How Chinese companies can navigate OFAC sanctions

The US Department of the Treasury’s Office of Foreign Assets Control (OFAC) enforces economic and trade restrictions, known as OFAC sanctions, to achieve foreign policy and national security goals. These sanctions support US policy objectives by restricting transactions with specific countries, regions, organisations or individuals. The OFAC’s primary functions include drafting sanctions lists, reviewing and issuing licences, and investigating and penalising violations of sanctions.

In recent years, numerous cases have emerged where companies have been forced to sign hefty settlement agreements with the US Treasury, or have seen their executives detained, because of violations of US OFAC sanctions. Navigating these sanctions has become essential for Chinese companies engaged in cross-border transactions.

Scope of OFAC sanctions

US entities. The OFAC mandates that all US entities comply with its sanctions and refrain from transactions with sanctioned parties. US entities include: (1) US citizens and permanent residents; (2) companies registered in the US (including US offices or subsidiaries of non-US companies); and (3) individuals and companies physically present in the US during the relevant transactions.

Non-US entities. The OFAC also sanctions non-US entities that have US connections. Although US law does not clearly define the criteria for US connections, the OFAC’s enforcement practices reveal the following standards:

1. Transactions involving US goods, technology or services;
2. Use of US dollars, or settling of transactions through US financial institutions; and
3. Transactions causing US entities to violate sanctions.

These standards mean that Chinese companies, their US branches, US employees and even Chinese employees on business trips to the US could fall under the OFAC’s jurisdiction. The broad criteria for US connections enable the OFAC to sanction a wide range of transactions and individuals, even those that seem unrelated to the US.

Types of OFAC sanctions

Primary sanctions. These sanctions target US entities and non-US entities that have US connections and engage in transactions with sanctioned parties. Violations can result in inclusion on related sanctions lists, hefty fines, and imprisonment of individuals found responsible.

Secondary sanctions. These sanctions target non-US entities that do not have US connections but engage in transactions with sanctioned parties. Violations can lead to inclusion on the Specially Designated Nationals (SDN) list. Some primary sanctions, such as those targeting Iran, include secondary sanctions forcing non-US entities to choose between operating in the sanctioned country’s market and the US market.

The SDN list

The SDN list is central to OFAC sanctions enforcement, requiring compliance by all individuals and entities under US jurisdiction, including foreign subsidiaries registered in the US, such as Chinese banks’ American branches.

The OFAC typically responds to those on the SDN list by freezing their assets within the US and prohibiting any transactions with them. This includes all property and interests in property located in the US, such as funds, real estate and dividends, and the policy extends to barring both US entities and non-US entities with US connections from conducting transactions with listed individuals and organisations.

Countermeasures

Due diligence on transaction parties. Companies should conduct due diligence before transactions to confirm whether transaction parties are within the OFAC’s sanction scope, or at risk of sanctions. The due diligence should include a thorough review of the transaction parties, their supply chains and intermediaries.

Additionally, companies must apply the OFAC’s 50% rule, conducting a deep analysis of ownership structures to determine if any party to a transaction is directly or indirectly owned at a level of 50% or more by entities on the sanctions list.

Verifying transaction subjects. Companies should thoroughly analyse the origin, production processes and upstream sources of transaction subjects to identify any US involvement across the supply chain, including cross-border transnational flows of patents and technologies. They must also verify the intellectual property and technological origins borne by the products to ensure there are no US connections in transactions.

Designing transaction documents. Companies can include OFAC compliance clauses in cross-border transaction documents, such as:

1. Requiring both parties to affirm they are not under OFAC sanctions, are not involved in related investigations, and will avoid activities that could trigger such sanctions;
2. Requiring both parties to disclose any information related to themselves or associated third parties concerning OFAC sanctions;
3. Restricting or prohibiting the transfer of products or funds to sanctioned regions or entities; and
4. Establishing exit and compensation mechanisms for substantial obstacles to contract performance caused by sanctions.

Building a sanctions compliance system. In 2019, the OFAC published “A Framework for OFAC Compliance Commitments”, providing guidance on the establishment of an effective sanctions compliance system. This framework emphasises that an effective system should include five key elements: management commitment; risk assessment; internal controls; compliance testing and auditing; and training.

Taking internal controls as an example, it is recommended that companies at a minimum:

1. Develop written policies and procedures for sanctions compliance;
2. Help internal staff identify, block, escalate and report activities prohibited by the OFAC;
3. Maintain OFAC compliance records including shipping invoices, certificates of origin, customs documents and recordings; and
4. Integrate compliance policies and procedures into their daily operations, with a focus on high-risk departments such as customer development, payments and sales.

Finally, companies should develop and implement effective OFAC compliance programmes, ensure that these programmes are aligned with their specific business sectors and high-risk exposures, routinely assess the sanctions risks of relevant countries and regions, stay updated on international developments and US sanctions, and ensure steady progress in cross-border ventures.

Zhou Le is a partner and Wang Yidan is an associate at Blossom & Credit Law Firm