Sanctionable Conduct: Is OFAC’s 50% Rule Constitutional?

by James Hardman, Associate Member, University of Cincinnati Law Review Vol. 91

I. Introduction

The U.S. government has used modern economic sanctions as a non-violent foreign policy tool since at least the early twentieth century.¹ Indeed, the Executive branch has near complete autonomy in issuing sanctions when acting on the basis of its constitutional authority in alignment with the will of Congress² as expressed in the International Emergency Economic Powers Act.³ However, some penalized for breaching U.S. sanctions have challenged those penalties on constitutional grounds, including the requirements of due process. This issue is particularly acute in relation to the so-called “50% rule”—a means of broadly and indirectly applying the effects of sanctions to a potentially endless number of subsidiary entities. The result of the 50% rule is that a third party can inadvertently breach U.S. sanctions, potentially finding themselves liable to huge financial penalties, even though a reasonably diligent party would find it very difficult—if not impossible—to discern the risk of such a breach in advance. This is, perhaps, an intended consequence—a deliberate chilling effect in pursuit of foreign policy goals—yet that does not necessarily mean that the approach is constitutional.

This article explores the constitutionality of these sanctions on due process grounds. Section II provides background on the United States government’s authority to issue sanctions and due process requirements under the U.S. Constitution. Section III discusses whether the 50% rule comports with constitutional requirements, and Section IV concludes with a recommendation on narrowing the rule to ensure that sanctioned entities are not erroneously deprived of due process rights.

II. Background

A. Sanctions Authority and Process

Unilateral use of force against another State is generally prohibited under Article 2 of the United Nations Charter.⁴ However, in modern international legal practice, unilateral economic sanctions are likely not covered by this proscription on the use of force.⁵

On the national level, the Executive branch generally has authority under Article II of the United States Constitution to conduct foreign relations.⁶ Additionally, the U.S. President has statutory authority from Congress to impose a variety of sanctions on entities.⁷ One way in which the Executive branch exercises this authority is the issuance of Executive Orders,⁸ creating legal bases and establishing policy goals that government agencies such as the U.S. Department of the Treasury’s Office of Foreign Asset Control (“OFAC”) implement in the form of regulations; these regulations create the so-called sanctions programs.⁹ Executive branch agencies may “designate” individuals and entities under these regulations, which may include “blocking”¹⁰ the property of or restricting U.S. residents from “transfers or dealings” with the designated entity or restricting the target from entering the United States.¹¹ The OFAC government website currently lists thirty-eight sanctions programs,¹² designed to counter terrorist activities,¹³ narcotics trafficking,¹⁴ or the activities of foreign governments and their agents including U.S. adversaries such as Cuba¹⁵, Venezuela,¹⁶ Iran,¹⁷ Syria,¹⁸ North Korea,¹⁹ and Russia.²⁰

There are two principal ways²¹ in which OFAC may designate a non-individual entity as “sanctioned”: The U.S. government treats such indirectly sanctioned entities consistently with the prohibitions placed on directly sanctioned entities and U.S. persons will equally be subject to penalties, also known as “secondary” sanctions, for conducting business with either a directly or indirectly sanctioned entity.²² The courts have held that U.S. persons or businesses are not permitted to engage in negotiations, enter into contracts, or process transactions involving directly or indirectly sanctioned entities.²³ Even when a company itself is not designated as an SDN, if an individual on the company’s board of directors is an SDN, any transaction with the company involving that individual is prohibited.²⁴

The 50% rule means that indirect U.S. sanctions are truly expansive. Designating a single entity, if it sits at the top of a large, multi-level corporate structure, can potentially result in a cascade effect of large numbers of other entities being indirectly sanctioned—despite OFAC never actually publishing the names of these blocked entities.²⁵ For example, the Cincinnati-headquartered Procter & Gamble conglomerate owns numerous household brands, such as Bounty, Dawn, Febreze, Gillette, Head & Shoulders, and Tide through a network of subsidiary companies.²⁶ If the president of P&G individually owned at least 50% of the company and was designated as an SDN, then not only P&G itself but every one of those subsidiaries in which the parent company owned a 50% or greater ownership interest—and everything in which each subsidiary held a 50% or greater ownership interest, etc.—would become indirectly sanctioned and “blocked”. However, the name “P&G” would never appear in OFAC’s official SDN list.²⁷

B. Requirements Under Due Process

The due process clauses of the Fifth and Fourteenth Amendments provide that life, liberty, and property shall not be taken from persons without due process of law.²⁸

