party causes a violation by, for instance, stripping information from a bank instruction for funds flowing to a U.S. financial institution or otherwise misleads a U.S. financial institution.

V. Export Controls

Changes on the ground in Libya will also affect U.S. export control policy and license administration. In addition, export control authorities will expect consignees to take precautions to ensure controlled items do not fall into the hands of unauthorized parties or destinations. This issue is particularly acute given a firm's diminished ability to safeguard controlled items as it pulls personnel out of Libya for safety reasons.

VI. United Nations Security Council Resolution 1970 (2011) and EU Actions

On February 27, 2011, the United Nations Security Council passed resolution 1970 (2011) ("Libyan USCR") in response to Muammar Qadhafi and other individuals for the repression of demonstrations and human rights abuses in Libya. Section 17 of the Libyan USCR provides that member states shall implement, within their territories, an asset freeze on funds and other economic resources of the six individuals listed in Annex II. The purpose of the freeze is identical to that of the Order. Unlike the Order, however, the U.N. freeze does not extend to funds and assets of the Government of Libya, its agencies, and its instrumentalities.

The U.N. freeze has exclusions for basic expenses such as food, rent, and utilities. It also excludes legal fees and fees related to the maintenance of funds. Such funds do however require notice and a five-day waiting period. Absent a negative response, those expenses may be paid without running afoul of the asset freeze. The exclusions provide practical solutions to many nettlesome challenges facing companies seeking to comply with the asset freeze. One can only hope that the United States will administer its Libyan Executive Order in such a fashion, but history does not suggest this is likely.

The Libyan USCR also permits a designated party to make a payment under a preexisting contract entered before the designation. This exclusion from the freeze is subject to a requirement to report and wait ten business days before making the payment. By contrast the Order prohibits the receipt of blocked funds of the Government of Libya and its instrumentalities. The prohibition may be overcome by obtaining an OFAC license, a process that will likely take months.

The Libyan USCR also imposes a travel ban on certain individuals and an arms embargo. It also refers the matter to the International Criminal Court.

EU and UK Implementation of the Libyan USCR

On February 27, 2011, the European Union released a statement supporting the Libyan USCR and announced it will implement the Libyan USCR as a matter of urgency.

Indeed, on the same day, Her Majesty's Treasury issued a notice that the UK has ordered the implementation of the Libyan USCR. As of this writing, the UK Order is not available. According to the notice, the UK Order applies to defined UK natural persons and UK corporate persons, including banks, financial institutions, charitable organizations and non-governmental organizations in the UK or established under UK law. It does not apply to non-UK subsidiaries of UK corporations. The UK Order freezes: (1) the funds of parties listed in Annex II of the Libyan USCR or designated by the United Nations Sanctions Committee, and (2) funds, financial assets, and economic assets owned or controlled by those persons. The UK notice notes that the financial sector and other persons "should bear in mind that Muammar Qadhafi and his family have considerable control over the Libyan state and its enterprises in deciding how to conduct proper due diligence over and transactions involving Libyan state assets."

Conclusion

The above is merely the beginning of a regulatory and foreign policy saga. OFAC will eventually publish implementing regulations. In the meantime, it will designate persons and entities pursuant to the Executive Order. Today, the White House announced that the Executive Order has blocked $30 billion in assets of the Libyan Government.

The European Union and its member states will implement sanctions and not necessarily in the same format as one another. Member States of the United Nations may or may not implement the Libyan USCR. More importantly, the facts on the ground in Libya will probably change. Will nations arm the protestors in Libya? Will Qadhafi hold on to power? Will the people of Libya retain the benefit of Libyan state assets regardless of whether the Qadhafi regime retains control in Libya? Will the asset freeze truly be multilateral? These are developments and answers financial institutions and corporations will have to follow in the days, weeks, and months ahead.

For more information, please contact:

Larry Christensen, lchristensen@milchev.com, 202-626-1469

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