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Do You Know What Your Sub Is Doing? New Legislation Expands Iran Sanctions to Subsidiaries

Tuesday, August 28, 2012

By D. Grayson Yeargin and Lindsey Nelson, Nixon Peabody LLP

On Aug. 10, 2012, when President Obama signed into law the “Iran Threat Reduction and Syria Human Rights Act of 2012” (Pub. L. No. 112-158), the clock started ticking for U.S. companies with foreign subsidiaries that conduct any business with Iran.

Within 60 days of the president signing the law, the relationship and responsibilities between parents and subsidiaries will undergo a significant shift, as the new law expands the reach of the sanctions to prohibit foreign subsidiaries with U.S. parent companies from transacting with Iran or Iranian persons. As a result, foreign subsidiaries of U.S. companies will have to divest their business with Iran or U.S. parent companies will have to sever their relationships with any foreign subsidiaries that transact business with Iran in order to avoid potentially massive penalties.

Current Status

The Iranian Transactions Regulations (ITR) (31 CFR part 560 et seq.) currently prohibit U.S. persons from exporting or reexporting, directly or indirectly, goods, technology, or services to Iran or the government of Iran. U.S. persons also are prohibited from engaging in any transaction dealing in, or related to, goods or services of Iranian origin or owned or controlled by the government of Iran. The regulations define a U.S. person as “any United States citizen, permanent resident alien, entity organized under the laws of the United States (including foreign branches), or any person in the United States.” The ITR also currently prohibits the reexport of most U.S.-origin goods or technology to Iran. Unlike other sanctions programs, however, the ITR usually does not apply to foreign subsidiaries if they were not engaging in transactions including U.S. products.

The new ownership or control standard is sufficiently broad to give the government ample room to pursue U.S. parents that have any type of significant relationship with a subsidiary that does business with Iran.


The role of a U.S. company with regard to any transactions conducted by its foreign subsidiary is not without restrictions. The ITR prohibits U.S. persons from “facilitating” transactions by foreign persons. A U.S. company cannot “approve, finance, facilitate, or guarantee any transaction by a foreign person where the transaction by that foreign person would be prohibited … if performed by a United States person or within the United States.” For example, a U.S. company cannot change its policies regarding approval of contracts entered into by its subsidiaries in order to remove itself from a transaction with Iran in which it would otherwise be involved.

Even with the prohibition against facilitation, the ITR still left latitude for foreign subsidiaries of U.S. companies. While the Comprehensive Iran Sanctions, Accountability, and Divestment Act of 2010 (CISADA) and recent Executive Orders created more obstacles to using the Iranian financial system to make or receive payment for such transactions, and foreign subsidiaries still had to comply with the Export Administration Regulations (EAR) for any EAR-regulated products, it was not until the president signed the Iran Threat Reduction and Syria Human Rights Act of 2012 that the United States imposed a blanket prohibition on subsidiaries.

Section 218

Tucked into the 56 pages of H.R. 1905 is Section 218, a four-paragraph section in between a section regarding sanctions against the government of Iran and the Central Bank of Iran and a section regarding new disclosure requirements to the Securities and Exchange Commission. Though small within the scope of the legislation, Section 218 will have a large effect on any U.S. companies that have foreign subsidiaries that currently conduct business with Iran.

The section states that the president shall prohibit any entity that is owned or controlled by a U.S. person from engaging in transactions with Iran that the sanctions program administered by the Treasury Department's Office of Foreign Assets Control (OFAC) would prohibit if performed by a U.S. person. The OFAC sanctions program, through regulations and orders issued pursuant to the International Emergency Economic Powers Act (IEEPA), prohibits virtually all exports of goods or services to Iran, all imports into the United States of all goods and services from Iran, and all trade-related transactions with Iran, including transactions related to goods or services of Iranian origin and transactions related to the export, sale, or supply of foods, technology or services to Iran or the government of Iran.

A foreign subsidiary of a U.S. company that violates, attempts to violate, or conspires to violate Section 218 will be subject to the same penalties as a U.S. company that itself violated the IEEPA regulations and orders, including a $250,000 fine per violation or a fine of twice the value of the transaction at issue (whichever is greater).

The legislation defines “own or control” through three possible methods: (1) holding more than 50 percent of the equity interest by vote or value in the entity; (2) holding a majority of seats on the board of directors of the entity; or (3) otherwise controlling the actions, policies, or personnel decisions of the entity. A U.S. parent company that meets any of those standards with regard to the foreign subsidiary will be considered to own or control the foreign subsidiary.

