The Letter of Credits in a “Debt” Perspective under Russia Sanctions of US

Since 2014 we are familiar with the sectoral sanctions, started with Russia Sanctions of the United States. Beside the common tendency to categorize the US sanctions into primary and secondary sanctions (which is totally important) ; we must not miss to evaluating the results and effects of the sanctions as well. Even primary sanctions could be effective to limit the target from acting freely in third countries for its transactions; where there is sufficient compliance process.

Starting with Executive Order 13622 DD. 20/03/2014 there are several maturity limitations implemented for supplying new debt and equity to the listed the targets – where they have a separate list called SSI (Sectoral Sanctions Identifications) in Directive 1 , Directive 2 and Directive 3 . Where the listed entities and their directly / indirectly ; owned / controlled subsidiaries are subject to same limitations. (Be careful that the limitation in Directive 4 does not include a maturity where the ownership implemented with a threshold 33% instead of 50% in the previous directives) The maturity limitation for new debt and equity is 14 days (on and after November 28, 2017) for Directive 1 listed entities and 60 days (on and after November 28, 2017) for Directive 2 listed entities and 30 days (on and after November 28, 2017) for Directive 3. (as of 04/02/2021)

There are several important issues and details for the SSI listed persons; one of them is the letter of credit dealings with them. In FAQ 395, OFAC states that :

“395. Do Directives 1, 2, and 3 prohibit U.S. persons from dealing in or processing transactions under a letter of credit that was issued on or after the sanctions effective date and that carries a term of longer than the applicable tenor specified in the relevant Directive when the beneficiary or the issuing bank of that letter of credit is one of the entities identified as subject to the Directives?

U.S. persons may deal in (including act as the advising or confirming bank or as the applicant (i.e., the purchaser of the underlying goods or services)) or process transactions under a letter of credit in which an entity subject to Directive 1, 2, or 3 is the beneficiary (i.e., the exporter or seller of the underlying goods or services) because the subject letter of credit does not represent an extension of credit to the SSI entity. U.S. persons may deal in (including act as the advising or confirming bank or as the applicant or beneficiary) or process transactions under a letter of credit where the issuing bank is an SSI entity provided that the terms of all payment obligations under the letter of credit conform with the debt prohibitions under the applicable Directives. For example, a U.S. bank acting as the negotiating bank for a letter of credit issued after November 28, 2017 by an SSI entity subject to Directive 1 should ensure that it receives reimbursement from the SSI entity within the allowable 14-day debt limit.

U.S. persons may not deal in (including act as the advising or confirming bank or as the beneficiary) or process transactions under a letter of credit if all of the following three conditions are met: (1) the letter of credit was issued on or after the sanctions effective date, (2) the letter of credit carries a term of longer than the applicable tenor specified in the relevant Directive, and (3) an SSI entity is the applicant of the letter of credit. This would constitute prohibited activity because the subject letter of credit would represent an extension of credit to the SSI entity.“

The following two scenarios (with the assumption of timing both after Nov 28, 2017) will be helpful to understand the above mentioned comment of OFAC:

1) The LC has been issued by an SSI listed bank on behalf of a non-SSI listed applicant. For that LC, US banks may act as a negotiating bank by doing the payment to the beneficiary part of the LC . Suppose that this LC is deferred; than in case of adding confirmation by the US bank or proceeding any payment done by accepting the issued LC as a guarantee the reimbursement must be done within the acceptable maturity limitations (depends on the directives) and payment should be received on time in order not to cause any defacto new debt to the SSI listed issuer bank. In this case the new debt had been accepted as provided by the confirmation side to the issuer SSI listed bank.

2) The LC has been issued by a SSI listed bank or not; but on behalf of a SSI listed applicant. That makes the first step (the non-cash credit line) for the SSI listed applicant may subject to maturity limitation caused by the directives. As a result of that any deferred LC exceeding the maturity limitation is accepted as providing new debt to the applicant. Regardless the SSI condition of the issuer bank; the LC started by a violation. Therefore the LC itself is not acceptable anymore.

Additional to the US persons (including banks) these limitations must be considered by the non-US persons (including banks) , that faced within the above mentioned two scenarios in USD currency as well. Using USD is more than enough to ensure the US nexus, which makes the case subject to primary sanctions even non of the parties are in the US jurisdictions.

All writings and comments could be shared by giving the link & reference information. The comments and writings are the individual point of views and directly / indirectly can not be used while making decisions about the issues. Each case, is another issue if the matter is sanctions and must be taken into consideration within its own factors.

Abdurrahman ÖZBEK, CGSS