Highlights:

• Sanctions relief presents new business opportunities with Iran

• Most U.S. companies are still prohibited from Iran business, but the U.S. government is encouraging lawful business by non-U.S. companies

• The line between permitted and prohibited financial transactions by non-U.S. banks is not clear

• Careful advice of counsel is critical

Opportunities for lawful business in Iran

As we reported here, sanctions relief under the Iran nuclear deal has opened up new business opportunities in Iran. Many restrictions remain in place, but whole industries, such as aviation, are seeing an influx of new Iran deals. U.S. banks are generally not permitted to partake in those deals, but the prohibitions on non-U.S. banks have largely been lifted. Nevertheless, those non-U.S. banks have been skittish, possibly in light of the recent string of massive enforcement cases against non-U.S. banks for violations of U.S. sanctions. To make matters worse, even after sanctions relief, there is still a vague general prohibition stating that banking transactions, even in connection with permitted business, “are prohibited from transiting the U.S. financial system.”

The U.S. government has recently been on a road show to encourage European and Asian banks to take advantage of the lawful business in Iran. The reason is clear – if sanctions relief is to be a legitimate incentive for Iran to keep its obligations under the nuclear agreement, it must result in positive financial flows.

But the banks are all asking the same question: what types of transactions are considered to be “transiting” the U.S. financial system, and thus prohibited? The answer is not clear, but we have some suggestions. First, the knowns:

The Clear Lines

There are a few clear lines. First, no U.S. person may be involved in an Iran-related transaction unless authorized. The regulations provide that no U.S. person may engage in any transaction or dealing in or related to goods or services for exportation, reexportation, sale or supply, directly or indirectly to Iran.^[1] It is thus unlawful for U.S. persons, including U.S. banks, to play a role^[2] in transactions involving the supply of goods or services to Iran. There are narrow exceptions for certain humanitarian activities and for licensed transactions (for example, one may apply for a license to export U.S.-origin equipment relating to the safety of civil aviation).

Second,  it is prohibited for any person anywhere (not just U.S. persons) to “cause” a violation of the U.S. Iran sanctions.^[3] Therefore, if a non-U.S. bank engages in a transaction that causes a U.S. bank to be involved in an Iran-related transaction, the non-U.S. bank may itself face liability.  This clear line was crossed when banks intentionally sent Iran-related transactions through U.S. correspondent banks, but stripped out the information identifying the sanctioned-country involvement. Banks recall all too well that BNP Paribas and Commerzbank paid billions in fines and penalties for allegedly engaging in such transactions.

A Complex Question to a Simple Solution

The somewhat simplistic guidance given by the United States government is to ensure that Iran-related transactions do not “transit” the U.S. financial system.

But the question becomes more complex when we look at the real working of a major global bank. Consider the following hypothetical:

A French construction company wins a bid for a major infrastructure project in Iran. The Government of Iran plans to make payments for the project to the French company’s account in a German bank. The payments will come from the Iranian Government’s account in Dubai and will be made in Euros.

So far, the transaction does not involve U.S. persons or the U.S. financial system (we will also assume the transaction does not involve U.S.-origin goods so there is no risk of a U.S. export controls violation). But consider the next step:   

In an unrelated transaction, the French construction company wishes to pay for consulting services in U.S. dollars using money in its account at the German bank, at least some of which was funded via the Euro payments from Iran.   

In this transaction, the German bank will likely use a U.S. correspondent bank to make the U.S. dollar transfer. This is where the clear lines start to disappear, and where banks are hesitant to draw their own conclusions. The German bank has access to documentation showing that the money in the French construction company’s account came from Iran. Thus the bank knows or has reason to know it is sending money from an Iran-related transaction into the U.S. financial system. Even though the account is denominated in Euros, the source of the funds was Iran.

We have heard U.S. enforcers take the position that any transaction with Iran on one side and U.S. dollars on the other, you have a sanctions violation. In our hypothetical, the bank’s compliance officer may shudder to think what will happen when the U.S. government comes knocking to ask why he is sending money from the government Iran to be changed into dollars through his correspondent account at Bank of America New York.

