Whether Sanctions Against Trading Counterparts Under U.S. Export Administration Regulations Can Serve as a Defense of Nonperformance of Contract (Taiwan)

May 2022

Teresa Huang and Lilian Hsu

In response to the rising international conflict, the Bureau of Industry and Security  of the U.S. Department of Commerce has recently imposed sanctions[1] on Russia and its related entities under the Export Administration Regulations.  If the target of the sanctions is a party to a contract, the other party may be caught in the dilemma between violating the sanctions and breaching the contract.  Regarding the effect of any violation of the U.S. Export Administration Regulations on a non-U.S. enterprise and on the performance of a signed contract, this article will first introduce the contents and effects of the U.S. Export Administration Regulations, followed by a discussion on the effect of a sanction on a contractual counterparty under the regulatory framework of Taiwan, before drawing conclusions and making recommendations.

I. Brief introduction to the U.S. Export Administration Regulations

In 2018, the U.S. Congress adopted the Export Control Reform Act (hereinafter, the “ECRA”), which authorizes the President and the Department of Commerce to control the export of items for national security and foreign policy purposes.[2] The Bureau of Industry and Security (hereinafter, the “BIS”) of the Department of Commerce promulgated the Export Administration Regulations (hereinafter, the “EAR”) under the authorization of the ECRA to control the export, re-export, and transfer of U.S. items.[3]

1. The objects controlled under the EAR

The “items” referred to in the EAR include commodities, software, and technologies.[4]  In particular, the items controlled under the EAR primarily include: (1) all items in the United States; (2) all U.S. origin items wherever located; and (3) specific items that contain U.S.-origin elements.[5]

If the above-mentioned controlled items are included in the Commerce Control List, they are assigned the Export Control Classification Numbers (hereinafter, the “ECCNs”)[6] and an application to the BIS for a license is required before the items with the ECCNs are exported.[7]  Items not included in the Commerce Control List are all coded “EAR99” and are typically low-tech consumer items , whose export usually does not require a license.

2. Sanction targets of the EAR

In addition to items, the BIS also has differentiated controls on export recipients, which can also be understood as “sanctions.”  The BIS’s sanction list includes the Denied Persons List, the Entity List, the Unverified List, and the Military End User List.  The legal effects of being put on the lists are described below.

(1) The Denied Persons List

The BIS issues the Denied Orders against specific entities, ordering that the denied entities not to directly or indirectly engage in any transaction related to EAR-controlled items , that the denied entities cannot obtain an export license, that no person may engage in export, reexport or transfer transactions with any denied entities or assist any denied entities to obtain or control any EAR-controlled items .[8]  The entities that are denied transactions constitute the Denied Persons List.

(2) The Entity List

The Entity List enumerates the entities that pose a significant risk to national security or foreign policy interests.  Entities enumerated in the Entity List are required to apply for a relevant license from the BIS for export, re-export, or transfer transactions.[9]

(3) The Unverified List

Due to factors beyond the control of the U.S. government, an “end-use check” such as a pre-license check or post-shipment verification cannot be performed.  As a result, if the BIS is unable to verify the bona fides of the parties, foreign parties that engage in EAR-controlled export, re-export, or transfer transactions may be put on the Unverified List.[10]

Before an export, re-export, or transfer transaction of EAR-controlled items is conducted with an entity on the Unverified List, the exporter is required to make a declaration via the Automated Export System and obtain a UVL statement from such an entity.[11]

(4) The Military End User List

Entities on the Military End User List are required to obtain permission to acquire EAR-controlled items since they are considered to pose a high risk of using the items for military purposes or in support of a military end-user.[12]  A “military end-user” as defined in Section 744.21(g) of the EAR means national armed services, national guard and national police, government intelligence or reconnaissance organizations, or any person or entity whose actions or functions are intended to support “military end uses.”

3. Details of EAR sanctions

BIS may impose the following sanctions pursuant to Section 764.3 of the EAR for having controlled transactions with any entities on the Denied Persons List or for failure to obtain a required license for export, re-export, or transfer transactions or to submit a required statement in violation of the above EAR requirements:

(1) Administrative penalties

a. Civil monetary penalties

The BIS may impose a fine in the amount of US$300,000 or equivalent to up to twice the value of the transaction on the actor (whichever is higher) for each violation.[13] 

b. Denial of export privileges

Denial of export privileges means that the recipient of a Denial Order will be restricted from exporting, reexporting, and transferring EAR-controlled items, and that the BIS can prohibit the recipient from receiving EAR-controlled items.

(2) Criminal liability

For any willful violation of the EAR, a fine of up to US$1 million will be imposed, and in case the actor is a natural person, imprisonment of up to 20 years may be imposed.

4. Extraterritorial effect of the U.S. EAR

Although the EAR is a domestic law of the U.S., the effects of its regulation are not only limited to U.S. entities.  The BIS has been active in sanctioning entities that violate the EAR but have no nexus to the U.S.  One notable example of the extraterritorial effect of the EAR is a landmark case involving a Singaporean company that was fined over $30 million[14] by the BIS in 2020 for violating the EAR, which exemplifies the extraterritorial effect of the EAR.

