EU Blocking Regulation vs. US secondary sanctions: companies increasingly between a rock and a hard place

The ECJ ruling in Bank Melli Iran v Telekom Deutschland GmbH (C-124/20)

Background

After receiving Advocate General Hogan’s Opinion in May 2021, the Court of Justice of the European Union (ECJ) handed down its highly anticipated ruling in the Bank Melli Iran case (C-124/20) on 21 December 2021. The Court of Justice was faced with the difficult question of whether companies are permitted, in response to impending US secondary sanctions, to give regular notice of termination of contracts to companies subject to US sanctions without stating their reasons or whether such termination is ineffective because it constitutes an infringement of Article 5(1) of the EU Blocking Regulation (Regulation (EC) No 2271/96).

The specific case upon which the Grand Chamber of the ECJ ruled was based on the fact that Telekom Deutschland GmbH, a subsidiary of Deutsche Telekom AG, which does significant business on the US market, terminated several telecommunications services contracts with Bank Melli Iran. The bank is owned by the Iranian State. After the US withdrew from the nuclear deal with Iran, it placed Bank Melli Iran on the Specially Designated Nationals and Blocked Persons List (SDN list). This list also entails secondary sanctions, i.e. US law prohibits all business relations worldwide, including those not related to the US, with listed entities such as Bank Melli Iran. Significant infringement of this prohibition by German and European companies places them in danger of being targeted by the US sanctions authorities and being placed on the SDN list themselves (Noerr reported). However, the EU considers US secondary sanctions to be contrary to international law because of their extraterritorial effect. In order to avoid this breach of international law and to reduce restraints on international trade, Article 5(1) of the EU Blocking Regulation prohibits economic players from complying with the third-country sanctions listed in the annex to the Regulation. The SDN listing of Bank Melli Iran is one such sanction.

Because Telekom Deutschland GmbH terminated its contracts with Bank Melli Iran very soon after the bank was placed on the SDN list, the bank cited Article 5(1) of the EU Blocking Regulation in its action against the termination, and Hamburg Higher Regional Court requested a preliminary ruling from the ECJ to interpret that legal provision (Hamburg Higher Regional Court, referral of questions to the ECJ on 2 March 2020 – 11 U 116/19).

Regarding the question of the scope of Article 5 of the EU Blocking Regulation, it was not particularly surprising that the ECJ agreed with the Advocate General’s assessment that such scope is not limited to cases in which specific orders were issued by a third country. The ECJ also addressed in particular the questions of burden of proof as regards the motivation for terminating the contract and the interpretation of the prohibition stipulated by Article 5(1) of the EU Blocking Regulation in the light of the principles of freedom to conduct a business and proportionality.

Reversal of burden of proof may be necessary

In view of the principle in German civil law that regular termination of contracts without stating reasons is permissible and the burden of proof is on the party invoking the ineffectiveness of a legal transaction according to section 134 of the German Civil Code, the ECJ examined the question of how this principle can be reconciled with the effectiveness of the prohibition in Article 5(1) of the EU Blocking Regulation.

Advocate General Hogan had positioned himself very clearly in this regard and stated that the prohibition under the Blocking Regulation can only be effectively implemented if the terminating party proves that its motivation for terminating the contract was not based on a third country’s sanctions regimes. The standard that the Advocate General placed on this evidence made it practically impossible to effectively terminate contracts with entities designated by the US as SDNs.

The ECJ does not agree with every aspect of this strict interpretation. In the light of Article 5(1) of the EU Blocking Regulation, it does at least acknowledge in principle that the burden of proof of the reason for termination may be on the party that invokes the infringement of that prohibition. In particular, the ECJ does not believe that, in principle, it follows from the EU Blocking Regulation itself that it is only possible to terminate contracts with economic players sanctioned by a third country if reasons are stated. However, the judges also underline how difficult it is for one party to provide proof of another party’s motivation for a business decision, and they emphasise the relevance of this difficulty to the effectiveness of the prohibition of the EU Blocking Regulation if customary evidence rules are applied. The ECJ resolves this conflict using an approach comparable to one used by the German Federal Court of Justice (Bundesgerichtshof) regarding secondary burden of proof: if the evidence in the proceedings indicates at first sight that the terminating party’s motivation for terminating was to comply with third-country sanctions, the terminating party must disprove this impression according to the requisite legal standard.

It is true that this makes the ECJ’s assessment less absolute than that proposed by the Advocate General. Nevertheless, the ECJ accords the prohibition of compliance with third-country sanctions more extensive effect than do either the wording of the Blocking Regulation or the EU Commission’s guidance document on the adoption of the updated Blocking Regulation. According to the latter, companies are free to choose to start, continue or cease doing business in Iran or Cuba.

Principle of proportionality limits Blocking Regulation’s prohibition

The only indication by the ECJ that there could be limits on the prohibition came in response to the third question referred for a preliminary ruling. The ECJ ruled that it is in principle compatible with the fundamental right of freedom to conduct a business (Article 16 of the Charter of Fundamental Rights of the European Union (CFR)) and with the principle of proportionality (Article 52 CFR) that a termination — if initiated due to the US sanctions — would be null and void in accordance with section 134 of the German Civil Code. However, the ECJ emphasises in this respect that it is the referring court’s compulsory duty to examine the proportionality of the ineffectiveness of the termination. To this end, the ECJ sets out aspects to be taken into account in order to guide national courts: the likelihood and extent to which the terminating party — in this case Telekom Deutschland GmbH — will be exposed to disproportionate effects if it is required to uphold a contract with an entity subject to US sanctions. However, the ECJ ruled that this evaluation is to include the fact that, before giving notice of termination, Telekom Deutschland GmbH did not exercise the option of applying to the European Commission for permission to terminate under Article 5(2) of the EU Blocking Regulation, an option which has not been established in practice.

Outlook – Companies increasingly in a dilemma

This much-anticipated ruling leaves little doubt about the ECJ’s position on the EU Blocking Regulation: EU economic players are strictly bound by EU sanction rules and prohibited in the vast majority of cases from complying with third-country sanction rules. Legal transactions contrary to this prohibition are usually ineffective. This leaves international economic players from the EU with the dilemma of being forced to decide between conduct in conformity with EU law and the risk of very severe economic consequences of US secondary sanctions. It is true that the emphasis on the necessary proportionality opens up a small window of leeway for national courts to use a case-by-case approach. In the main proceedings discussed here, Hamburg Higher Regional Court will now have to decide on the case and determine whether the termination was motivated by US secondary sanctions and whether Telekom Deutschland GmbH, with its extensive activities in the USA, is in danger of “disproportionate effects” if it upholds contracts with Bank Melli Iran.

Ultimately, it remains a legally and economically challenging situation for EU economic players. The ECJ does not side with the Advocate General’s outright criticism of the EU Blocking Regulation and clear appeal to the European legislator in its ruling. It remains to be seen whether, regardless of this, the EU will arrive at a more workable solution for conflicting sanction regimes. In any event, the consultation process conducted by the European Commission in autumn 2021 with a view to amending the Blocking Regulation leaves this possibility open.