The legislation essentially offers U.S. companies two grace periods during which they can dissociate their business from any transactions with Iran, depending on how the divestment occurs. The first is the 60-day window the president has, pursuant to the legislation, to implement the laws as designed by the Act. The second is a period specifically designated in the Act for U.S. parent companies. Pursuant to the Act, U.S. parent companies are given a grace period in which to divest from a foreign subsidiary doing business with Iran before being penalized. According to Section 218(d), a U.S. company will not be penalized for any prohibited transactions conducted by its foreign subsidiary if the U.S. company divests or terminates its business with the foreign subsidiary within 180 days of the enactment of the Act. Strangely, the Act does not include a similar 180-day grace period during which foreign subsidiaries can divest their business with Iran. Thus, any foreign subsidiaries seem to have only 60 days or less from the enactment of the Act to divest business with Iran so as not to violate the sanctions.

What Now?

As the new sanctions take effect, U.S. companies with foreign subsidiaries that do business with Iran will have to make a choice: either they can instruct their foreign subsidiaries to divest their business with Iran or the parent company can divest their business with the foreign subsidiaries. The first option is relatively clear-cut, but requires nearly immediate action. This divestment would need to occur within the 60-day time period the president has in instituting the prohibitions of the legislation.

Companies should have a comprehensive compliance program in place at both the parent and subsidiary levels that makes clear what is prohibited under the law.


The second option would be to sever the ownership or control of the foreign subsidiary by the U.S. parent. Per the legislation, a parent company and its subsidiary would not be subject to the restrictions if the parent does not meet any of the following attributes: (1) holding more than 50 percent of the equity interest by vote or value in the entity; (2) holding a majority of seats on the board of directors of the entity; or (3) otherwise controlling the actions, policies, or personnel decisions of the entity.

Thus, if a parent company can sufficiently modify its relationship with its foreign subsidiary so that it does not meet any of these qualifications, the foreign subsidiary could continue to conduct business with Iran. That being said, the third element of ownership or control is sufficiently broad to give the government ample room to pursue U.S. parents that have any type of significant relationship with a subsidiary that does business with Iran.

If neither option seems possible, the company can always apply for OFAC licenses for the foreign subsidiary to enter into transactions with Iranian entities. Depending on the amount of business, this option could be quite burdensome. In addition, the likelihood of such licenses being granted is slim.

Compliance

U.S. companies with foreign subsidiaries that currently conduct business with Iran must take heed of this new law, as there are a number of ways that the government can discover information relating to prohibited transactions. Some of the more common ways that the government learns of potential violations of U.S. sanctions include financial institution reports regarding attempted financial transactions with Iran, SEC disclosures, government audits, reports from disgruntled employees, complaints from whistleblowers or competitors, and other government investigations.

In addition, U.S. companies with foreign subsidiaries that do not currently do business with Iran must ensure that their subsidiaries do not transact business with Iran in the future. The new law transforms the Iranian sanctions to a program similar to the Cuban Assets Control Regulations promulgated under the Trading with the Enemy Act. Pursuant to the Cuba sanctions, U.S. parents are liable for the actions of their foreign subsidiaries. In a review of OFAC actions during the past five years, several U.S. companies have entered into settlement agreements relating to the acts of their subsidiaries involving transactions with Cuba, with penalties ranging from around $1,000 to more than $2 million. As Iran is a significantly larger market than Cuba, it is likely there will be significantly larger, and more frequent, penalties.

There are several steps a U.S. company can take to ensure that its foreign subsidiaries do not engage in transactions with Iran. The first is to have a comprehensive compliance program in place at both the parent and subsidiary levels that makes clear what is prohibited under the law. The compliance program should include a written compliance manual as well as regular trainings regarding the restrictions in place. Management at all levels must be committed to compliance and impress a culture of compliance on all employees of the company.

Companies should also institute a formal reporting process for potential violations, a way for employees to anonymously report potential violations, and a system for internal investigations arising from complaints. OFAC offers mitigation of penalties for companies that self-report violations, so it is essential for companies to promptly investigate potential violations and make the appropriate self-reports. Finally, companies should periodically monitor and audit their compliance programs to make sure that they remain effective.

D. Grayson Yeargin is a partner with Nixon Peabody LLP and a member of the firm's Government Investigations & White Collar Defense practice group. Lindsey Nelson is an associate with Nixon Peabody and is also a member of the Government Investigations & White Collar Defense practice group. Both Mr. Yeargin and Ms. Nelson are based in the firm's Washington, D.C. office.

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