Some Policy Options

The banks may have several options for dealing with funds originating in Iran, including the following:

1. Tag the account as containing Iran-related funds and do not allow money from that account to enter the U.S. banking system

Since the money came to the French construction company’s account from Iran, one might try to enforce a policy that money from that account cannot be sent through the U.S. financial system. It can be still be transferred in Euro or Yuan or Reals. That’s a lot of options.

But then presume the French construction company buys Brazilian equipment by sending payment in Brazilian Real. No U.S. financial system connection. But ultimately it presents a further question that the U.S. government has not definitively answered: Does the Brazilian bank now have money that it cannot send into the U.S. system?

If the U.S. government answers “Yes”: If the answer is that the money is still Iran-related and cannot enter the U.S. system, then all banks would be responsible for tracing all money that ever came from Iran to ensure it does not enter the U.S. system. That sort of tracking would be virtually impossible. It would also ignore the fact that any customer could take Iran-origin Euros out of its German account, in cash, and deposit that money across the street, neat and clean and not Iran-related, to be changed into U.S. dollars for use as needed.

That solution also does not take into account the possibility that the customer takes money into its account from sources other than Iran, creating a question of how to determine what payments from the account are Iran-origin and what payments are not.

If the U.S. Government Answers “No”: The U.S. government may take the position that once the Euros paid by Iran to a French company are spent in Brazilian Real, they are no longer Iran-related and can enter the U.S. financial system. That position would not only be arbitrary, but would invite companies to simply interpose an extra step in their business model to clean money of its Iranian origin. A company could simply move money from one account to another – presumably at another bank – maybe changing the currency or maybe not. The market would find the most efficient way to place an extra transaction (or two or three or wherever the U.S. government drew the line) between the Iran transaction and the entry of funds into the U.S. financial system.

Because the question has not yet been definitively answered, the banks are taking another option.

2. Refuse to support businesses entering into Iran

This is the option we have seen many banks taking. We see European companies ready to enter a newly opened market of 77 million people but unable to get financing or open accounts to receive payments. We have seen Chinese banks refusing to exchange Korean Wan (KRW) into Chinese Yuan (RMB) where a Korean company has sold Chinese products in Iran. Many banks decline this business even where there is no immediate involvement of the U.S. financial system.

A Modest Proposal: A Single Clear Line

It is our position that when a legitimate, lawful Iran transaction is completed by a non-U.S. company, the proceeds of that transaction are the property of that company and can freely enter the U.S. financial system. U.S. dollars could not be used for any transaction related to the Iranian business (e.g., to buy supplies to fulfill an Iranian order), but so long as the Iranian transaction is complete, the proceeds from that transaction should be permitted to transit the U.S. financial system.

There are three main benefits to our position:

1) It promotes transparency, reducing the incentive for companies or banks themselves to create transactions or move cash in order to hide its Iranian origin.

2) It gives the Iran nuclear agreement the effect it was intended to have – a means for non-U.S. companies to conduct business with Iran outside of the U.S. financial system – without locking the companies and their banks out of the U.S. financial system; and

3) Adequate safeguards are still available. Banks would still be responsible for taking reasonable due diligence steps to ensure that their clients are conducting legitimate business and not acting as illicit conduits of U.S. dollars to Iran. Such due diligence would be required in the normal course under existing sanctions and anti-money laundering regulations. Companies engaging in fraud on the bank to provide U.S. financial services or access to the U.S. financial system to Iran would still be subject to penalties for conspiring to violate or causing violations of U.S. sanctions.

Seek Competent Advice

While we believe our proposal represents the most reasonable resolution of the question facing the U.S. government, clear regulatory guidance has not yet been issued on this question. Until this critical question is answered, non-U.S. companies and their banks will continue to hesitate to enter the newly-opened Iranian market. Anyone planning to be involved in substantial Iranian business under the new regulations should seek legal advice from careful U.S. sanctions counsel to avoid running afoul of these complex rules.

^{[1] Iran Transactions and Sanctions Regulations 31 C.F.R. § 560.206(a)(2).}

^{[2] The term “transaction or dealing” is defined broadly and “includes but is not limited to purchasing, selling, transporting, swapping, brokering, approving, financing, facilitating or guaranteeing.”  31 C.F.R. § 560.206(b).  A U.S. bank serving as a correspondent bank through which dollars pass would trigger involvement for purposes of Section 206.}

^{[3] See U.S. International Economic Emergency Powers Act, 50 U.S.C. § 1705.}