Primary and Secondary Sanctions

What are Sanctions?

Sanctions are official orders, such as banning trade, taken against a state. This is done to make that state obey the international law principles. When a state breaks international law regulations or it causes a threat to the security of international peace, sanctions are imposed. In most cases, after the implementation of sanctions, the state tends to obey the law because of the deterrence created by such sanctions.

Definition of Primary and Secondary Sanctions

There are economic restrictions that are imposed on countries to compel them to comply with international law principles. Such restrictions are known as Primary sanctions. Some examples of such economic restrictions are embargoes and asset freezes, which are imposed by the Office of Foreign Assets Control (OFAC). 

Secondary sanctions are an indirect form of sanction. They prevent third parties from trading with states subject to sanctions issued by another state. If the third party does business with such a state, it will face a penalty or restrictions for doing business. These are applied against entities engaged in the same deal as prohibited under the Primary sanctions. 

Primary Sanctions

Traditionally, US sanctions apply to US persons, which means US citizens or permanent residents, including foreign branches and anyone in the US. It is imposed according to the sanctions regime of the US. It is imposed on states, organizations, and individuals who are guilty of international crimes or working against the national security interest of the US.

They can also be relevant for non-US persons. It has a substantial extraterritorial effect due to the prominence of the use of US dollars across the world. US individuals and entities must adhere to Primary sanctions as a matter of US law or face potential criminal or civil penalties. 

Therefore, primary sanctions are mainly applicable to the following categories:

• The US citizens or permanent US residents, irrespective of where they are located worldwide. 
• Entities organized in the US
• US residents, irrespective of the nationality that they belong to.
• Entities incorporated in the US (including foreign branches)
• Any transaction that is done in US dollars or any transaction that is processed through the US financial system. 

The US imposes primary penalties by freezing or banning the country’s assets (the Specially Designated National (SDN)). The SDN assets in the United States can no longer be reclaimed without the permission of OFAC (Office of Foreign Assets Control). The penalties can be up to $1 million per violation. Primary sanctions can sometimes be used to target entire countries or geographic regions. As a result, US citizens are prohibited from doing business with these countries.

While the primary sanctions are limited to transactions involving US individuals with SDNs, the scope of such restrictions will be expanded by considering the “facilitation” element rule. This rule states that a US person may not utilize a non-US person to execute an illegal transaction under sanctions/penalties. The US dollar transactions account for the majority of the facilitation factor.

Secondary Sanctions

These sanctions target non-US persons and threaten them with various exclusions from the US and its markets. It can be explained with an example of the inability of a country to import goods from the US. Therefore, these sanctions are mainly applicable to Non-US entities having business relations with the US.

The SDN (Specially Designated Nationals) list includes all the primary risks to non-US persons if the sanctions are violated. They generally target the economic sectors of the targeted country, like the gas and shipping sectors.

Secondary sanctions were imposed strictly against Iran after 2010. President Trump’s administration dramatically expanded the use of Secondary sanctions against Iran. It was lifted in 2016 post the Iran nuclear deal. Since then, Secondary sanctions have been imposed by the US against North Korea, Russia, Syria, China, Venezuela, etc.

Any violation of Secondary sanctions results in a non-US person being barred from transacting with the US at varying levels. Secondary sanctions present non-US targets with a choice of either doing business with the US or with the sanctioned target. It has provided leverage over foreign entities, as the threat of isolation from the US financial market almost always outweighs the value of commerce with the sanctioned state. 

According to CNAS (Center for a New American Security), out of total Secondary sanctions designations, Iran accounts for 68% of the sanctions imposed by the US. The US is using these sanctions as a tool to push through its foreign policy agenda. The agenda is to make the US a global economy. The US has penalized foreign firms several times for breaching US sanctions legislation.

The lawfulness of these sanctions is often contested before domestic and international judicial mechanisms. The European Union uses various non-judicial mechanisms, such as blocking statutes, and special purpose vehicles, to circumvent the reach of sanctions or countermeasures. However, the effectiveness of this mechanism is not certain. 

Things to keep in mind when watching US sanctions regulations that may affect your business:

• The 50% Rule: If an SDN controls 50% or more of a company, that company is classified as an SDN.
• The SDN list is updated regularly, and ownership is the criterion, not the governing factor of the company, according to this rule.

An updated SDN list is available by OFAC.

OFAC has stated the sanctions prohibiting financial transactions related to Iranian proceedings before the International Criminal Court (ICC) have been lifted. Iranian nationals who have chosen the ICC as the arbitral tribunal in their international commercial dealings will not have difficulty submitting the arbitral fees to the ICC starting this month. It’s fantastic news for Iranian businesspeople to have access to the ICC’s trustworthy dispute resolution services. The same thing will happen to overseas firms which breached contracts by taking advantage of Iranian parties’ inability to file their claims before the ICC.

