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Several months ago, I was sitting in the hallowed halls of Big Law Firm XYZ talking to a few of my fellow OFAC lawyers about the Epsilon Electronics (“Epsilon”) litigation pending in the United States District Court for the District of Columbia. That case involves a challenge to an OFAC civil penalty for violations of the Iranian Transactions and Sanctions Regulations (“ITSR”) arising from Epsilon’s export of car audio equipment to a company in Dubai, who reexported the equipment to Iran.

During our discussion, I brought up the fact that Epsilon, through its civil complaint, alleged that OFAC failed to consider the “inventory exception”–a rule that has been inferred from a 2002 guidance letter issued by the United States Department of the Treasury’s Office of Foreign Assets Control (“OFAC”) that nearly every OFAC lawyer follows–in calculating the penalty imposed.  That rule, as described in the Epsilon complaint, states that, despite the prohibition on exports and reexports found in 31 CFR 560.204, U.S. persons can freely export goods to a third country knowing that such goods may go to Iran provided that the goods are not subject to the Export Administration Regulations, that the U.S. person is not filling a specific order for export to Iran, and that the majority of the buyer’s business and sales are not to Iran.

At the time, I commented to my colleagues that this litigation would finally resolve the question as to whether or not OFAC actually intended an inventory exception as part of that guidance, and whether or not such an exception actually exists. In response I was emphatically told, “oh, it exists, it definitely exists.” I held my tongue, because over the years I’ve had a number of disagreements with my peers about the existence of this exception, which has led me to realize my opinion is squarely on the side of the minority.

Today, OFAC filed a motion for summary judgment which included a footnote addressing Epsilon’s reliance on the “inventory exception.”  That footnote stated, “The Guidance cited by plaintiff does not establish an exception from the export prohibitions for Epsilon’s exports to Asra.” One reading of this could be that the Guidance does not create such an exception, and as such Epsilon’s exports to Asra could not be excepted from the relevant prohibition. That reading would be a minor victory for yours truly, and a death knell for the inventory exception.

However, with OFAC it’s never that easy. True to form, OFAC remained flexible by elaborating further on the 2002 Guidance on Transshipments to Iran’s reason to know language, stating that Epsilon’s reliance on the guidance was misplaced, and that “…Epsilon, through its knowledge of and working relationship with Asra, knew or had reason to know that the goods it exported to Asra were intended for reexport to Iran.” The additional language leaves one to contemplate whether OFAC isn’t totally discounting the inventory exception, but rather stating that any exception that may have come out of that guidance does not extend to situations where it is established the party in violation had reason to know the items may go to Iran.

So does the inventory exception exist or not? The debate over that question will have to continue. However, what OFAC’s footnote did accomplish was to lay to rest any interpretation of the 2002 OFAC Guidance on Transshipments to Iran that would suggest parties could export U.S. origin goods knowing they may go to Iran. As such, OFAC hasn’t definitively closed the door on the inventory exception; however, it has delivered a fatal blow to at least one interpretation arising from the guidance.  Unfortunately, it was the interpretation that Epsilon was relying upon.

More reporting to come on this important case, so in order to stay tuned, and keep up on all things OFAC related, make sure to subscribe to the newsletter at the bottom of the homepage.

The author of this blog is Erich Ferrari, an attorney specializing in OFAC matters. If you have any questions please contact him at 202-280-6370 or ferrari@ferrariassociatespc.com.

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