OFAC Designates PDVSA to Initiate End Game in Venezuela

UPDATE: Sanctions prohibitions regarding PDVSA are in flux. After designating the entity and issuing related general licenses on January 28, 2019, OFAC issued FAQs about the January 28 action on January 31, only to issue revised general licenses and more FAQs on February 1. OFAC subsequently issued amended general licenses and FAQs again on February 11 and March 8. While Morrison & Foerster’s National Security group will continue to update you with what you need to know about the situation, for real-time updates on Venezuela-related sanctions, we encourage you to regularly check OFAC’s Recent Actions and Venezuela Sanctions Program pages.

Last updated on 3/18/2019

In what was perhaps an inevitable escalation, on Monday, January 28, 2019, the U.S. Treasury Department’s Office of Foreign Assets Control (OFAC) imposed sanctions on Venezuelan state-owned oil and gas company Petróleos de Venezuela, S.A. (PDVSA), adding the entity to its List of Specially Designated Nationals and Blocked Persons (SDN List). The move comes just days after U.S. President Donald Trump recognized National Assembly head Juan Guaidó as Venezuela’s rightful interim leader following sanctioned Venezuelan President Nicolás Maduro’s recent sham re-election, prompting many other nations and the Organization of American States to do the same. In an FAQ issued after the action, OFAC indicated that Guaidó or a democratically-elected government assuming control of PDVSA is a condition precedent for the company’s removal from the SDN List.

At the same time it designated PDVSA, OFAC issued seven new general licenses and amended a preexisting one to allow certain activity involving PDVSA and its subsidiaries to continue for varying durations. OFAC subsequently issued FAQs explaining the authorizations, then amended the general licenses, and issued more FAQs.

Taking stock of the designation, the general licenses, and the FAQs issued thus far, here are some key takeaways to keep in mind:

1. The U.S. government did not block the Government of Venezuela (GOV). Although PDVSA is a government-owned entity, its designation does not “travel up the chain” to apply to the entire GOV. U.S. persons can continue to deal with the GOV, albeit subject to the prohibitions set forth under Executive Orders 13692, 13808, 13827, and 13835.
2. Anyone operating in the Venezuelan oil sector may be targeted for sanctions. OFAC designated PDVSA under Executive Order (E.O.) 13850 for operating in the oil sector of the Venezuelan economy. In order to do that, the Secretary of the Treasury had to determine that persons operating in the oil sector of the Venezuelan economy may be subject to sanctions. Anyone considering activity in the Venezuelan oil sector should keep that risk in mind.
3. There is a wind-down period for doing business directly with PDVSA. The wind-down period ends soon on February 27, 2019. That said, other authorizations allow specified activities involving PDVSA and select subsidiaries to continue for a longer period of time, as outlined in the next takeaway and described in detail below.
4. U.S. persons are authorized to deal with different PDVSA entities in different ways and for different time periods. For the moment (until July 27, 2019), OFAC has authorized U.S. persons to engage in all transactions and activities in which the only PDVSA entity involved in a transaction is PDV Holding, Inc. (PDVH), CITGO Holding, Inc. (CITGO), Nynas AB (Nynas), or one of their subsidiaries. We’ll call these “Gray List Entities.” On the other end of the spectrum are Alba de Nicaragua S.A. and the entities it owns 50% or more of (together, “Albanisa”), for which there is no wind-down period, presumably because of ongoing political violence in Nicaragua. In the middle are other entities in which PDVSA owns a 50% or greater interest that are given the same short wind-down period as PDVSA (expiring on February 27, 2019). PDVSA and all of its subsidiaries, including the Gray List Entities and Albanisa, are “PDVSA entities.” Trust us, this glossary will prove useful.
5. OFAC is setting tough deadlines . . . for now. As indicated above, the wind-down period on general dealings with PDVSA ends in February. Oil imports from PDVSA must cease at the end of April. Companies with long-standing operations in Venezuela and massive sunk costs have to stop dealing with PDVSA entities in July. These deadlines demonstrate that the U.S. government is serious about inflicting damage on the Maduro regime by way of the state-owned entity that accounts for 95% of Venezuelan exports. Don’t be surprised, however, if OFAC extends some of the authorizations as U.S. companies make business and policy arguments for not forcing them out of the Venezuelan energy sector.
6. U.S. financial institutions have narrow authorization to reject certain payments. For a limited time, financial institutions are authorized to reject PDVSA-related payments instead of blocking them if the payments don’t have a U.S. nexus other than passing through a U.S. financial institution.
7. The U.S. government is pushing harder to get GOV securities out of the U.S. financial system. In addition to the existing prohibition on dealing in specified GOV (including PDVSA) debt and equity issued after August 25, 2017, OFAC has now imposed a rule that U.S. persons holding specified GOV bonds or a broader basket of PDVSA entity-related holdings (including equity in PDVSA entities) may only transfer such holdings to non-U.S. persons. There is still time, however, for U.S. persons to settle trades and wind-down agreements that might run afoul of that requirement if placed or entered into by specified deadlines.
8. More sanctions are coming. Given the deteriorating political situation in Venezuela and escalating tensions with the United States, OFAC is not likely to let up until Maduro has relinquished power. That said, OFAC may take a short pause to deal with the fallout from the PDVSA designation, and any additional sanctions in the medium term will probably focus on individuals and their networks (as hinted at in the new E.O. discussed toward the end of this alert).
9. Bonus: Guidance of seemingly general applicability for funds. When issuing FAQs regarding the PDVSA designation and related general licenses, OFAC took the opportunity to answer two questions that have long plagued the financial community. (And if you are not a member of the financial community, you might want to skip this takeaway.) The first question, captured in FAQ 652, is whether mutual or exchange‑traded funds that are also U.S. persons may buy, sell, or otherwise engage in transactions related to holdings in blocked persons. OFAC answers that question with a firm no, but adds that funds containing such blocked holdings are generally not themselves blocked or prohibited from operating, and U.S. persons may continue to invest in them. The other question, captured in FAQ 653, is whether it is permissible for a synthetic exchange‑traded fund to track (not hold) a basket of holdings that includes holdings in blocked persons. The answer to that question is yes, provided that “the underlying basket being tracked includes less than a predominant share by value of . . . holdings in blocked persons.”

Now with the big picture in view, let’s examine the finer details. Rather than summarizing the general licenses in numerical order and running the risk of causing more confusion than necessary, we’ll approach them thematically.

Importing Petroleum from PDVSA

PDVSA’s production has plummeted over the years, but some U.S. companies still rely on it as a supplier. Rather than cut those companies off at the knees, OFAC has given them time to find new sources. In General License 12, OFAC authorizes most transactions and activities “ordinarily incident and necessary to” purchasing and importing into the United States petroleum and petroleum products from PDVSA entities.

We say “most” transactions and activities because there are a few things U.S. persons are prohibited from doing even if ordinarily incident and necessary to buying and importing petroleum from PDVSA entities. These are: (1) dealing with Albanisa; (2) divesting or transferring debt, equity, or other holdings in, to, or for the benefit of PDVSA entities; or (3) exporting or re-exporting diluents (diluting agents) from the United States to Venezuela or PDVSA entities.

Payments made pursuant to the authorization to purchase and import petroleum from PDVSA that are to or for the direct or indirect benefit of a blocked person must be made into a blocked, interest-bearing account located in the United States unless an authorization in General License 7A, 8, 11, or 13 applies. In cases involving swaps or other non-cash agreements for petroleum with PDVSA, FAQ 658states that U.S. persons should contact OFAC for guidance on how to handle blocked proceeds. Keep in mind that U.S. persons must report blocked payments to OFAC.

Under General License 7A, PDVH, CITGO, and their subsidiaries are also authorized to engage in most transactions and activities “ordinarily incident and necessary to” purchasing and importing petroleum and petroleum products from PDVSA. This general license does not specify importation into the United States as a requirement, and does not explicitly exclude Albanisa from the scope of authorized suppliers.