Sanctions may take a right to liberty or property. Depending on the specific restrictions imposed by the sanctions program, a designated individual may have a freeze placed on their property in the United States, may be forbidden from transacting with any U.S. entities (including foreign entities owned by U.S. entities),²⁹ and the Department of State might also prohibit them from travelling to the United States.³⁰ Receiving a sanctions designation can thus have a deleterious effect on an entity’s liberty and property; for example, when Oleg Deripaska was sanctioned by OFAC in April 2018, he was eventually forced to reduce his apparent ownership interest in his aluminum trading empire to under 50% to relieve it from indirect sanctions.³¹

The Constitution determines the process due when a person’s liberty or property is taken. The Supreme Court, in Cleveland Board of Education v. Loudermill³² held that for the government to lawfully remove property, the due process clause requires a careful weighing of the interests of the government in removing the property against the interests of the private party in retaining the property while incorporating the “essential requirements of due process,” which “are notice and an opportunity to respond.”³³ Additionally, in Matthews v. Eldridge,³⁴ the Court balanced certain factors in determining the fairness of a governmental deprivation, weighing (1) the private interests affected by the official action; (2) the risk of an erroneous deprivation of such interest, and the probable value of additional or substitute procedural safeguards; and (3) the government’s interest, including the function of the deprivation and the fiscal and administrative burdens that an additional or substitute procedural requirement would entail.³⁵ In essence, the Matthews test calls upon public administrators and reviewing courts to devise procedures that are as likely to avoid errors on important matters as seems reasonable in the particular administrative setting. In Hamdi v. Rumsfeld,³⁶ for example, the Court held that the s, although the “essential constitutional promises” of due process could “not be eroded.”³⁷ Therefore, the government can deprive a person of liberty or property and comply with due process requirements if the person has notice and an opportunity to respond, and the deprivation procedure does not create an unfair risk of error.

The courts have heard at least one case in which plaintiffs disputed the constitutionality of OFAC sanctions on due process grounds. In December 2019, the Fifth Circuit Court of Appeals found in favor of U.S. energy giant Exxon Mobil in a dispute over the validity of penalties the government issued for a breach of Ukraine-related Russia sanctions in 2017.³⁸ The government argued that Exxon breached the prohibition on transacting with a blocked entity when it entered into a contract with Rosneft, the non-sanctioned Russian state oil company, countersigned by Rosneft’s president Igor Sechin, an .³⁹ The court found for Exxon, explaining that OFAC’s regulatory language purportedly prohibiting Exxon from transacting with Sechin in his official capacity as president of Rosneft failed to provide “ascertainable certainty”⁴⁰ to Exxon in advance. Further, OFAC’s failure to sufficiently clarify the implications of the sanction’s language breached the constitutional requirement that “under the Due Process Clause of the Fifth Amendment, laws that regulate individuals or entities ‘must give fair notice of conduct that is forbidden or required.’”⁴¹ In other words, OFAC’s regulatory language (before it was revised), was too vague for even sophisticated commercial actors like Exxon to distinguish which transactions were permitted and which were not. However, this approach is not yet widely adopted; other courts have upheld indirect sanctions in several other cases where plaintiffs argued that the language of the government’s restriction was so vague that they did not have proper notice of the illegality of their actions.⁴²

III. Discussion

The application of the 50% rule captures such a broad and nearly indeterminable swathe of entities that it is impossible for a party to receive fair notice of forbidden conduct, and thus may be unconstitutional. This approach imposes rank unfairness on private rights when considered under Matthews, because the private interests of the individuals are so grossly affected. Unknowingly transacting with an indirectly sanctioned entity—or worse, receiving an erroneous designation as an indirectly blocked entity—could destroy the businesses and livelihoods of large numbers of people.⁴³

The designation of any entity pursuant to a U.S. government sanctions regime thus runs an unacceptably high risk of erroneously depriving an innocent party of their property because the sanctions apply so broadly and deeply as a result of the 50% rule. This risk could be easily curtailed by limiting the cascade effect of the 50% rule to only a single “level” of ownership. For example, rather than sanctions applying directly to an SDN and indirectly to their 50% or more owned holding company, as well as all the entities that fall under the holding company (and so on), a narrower rule may halt the effect of sanctions at the first level down from the SDN. Applying the earlier example, if the president of P&G were designated as an SDN, only P&G itself, and not the web of P&G’s subsidiary companies, would be indirectly sanctioned. Indeed, the U.S. sanctions regime is unusual in having such an over-inclusive rule; EU sanctions, in comparison, do not appear to have such an expansive approach because the EU’s own “50% rule” applies only to the first level of ownership or control.⁴⁴

