Encryption disappears in Outlook - Sensitivity Label not working

Hello everyone,

we implemented Sensitivity Labels at our client and have iconsistent and unexpected behavior, we cannot explain. Maybe some of you can help or have ideas on whats going on:

Scenario / Use Case

A customer is using Sensitivity Labels to encrypt emails in Exchange Online.

Label configuration:

The sensitivity label applies encryption
The label is scoped (published) to a Microsoft 365 group
User A and User B are members of this Microsoft 365 group and therefore can apply the label
User are licensed with M365 Business Premium
The label is published and available to User A and User B (member of above M365 group)
User C is an external recipient and not included in the label’s publishing scope

Observed Behaviors

Scenario 1 – Encryption Lost When Forwarded Externally

User A (internal) sends an email to User B (internal) using a sensitivity label that applies encryption.
User B receives the email correctly:
- The lock icon in Outlook is displayed, the message is encrypted as expected
User B forwards the email to User C (external)
User C receives the forwarded email unencrypted:
- No lock icon is shown, User C can read the entire conversation history, including content that was previously encrypted

Scenario 2 – Encryption Disappears Within an Internal Email Conversation

In addition to the external forwarding scenario, we are also observing the following behavior within an internal email thread:

User A sends an encrypted email to User B using the sensitivity label.
User B replies to User A:
- The reply remains encrypted
User A replies again within the same conversation
Suddenly, the encryption disappears:
- The lock icon is no longer shown
- The message and the full conversation history is no longer protected

This happens without any user action to remove or change the sensitivity label.