Under the BIS’s proactive enforcement, when the subject matter of a contract involves items under the export control of the U.S., even if the parties do not agree to the U.S. law as the governing law, the EAR is in reality the law that should apply to the parties.  Once the BIS expands the list of sanction targets, the performance of a contract may be affected.  As a result, the parties will have to pay extra costs to obtain an export license, look for alternative sources of goods, or even be prevented from performing their contractual obligations.  Such circumstances may leave the contract parties in a dilemma between a potential sanction by the U.S. for violation of the EAR requirements and damages liability for breach of contract.

II. Application of the regulations in Taiwan

In the face of the above-mentioned dilemma, if the contract does not have provisions that deal with this, how the regulations and relevant practices in Taiwan assess the effect of such a contract and the liability of the debtor, whether contractual terms that violate the EAR are invalid, whether the inclusion of a contractual counterparty on an export control sanction list constitutes a change of circumstances, and whether the failure of the debtor to perform according to the purposes of the obligation is attributable to the debtor when the parties to the contract have difficulties in performing their obligations under the original contract due to changes in the U.S. export control policy.  Separate explanations are provided below.

1. Contract provisions that violate the EAR are still valid

Under Article 71 of the Civil Code, a juridical act that violates an imperative or prohibitive provision is void.  If the parties agree that the governing law is the Taiwan law, this will give rise to the issue of whether the above-mentioned “imperative or prohibitive provision” can be construed to cover foreign laws or sanctions.

To address this issue, the court once opined that even if the laws and regulations in Taiwan are stipulated as the governing law, the common law doctrine of equity still applies, since the court held that the so-called “jurisprudence” under Article 1 of the Civil Code specifically spells out the common law doctrine of equity (the 88-Chong-Shang-492 Civil Decision of the Taiwan High Court).  The court also cited the “fraud-on-the-market theory” in a case involving false financial statements and held that such a theory is part of “jurisprudence” and can serve as an adjudication reference (the 102-Jin-11 Civil Decision of the Taiwan New Taipei District Court).  However, the above opinion still cannot be directly interpreted to mean that the so-called “imperative or prohibitive provision” generally includes foreign laws or sanctions when the Taiwan law is designated as the governing law.

On the other hand, even if the scope of “imperative or prohibitive provisions” is extended to cover foreign law, since the U.S. EAR does not treat illegal transactions as invalid and is a supervision provision, in case the U.S. imposes an export control sanction against one of the contract parties to the extent that the other party cannot perform the contract as expected, the other party still cannot refuse to perform by asserting the invalidity of the contract in accordance with Article 71 of the Civil Code.

2. The determination of a case concerning if the sanction on the contractual counterparty constitutes a change in circumstances shall be made on a case-by-case basis

Under Article 227-2, Paragraph 1 of the Civil Code, if there is a change in circumstances that is not predictable at that time after the establishment of the contract, and if the performance of the original obligation arising therefrom will become obviously unfair, the party may apply to the court to increase or reduce the payment or alter the original obligation.  This is the provision on the “principle of change in circumstances.”  In court practices, the criteria for applying such a requirement are summarized in the following five points, including: (1) the occurrence of a change in circumstances; (2) the occurrence of a change in circumstances after the contract is established but before its effect is completed; (3) the occurrence of such a change in circumstances unforeseen by the parties at that time; (4) the occurrence of a change in circumstances for reasons not attributable to the parties; and (5) obvious unfairness according to general concepts if the originally valid obligations still apply after a change in circumstances (see the 95-Chung-Shang-35 Civil Decision of the Tainan Branch of the Taiwan High Court, the 100-Tai-Shang-1392 Civil Decision of the Supreme Court, and the 104-Tai-Shang-2433 Civil Decision of the Supreme Court).  In the above-mentioned criteria, how to determine the “unforeseeability” of such circumstances and the so-called “obviously unfair circumstances” should be determined by the court on a case-by-case basis.  Therefore, litigation uncertainties always exist.

3. The court adopts a strict standard in determining if the nonperformance of a debtor is not attributable to obligor.

Article 225 of the Civil Code provides: “The debtor shall be released from his obligation to perform if the performance becomes impossible for reasons to attributable to the debtor, ” and Article 230 of the Civil Code provides: ” The debtor shall not be liable for delay in case of nonpayment for reasons not attributable to the debtor.”  If debtors are unable to perform their contractual obligations due to any change in foreign laws, regulations, or policies that increases the debtors’ performance difficulties, is such outcome attributable to the debtors?