However, the government’s own compelling interest may justifiably override these concerns. The purpose of U.S. sanctions is a grave one: they are a means of imposing external extraterritorial pressure on foreign entities without resorting to war. In conjunction with other peaceful alternatives, such as international diplomacy and international legal proceedings, economic sanctions can be a powerful—albeit relatively peaceful—tool for furthering U.S. foreign policy aims.⁴⁵ Further, to have exactly the same broad effect, the U.S. government would need to manually identify and publish the identity of all the entities it wished to sanction. This would greatly increase the administrative burden, especially when dealing with opaque corporate structures. Instead, the present approach seemingly incorporates the motto of the Albigensian crusade: “novit enim Dominus qui sunt eius”—kill them all and let God (or the courts) sort it out.

Nevertheless, reforming the 50% rule could result in sanctions programs that are just as effective as the current system. Indeed, the U.S. government is already demonstrably able to identify key entities to make sanctions hit with precision, targeting specific entities or economic sectors to minimize collateral damage⁴⁶: in this, a scalpel may be a more effective tool than a grenade.

Further, reforming the 50% rule could, on balance, actually reduce the potential administrative burden on the courts of challenges brought by indirectly sanctioned entities or U.S. persons challenging sanctions-violations penalties. Further research is required to determine the effect of reforming the 50% rule on the number of sanctions cases brought before the courts.

IV. Conclusion

In conclusion, a court may defer to the government’s argument that OFAC’s 50% rule in its present form is constitutional due to the gravity of its function. However, narrowing the rule by limiting its effects to a single layer of ownership could result in a smaller administrative burden on the government, and a lower risk of an erroneous deprivation of private individuals’ rights, without a concurrent diminishing of the effectiveness of U.S. government sanctions.

Cover Photo by Ryan McFarland on Flickr and licensed under CC BY 2.0.

James Hardman

After graduating from the University of Cambridge with a degree in French and Russian, James Hardman worked for over six years as a consultant investigator for a boutique London investigations firm with a focus on international dispute resolution and cross-border asset tracing. He and his wife moved to Cincinnati in 2020 to be closer to her family and to embark on a new career in law. James is particularly interested in international commercial law and in his free time is an avid player of boardgames.

