The Redmond, Washington, businessman, who exports to Iran under a humanitarian license from the U.S. Treasury Department, says he is owed close to $3.8 million by Iranian companies who cannot pay him because of the latest U.S. and European Union sanctions.

He is not alone.

U.S. firms from major drug makers like Merck & Co. to mom-and-pop outfits like Harrington's American Pulp & Paper Corp. are finding it hard to get paid even for medicines and other humanitarian exports explicitly allowed by the U.S. Treasury, according to officials, sanctions lawyers and the companies.

"Everything from aspirin to multivitamins - you name it - it's all jammed up," said Cari Stinebower, an international trade lawyer with Crowell & Moring, a Washington, D.C.-based law firm, and a former counsel for the Treasury Department's Office of Foreign Assets Control (OFAC).

The payments gridlock is a testament to the effectiveness of the latest round of financial sanctions, which aim to force Iran to curb its nuclear program and which have made the Iranian banking sector even more radioactive for major global banks.

But they also undercut the long-standing U.S. argument that its sanctions are not meant to squeeze the Iranian people but rather the Islamic republic's leaders and their suspected pursuit of nuclear weapons.

"I am not against punishing Iran for being a rogue country but the United States, or the Europeans, when they start imposing sanctions, then they must consider, also their own companies," Harrington said.

Harrington, an Iranian American who changed his name from Farhad Fouroohi, had to lay off three people in February because of the payments delays, cutting his staff from seven to four.

OUTSIZE IMPACT

While a new U.S. law targeting financial institutions that deal with the central bank of Iran has garnered much attention, sanctions lawyers said the January 23 blacklisting of one Iranian bank had a more immediate, sharp effect on humanitarian trade.

Bank Tejarat, Iran's third-largest bank, was "designated" - or blacklisted - under a U.S. executive order targeting people and companies that promote the proliferation of weapons of mass destruction as well as their support networks.

The action has the effect of cutting them off from the U.S. financial system, along with any bank who deals with them - a risk that many banks find impossible to take.

Over the last five years, the Treasury has blacklisted 23 such Iranian-linked entities, gradually squeezing Iran's ability to do business with the world.

Tejarat's blacklisting has had an outsize impact, sanctions lawyers said, because it had been the last major Iranian bank available for legal trade with Iran. With it now off limits, companies are having to sift through smaller banks to find some that can carry out the transactions - which is no mean feat.

"That has had a huge ripple effect," said Douglas Jacobson, a Washington attorney who focuses on sanctions work.

"On the one hand, you can get a license. The government is saying, 'OK you can sell.' But the practical reality is that you can't get paid," he added.

The lawyer said one of his clients is out several hundred thousand dollars because of the Tejarat blacklisting and that he knows of several medical companies that have stopped exporting to Iran because of the payment problems.

"Where you had a small window of opportunity previously, that window is now almost completely closed," said Erich Ferrari, another lawyer who specializes in trade sanctions.

The decision on Thursday by Belgium-based SWIFT, the world's biggest electronic payment system, to expel all Iranian banks blacklisted by the European Union, may make it even harder to conduct transactions, sanctions lawyers said.

The United States has gradually tightened sanctions because of Iran's failure to answer questions about its nuclear program, which Washington and its allies suspect is a cover to develop nuclear weapons. Iran says it is solely to generate power.

The sanctions became much tougher when U.S. President Barack Obama on December 31 signed a law designed to choke off Iran's oil sales by threatening to cut off foreign banks from the U.S. financial system if they dealt with Iran's central bank.

Merck & Co., the world's third-largest pharmaceuticals company, said it has licenses to sell Iran products to treat diabetes, cancer, respiratory illnesses and infections.

"(Merck) has experienced a challenging situation in 2012 in terms of securing payments for goods shipped," said Merck spokeswoman Kelley Dougherty, adding the company was open to ideas to "facilitate exports of humanitarian goods, including medicines," in accordance with U.S. law and regulations.

Pfizer Inc, the world's largest pharmaceuticals maker whose flagship products include the cholesterol-lowering drug Lipitor, acknowledged challenges in getting paid for Iranian sales, saying it would work through them. Both Merck and Pfizer declined to provide details.

"There is some turbulence right now," said Pfizer spokesman Peter O'Toole, saying the company wished to ensure that Iranian patients have access to needed medications. "If we have to work through a little turbulence, that's what we'll do."

A Treasury Department official who spoke on condition of anonymity said its approach on humanitarian exports to Iran had not changed, though he did not directly address questions about the difficulty that U.S. companies were having getting paid.

"There's been no decrease in applications to OFAC to export humanitarian items to Iran," the spokesman added. "The recent sanctions imposed on Iran have not changed our approach to the export of food, medicine and medical devices to Iran."

For companies such as Pfizer or Merck, exports to Iran are a tiny fraction of their worldwide business.

If ordinary Iranians ultimately suffer shortages of drugs and medical devices, the Iranian government may use it to score public relations points with their own people against the West, much as former Iraqi dictator Saddam Hussein did in Iraq.

"They need to defend their position to their own population. They need to continue to create this image of an international community that is implacably aligned against the interests of a defenseless Iran," said Suzanne Maloney, a senior fellow at the Brookings Institution's Saban Center for Middle East Policy.

"This kind of imagery would play into that and it'll have a certain resonance among Iranians who have a long experience with sanctions, resent the impact of sanctions on ordinary citizens and believe ... the government is well able to insulate itself."

'WASHINGTON'S EARS ARE CLOGGED'

The United States bars virtually all trade with Iran. It cut diplomatic ties with Iran in 1980 after Iranian students seized its embassy in Tehran and ultimately held 52 Americans hostage for 444 days.

Last year, the United States exported only $229.5 million worth of goods to Iran.

"Woodpulp and pulpwood" - which includes the raw material for diapers - accounted for $57.9 million, followed by $50.1 million for pharmaceuticals, $29.5 million for plastics, $23.4 million for unmanufactured farm products and $22 million for medical devices, according to U.S. Commerce Department data. (Graphic: link.reuters.com/qas27s).

Under a quirk in U.S. law, the export of diapers to Iran is not allowed but the export of fluff pulp, their key component, is, creating an opportunity for Harrington to sell it to Iran.

Of the $26.6 million in sales his company had last year, Iran accounted for roughly 70 percent.

The impact has been so big that Harrington wrote U.S. President Barack Obama a plaintive letter on February 9, saying the latest U.S. sanctions "have virtually stopped our business overnight."

"We would appreciate your comments and any suggestions as to what we could possibly do at this point," Harrington wrote. "From our perspective, it would seem that there is nothing left to be done except to close our doors."

Harrington, who argues there should have been a "wind-down" period to clear existing payments, has received no reply.

"We have not received any reaction and I don't expect to," he said. "Washington's ears are clogged. They don't hear it at all."

(Reporting By Arshad Mohammed; additional reporting by Lewis Krauskopf in New York and Doug Palmer in Washington; Editing by Paul Simao)

• A Permanent Economic Emergency