Implications Arising from the Recent Venezuelan Sanctions
Though intended to avoid stifling trade in existing Venezuelan government bonds, the sanctions include restrictions on dealings in certain bonds that could impact bond holders.
The US government imposed additional sanctions on the Venezuelan government on August 25, 2017, for a variety of actions that the administration deems violations of the human and political rights of the people of Venezuela. The sanctions are the latest in a series of actions taken by the US government against Venezuelan President Nicolás Maduro and those in his inner circle. These sanctions are designed to close some of the loopholes in prior sanctions aimed at Venezuela and further restrict the Maduro government from access to cash, which has been used to fund the human rights violations and political oppression of the Venezuelan people and political opposition. The newest sanctions restrict the ability of the Venezuelan government and its state-owned oil company Petroleos de Venezuela, S.A. (PdVSA) to raise funds through new debt or equity offerings, and make it illegal for US persons (individuals or entities) to participate in debt or equity offerings that extend beyond 30 days for the government and 90 days for PdVSA.
The approach to these new sanctions follows the “catch-and-release” methodology that has become typical in the implementation of targeted sanctions by the US government. Executive Order 13808, which imposes the sanctions, includes broad prohibitions, in this case making it illegal for US persons to transact or otherwise deal in: new Venezuelan or PdVSA “debt” longer than 30 or 90 days, respectively; and Venezuelan government bonds. The Order also prohibits dividend payments to the Venezuelan government. At the same time, the US Office of Foreign Assets Control (OFAC) issued General Licenses authorizing activities that would otherwise violate the Executive Order, having the effect of narrowing the sanctions. By using the catch-and-release approach, the United States has in place broader sanctions, giving OFAC the authority to tighten the sanctions should the need arise.
In the case of the Venezuela action, OFAC issued four General Licenses simultaneous with implementation of the Order. The General Licenses cover actions needed to wind down existing contracts with the Venezuelan government (General License 1), debt related to exports of certain agricultural and humanitarian goods and services (General License 4), transactions with Citgo Holdings, Inc. (General License 2), and, the focus of this discussion, dealings in “certain bonds” (General License 3).
Interpreting the New Sanctions
As with any new sanctions, the imperative is to determine what actions, previously permitted, are now prohibited. When sanctions follow the catch-and-release approach described above, it allows OFAC to take the position that because an Executive Order broadly describes the scope of prohibited activity, that which is not expressly permitted remains prohibited. For example, the Executive Order 13808 broadly prohibits “all transactions related to, provision of financing for, and other dealings” in:
new PdVSA “debt” with a maturity greater than 90 days;
new Venezuelan government “debt” with a maturity greater than 30 days;
bonds issued by the Venezuelan government prior to August 25, 2017; and
dividend payments or other distributions of profits to the Venezuelan government “from any entity owned or controlled, directly or indirectly, by” the Venezuelan government—depriving the Venezuelan government of dividends and/or profits from Citgo in the United States.
Recognizing that significant Venezuelan and PdVSA debt is currently traded in world markets, including the United States, and that the objectives of the sanctions—to deprive the Venezuelan government of new funds—would not be served by prohibiting transactions involving that debt, OFAC issued General License 3 authorizing “all transactions related to, the provision of financing for, and other dealings in” virtually every known Venezuelan and PdVSA existing bond as of August 25, 2017, except one 2036 bond that was not then trading. Thus, although the Order initially prohibits transactions relating to Venezuelan government bonds, in fact, this provision is substantially diluted by General License 3, which allows for the continued trading in the bonds listed in the Annex to that license.
While the implementation of these sanctions was covered extensively (See, e.g., Rebecca M. Nelson, “New Financial Sanctions on Venezuela: Key Issues,” CRS Insight, September 1, 2017), little attention has been given to the long-term impact these sanctions may have on the bonds currently being traded. These are significant questions that can impact the viability of continuing to hold these instruments, and which OFAC has yet to address.
