European Court Interprets EU Blocking Regulation For First Time

The Court of Justice of the European Union (the Court) has, for the first time, provided its interpretation of Article 5 of the EU Blocking Regulation, which prohibits EU persons from acting in compliance with certain sanctions imposed by the US on Iran and Cuba. In this update, we provide an overview of the Court’s decision and consider the implications of the issues addressed.

Factual Background

The Court addressed four interpretive questions regarding the EU Blocking Regulation[1] which were referred by a German higher regional court (see our previous post regarding the referral).

In summary, the reference to the Court was made in the following circumstances:

• In 2018, the United States of America (US) withdrew from the Joint Comprehensive Plan of Action and reimposed certain sanctions on Iran with effect from 5 November 2018.
• Shortly thereafter, Telekom Deutschland GmbH (Telekom) cancelled its contracts with the German branch of Bank Melli Iran (Bank Melli), an Iranian bank owned by the Government of Iran, for the provision of telephone and internet services.
• Telekom cancelled its contract with Bank Melli on the basis of paragraph 134 of the Bürgerliches Gesetzbuch (German Civil Code), which, as translated by the Court, provides: "Any legal act contrary to a statutory prohibition shall be void except as otherwise provided by law."
• Bank Melli disputed Telekom’s termination of its services and commenced proceedings in the Hamburg courts, requesting specific performance of the cancelled contracts.
• One of the arguments made by Bank Melli was that the sole reason for termination was Telekom’s wish to comply with US secondary sanctions, in contravention of Article 5 of the EU Blocking Regulation.
• Article 5 prohibits EU persons from "comply[ing], whether directly or through a subsidiary or other intermediary person, actively or by deliberate omission, with any requirement or prohibition, including requests of foreign courts, based on or resulting, directly or indirectly, from [specified US sanctions] or from actions based thereon or resulting therefrom", unless authorised by the European Commission.
• The Hamburg court subsequently sought a preliminary ruling from the Court regarding the interpretation of Article 5 and its application to the dispute between Bank Melli and Telekom.

We consider below the questions referred and the Court’s analysis. In May 2021, an Advocate-General (AG) of the Court provided an opinion on the questions referred. As explained below, the Court’s ruling differs from the positions expressed by the AG in some material respects.

First Question: Does Article 5 apply in the absence of an order directing compliance issued by US administrative or judicial authorities?

Yes. The Court considered that Article 5 was broadly drafted and confirmed that it prohibited EU persons from complying with the requirements or prohibitions laid down in the laws specified in the EU Blocking Regulation’s annex, even in the absence of an order directing compliance issued by a US administrative or judicial authority.

The Court recognised that certain of the US sanctions laws specified in the EU Blocking Regulation’s Annex were capable of achieving their intended objective through the threat of potential legal consequences (i.e., US secondary sanctions). Therefore, the EU Blocking Regulation would not be able to achieve its intended effect if its application was limited to compliance with the orders of US administrative or judicial authorities.

Second Question: Can an EU operator terminate a contract with a person designated under US sanctions (SDNs) without providing reasons for termination?

Yes. The Court confirmed that the EU Blocking Regulation does not prohibit EU persons from terminating contracts with SDNs without providing reasons. Therefore, if a contractual party is permitted by national law to terminate a contract without providing reasons, they can do so without contravening Article 5.

However, the Court went on to state that a counterparty may challenge the termination of a contract in civil proceedings on the basis that such termination was in contravention of Article 5. In this scenario, the burden of proof would fall on the terminating party to demonstrate, to the requisite legal standard, that they did not act in prohibited compliance with the US sanctions specified in the EU Blocking Regulation’s Annex.

The Court, however, did not go on to opine on the kinds of evidence that could demonstrate that an EU operator did not act in prohibited compliance with US sanctions. In this regard, the AG commented in his opinion that "there are many companies and individuals who would have ethical qualms and reservations about doing business [with Iran]", and that any "sincere" decision to terminate a contract on this basis would need to be demonstrated (such as engagement in a "coherent and systematic corporate social-responsibility policy").

However, it seems, that such broader questions as to the relevant evidence and requisite standard of proof has been left to national courts for now.

Third and Fourth Questions: Is the termination of a contract in contravention of Article 5 ineffective? Would such termination be ineffective where it would expose the EU operator to substantial economic loss?

This question before the Court was important for the Telekom Deutschland group as it generated around 50 percent of its turnover in the US market. The Court concluded that a contravention of Article 5 could lead to the annulment of a contractual termination, provided that such annulment did not lead to "disproportionate effects" for the EU operator concerned.

In terms of what could amount to "disproportionate effects", the Court left this matter to be decided by national courts. They instructed national courts to balance the objectives of the EU Blocking Regulation against the probability that the EU operator in question would be exposed to severe economic losses if it was unable to terminate its contractual relationship.

The Court emphasised that it would be relevant for national courts to consider whether the EU operator in question had sought to apply to the European Commission for authorisation to comply with US sanctions targeted by the EU Blocking Regulation, suggesting that a failure to do so could weigh against the EU operator in an assessment of "disproportionate effects".

Key Takeaways

The Court’s judgment helpfully clarifies a number of important points for EU persons around the interpretation of Article 5, though it also leaves other important questions unaddressed.

The key takeaways from the Court’s judgment are that:

1. The judgment confirms that commercial decisions taken by EU persons in response to US sanctions risks may be subject to scrutiny in litigation. Such decisions may be reversed by EU Member State courts;
    
2. The Court did not opine on the types of conduct that might amount to prohibited compliance with US sanctions. In particular, it did not comment on whether an EU operator’s reliance on contractual risk allocation provisions (which may not necessarily provide for termination of contracts) could amount to such prohibited compliance. It seems that this matter will likely be decided by EU Member State courts according to the particular facts of each case and applicable law;
    
3. An EU operator's appetite for business with persons targeted by specified US sanctions may be influenced by a number of factors. The Court’s judgment leaves open for contracts to be terminated without contravening Article 5, provided that the reason(s) for doing so are clearly and demonstrably based on grounds other than compliance with such US sanctions. Given the risk that such termination could be challenged in civil litigation, EU persons should ensure that their reasons for termination of contracts with a nexus to sanctioned counterparties or jurisdictions are clearly documented and evidenced;
    
4. The Court acknowledged that penalties and remedies for a contravention of Article 5 are not harmonised across EU Member States. Therefore, it could be the case that the courts of some EU Member States may order payment of damages, rather than specific performance;
    
5. It also remains to be seen how US sanctions enforcement authorities might react to a scenario in which an EU court has ordered specific performance of a contract that would expose an EU company to US sanctions; and
    
6. Finally, the United Kingdom has retained the EU Blocking Regulation in UK law following its withdrawal from the European Union (with the necessary amendments to place it on a UK law footing). Whilst courts in the UK are not required to follow the Court’s judgment, they may find the Court’s reasoning to be persuasive.

What Next?

At the beginning of 2021, the European Commission announced that it would consider potential amendments and/or revisions to the EU Blocking Regulation with a view to streamlining its application by reducing compliance costs for EU citizens and businesses.

A public consultation closed in November 2021, and the nature and extent of any amendments or proposed replacement is forthcoming. It is anticipated that any amendments arising from this evaluation and impact assessment will be adopted in Q2, 2022.^[2]

It remains to be seen whether any such amendments can address the current uncertainties and compliance risks faced by EU persons and businesses.