References

1
Barbara J. Van Arsdale, Annotation, Validity, Construction, and Operation of International Emergency Economic Powers Act, 50 U.S.C.A. §§ 1701 to 1707, 183 A.L.R. Fed. 57 (2003).
2
Youngstown Sheet & Tube Co. v. Sawyer, 343 U.S. 579, 635–38 (1952) (Jackson, J., concurring).
3
50 U.S.C.A. §§ 1701 to 1707.
4
U.N. Charter art 2., ¶¶ 3-4.
5
Iryna Bohdanova, Unilateral Sanctions in International Law and the Enforcement of Human Rights: The Impact of the Principle of Common Concern of Humankind, in World Trade Inst. Advanced Studies 9 (2022), https://brill.com/display/book/9789004507890/BP000004.xml?language=en#ref_FN000433. Other questions remain outstanding regarding the legitimacy of unilateral sanctions under the non-interference principle contained in Article 2(4) of the U.N. Charter. Id.
6
See U.S. Const. art. 2, § 2; see also, e.g., Zivotofsky ex rel. Zivotofsky v. Kerry, 576 U.S. 1 (2015).
7
See, e.g., International Emergency Economic Powers Act, 50 U.S.C. §§ 1701-1707; National Emergencies Act, 50 U.S.C. §§ 1601, 1621, 1622; Immigration and Nationality Act of 1952, 8 U.S.C. § 1182(f); 3 U.S.C. § 301.
8
The President’s power to issue such orders is “implied from the executive’s core authority to administer the laws” arising from the language of Article 2 of the Constitution. See M. Patrick Moore & Kate R. Cook, Executive Order: Strike of A Pen, Law of the Land?, 61-Sum Boston B.J. 13 (2017).
9
For example, in October 1995, President Clinton issued E.O. 12978, “Blocking Assets and Prohibiting Transactions with Significant Narcotics Traffickers,” to counter Colombian drugs traffickers. On March 5, 1997, the U.S. Department of the Treasury’s Office of Foreign Assets Control issued the Narcotics Trafficking Sanctions Regulations, 31 C.F.R. Part 536, which implemented E.O. 12978. See OFAC, Narcotics Sanctions Program 3, (2014), https://home.treasury.gov/system/files/126/narco_overview_of_sanctions.pdf.
10
See Basic Information on OFAC and Sanctions: FAQ 9. What do you Mean by “Blocking?”, U.S. Dep’t of the Treas., https://home.treasury.gov/policy-issues/financial-sanctions/faqs/9 (last visited Feb. 27, 2023) (“Another word for it is “freezing.” It is simply a way of controlling targeted property. Title to the blocked property remains with the target, but the exercise of powers and privileges normally associated with ownership is prohibited without authorization from OFAC. Blocking immediately imposes an across-the-board prohibition against transfers or dealings of any kind with regard to the property.”); 31 C.F.R. § 589.303.
11
For example, Executive Order 14065 of February 21, 2022, prohibits investments in or the transfer of property, goods, or services into the Russian-occupied regions of the Donbass in Ukraine, blocks the property and interests in property of individuals or entities ‘to be determined by the Department of the Treasury in consultation with the Secretary of State,” prohibits any transactions with said individuals or entities, and prohibits the named individuals from entry into the United States. Exec. Order No. 14,065, 87 Fed. Reg. 10293 (Feb. 23, 2022).
12
See Sanctions Programs and Country Information, U.S. Dep’t of the Treas., https://home.treasury.gov/policy-issues/financial-sanctions/sanctions-programs-and-country-information (last visited Feb. 27, 2023).
13
Counter Terrorism Sanctions, U.S. Dep’t of the Treas., https://home.treasury.gov/policy-issues/financial-sanctions/sanctions-programs-and-country-information/counter-terrorism-sanctions (last visited Feb. 27, 2023).
14
Counter Narcotics Trafficking Sanctions, U.S. Dep’t of the Treas., https://home.treasury.gov/policy-issues/financial-sanctions/sanctions-programs-and-country-information/counter-narcotics-trafficking-sanctions (last visited Feb. 27, 2023).
15
Cuba Sanctions, U.S. Dep’t of the Treas., https://home.treasury.gov/policy-issues/financial-sanctions/sanctions-programs-and-country-information/cuba-sanctions (last visited Feb. 27, 2023).
16
Venezuela Sanctions, U.S. Dep’t of the Treas., https://home.treasury.gov/policy-issues/financial-sanctions/sanctions-programs-and-country-information/venezuela-related-sanctions (last visited Feb. 27, 2023).
17
Iran Sanctions, U.S. Dep’t of the Treas., https://home.treasury.gov/policy-issues/financial-sanctions/sanctions-programs-and-country-information/iran-sanctions (last visited Feb. 27, 2023).
18
Syria Sanctions, U.S. Dep’t of the Treas., https://home.treasury.gov/policy-issues/financial-sanctions/sanctions-programs-and-country-information/syria-sanctions (last visited Feb. 27, 2023).
19
North Korea Sanctions, U.S. Dep’t of the Treas., https://home.treasury.gov/policy-issues/financial-sanctions/sanctions-programs-and-country-information/north-korea-sanctions (last visited Feb. 27, 2023).
20
Russia-related Sanctions, U.S. Dep’t of the Treas., https://home.treasury.gov/policy-issues/financial-sanctions/sanctions-programs-and-country-information/russia-related-sanctions (last visited Feb. 27, 2023).