Trading in Bonds Exempt From the Sanctions
OFAC issued General License 3 to authorize continued trading in about 75 bonds issued by either the Venezuelan government or PdVSA. The maturity dates on these bonds extend from before the issuance of the sanctions to 2038. While paragraph (a) of General License 3 authorizes “all transactions related to the provision of financing for, and other dealings” in the bonds listed in the License 3 Annex, the license excepts from its coverage any transactions “otherwise prohibited by” the Executive Order. As with other sanctions regimes, no specific guidance was provided describing what actions fall within the meaning of “financing for and other dealings in.” OFAC has offered only limited suggestions as to what these terms might mean in its FAQ responses, where it states that dealings or transactions include entering into contracts, negotiations, or processing transactions. (See OFAC FAQ 505). Therefore, understanding OFAC’s approach to these terms is essential to ensuring compliance with the sanctions.
While General License 3 clearly authorizes continued trading in the bonds listed in the Annex, the authorization to engage in “financing for and dealings in” extends only to activities associated with the existing bonds in the Annex (i.e., trading in, financing and other dealings in those specific bonds). Section (c) of the General License confirms that it extends no further by making clear that actions “otherwise prohibited” by the Executive Order remain prohibited. In OFAC terms, this language is designed to limit the scope of activities to the existing bonds and make clear that actions relating to “new debt” longer than authorized remain prohibited, even if that “new debt” is meant to replace the bonds in the Annex.
OFAC regulations traditionally preclude any action that “facilitates” a violation of the sanctions. As with other sanctions programs, the authority to prohibit facilitation is found in language prohibiting any act that “causes” a violation. (See, e.g., Executive Order 13808, Section 1(c)). Facilitation generally is not well defined by OFAC but construed broadly, and can include almost any activity that assists with or otherwise aids in violating the sanctions. For example, OFAC has found facilitation violations where a company provided “various back-office functions for the sales by a foreign affiliate” (Great Western) and where a US entity assisted its foreign affiliate with prohibited sales (World Fuel Services Corp). Thus, while US persons may continue to trade in the bonds in License 3’s Annex, and the license should also act to authorize those actions necessary to deal in them (i.e., dividend payments or potentially even pay off at maturity), it does not go so far as to authorize the issuance of new debt longer than 30 or 90 days, as the case may be, to replace those bonds. Moreover, because the issuance of such new debt is prohibited, any actions to “facilitate” the issuance of the new debt remains prohibited. For example, engaging in negotiations to establish such “new debt” would generally be viewed as “facilitation.”
These prohibitions highlight the risks in trading (and owning) even the bonds in the Annex. Since government bonds are often (if not always) paid from newly issued bonds, and US persons cannot facilitate the issuance of nor accept new debt from the Venezuelan government longer than 30 days, a holder of these bonds may be functionally unable to collect from the Venezuelan government at maturity.
It is not clear whether the Venezuelan government will locate new sources to repay these bonds as they become due. Presumably, however, if Venezuela is able to repay the bonds at maturity, and a bondholder has not facilitated the issuance of any new debt, then the authorization to deal in these bonds should extend to accepting payment at maturity. Nonetheless, these uncertainties have led some US firms to stop trading even in the Venezuelan bonds listed in the Annex to License 3. The overall reticence is already impacting the market as Citgo was reportedly having difficulty with routine financing even though General License 2 specifically exempts Citgo Holdings and its subsidiaries from the sanctions. Suppliers and others who provide credit to Citgo expressed fears of default and the uncertainties surrounding the sanctions outlook.
“Debt” and “Equity” Covered by the Sanctions
Like the Ukraine-related sanctions imposed on Russian authorities and entities, the Venezuela sanctions leave open some of the same questions about when a transaction constitutes “debt” or “equity.” While the Executive Order does not define these terms, OFAC confirms in its FAQs that debt includes “bonds, loans, extensions of credit, loan guarantees, letters of credit, drafts, bankers acceptances, discount notes or bills, or commercial paper,” and “equity” includes “stocks, share issuances, depositary receipts, or any other evidence of title or ownership.” As broad as these lists are, they do not address numerous types of transactions that may or may not constitute “debt” or “equity”.
With debt including any “extension of credit,” even routine transactions can be subject to the sanctions. Further, except for debt relating to Citgo Holdings, none of the general licenses authorizes these other forms of new debt for the Venezuelan government or PdVSA. For a country like Venezuela, where most significant industry and commerce has been nationalized, this means that any transactions where goods or services could end up in or for the benefit of a Venezuelan entity must be subjected to extra scrutiny. Routine transactions such as leases or payment terms would fall within the broad definition of debt if they run past the 30 or 90-day limits in the Executive Order. These transactions would be prohibited absent OFAC authorization.
