The Office of Foreign Assets Control (OFAC) is facing a rare judicial challenge to its authority to impose penalties for violations of U.S. sanctions programs.  The plaintiff, Epsilon Electronics, Inc. (“Epsilon”), is a family-owned California wholesaler of automotive sound and video systems.  Last summer, OFAC hit the company with a civil penalty of more than $4 million for violations of the Iranian Transactions and Sanctions Regulations (ITSR).  According to OFAC, between 2008 and 2012 Epsilon exported more than $3.4 million in car audio and video equipment to UAE-based Asra International Corporation LLC (“Asra”), despite having reason to know that these goods were intended for reexport to Iran.  Finding 39 violations of the ITSR, some egregious, OFAC assessed a civil penalty of $4,073,000.

Epsilon has filed suit in the U.S. District Court for the District of Columbia, alleging that the penalty violated the Administrative Procedures Act, was in violation of the Eighth Amendment, and violated Epsilon’s Fifth Amendment right to due process.  While such challenges are rare, as companies generally prefer to minimize publicizing penalties for fear of further reputational harm, Epsilon has chosen a very different route, and raises some interesting claims.

For example, Epsilon claims that OFAC disregarded mitigating factors that it was required to consider under its Economic Sanctions Enforcement Guidelines, such as Epsilon’s cooperation with OFAC’s investigation, including responding to several administrative subpoenas.  OFAC, however, states that Epsilon attempted to mislead it by providing false information in its communications to OFAC, and even attempted to conceal its sales to Iran by removing photographs from its website that showed its products in Iran.

Perhaps more interesting and practically relevant to practitioners is Epsilon’s claim regarding the oft-debated “inventory exception.”  Epsilon contends that this exception allows U.S. persons to ship items to a third country knowing that they may end up in Iran, provided that the U.S. person is not itself filling a specific order intended for Iran; the majority of the third-country buyer’s business is not in/with Iran; and the goods are not subject to the Export Administration Regulations (“EAR”), which control exports and reexports of certain dual-use items.  While Epsilon claims that the exception arises from guidance that OFAC issued in 2002, it is unclear whether OFAC actually considers such an exception to exist.

Indeed, the main outcome of this case could be to force OFAC to clarify whether there is an “inventory exception,” and, if so, how far it stretches. Notably, even if the exception does exist, it is unclear whether Epsilon could avail itself of it – OFAC contends that Asra’s website made clear that its business was primarily in/with Iran.

The Epsilon litigation could have a significant impact on OFAC’s investigations and enforcement efforts, and the weight it affords various factors in its penalty assessments.  Stay tuned for updates as this litigation proceeds.