Another OFAC enforcement action was against a foreign corporation (headquartered in Hong Kong) with no US nexus in its contacts but which had contact with a sanctioned jurisdiction (Iranian-origin items purchased from Thailand), other than the fact that the goods were paid for in US dollars. When the US financial system is used (even indirectly) for transactions involving sanctioned persons or jurisdictions, non-US entities risk violating US sanctions.

The company revised its sanctions screening methods to include a mandatory screening of all counter-parties in its transactions, which was an interesting remedial approach. The main cause of the infractions, on the other hand, was limited to a few workers intentionally bypassing company-wide sanctions compliance measures, such as being unable to make US currency payments in connection with Iran-related business transactions. All of them were fired, and the corporation bolstered its sanction compliance team by relocating it to its Legal Department and adding more experts.

Financial Transactions Sanctions

Secondary sanctions are economic sanctions which are a political tool. They are used to force sanctions targets to fall in line with the targeting state’s political preferences relating to disarmament, human rights compliance, or even the choice of the regime. They can be trade, finance, investment, and asset restrictions. 

Primary sanctions prohibit or condition economic relations between the territory of the target state and the state targeted by the sanctions or between nationals of the target state and the target state. Secondary sanctions are retaliatory sanctions that do not impose monetary penalties but seek foreign parties from accessing the US financial and commercial markets if these entities conduct business in a manner considered detrimental to US foreign policy. 

In Iran, these sanctions have been destructive to the economy and financial market. For instance, the Iranian Transactions and Sanctions Regulations (ITSR) prohibit, among other things:

“The export, re-export, supply or sale, indirectly or directly, by a US person or from the US, wherever located, of any technology, goods, or services to Iran; and

The facilitation by a US person of transactions by a foreign person that they would otherwise be prohibited from engaging in under the ITSR.” 

For foreign entities owned or controlled by a US person, the prohibitions in the ITSR are also applied.

Foreign investment has been kept away from the Iranian market due to these sanctions by the US. This means that foreign competition will avoid Iran, and it will be challenging to raise funds in Iran. Apple has removed all Iranian apps, including Snapp, from its App Store. As a result, the company started cooperating with the Android marketplace. Some other Iranian startups with apps on the App store were affected by this decision. There were attempts made to resolve the conflict, but nothing happened. They also went to social media to stop this banning of apps.

The valuation of the company suffered a lot, and its shareholders and employees suffered. The hardware was supplied by the US to Iran for the working of Iranian apps, and now they have to make sure that there was no sanctioned senior executive at Snapp. It also has to find alternatives for advertisements that were earlier done on Instagram and Google. The US also withdrew from the JCPOA (Joint Comprehensive Plan of Action), due to which Iran entered a hyperinflationary period!

Due to the imposed sanctions on Iran, investing in Iran might have always been a source of doubt for foreign investors. What should be considered are the post-sanction possibilities and opportunities that come with factors such as the country’s vast population and geographic location.

According to an overview by US Congressional Research Service, various forms of restrictions can be imposed, including:

1. Denial of export-import bank loans, credit, or credit guarantees for US export to the sanctioned entity
2. Denial of licenses for the US export of military or militarily useful technology to the entity.
3. Denial of US bank loans which is exceeding $10 million in one year to the entity
4. If the entity is a financial institution, a prohibition on its service as a primary dealer in US government bonds; and/or a prohibition on its serving as a repository for US government funds
5. Prohibition on US government procurement from the entity
6. Prohibition on any credit or payments between the entity and any US financial institution
7. Prohibition of the sanctioned entity from acquiring, holding, using, or trading any US-based property in which the sanctioned entity has a (financial) interest
8. Restriction on imports from the sanctioned entity, per the International Emergency Economic Powers Act
9. A ban on a US person from investing in or purchasing significant amounts of equity or debt instruments of a sanctioned person
10.  Exclusion from the United States of corporate officers or controlling shareholders of a sanctioned firm
11. Imposition of the ISA sanctions on principal offices of a sanctioned firm

US Secondary sanctions are based on penalties rather than access denials. There are four jurisdictional triggers for the access denial: control by a US company, use of US technology or the US financial system, and trafficking in confiscated US property. The issue is these triggers might be compatible with the customary international law of jurisdiction, as the relevant conduct subject to US sanctions appears to be extraterritorial.  

How to comply with Primary and Secondary Sanctions?

