Sanctions overview: EU and US loan markets

The following is an overview of EU and US sanctions regimes, together with the primary sanctions risks arising in international lending transactions and appropriate risk mitigation mechanisms for lenders. By Nicola Ezra, Matthew Levy and Enis Hallaçoğlu.

EU regime

EU sanctions are implemented through regulations which are directly applicable in all Member States and are administered by the competent authorities in each Member State. In the UK, EU financial sanctions are administered by HM Treasury.

EU sanctions are generally applicable to ‘EU Persons’, being persons within the EU; EU nationals; any legal person, entity or body constituted in a Member State or conducting business within the EU; and any person on board an aircraft or vessel under EU jurisdiction.

EU sanctions are targeted against ‘Designated Persons’ (whether individuals or entities) or directed to specific industries or activities. EU sanctions generally prohibit EU Persons from making any funds or economic resources available, directly or indirectly, to or for the benefit of a Designated Person, and require them to freeze funds or economic resources which are owned, held or controlled by a Designated Person. EU sanctions may also impact the ability of EU Persons to engage in transactions with entities owned or controlled by Designated Persons.

US regime

The Office of Foreign Assets Control of the US Treasury Department (OFAC) is the primary federal agency administering US economic sanctions programs. Sanctions may be imposed against geographical areas (and all Persons within those areas) or against designated governments, organizations, individuals and/or entities.

US sanctions apply globally to ‘US Persons’, being US citizens and permanent residents, persons within the US and entities organized under US law (including their foreign branches). OFAC regulations can also apply to non-US subsidiaries of US firms, either directly (in the case of Cuba and Iran sanctions programs) or in the form of ‘secondary’ sanctions targeting certain territories.

Secondary sanctions can also apply to non-US Persons (without a US parent company) in relation to transactions through the US financial system (including US dollars transactions) or in some cases to trade with certain embargoed jurisdictions like Iran and Cuba. Separately, US export controls apply to the exportation or re-exportation of US-origin goods by non-US Persons.

US Persons are generally prohibited from engaging in transactions, directly or indirectly, with certain designated Persons and countries (together, ‘Sanctions Targets’) unless the transactions are generally or specifically licensed by OFAC. OFAC regulations additionally prohibit US Persons from ‘exporting’ services for the benefit of a Sanctions Target or ‘facilitating’ transactions undertaken by a non-US Person which would be lawful under local law for the non-US Person but would be a breach of US sanctions if undertaken directly by a US Person.

Types of US sanctions

Territorial sanctions: These are comprehensive sanctions imposed against specific countries or regions (and Persons located within them) and their governments, government entities, agencies and instrumentalities. They include trade embargoes on goods,software, technology and services by US Persons (and potentially their non-US subsidiaries). The countries or regions currently under US embargo are Crimea, Cuba, Iran, North Korea and Syria.

List-based sanctions: These are targeted at Persons placed on OFAC’s list of Specially Designated Nationals and Blocked Persons (SDNs). US Persons are prohibited from transacting with SDNs, and any assets of SDNs within the US or controlled by US Persons are blocked, as are entities owned at least 50% by any SDNs individually or in the aggregate.

Secondary sanctions: Secondary sanctions are an extension of US jurisdiction to non-US Persons who would not normally be subject to US law. They are intended to discourage non-US Persons from transacting with Persons or territories targeted by US sanctions. A non-US Person who transacts with a target Person or territory may lose access to the US financial system, credit support from US Eximbank, US export licenses or visas, or even become a targeted Person itself.

Sanctions risks and mitigation in lending transactions

Financial institutions should consider the following primary sanctions-related risks that may arise in lending transactions:

• Substantial civil and criminal penalties.
• For non-US lenders, risk of secondary sanction by OFAC for transacting with Sanctions Targets.
• Possible non-repayment if a borrower becomes target of blocking sanctions.
• Franchise and reputational risks resulting from sanctions violations.

These risks are mitigated by lenders via their due diligence process and appropriate contractual assurances in the credit agreement.

Due diligence

The ‘sanctions’ issues to be addressed by lenders under their diligence process should include:

• Whether the transaction directly or indirectly involves:

1. A target country or target person; or
2. An entity with substantial business interests with target countries or target persons;

• Whether US Persons or EU Persons will be involved in the transaction;
• Details about the borrower group’s level and nature of business activities with Sanctions Targets (allowing for possible application of a ‘de minimis’ exception permitted by OFAC in narrow circumstances); and
• If the borrower group conducts any business with or relating to Cuba, Iran, North Korea, Russia or Syria, additional due diligence related to whether these activities could make them targets of US secondary sanctions.

Contractual provisions in the credit agreement

In terms of the key risks, lenders’ opening proposals often seek assurances in relation to the following:

• Target persons and target countries 
• Compliance with specified ‘Sanctions’
• Use of proceeds
• Repayment with ‘clean funds’
• Absence of pending sanctions-related investigations
• Absence of past sanctions violations
• Policies and procedures addressing sanctions compliance

Once the areas on which contractual assurances will be provided are agreed, the representations and undertakings themselves are formulated. Common negotiating points include:

• Limitations on the ‘sanctions’ concept or applicable regimes
• Limitations by reference to the borrower’s knowledge
• ‘Materiality’ qualifications or specific carve-outs
• Potential avoidance of hair-trigger event of default using grace periods, mandatory prepayment alternatives or bilateral side letters
• Application of alternative repayment currencies where US dollars subsequently becomes blocked

The Loan Market Association has advised that it does not intend to draft recommended sanctions-related contractual assurances for its European market template facility in the light of the breadth of regimes and issues that may affect individual lenders.

In addition, conflicts of laws may be relevant, for example under the EU’s ‘blocking’ legislation designed to counteract US extra-territorial sanctions relating to Iran and Cuba, creating conflicts between the two regimes. This, in turn, may impact the ability of relevant borrowers to provide sanctions-related assurances.

In the US, however, the Loan Syndications and Trading Association has provided detailed commentary and drafting of recommended representations and undertakings for its template credit facility agreements.

Conclusion

Given the complexity and breadth of the issues, international lenders must be cognizant of the sanctions risks that may arise in lending transactions, and they must duly mitigate these risks through due diligence and appropriate contractual provisions in credit agreements.

The ultimate goal is both to avoid sanctions violations and to establish a documentary record demonstrating that the lender’s compliance efforts were appropriate to the risk presented by the particular transaction.

About the authors

Nicola Ezra is counsel, Matthew Levy is a partner, and Enis Hallaçoğlu is a paralegal in Faegre Baker Daniels’ Corporate Group.