Smart sanctions and due diligence requirements in practice – a bottomless pit?

Over the past years, “smart sanctions” – that is, the targeted imposition of restrictive measures against individuals, organisations and institutions – have established themselves as an important foreign policy instrument on the geopolitical and security policy stage. Switzerland supports sanctions that are broadly supported worldwide and are based on compliance with international law and humanitarian values. The nationally formulated sanctions ordinances take their cue, above all, from resolutions of the United Nations and partly from sanctions resolutions of the EU.

Of particular relevance are financing bans, which among other things prohibit the direct or indirect provision of any economic resources to persons or institutions included in the sanction lists.[i] For companies, this means that it has become vitally important to regularly check potential and existing business relationships against current sanctions lists, since a violation of this provision ban has serious consequences – from heavy fines to prison sentences or the disruption of a company’s business operations.

A practical challenge

The practical challenge for companies is to understand and manage the boundaries of sanction regulations. The European Court of Justice, for example, makes it clear that the provision ban must be understood as particularly broad – but what this means in concrete terms with regard to the indirect provision ban is left open in Luxembourg. Although the direct provision ban – that is, the direct provision of monetary benefits to listed persons or institutions – is clear, the indirect provision of economic resources has turned out to be problematic. What about the subsidiary of the “bad” parent company? How broadly should “very broad” be interpreted?

The fact that the open definition of the indirect provision ban is a conscious decision by the Court of Justice shows the meaning and purpose of sanctions law, which it must be possible to apply as flexibly, dynamically and effectively as possible in order to keep up with the fast pace of foreign policy decisions. The foreign trade instrument of the financing bans thus negotiates a constant balancing act between the highest possible degree of effectiveness and economic operators’ need for legal certainty and precision.

A statement by the European Commission offers guidance here: It states that the provision of any economic resources to persons or institutions that are owned or controlled by a listed person or institution constitutes an indirect provision within the meaning of the provision ban. The indirect provision ban therefore applies if a listed company is in possession of 50% or more of the proprietary rights or has a majority interest therein. This also applies if shareholders are able to exercise a controlling influence in accordance with the criteria of the Anti-Terrorism Ordinance by other means.[ii]

However, this statement is not legally binding and is therefore nothing more than an expression of the legislative will. A similar clarification by the Swiss authorities is still pending. However, Swiss sanctions measures already stipulate, in a legally binding manner, that the provision bans can also extend to the entities owned or controlled by the listed (legal) persons.[iii] Accordingly, the subsidiary of the listed parent company may be taboo, at least insofar as it cannot be proven in individual cases that the funds remain exclusively with the subsidiary.

Limits of the indirect provision ban

However, it cannot be in the interests of the European Court of Justice, Switzerland and the international community to interpret the indirect provision ban without limits, since the legal uncertainty due to the vagueness of the legal term can result in economic paralysis. On the other hand, every economic operator must be aware that there cannot be any specific criteria for compliance with the indirect provision ban, since for sanctions law what matters is not the manner of provision, but only the aim of the sanction: Economic resources must not fall into the hands of the listed persons or institutions, or else any restrictive measures would be practically ineffective. For the economy, this means that it must choose a risk-based approach that minimises the risk of a breach, on the one hand through internal due diligence processes and on the other through good risk and compliance management.

Significance for companies

Swiss sanctions law does not provide for any explicit dischargeability clauses, but the general principles of personal fault under criminal and administrative law apply, with liability limited as a result. Accordingly, companies must show that they can rule out the possibility of a breach through risk-based compliance and control structures. The best way to ensure this is by taking the following three measures:

1. Modified sanctioned party list screening:

Companies are highly encouraged – depending on the respective industrial sector and the trade structure – to introduce a modified sanctions list comparison system, which, in addition to a direct list comparison between business partners and entries on sanction lists, also takes into account ownership and control structures. This will not be manageable without the use of automated solutions from specialist providers. In addition, the complex logic in the system and in the processes must be configured and developed accordingly. A “one size fits all” approach will not work here, unless companies adhere to the strictest regulations in each case and accept that they will have to relinquish otherwise lawful transactions. But this procedure should also be the result of a conscious business decision and not take place “by chance” because of the respective IT solution.

2. Risk-based know-your-customer processes:

Companies should ensure processes that provide them with the best possible knowledge of their business partners in order to rule out, as far as possible, any negligent violations of foreign trade law. This depends on the coordinated integration of the “first line of defence” (operational business units with their greater knowledge of clients, market and industry) into the “second line of defence” (trade compliance functions). Risk indicators can be conveyed and retrieved through appropriate training courses and checklists.

3. Accompanying drafting of contracts:

The third element of risk mitigation consists of taking contractual precautions in order to rule out, as far as possible, any violations of the (indirect) provision ban. A multi-layered approach has proven its worth here, addressing not only compliance and end-user clauses under foreign trade law, but also basic provisions on subcontracting and distribution channels, for example.

Homework for everyone

Although the international community should ideally define, in a legally binding and precise manner, what is meant by indirect provision as well as the underlying ownership and control structures, it would be up to the economy to proactively address the issue in companies’ respective compliance organisations. Why not as a first step expand the Swiss Embargo Act[iv] to include a legal definition of ownership and control structures in connection with financing bans?

[i] Art. 4a Para. 2 of COUNCIL REGULATION (EU) No. 401/2013 of 2 May 2013; formulated in Switzerland as "making available indirectly" and standardised in the Ordinance on Measures against Myanmar (946.231.157.5) of 17 October 2018 (version as at 25 August 2020).

[ii] Art. 1 No. 5/6 of COUNCIL REGULATION (EC) No. 2580/2001 of 27 December 2001.

[iii] As an example, reference is made to Article 2 letter c of the Ordinance (946.231.157.5) on Measures against Myanmar of 17 October 2018 (version as at 25 August 2020).

[iv] Federal Act (946.231) on the Implementation of International Sanctions (Embargo Act, EmbA).