Directive 1 (as amended on September 12, 2014) provides in pertinent part that:
the following activities by a U.S. person or within the United States are prohibited, unless otherwise permitted by law or licensed or authorized by . . . [OFAC]: (1) all transactions in, provision of financing for, and other dealings in new debt of longer than 30 days maturity or new equity of persons determined to be subject to this Directive, their property, or their interests in property, and (2) all activities related to debt or equity issued before [September 12, 2014,] the date of . . . Directive 1 (as amended) that would have been prohibited by the prior version of this Directive [as amended] (emphasis added).[i]
What is the Difference Between Original and Amended Directive 1?
With respect to transactions prohibitions, the original version of Directive 1 (July 16, 2014) prohibited the same transactions but allowed a maturity period of up to 90 days for new financing and debt; amended Directive 1 (September 12, 2014) shortened the allowed maturity period to up to 30 days.
- United States Person. “‘United States person’ means any United States citizen, permanent resident alien, entity organized under the laws of the United States or any jurisdiction within the United States (including foreign branches), or any person in the United States” (emphasis added).[i]
- Debt and Equity Defined Broadly. Debt includes “bonds, loans, extensions of credit, loan guarantees, letters of credit, drafts, bankers acceptances, discount notes or bills, or commercial paper.”[ii] Equity includes “stocks, share issuances, depository receipts, or any other evidence of title or ownership.”[iii]
- Debt and Equity “of” SSIL Entities. According to OFAC, “the equity prohibitions of Directive 1 pertain to equity issued, directly or indirectly, by an SSIL entity on or after the sanctions effective date,” and not, for example, to “equity purchased or acquired by an SSI[L] Entity from a third party after the sanctions effective date.”[iv] “Directive 1 does not prohibit U.S. persons from dealing with an SSIL entity as counterparty to transactions involving equity issued by a non-sanctioned party.”[v]
- “New” Financing, Debt, or Equity; Sanctions Effective Date. Financing, debt, or equity is “new” if extended, issued, or otherwise transacted in on or after the “sanctions effective date,” which is “the date a person is determined to be subject to the prohibition(s) of the relevant Directive.”[vi]
- For parties, like the Vnesheconombank (VEB)-owned entities, that were initially subject to a directive that was later amended, two sanctions effective dates are relevant to transactions involving such parties: (1) the date on which the party became a sanctioned entity (by its addition to the SSIL or its 50% or more ownership by one or more SSIL entities) and (2) the date that the relevant directive was amended.
- Property or Interests in Property, 50% Rule. As discussed above, the prohibitions of Directive 1 apply to entities directly or indirectly owned 50% or more by one or more (in the aggregate) SSIL entities, even if such owned entities are not separately identified on the SSIL. Thus, Directive 1’s transactional prohibitions apply with respect to all 50% or more owned entities, as well as to the owned entities’ interests in property.
Financing or Services in Support of New Financing, Debt, and Equity Prohibited
- Financing or Services in Support. Within the United States or by U.S. persons (wherever located), “all financing in support of . . . [prohibited] new debt or new equity” is prohibited. Likewise, “any dealing in, including provision of services in support” of, new debt or new equity is prohibited.[i]
- Correspondent Accounts, U.S. Dollar Clearing Permitted if Not Related to “New” Financing, Debt, or Equity. OFAC has indicated that U.S. financial institutions may “continue to maintain correspondent accounts and process U.S. dollar-clearing transactions” for SSIL entities, “so long as those activities do not involve transacting in, providing financing for, or otherwise dealing in transaction types prohibited” by Directive 1.[ii]
Creation of “New” Financing or Debt Under Pre-Existing Agreements
- “Rollover” of Existing Debt Prohibited. Directive 1’s prohibitions on “new” debt apply to the “rollover of existing debt, if such rollover results in the creation of new debt with a maturity of longer than 30 days (for persons subject to Directive 1.”).[i]
- Negotiation of “New Debt” Under Existing Revolving Facilities or Term Loans Prohibited, But Adherence to Pre-Existing Commitments Permitted. OFAC has stated that “[d]rawdowns and disbursements whose payment terms exceed the applicable authorized . . . [maturity period] are not prohibited if the terms of such drawdowns and disbursements . . . were contractually agreed to prior to the sanctions effective date and are not modified on or after the sanctions effective date.”[ii]
Islamic “Debt” or “Equity”; Substance Over Form
Parties that have considered Islamic financing structures involving the RDIF other SSIL entities should assume that OFAC’s definitions of debt and equity would include Islamic transactions. In determining whether a transaction constitutes new debt or equity, OFAC appears to be interested in the substance, rather than the form, of transactions. For example, OFAC has indicated that “deferred purchase agreements extending payment terms of longer than 30 days . . . would constitute a prohibited extension of credit to an SSIL entity.” Moreover, “OFAC does not consider the inclusion of an interest rate to be a necessary condition for establishing whether a transaction represents new debt.”[i]
Applying a substance over form approach, Islamic transactions would likely fit within relevant definitions—e.g., murabaha as credit/financing or sukuk as debt or equity (under different classification approaches and circumstances).
Sanctions Evasion, Conspiracy to Evade; Known Evasion Tactics
- Liability for Evasion and Conspiracy. The amended version of Directive 1 added language about liability for evasion and conspiracies to evade sanctions. Amended Directive 1 provides that any transaction that “evades or avoids, has the purpose of evading or avoiding, causes a violation of, or attempts to violate any of the prohibitions contained in . . . [Directive 1] is prohibited . . . and . . . any conspiracy formed to violate any prohibitions of . . . [Directive 1] . . . is prohibited.”
- Known Evasion Tactics. OFAC has identified, in various sanctions enforcement and guidance contexts, tactics that have been employed by parties to evade sanctions. Most recently, and in connection with Ukraine/Russia/Crimea non-sectoral sanctions, OFAC issued an advisory describing some known evasion tactics in financial transactions (g., omissions of originator or beneficiary identifying information in SWIFT messages, an evasion method well-documented in sanctions enforcement settlements with banks) and international trade settings.[i] Parties should, in addition to conducting situationally appropriate due diligence, acquaint themselves with known evasion tactics to detect and avoid them.
U.S. Persons Must “Reject” Prohibited Transactions; U.S. Financial Institutions Must Report
- U.S. Persons must “reject” transactions prohibited by Directive 1.
- U.S. “financial institutions” subject to the reporting requirements of 31 C.F.R. § 501.604 must report to OFAC funds transfers that, if processed, would have violated or facilitated a violation of Directive 1’s prohibitions.[i] Recordkeeping and reporting protocols designed to meet the requirements of § 501.604 should be tailored for and observed in connection with Directive 1.
[ii] Executive Order No. 13662. See also 31 C.F.R. § 589.312.
[iii] No. 371, Sectoral Sanctions FAQs.
[v] No. 404, Sectoral Sanctions FAQs.
[vii] No. 370, “Sectoral Sanctions FAQs.
[x] No. 371, Sectoral Sanctions FAQs.
[xi] No. 394, Sectoral Sanctions FAQs.
[xii] No. 410, Sectoral Sanctions FAQs.
[xiii] OFAC Crimea Sanctions Advisory, Obfuscation of Critical Information in Financial and Trade Transactions Involving the Crimea Region of Ukraine, July 30, 2015.
[xiv] Reports by U.S. financial institutions on rejected funds transfers, 31 C.F.R. § 501.604.