Transactions and activities ordinarily incident and necessary to purchasing and importing petroleum and petroleum products from PDVSA entities are authorized until April 28, 2019.

The Select Few

General License 8 authorizes five major corporations by name, as well as their subsidiaries, to engage in all transactions and activities ordinarily incident and necessary to operations in Venezuela involving PDVSA entities. The authorization does not extend to exporting or re-exporting diluents from the United States to Venezuela.

General License 8 expires on July 27, 2019.

Gray List Entities

American entities PDVH and CITGO and Swedish company Nynas are in the unfortunate position of being tethered to PDVSA and the GOV. General Licenses 7A and 13 reflect OFAC’s recognition of the difficult position that the companies and their subsidiaries are in by permitting U.S. persons to engage in all transactions and activities in which the only PDVSA entity involved is one of them. Interestingly, neither authorization seems to allow transactions involving more than one Gray List Entity.

In transactions involving only PDVH, CITGO, or one of their subsidiaries, General License 7A requires that payments to or for the direct or indirect benefit of any other blocked persons be made into a blocked interest-bearing account located in the United States. General License 13 imposes the same requirement on transactions involving only Nynas or one of its subsidiaries, unless General License 11 applies.

Neither of these authorizations permits U.S. persons to export anything to a PDVSA entity other than to a Gray List Entity covered under the relevant general license. The General License 7A authorization “automatically renews on the first day of each month, and is valid for a period of 18 months from [March 14, 2019] or the date of any subsequent renewal of General License No. 7A, whichever is later.” The General License 13 authorization expires on July 27, 2019.

Transactions Involving Bonds and Other Debt

Bonds and other debt have long been a thorny issue in the Venezuela sanctions program. The U.S. Treasury has worked hard to strike a balance between hindering the GOV’s ability to raise capital at the long-term expense of the Venezuelan people on one hand and wreaking havoc on secondary debt markets on the other. This has created considerable complexity that only increases with PDVSA’s designation, at least until OFAC issues additional guidance.

Initially, subsection 1(a)(iii) of E.O. 13808 prohibited U.S. persons from all transactions related to, the provision of financing for, and other dealings in bonds issued by the GOV, including PDVSA, prior to August 25, 2017. When President Trump issued that E.O. in August 2017, OFAC simultaneously issued General License 3, which authorized U.S. persons to deal in bonds that were either (1) listed in an annex to the general license, or (2) issued prior to August 25, 2017 by U.S. person entities owned or controlled, directly or indirectly, by the GOV. The General License 3 annex included bonds issued by both PDVSA and other organs of the GOV.

Concurrent with OFAC designating PDVSA, OFAC issued amended General License 3A, which superseded General License 3. OFAC subsequently revised the general license several more times, culminating (for now) in its latest iteration, General License 3D. The flux is OFAC trying to keep pace with market conditions in real time to limit disruption and provide market participants with clear guidelines.

Whereas General License 3 covered GOV and PDVSA bonds, amended General License 3D only deals with GOV bonds, authorizing U.S. persons to deal in those listed in the license’s revised annex (“3D Annex Bonds”). An important caveat to that authorization is that if U.S. persons divest or transfer holdings in such debt, or facilitate such transfers, the transfers must be to non-U.S. persons. Per revised FAQ 662, the authorization includes “engaging in transactions related to the receipt and processing of interest or principal payments, and acting as a custodian for U.S. and non-U.S. persons’ holdings in [3D Annex Bonds], including acting as a custodian for a non-U.S. person after that person has received [3D Annex Bonds] from a U.S. person in a divestment transaction.”

General License 3D further authorizes all dealings in bonds issued before August 25, 2017 by U.S. person entities owned or controlled, directly or indirectly, by the GOV other than Gray List Entities. The restriction on transfers to U.S. persons does not appear to apply to this authorization.