Compliance with sanctions is important for multinational firms or firms with foreign clients. While keeping track of primary sanctions through the sanctions list is easy, compliance with secondary sanctions requires the firms to expand the scope of their screening solutions to include a broader range of international sanctions. For instance, UK firms undertaking business with US and Russian clients must screen against both the UK Sanctions list and the OFAC Sanctions List. Not doing so would result in a violation of the US restrictions. 

Blocking Laws

When governments think that secondary sanctions are unreasonable, they usually implement regulations called ‘blocking laws’. These are regulations used to protect domestic businesses from foreign regulations. Blocking laws block secondary sanctions and penalize domestic firms that comply with them while authorizing civil suits for firms that suffer financial damages due to such non-compliance with secondary sanctions. 

An example of blocking laws would be the EU’s Blocking Statute of 2018, which was used to prevent compliance with US Sanctions on Iran. Another example is China’s Blocking Rules of 2021, which were implemented due to the increasing economic tensions with the US. 

Licensing options provided by OFAC

While sanctions prohibit specified activities, OFAC provides the option of issuing general and specific licenses in some cases. These licenses allow the authorization of activities that would otherwise have been prohibited. 

General licenses. This type of license is used to authorize the performance of specific categories of transactions. Therefore, once this license has been obtained, individuals and entities do not need to complete any application procedure at OFAC to complete any activity. These licenses are generally provided for sanctions that apply to the export of food, medicine, medical devices, or any other informational material. 

Specific licenses. This type of license is granted on a case-by-case basis. This means that the license is given only under limited situations and conditions. Usually, these licenses are granted when the activity is deemed in the interest of the US foreign policy, not otherwise. This means that it is quite rare for these licenses to be obtained since sanctions are used to comply with US foreign policy, and exceptions to sanctions are applicable in limited circumstances. 

Frequently Asked Questions (FAQs)

Why are sanctions important?

Sanctions are official orders, such as banning trade, taken against a state. This is done to make that state obey the international law principles. When a state breaks international law regulations or causes a threat to the security of international peace, and hence, sanctions are imposed. 

Is it important to follow the US sanctions?

If you want continued access to the US market, then yes, you need to follow the US sanctions (both primary and secondary). However, if your country doesn’t want domestic firms to comply with the US sanctions, they can implement a blocking law. However, if the domestic firm is facing losses due to such a law, it is recommended to proceed with a civil suit within the jurisdiction.

What are the types of restrictions imposed through sanctions?

Some of the common restrictions include the following:

1. Denial of export-import bank loans, credit, or credit guarantees for US export to the sanctioned entity
2. Denial of licenses for the US export of military or militarily useful technology to the entity.
3. Denial of US bank loans which is exceeding $10 million in one year to the entity
4. If the entity is a financial institution, a prohibition on its service as a primary dealer in US government bonds; and/or a prohibition on its serving as a repository for US government funds
5. Prohibition on US government procurement from the entity
6. Prohibition on any credit or payments between the entity and any US financial institution
7. Prohibition of the sanctioned entity from acquiring, holding, using, or trading any US-based property in which the sanctioned entity has a (financial) interest.

However, restrictions are always unique to the kind of sanction and the country against whom the sanctions are imposed. Therefore, complete your study before indulging in any restricted activity. 

To whom are primary and secondary sanctions applicable?

Primary sanctions are applicable to:

• US citizens or permanent US residents, irrespective of where they are located worldwide. 
• Entities organized in the US
• US residents, irrespective of the nationality that they belong to.
• Entities incorporated in the US (including foreign branches)
• Any transaction that is done in US dollars or any transaction that is processed through the financial system of the US. 

Secondary sanctions mainly apply to Non-US entities with business relations with the US.

Conclusion

The penalties imposed by the US must be proportionate. Thus, when we question the penalty or restriction imposed as a sanction, we must focus on the proportionate principle of offence and penalties rather than questioning the jurisdiction of the US under international law.

Post the reinstatement of US sanctions against Iran in 2018, a more active attitude amongst foreign states and the EU is apparent. The EU blocking Statute appears to officially condemn the imposition of penalties on foreign firms for violations of Secondary sanctions incompatible with international law.

This aggressive use of Secondary sanctions may harm rather than further US interests if economic operations pivot away from the US financial system or third-party states retaliate. There is a need for international dialogue on the role of, and limits to, unilateral sanctions to prevent further escalations to the detriment of the international legal order.

To know more about sanctions and how they are applicable, please refer to the online legal platform of LegaMart, with more than 450 lawyers and legal experts from 51 different countries. In any foreign jurisdiction, we try to make it easier for clients to access affordable legal services with just a few clicks.