On May 26, 2017, in Epsilon Electronics v. US Department of the Treasury, a split panel of the DC Circuit Court of Appeals partially upheld and partially remanded to the district court a determination by the Treasury Department’s Office of Foreign Assets Control (OFAC) to impose a penalty of over $4 million against Epsilon for violating the Iranian Transaction and Sanctions Regulations, 31 CFR Part 560 (ITSR). (See this link for a summary of the May 2016 district court decision granting summary judgment in favor of OFAC.)
The case, which has been watched with interest by U.S. companies whose products can be found in Iran, considered the meaning and application of an OFAC regulation prohibiting the transshipment of U.S. goods to Iran through third countries. The relevant regulation prohibits U.S. persons from exporting “goods, technology or services to Iran,” including exports to third countries with “knowledge or reason to know” that the exports are “intended specifically” for shipment to Iran. 31 CFR § 560.204.
The transshipment provision is a critical component of the U.S. sanctions program. U.S. sanctions against Iran are far more significant than sanctions that most other countries in the world maintain on Iran, with virtually all trade between the United States and Iran being prohibited by the U.S. government. Thus, companies in the United States that must comply with U.S. sanctions on Iran frequently interact with non-U.S. firms that are not similarly restricted under their local law in their dealings with Iran. For U.S. exporters, this may include trade with wholesalers or distributors in third countries who also do business in Iran.
Epsilon addresses a threshold question that is potentially relevant to any transaction that may implicate the ITSR’s prohibition on transshipments to Iran. The U.S. government argued, and a majority of the D.C. Circuit panel agreed, that under the plain language of the regulation, the actual delivery of U.S. origin products to Iran is not required for the regulation to be violated. Instead, the regulations restrict a U.S. exporter at the point it ships items out of the United States, where that exporter knows or should know that a third country specifically intends to re-export the goods to Iran, regardless of whether the goods ultimately arrive in Iran. The Court reached this conclusion over the objection of Epsilon and amicus, which argued that the regulation cannot be violated absent evidence of an export that is actually sent to Iran. Relying in part on the definition of “export” in the separate, but related, Export Administration Regulations, 15 CFR Parts 730-774, the court reasoned that an “export” occurs at the time of sending an item out of a country, not at the time that the item arrives in its country of ultimate destination.
Epsilon also provides guidance that is relevant to how U.S. companies might think about an interpretation of the transshipment regulations that is sometimes referred to as the “inventory exception.” While it is not specifically recognized as such in OFAC’s regulations or guidance, the inventory exception is implicit in the plain language of the ITSR transshipment regulation. As the DC Circuit acknowledged in Epsilon, the transshipment regulation is not a strict liability provision. Instead, it prohibits exports made to third countries with “knowledge or reason to know” that the exports ultimately are “intended specifically” for Iran. Thus, a U.S. exporter that reasonably could not have known that a third party would ship its goods to Iran would have a defense under the regulations.
In 2002, OFAC published guidance, however, indicating that the “reason to know” threshold may be crossed “when the third part deals exclusively or predominantly with Iran or the Government of Iran.” What some characterize as the inventory exception, therefore, describes scenarios in which a U.S. exporter has no knowledge or reason to know that its export is to be transshipped to Iran by the third-country customer, including where the relevant third-country customer does not deal exclusively or predominantly with Iran (such factors presumably being evidence of “reason to know” of a transshipment).
Reviewing OFAC’s determination under the “substantial evidence” standard of the Administrative Procedures Act, Epsilon upheld an OFAC determination that the transshipment provision could be triggered where substantial evidence (in the form of a supposedly erroneous shipment to Iran, along with archived website materials from Epsilon and the customer) supported a conclusion that, during one period of time, all of the relevant third-country customer’s sales were to Iran.
On the other hand, the DC Circuit found that OFAC’s determination of a violation was arbitrary and capricious with respect to alleged violations that took place during another period of time, because OFAC failed to adequately account for evidence provided by the company suggesting that the customer was purchasing goods for sales in its home country.
What lessons should a U.S. exporter draw from this decision?
First, while Epsilon’s guidance on the question of actual sales into Iran is important (and was the main subject of disagreement by the dissenting judge), it does not otherwise appear to impact the key limiting features of the transshipment regulation. Specifically, the D.C. Circuit explicitly acknowledged that the regulation does not establish a strict liability scheme for transshipments to Iran. Knowledge or reason to know of transshipments remains the relevant standard, and reasonable care must be taken, consistent with OFAC’s 2002 guidance, to ensure that exports to third countries are not specifically intended for Iran, and that third-country customers do not deal exclusively or predominantly with Iran. While an exporter may satisfy itself that its exports to a third country are not specifically intended for Iran, some due diligence is required to demonstrate no “reason to know” that a customer is exclusively or predominantly doing business with Iran.
Second, the decision underscores the importance of fully engaging with OFAC during the administrative enforcement process – and outside the enforcement process. OFAC’s original 2002 guidance was issued as a result of request for guidance from a U.S. exporter. Exporters can raise questions with OFAC where necessary. Moreover, in the unhappy event of an enforcement proceeding, exporters should consider participating fully in OFAC’s administrative proceedings, including by presenting any contrary evidence, in order to drive the development of a detailed record and strengthen a possible case on appeal. The APA’s “substantial evidence” standard is deferential to agency decision-making, but Epsilon shows that courts will examine whether an agency has taken into account evidence presented during a proceeding that rebuts the agency’s ultimate determination.