So what about PDVSA bonds, including those issued by Gray List Entities? OFAC issued new General License 9 to cover those, and subsequently amended the license three times to ultimately give us General License 9C. Section (a) of General License 9C authorizes U.S. persons to engage in all transactions and activities that are ordinarily incident and necessary to dealing in any PDVSA entity debt issued before August 25, 2017. Per that section, “PDVSA entity debt” here includes – though this does not necessarily mean “is limited to” – bonds listed in the annex to General License 9C, promissory notes, and other receivables. Section (a) provides the same authorization for dealing in equity in PDVSA entities. PDVSA entity debt and equity are “PDVSA entity securities.”   

Just like under General License 3D, if U.S. persons divest or transfer holdings in PDVSA entity securities, or facilitate such transfers, the transfers must be to non-U.S. persons. Section (b) of General License 9C explains that authorized transactions and activities include “facilitating, clearing, and settling transactions to divest to a non-U.S. person PDVSA-related debt, including on behalf of U.S. persons.” FAQ 661 mirrors FAQ 662 in identifying as an example of authorized activity serving as custodian for a non-U.S. person after that person has received PDVSA entity securities from a U.S. person.

Section (e) of General License 9C authorizes U.S. persons to engage in all transactions and activities ordinarily incident and necessary to dealings in Gray List Entity bonds issued before August 25, 2017. While OFAC has not explicitly said as much, the restriction on transfers to U.S. persons does not appear to apply to this authorization, with the exception of one Nynas bond listed in the General License 9C annex.

Recognizing that trade settlement timelines can make for sticky sanctions compliance situations, General License 3D and General License 9C authorize U.S. persons to engage in all transactions ordinarily incident and necessary to facilitating, clearing, and settling trades of holdings in 3D Annex Bonds and PDVSA entity securities if such trades were placed prior to 4:00 p.m. eastern standard time on specified dates. For General License 3D, that date is February 1, 2019. For General License 9C, the applicable date is January 28, 2019. Per FAQs 661and 662, “this authorization aims to ensure that trades that were placed prior to the imposition of blocking sanctions on PDVSA are allowed to settle in the ordinary course, irrespective of whether the sale or transfer is to a non-U.S. person.”

The general licenses also authorize winding down financial contracts or other agreements involving, or linked to, 3D Annex Bonds and PDVSA entity securities if such agreements were entered into prior to 4:00 p.m. eastern standard time on the applicable dates specified above. In both general licenses, this authorization expires on May 10, 2019. (OFAC has twice pushed back this expiration date.) FAQs 661 and 662 state that OFAC had “resolving the purchase and sale of securities, securities lending, repurchase agreements, and swaps and derivative contracts in securities” in mind when it issued the authorization.

Finally, while neither General License 3D nor General License 9C generally authorizes U.S. persons to purchase or invest in, or to facilitate the purchase of or investment in, 3D Annex Bonds or PDVSA entity securities, they do permit U.S. persons to make purchases and investments ordinarily incident and necessary to (presumably authorized) divestments and transfers. General License 9C explicitly states that it does not authorize U.S. persons to sell, or to facilitate the sale of, PDVSA entity securities to anyone designated or blocked pursuant to E.O. 13850, which includes PDVSA itself.   

Regarding intermediary due diligence standards with respect to ensuring that prohibited transfers to U.S. persons do not occur, FAQ 650 states that “OFAC expects U.S. persons to conduct due diligence on their own direct customers,” and “[f]inancial institutions or registered broker-dealers in securities may rely upon the information ordinarily available to them for purposes of conducting the activities authorized under General License 9.” FAQ 650 helpfully points to FAQ 116, which elaborates on the matter. The question, as always, is whether available information gives knowledge or reason to know that a sanctions violation is likely to occur.

With the above in mind, in any continued dealings involving PDVSA securities or 3D Annex Bonds, non-U.S. persons should take care to avoid causing a violation of U.S. sanctions by engaging in transactions involving U.S. persons or the U.S. financial system that do not comply with General Licenses 3D or 9C, as applicable. Causing a sanctions violation is, itself, a violation that can result in penalties.

