The EU Blocking Regulation: EU Advocate General's Opinion puts pressure on companies dealing with Iran

What has happened?

EU Advocate General Hogan ("AG Hogan") has delivered an Opinion in the preliminary ruling requested by a German court from the European Court of Justice ("ECJ") in a case between Bank Melli, an Iranian bank, ("BM") and Deutsche Telekom ("DT"). The case concerns the interpretation of EU Regulation 2271/96 ("Blocking Regulation"), and DT’s termination of a services contract with BM following the U.S. withdrawal from the JCPOA and the subsequent reimposition of U.S. secondary sanctions in respect of Iran.

AG Hogan concluded that DT must provide reasons for the termination of the contract with BM, and to the extent that it does not or that these reasons refer to compliance with U.S. sanctions, DT’s termination would be ineffective and the contract would remain in force. This decision is surprising and puts a great deal of pressure on EU businesses to explain publicly their reasons as to why they act in a particular way.

If the ECJ follows the Opinion, and it may, the effect of the Blocking Regulation will be to place EU companies in a position where they may be caught between the risk of breaching US sanctions law and EU law. Avoiding this invidious position will require careful thought and planning.

What is the background?

The case arose from the Trump Administration’s May 2018 decision to withdraw from the 2015 JCPOA deal with Iran and threaten “secondary” sanctions on non-US persons dealing with Iranian businesses. The EU responded to the US threat of sanctions on non-US persons by adding certain US measures in respect of Iran to the Annex of its 1996 Blocking Regulation, meaning that EU businesses were prohibited from complying with those U.S. “secondary” sanctions.

In November 2018, DT took the decision to terminate its services contract with Bank Melli and four other parties with connections to Iran. DT did not provide reasons for that decision. BM is Iran largest public bank, which was designated by U.S. Treasury Department on the U.S. SDN list on 25 October 25 2007. BM is not targeted by EU sanctions. BM brought proceedings against DT to keep the services in place. The German Court of first instance found that the decision to terminate was valid, and DT’s action did not breach the Blocking Regulation. BM appealed to the referring German Court. The referring German Court asked the ECJ to give a ruling on four questions:

1. Does the obligation under the Blocking Regulation not to comply with the listed U.S. measures only arise when it is ordered by a US court or other relevant body?
2. Does an EU person terminating an arrangement with an SDN need to provide a reason for termination, i.e. without having to show and prove in civil proceedings that the reason for termination was not to comply with US sanctions?
3. If the terminating party is held to have breached the Blocking Regulation, is the termination ineffective, or is there some other remedy for the terminated party, e.g. damages?
4. Does a conclusion that the termination was ineffective (and so services need to be resumed) call into question the right of the terminating party’s freedom to conduct business protected by Article 16 of the Charter of Fundamental Rights of the European Union, and proportionality under Article 52 of the same?

AG Hogan's Opinion

Questions one and four were decided in favour of BM. We will concentrate on questions two and three.

On the question two, relating to a possible obligation to provide reasons for termination, AG Hogan started by looking at whether the Blocking Regulation conferred any rights on parties such as BM. After noting a number of arguments as why the Blocking Regulation should not do this, AG Hogan pointed out that without some ability for the requirements of the Blocking Regulation to be brought before a court and tested “a state of affairs” would occur “in which many European entities quietly decide to comply (even indirectly) with those sanctions.”

AG Hogan confirmed that the Blocking Regulation imposes an obligation on the terminating party to provide reasons for terminating a contract with a person subject to U.S. primary sanctions. Looking at the main argument, AG Hogan noted:

“In order . . . to establish that the reasons given in respect of any decision to terminate a contract on this ground were in fact sincere… Telekom Deutschland … would need, in my view, to demonstrate that it is actively engaged in a coherent and systematic corporate social-responsibility policy (CSR) which requires them, inter alia, to refuse to deal with any company having links with the Iranian regime.

In any case, it nevertheless follows from the uncompromising terms of the first paragraph of Article 5 of the EU blocking statute that – in principle, at least – an undertaking seeking to terminate an otherwise valid contract with an Iranian entity subject to the US sanctions must demonstrate to the satisfaction of the referring court that it did not do so by reason of its desire to comply with those sanctions.”

AG Hogan went on to consider the burden of proof, noting that, in normal cases, the applicant bore the burden of proof of its claim. However:

“third parties will obviously have the greatest difficulty in gathering evidence that the decision not to enter into or not to continue a commercial relationship is the consequence of the will of a person referred to in Article 11 of [the Blocking Regulation] to comply with US law. Apart from the unlikely event that a person …. would ever, for example, publicly admit its willingness to comply with the legislation listed in the annex to that statute, I do not see what evidence could be provided by the applicants. A concomitance of decisions terminating business relations or refusing to enter into relations with persons subject to primary sanctions? However, in practice, business secrecy makes it extremely difficult for a company to know the real decisions taken by a supplier with regard to other companies.

In these circumstances, I consider that where the claimant has simply provided prima facie evidence, on the one hand, that the person falling under the scope of Article 11 of [the Blocking Regulation] with whom that claimant wishes to enter into or remain in a business relationship may feel concerned by one of the pieces of legislation mentioned in the annex thereto and, on the other hand, that it fulfilled the expected conditions for becoming or remaining a customer of that undertaking, the effect of the first paragraph of Article 5 of [the Blocking Regulation] is that the person referred to in Article 11 of that statute must justify its business decision to terminate the contract at issue or to refuse that claimant as a client.”

