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Distribution Chains and Sanctions Compliance (Part II of IV)

Companies rely on robust distribution chains as an efficient mechanism to enter new markets without requiring a significant investment.  Additionally, companies may maintain parallel sales activities in markets between their own sales staff and third-party distributors, agents, resellers and dealers.  It is interesting how certain industries have evolved and relied on different models for use of third parties with the intent of reaching customers in the most effective means possible.

The Epsilon Case

Sanctions liability, like anti-bribery liability, can occur when a company relies on third parties who then violate sanctions prohibitions.  The classic case — Company A sells its product to Distributor B who resells the product to Customer C in Iran.  Is Company A always liable for that sale to Customer C in Iran?

The case of Epsilon Electronics, Inc. v. United States Department of Treasury (D.C. Cir. 1:14-cv-02220, May 26, 2017) answers this important question.  In reviewing an OFAC enforcement action, the U.S. Court of Appeals affirmed in part (34 transactions) and reversed in part (OFAC’s finding of five post-cautionary letter violations) OFAC’s and the District Court’s decision affirming OFAC’s enforcement action against Epsilon electronics, a subsidiary of Power Acoustik.

The facts of the case are a cautionary tale — OFAC began investigating Epsilon in 2011, when OFAC learned about a 2008 shipment from Epsilon to an address in Tehran, Iran. OFAC issued a warning letter to Epsilon as a result of this investigation.

Later, in 2011, OFAC learned  that Epsilon had received multiple wire transfers from a Dubai bank, made on behalf of Asra International.  OFAC examined Asra’s website, which referenced the company’s success in the Iran market, listed dealers located in Iran, and displayed photos from trade shows in various Iranian cities.  Some of these photos appeared on Epsilon’s US-website.  OFAC initiated an investigation.

In May 2012, OFAC sent Epsilon another administrative subpoena, requesting further details on the company’s transactions with Asra and with Iran. Epsilon produced invoices for 34 transactions with Asra, and five additional transactions that occurred during February to May 2012, which were destined for Dubai and not Iran.  OFAC imposed a penalty of over $4 million. Epsilon claimed that it did not have any knowledge or reason to know that Asra distributed Epsilon’s products in Iran. 

In rejecting Epsilon’s challenge to OFAC’s enforcement action, the Court of Appeals articulated the standard for liability when an exporter distributes its product through a third-party — when an exporter has “reason to know” that goods are specifically intended for reexport to a prohibited customer (in Iran), the exporter is liable.  Interestingly, the Court of Appeals specifically held that OFAC need not prove that the goods ultimately ended up in Iran, and instead noted that liability attaches once the exporter acts with the prohibited state of mind. 

The Court of Appeals explained that an exporter has taken all the steps he must take to put goods in transit to Iran, and the goods are then out of his control — no other actions are required to violate OFAC’s regulations barring exports to Iran.   “The arrival of the goods is a “result” of his “voluntary conduct,” not part of the conduct itself, and thus is not a component of the “act” of exportation.

The Court of Appeals further stated that the “reason to know” standard can be satisfied “through a variety of circumstantial evidence,” including “course of dealing, general knowledge of the industry or customer preferences, working relationships between the parties, or other criteria far too numerous to enumerate.”

In affirming OFAC’s finding that Epsilon had “reason to know” that the shipments to Asra were destined for an Iran customer, the Court of Appeals cited the fact that Asra distributed exclusively to Iran as late as December 2011, Asra’s website referenced its affiliate in Iran, listed only two contact locations, one in Dubai and one in Iran, its website touted its 10-years of experience in Iran, and its website included a list of dealers located in Iran.

Apollo Aviation

Apollo Aviation Group settled with OFAC for $210,600 for violations of the Sudanese Sanctions Program.  Apollo leased two aircraft engines to Company 1 (UAE), which subleased to a Ukrainian airline, Company 2, which then installed the engines on an aircraft to Sudan Airways, a prohibited entity at the time.

The lease agreements Apollo entered into with Company 1 contained a provision prohibiting the lessee from maintaining, operating, flying, or transferring the engines to any countries subject to United States or United Nations sanctions. Notwithstanding the inclusion of this clause, Apollo did not ensure the aircraft engines were utilized in a manner that complied with OFAC’s regulations. For example, at the time, Apollo did not obtain U.S. law export compliance certificates from lessees and sublessees. Additionally, Apollo did not periodically monitor or otherwise verify its lessee’s and sublessee’s adherence to the lease provision requiring compliance with U.S. sanctions laws during the life of the lease. As a result, Apollo learned where its engines had actually flown only after the engines were returned to Apollo at the end of the lease.

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