Posted on behalf of Jonathan Benner and Matt Thomas.

On New Year’s Eve 2011, President Obama signed the National Defense Authorization Act for Fiscal Year 2012 (“NDAA”). It authorizes all US defense programs, functions and projects for the coming fiscal year. Because of their critical importance to the continued operation of US military programmes, bills like NDAA 2012 are frequently used by Members of Congress as vehicles on which to attach measures that might not pass quickly or at all if considered in isolation. The NDAA contains several such provisions that are noteworthy beyond the general military focus of the statute. For example, considerable domestic controversy in the United States has arisen from provisions dealing with the detention of suspected terrorists, including suspects who are citizens of the United States.

Also included in NDAA is a section that imposes sanctions on the Central Bank of Iran and other Iranian financial institutions. Citing concern that the Iranian banking system is a potential avenue of support for proliferation and development of nuclear weapons, international terrorism, money-laundering, and fraud on non-Iranian financial institutions, Congress attached provisions to NDAA intended to isolate the Iranian financial sector from the global financial system

Section 1245 of NDAA prohibits transactions in property interests of an Iranian financial institution if such interests are in the United States, or are within the possession or control of a United States person.  This formulation extends prior US law to all Iranian financial institutions, not only Iranian institutions on the U.S. “SDN List.” Significantly, foreign financial institutions will, after 29 February 2012, be restricted or prohibited from maintaining correspondent or pay-through accounts in the United States if they have “knowingly conducted or facilitated any significant financial transaction with the Central Bank of Iran. . . .”

Sponsors of this provision made clear in floor statements that their intent was to further constrict trade in Iranian petroleum exports and to extend pressure previously applied to Iranian institutions to banks in third countries.  The U.S. Administration, while actively pursuing and promoting diplomatic and sanctions initiatives intended to impede or halt Iranian nuclear developments, had expressed its discomfort with Congressional measures that, through over-reach, might complicate U.S. diplomatic efforts or restrict the flexibility of the Administration to craft sanctions measures that are selective and easily modulated.  Nonetheless, the urgency of NDAA to the overall defense effort dictated that it was signed into law despite the presence of certain controversial provisions.

In general, the sanctions in the legislation will only apply with respect to financial transactions conducted or facilitated by a foreign financial institution on or after the date that is 180 days after the date of the enactment.

However, under the text of the bill, sanctions will only be applied with regard to petroleum transactions if the President determines (in a report due after 90 days, and ever 180 days thereafter) that there is a sufficient supply of petroleum and petroleum products from countries other than Iran to permit a significant reduction in the volume of petroleum and petroleum products purchased from Iran by or through foreign financial institutions.  This provision reflects a general awareness in the U.S. government that global economic conditions dictate that sanctions actions with marked impacts on the supply of petroleum could cause unintended collateral damage outside Iran.

The president has other discretionary powers to forestall imposition of these sanctions, including deferring sanctions where host countries have reduced the purchase of petroleum from Iran, and a broad 120-day renewable waiver power. As a result, it is difficult to say with certainty when the White House might actually elect to invoke these sanctions. The sanctions are not “self-executing,” that is, the Administration affirmatively would have to take action against banks that fall afoul of these rules. Thus, for practical purposes, the actual implementation of these sanctions will be at the President’s discretion, but the political pressure to deploy them will certainly continue to mount, particularly in an election year.

For Reed Smith shipping clients, there are two primary impacts of NDAA.  The first is that the international banking system is likely to become more and more sensitized to U.S. Government concerns over Iranian transactions.  Even prior to the enactment of NDAA, shipping interests have experienced delays or disruptions of routine international transactions by U.S. banks or their overseas branches because of suspicions that an underlying transaction related to forbidden Iranian activity.  These incidents can sometimes be remedied, but, even in the best of circumstances, they impose stress and delay on the prompt clearance of funds in international markets.  The second impact is that it has been widely, but mistakenly reported that the NDAA contained requirements that vessel owners or operators certify that ships have not called at Iranian ports prior to port calls in the United States.  While legislation that would impose such restrictions (similar, in some respects to restrictions already in place with regard to vessel calls in Cuba), has passed the House of Representatives and is pending in the United States Senate, it is not yet effective.  Last month the House passed two new sanctions bills, HR 1905, the “Iran Threat Reduction Act of 2011”, and HR 2105, the “Iran, North Korea, and Syria Nonproliferation Reform and Modernization Act of 2011.”  These bills have not yet passed the Senate.

Of primary importance to shipping, HR 2105 would amend the Ports and Waterways Safety Act (33 USC § 1221 et seq.) to require either “the owner, charterer, operator, or master” of a vessel to “certify” prior to arrival in a US port, “that the vessel did not enter a port in Iran, North Korea, or Syria during the 180-day period ending on the date of arrival of the vessel” at U.S. port.  False certifications would be subject to a two-year ban on the offending owner/operator from landing of any of its vessels (including vessels owned by a parent company) in any U.S. port, in addition to other applicable criminal and civil penalties. The 180-day rule is patterned on a rule that already exists for vessels that call at Cuban ports.

Regarding vessels, HR 2105 also:

• Directs federal authorities to inspect vessels that have landed in Iranian, North Korean or Syrian ports during the preceding twelve months to determine whether the vessel was involved in any sanctioned nuclear proliferation-related activity.
• Provides for new sanctions on any person providing shipping services for the transportation of goods to or from Iran, North Korea, or Syria for purposes relating to nuclear, biological, or chemical weapons, or ballistic or cruise missile development programs.

Sanctions Outlook

Also before the Senate is another comprehensive sanctions bill, S. 1048, the “Iran,North Korea, and Syria Sanctions Consolidation Act of 2011.”  This bill contains a number of measures similar to HR 2105 and 1905, including a similar (but not identical) 180-day bar on vessels calling in the U.S. if they have called in the sanctioned states.

S. 1048 also provides for new sanctions on shipping services with respect to the exportation of petroleum, oil, or liquefied natural gas to be refined or otherwise processed outside of Iran if Iran’s Republican Guard or any of its affiliates are involved in the development, extraction, production, transportation, or sale of such commodities.

We believe that the confusion between this pending legislation and NDAA relates to similar time frames relating to effective dates.

We have advised friends and clients of the Firm that the pending vessel restriction legislation has few enemies in the United States Congress and that, at this time, we see no obstacle to its ultimate passage.  Prudent planning may merit some attention to review of vessel trading patterns to avoid disruption of voyages and charters should such legislation take effect.  However, for the moment, a ban on U.S. port calls by vessels that have recently called Iran is not in place.  Such vessels may be subject to strict physical inspection by U.S. authorities, however.

For additional information, please contact Jonathan Benner (202-414-9827) or Matt Thomas (202-414-9257).