In reference to the Supreme Court’s opinions, a debtor is required to perform according to the original purpose of the debt and is exempted from liability only under special circumstances, which is the major principle under the law of obligation.  If the debtors’ performance is not consistent with the contract while they are seeking to claim liability exemption, they are required to assume the burden of proof for the nonexistence of reasons attributable to them (the 89-Tai-Shang-2097 Civil Decision of the Supreme Court).  Some courts opined that if the debtor is aware that the subject matters of the contract are subject to the control of the exporting country before the contract is signed, the debtor should be able to expect that the government of the exporting country may not necessarily grant an export license to the supplier.  Therefore, to perform the contractual obligations, the debtor should extensively look for sources of goods to secure the supply of goods.  If the objects of the contract can be exported from another country, the debtor may not claim the exemption of its liability under the contract on the ground that a single country refuses to issue an export license and claim on such a basis that such a reason is not attributable to the debtor (the 102-Su-276 Civil Decision of the Taoyuan District Court of Taiwan).  This shows that the courts tend to adopt a stricter standard for determining whether a debtor is to be held liable for the nonperformance of a debt, and hold that if the cost of performance increases due to circumstances that can be anticipated in advance, the debtor cannot be relieved of default liability as long as the debtor still has the possibility of performing according to the original purpose of the debt.

III. Conclusions and Suggestions.

The foregoing cases show that when a contractual counterparty is sanctioned, the other party’s obligation to perform the contract may not necessarily be exempted or adjusted, and the Taiwan courts adopt a more stringent standard to determine whether the nonperformance of the debtor’s debt is attributable to the debtor or not.  Therefore, this article recommends that when entering into a multinational contract or when the subject matter of the contract may involve the regulations of another country, companies should pay special attention to whether the contract need to contain necessary liability exemption provisions, such as force majeure exemption provisions or legal compliance exemption clauses.

With regard to the force majeure exemption provision, it should be noted that the practical interpretation of force majeure refers to an objective situation of natural and social phenomena that cannot be foreseen, avoided, or overcome by people.  The natural phenomena include, without limitation to, acts of gods such as earthquakes, typhoon, floods, and tsunamis, while social phenomena include, without limitation to, wars, municipal project construction, and other government policies (the 104-Chung-Su-182 Civil Decision of the Hsinchu District Court of Taiwan and the 100-Cai-2725 Ruling of the Supreme Administrative Court).  The courts hold that even if the parties have a force majeure provision in the contract that exempts the parties from liability in advance for special circumstances, the application of the provision should be subject to the occurrence of force majeure circumstances that are “unforeseeable, unavoidable and insurmountable” (the 100-Cai-2725 Ruling of the Supreme Administrative Court).

The disclaimer provision on legal compliance stipulates that the parties shall be obligated to perform the contract only when the mandatory provisions are not breached.  Attention should be paid to the interpretation of the “mandatory provisions.”  In the event of future disputes when the scope of the “mandatory provisions” is not specifically specified in the contract to include “sanctions, prohibitions or restrictions imposed by United Nations resolutions, or regulations or trade sanctions imposed by the European Union, the United Kingdom or the United States,” it may be costly to interpret the terms of the contract.  Therefore, it is recommended to define or describe the scope of the “mandatory provisions” in the contract.

In view of the growing international trade, the effect of sanctions by major countries and international organizations to achieve national or regional security and foreign policy objectives through export control has become more and more obvious in recent years.  Therefore, how to reduce the impact of sanctions on the performance of trading counterparties and minimize the risk of related damages has become a topic that enterprises must consider in their daily business operations.  It is recommended that enterprises should consult legal professionals when signing multinational contracts in the future, and take into account the risks of sanctions by major countries and international organizations.

(The authors’ opinions do not represent the position of this law firm.)

[1] BIS’s website (https://www.bis.doc.gov/index.php/federal-register-notices#fr12856 )

[2] Sections 1752 and 1753 of the Export Control Reform Act

[3] Section 730.1 of the Export Administration Regulations

[4] Section 1742 of the Export Control Reform Act

[5] Section 734.3(a) of the Export Administration Regulations

[6] Section 734.3(c) of the Export Administration Regulations

[7] BIS’s website (https://www.bis.doc.gov/index.php/regulations/commerce-control-list-ccl )

[8] BIS’s website  (https://www.bis.doc.gov/index.php/all-articles/12-policy-guidance/list-parties-of-concern/321-the-denied-persons-list-standard-order)

[9] Section 744.16(a) of the Export Administration Regulations; BIS’s website (https://www.bis.doc.gov/index.php/policy-guidance/lists-of-parties-of-concern/entity-list )

[10] Section 744.15(c)(1) of the Export Administration Regulations

[11] Section 744.15(b) of the Export Administration Regulations; BIS’s website (https://www.bis.doc.gov/index.php/policy-guidance/lists-of-parties-of-concern/unverified-list )

[12] BIS’s website (https://www.bis.doc.gov/index.php/policy-guidance/lists-of-parties-of-concern/1770 )

[13] Section 4819(c)(1) of the Export Control Reform Act

[14] The background fact of this case is provided as follows: A Singaporean company acquired the right to use a vessel loaded with US technology equipment through a lease contract.  To perform a contract with another company (whose parent company is a sanctioned Iranian company), the Singaporean company used the vessel to carry out oil field exploration in Iranian territorial waters.  Since the Singaporean company was found to have violated the EAR for engaging in a reexport transaction without obtaining the relevant license, it was severely penalized by the BIS.  Source: BIS’s Press Release on August 20, 2020 (https://www.bis.doc.gov/index.php/documents/about-bis/newsroom/press-releases/2596-nordic-maritime-press-release-final-08-24-20/file ).