21
The exact application can vary between sanctions programs. See 31 C.F.R. § 589.101 (“Differing foreign policy and national security circumstances may result in differing interpretations of similar language among the parts of this chapter”).
22
Revised Guidance, supra note 23. See also Jeremy Paner, Lessons From OFAC’s First Public ‘50 Percent Rule’ Penalty, Law360 (Feb. 19, 2016) (describing a penalty paid by Barclays Bank for facilitating a transaction for a Zimbabwean entity indirectly blocked pursuant to the 50% rule); Enforcement Information for February 8, 2016, U.S. Dep’t of the Treas., https://home.treasury.gov/system/files/126/20160208_barclays.pdf; see also Enforcement Information for November 17, 2018, U.S. Dep’t of the Treas. (Nov. 17, 2018), https://home.treasury.gov/system/files/126/20181127_metelics.pdf.
23
See, e.g., Exxon Mobil Corp. v. Mnuchin, 430 F. Supp. 3d 220 (N.D. Tex. 2019).
24
See OFAC 50% Rule FAQs, supra note 23, at FAQs #398, #400.
25
For example, a large, centralized corporation such as Rosneft, the Russian state oil company, has a 50% or greater ownership interest in many subsidiary corporations in Russia and elsewhere. See ПАО НК-Роснефть Ежеквартальный отчет 2021, 2 квартал [Rosneft Oil Company plc Quarterly Report, 2021 quarter 2] at 291-98, https://www.e-disclosure.ru/portal/files.aspx?id=6505&type=5; see also Список аффилированных лиц: Публичное акционерное общество «Нефтяная компания «Роснефть» [List of Affiliated Entities: Rosneft Oil Company plc], https://www.e-disclosure.ru/portal/files.aspx?id=6505&type=6.
26
See Brands, Proctor & Gamble, https://us.pg.com/brands/ (last visited Mar. 5, 2023).
27
See, e.g., Sanctions List Search, U.S. Dep’t of Treas., https://sanctionssearch.ofac.treas.gov (last visited Mar. 5, 2023).
28
U.S. Const. amends. V, XIV.
29
See Specially Designated Nationals (SDNs) and the SDN List: FAQ 18. What is an SDN?, U.S. Dep’t of the Treas., https://home.treasury.gov/policy-issues/financial-sanctions/faqs/18 (last visited Feb 27, 2023); Blocking and Rejecting Transactions: FAQ 35. Do all OFAC Programs Involve Blocking Transactions?, U.S. Dep’t of the Treas., https://home.treasury.gov/policy-issues/financial-sanctions/faqs/35 (last visited Feb 27, 2023).
30
See, e.g., FACT SHEET: The United States Continues to Target Russian Oligarchs Enabling Putin’s War of Choice, White House (Mar. 3, 2022), https://www.whitehouse.gov/briefing-room/statements-releases/2022/03/03/fact-sheet-the-united-states-continues-to-target-russian-oligarchs-enabling-putins-war-of-choice/.
31
Joshua Kirschenbaum, Deripaska, EN+, and Rusal: A Split Decision with Implications for U.S. Sanctions, Alliance for Securing Democracy (Jan. 2, 2019), https://securingdemocracy.gmfus.org/deripaska-en-and-rusal-a-split-decision-with-implications-for-u-s-sanctions/.
32
470 U.S. 532, 541 (1985) (holding that a discharged public-school teacher was constitutionally entitled to the opportunity for a hearing before being deprived of his property interest in his employment).
33
Id. at 546.
34
424 U.S. 319 (1976) (finding that a social security claimant did not have their constitutional right to due process breached when considered against the interests of the state and the risk of an erroneous deprivation of the claimant’s rights).
35
Id. at 335.
36
542 U.S. 507 (2004) (concerning whether an enemy combatant had a due process right to contest indefinite detention).
37
Id. at 533.
38
Exxon Mobil Corp. v. Mnuchin, 430 F. Supp. 3d 220, 225 (N.D. Tex. 2019).
39
Id. at 234.
40
Id.
41
Id. at 229 (citing FCC v. Fox Television Stations, Inc., 567 U.S. 239, 253 (2012)).
42
See, e.g., U.S. v. Amirnazmi, 645 F.3d 564 (3d Cir. 2011), petition for cert. filed (U.S. Aug. 10, 2011); U.S. v. Mirza, 454 Fed. Appx. 249 (5th Cir. 2011), cert. denied, 2012 WL 314689 (U.S. 2012); U.S. v. Anvari-Hamedani, 378 F. Supp. 2d 821 (N.D. Ohio 2005); U.S. v. Zhi Yong Guo, 634 F.3d 1119 (9th Cir. 2011); U.S. v. Soussi, 316 F.3d 1095 (10th Cir. 2002); U.S. v. Quinn, 401 F. Supp. 2d 80 (D.D.C. 2005).
43
See, e.g., Michael Volkov, A Kinship with Sisyphus: Challenging an OFAC SDN Designation, Volkov Law Blog (Aug. 30, 2021), https://blog.volkovlaw.com/2021/08/a-kinship-with-sisyphus-challenging-an-ofac-sdn-designation/.
44
See Council Item Note, Sanctions Guidelines – Update, ¶55a (May 4, 2018), https://data.consilium.europa.eu/doc/ document/ST-5664-2018-INIT/en/pdf.
45
Although their effectiveness is disputed. See Nicholas Mulder, How America Learned to Love (Ineffective) Sanctions, Foreign Policy (Jan. 30, 2022, 10:33 AM), https://foreignpolicy.com/2022/01/30/us-sanctions-reliance-results/.
46
See, e.g., Targeting Key Sectors, Evasion Efforts, and Military Supplies, Treasury Expands and Intensifies Sanctions Against Russia, U.S. Dep’t of the Treas. (Feb. 24, 2023), https://home.treasury.gov/news/press-releases/jy1296.