The restrictions on the issuance of new equity similarly prohibit any transaction whose effect is to “deal in” or provide “financing for” anything that would constitute any new equity interest. This restriction does not prohibit, for example, trading in existing equity, but means that entities that engage in underwriting or transactions must be careful not to engage in actions that result in new equity for Venezuelan government entities.
When the Music Stops
One risk created by the new sanctions that seems to have evaded extensive discussion is what happens to those holding Venezuelan bonds at their time of maturity. Although the Venezuelan government might want to roll over the debt, the sanctions prohibit any formal or effective rollover, because any such “new debt” could not be for longer than 30 days. If the maturity date for a bond passed, only default would avoid this result, since accepting continued payments extends the debt. But OFAC has yet to provide guidance on the implications of a default by the Venezuelan government. Although defaults are not extensions of credit per se, they can operate like a credit extension. Thus, it is not clear if a license would be required to collect following a default because the effective extension operates as “new” debt, even though involuntarily created. Certainly, any extension of an existing credit facility or other debt could trigger the sanctions, but OFAC has not advised whether this would be the case where the “credit” results from a refusal to pay. If it did, the sanctions could give Venezuela an excuse to unilaterally extend repayment terms while the sanctions are in place.
OFAC will likely provide further guidance on how or whether it will address these problems, but until it does, there is enhanced risk in holding even the debt authorized by General License 3. While non-US persons can purchase the debt, as the bonds get closer to maturity, the price could plummet in a reverse auction atmosphere as foreign buyers seek to take advantage of the sanctions’ impact on US bond holders.
 Executive Order 13808, August 24, 2017, effective August 25, 2017 (the “Order”). The EO details the following bases for the sanctions: “serious abuses of human rights and fundamental freedoms; responsibility for the deepening humanitarian crisis in Venezuela; establishment of an illegitimate Constituent Assembly, which has usurped the power of the democratically elected National Assembly and other branches of the Government of Venezuela; rampant public corruption; and ongoing repression and persecution of, and violence toward, the political opposition.” On September 22, 2017, Canada announced sanctions against 40 Venezuelan government officials, but these are not the type of targeted sanctions as those in the Order.
 As noted both by the White House and in many articles when the Executive Order was signed, these sanctions are similar to the earliest sanctions against Russia imposed in response to its incursion into Ukraine. Such “targeted” sanctions seek to either hold specific parties accountable, constrict particular activity, or both. As with the early Ukraine-related sanctions, the intent behind these sanctions is to make financing almost impossible for the Venezuelan government and PdVSA, but not to completely cut off all funding, or render existing bonds worthless.
 General License 3 makes clear that the authorizations in section (a) apply only to “bonds” by stating that the only dealings authorized are those otherwise prohibited by subsection 1(a)(iii) of the Order, which addresses only Venezuelan government bonds issued before August 25, 2017.
 OFAC FAQ No. 523 states: “OFAC intentionally excluded the Venezuela Government International Bond issued on December 29, 2016 (ISIN USP97475AQ39, CUSIP AM1108092) (“the 2036 bond”) from the Annex to General License 3 because available information indicates that the Government of Venezuela is both the bond’s issuer and sole holder. At this time, the 2036 bond is the only bond we have identified and purposely omitted from the Annex to General License 3.”
 Paragraph (b) of the license also authorizes “all transactions” in bonds that meet two specific criteria: (1) the bonds were issued prior to August 25, 2017, and (2) the bonds were issued by a US entity “owned or controlled, directly or indirectly” by the Venezuelan government. This provision is potentially redundant, in part, in light of General License 2, which authorizes “all transactions” relating to Citgo Holdings, Inc., but reflects OFAC’s concern that there might be further debt, and other entities owned by the Venezuelan government, of which it was unaware.
 OFAC occasionally provides more direction with respect to facilitation. For example, in the Sudan Sanctions regulations, 31 CFR part 538, “facilitation” is defined to include “any unlicensed action by a U.S. person that assists or supports trading activity with Sudan by any person.” 31 CFR §538.407. Activity of a purely clerical or reporting nature that does not further trade or financial transactions with Sudan or the Government of Sudan is not considered prohibited facilitation. Id.