Other Dealings with PDVSA

When a significant number of U.S. persons have exposure to a sanctioned party, OFAC will often issue “wind-down” licenses authorizing U.S. persons to resolve any outstanding business with the sanctioned party by a set date. So it is here. General License 12 authorizes U.S. persons to engage in all transactions and activities “ordinarily incident and necessary to the wind-down of operations, contracts, or other agreements” involving PDVSA entities if the operations or agreements were in effect prior to January 28, 2019.

Note that this authorization is distinct from the one related to importing petroleum, and expires sooner on February 27, 2019, as opposed to April 28, 2019. As with the petroleum import authorization, the general wind-down authorization does not extend to (1) dealing with Albanisa; (2) divesting or transferring debt, equity, or other holdings in, to, or for the benefit of PDVSA entities; or (3) exporting or re-exporting diluents from the United States to Venezuela or PDVSA entities.

While the information above applies to all U.S. persons, there is a special authorization for U.S. person employees and contractors of non-U.S. entities located in a country other than the United States or Venezuela. General License 11 authorizes such persons to engage in all transactions and activities ordinarily incident and necessary to maintaining or winding down operations, contracts, or other agreements involving PDVSA entities if the operations or agreements were in effect prior to January 28, 2019. General License 11 further authorizes U.S. financial institutions to reject a funds transfer (rather than block it) if (1) the underlying activities are authorized under General License 11 (per FAQ 654), (2) the transaction involves PDVSA entities and non-U.S. entities, (3) the non-U.S. entities are located in a country other than the United States or Venezuela, (4) the funds transfers originate and terminate outside of the United States, (5) neither the originator nor the beneficiary is a U.S. person, and (6) the funds are not destined for a blocked account on a U.S. person’s books.

OFAC has used the maintenance concept in other sanctions programs, most recently in general licenses applicable to En+ Group plc, Rusal PLC, JSC EuroSibEnergo, and GAZ Group (some of which have since been removed from the SDN List) under the Ukraine/Russia-related regime. In that program, OFAC defined “maintenance” as “all transactions ordinarily incident to the continuity of operations” and indicated that the level of performance must be “consistent with past practices that existed between the party and the blocked entity” prior to the applicable threshold date. (See FAQ 625.) While OFAC typically discourages using interpretations from one program in another, here it seems safe to assume that OFAC won’t depart substantially from that general guideline or its implications.

The General License 11 authorizations expire on March 29, 2019. Note that U.S. persons must report rejected payments to OFAC.

Miscellaneous

New General License 10 authorizes U.S. persons in Venezuela to buy refined petroleum products for personal, commercial, or humanitarian use from PDVSA entities. Commercial resale, transfers, exports, and re-exports are not authorized. In FAQ 656, OFAC offers buying refined petroleum products to power “means of conveyance” (including aircrafts, if you’re a U.S. commercial airline) or generators as an example of permissible activity.

General License 14 authorizes all transactions “for the conduct of the official business of the United States Government” that are prohibited under Venezuela sanctions. Yes, even the U.S. government needs OFAC licenses.

New Executive Order

Concurrent with OFAC designating PDVSA, President Trump issued a new E.O. modifying the definition of the term “Government of Venezuela” in the other Venezuela sanctions Executive Orders. As indicated in the new FAQ 649, the change allows OFAC to target “any person who has acted or purported to act directly or indirectly for or on behalf of” the Venezuelan government, “including as a member of the Maduro regime.” This broadens the scope of actors OFAC can impose sanctions on to include persons who are not technically Venezuelan government officials but purport to act on the government’s behalf.

Conclusion

Aside from the “Miscellaneous” authorizations and the debt/securities-related authorizations, all of the new general licenses are slated to expire within six months. U.S. persons with operations or holdings involving PDVSA entities should therefore have a sense of urgency about identifying the bounds of permissibility and devising exit strategies as needed.

Non-U.S. persons who rely on U.S. persons for their operations involving PDVSA should be similarly motivated to devise alternative options.

Both U.S. and non-U.S. persons should be wary of the Venezuelan oil sector generally, as anyone operating in it is now fair game for sanctions.

As always, we in Morrison & Foerster’s National Security Practice Group stand ready to provide counsel on specific facts and circumstances as needed.