AG Hogan then turned to question three. He noted that the wording of Article 5 of the Blocking Regulation “prohibits the persons referred to in Article 11 of that statute [i.e. EU companies] from complying with the legislation listed in the annex thereto”. Therefore, he concluded, any remedy that permitted compliance with the U.S. measures would defeat the prohibition in Article 5. On this basis, “any decision by a person referred to in Article 11 of [the Blocking Regulation] to terminate a contractual relationship with a person subject to primary sanctions which cannot be justified on any ground, other than the desire to comply with one of the pieces of legislation listed in that statute, should be regarded as invalid and ineffective, with the consequence that national courts are obliged to treat the contractual relationship as having continued on the same commercial terms as those previously existing.”

Therefore, according to the Opinion, if an EU business cannot provide reasons for termination of the contract other than compliance with U.S. sanctions, the purported termination of the contract shall be ineffective and it will remain in force.

What are the practical implications of this Opinion?

The ECJ may decide not to follow AG Hogan's Opinion. As such, the impact of the Opinion will need to be reassessed once the preliminary ruling in the BM case has been issued.

Further, the English courts are not required to follow the Opinion, or indeed the final preliminary ruling.

Dealing with the Blocking Regulation places EU (and UK) companies who have significant business both in the U.S. and in the EU in a difficult position and requires them to weigh up their obligations under both U.S. and EU law to determine how to proceed in respect of Iran-related interest. In our view, putting businesses into this position is wholly unreasonable. While some actions taken in compliance with U.S. sanctions are voluntary, some are not, including complying with information requests from U.S. agencies, entering into settlement discussions, and paying fines when levied. All of these would, in principle, breach the Blocking Regulation.

When new sanctions are introduced, businesses will seek to comply with them. Specifically, when new US sanctions are imposed, most businesses will consider the impact of such sanctions on their business and may take the decision to comply with them (even sometimes when they are not directly applicable and in the absence of a risk of designation pursuant to secondary sanctions). The Blocking Regulation, as interpreted by AG Hogan, means that this very analysis may require an EU entity not to comply with those sanctions, because that company will have to reveal its analysis of the impact of these newly adopted U.S. sanctions on its activities.

Will cloaking that process in legal privilege help? It might (not all Member States recognise legal privilege), but that will depend on how a court deals with the privileged advice: if privilege is not waived, will the Court assume that U.S. sanctions were the reason for termination? Or will the national court accept the reasoning offered?

AG Hogan's reference to a decision that “cannot be justified on any ground, other than the desire to comply with one of the pieces of legislation listed in that statute” (emphasis added) leaves open the possibility that another justification (however unconvincing) could be deployed by the terminating party.

There is also the question as to the relevant timeframe for considering the justification: is it at the time the decision was made, in which case many decisions will be ineffective, or can ex post facto reasoning be provided in any subsequent litigation? The Opinion is unclear on this.

Further, in Member States where discovery/disclosure is limited or does not exist, there may be some opportunity for companies to provide “new” reasoning to the Court, but in Member States where discovery/disclosure is ordered, companies will have to provide details of their decision-making processes, and it may be hard to demonstrate that the termination of the contractual relationship was not based upon compliance with U.S. sanctions.

Furthermore, the Opinion does not clear the air concerning the discrepancy of interpretation of the Blocking Regulation between EU Member States on the adoption, content and application of national legislation which incriminates the violation of the provision of EU Blocking Regulation which has some critical operational impacts. As such, in countries such as the Netherlands, where the breach of the Blocking Regulation is a criminal offence, the obligation to provide reasoning set out in the Opinion could engage the right not to self-incriminate. Arguably it does.

There is also a question as to the extent of the obligation to provide an explanation. Initially, AG Hogan seems to apply this to both: (i) termination of contracts; and (ii) refusal to deal with a client because of existing ties with Iran.. However, in looking at the legal effect of the actions, the issue of refusal to deal has disappeared. This may be an omission but is slightly confusing as the primary obligation to explain is stated to apply also to refusal to deal. Extension of the duty to explain to new dealings seems to be a step too far.

What about the position in England?

As to the English law position under the retained version of the Blocking Regulation, it seems unlikely that an English Judge would come to a similar conclusion as AG Hogan, since the English legal system has extensive disclosure in litigation which would permit the reasoning behind a decision to terminate a contract to be revealed thus demonstrating how the relevant decision was made.

The interests of justice would not require that a positive duty be imposed on a party to provide reasons for terminating.

We also doubt whether, in these circumstances, an English judge would:

1. reverse the burden of proof (requiring the defendant to prove that it did lawfully terminate the contract);
2. order continuation of the contract, rather than some other remedy such as damages; or
3. apply the conclusion reached in the AG Hogan Opinion to refusals to deal (as opposed to the termination of an existing contract).

However, UK companies should be aware that the Blocking Regulation has been retained in UK law as part of the Protection of Trading Interests legislation. As the UK's guidance states: "Breaches of […] the retained Blocking Regulation are criminal offences in the UK, punishable by a fine. However, the intention of the Protection of Trading Interests legislation is to protect UK persons from the extraterritorial effect of legislation imposing the proscribed sanctions". This conveys the tension within the Blocking Regulation architecture: it exists to protect EU/UK companies from the extraterritorial reach of U.S. sanctions, but its primary means of achieving this is to criminalise conduct of the same EU/UK companies. European entities with significant turnover or activities in the U.S. or dealing in U.S. Dollars are left in a very difficult position. AG Hogan's Opinion does not make the position easier for them. The preliminary ruling in the BM case could provide an opportunity to clarify this issue and provide long awaited guidance to EU/UK companies.