Russian sovereign debt defaults: a disputes perspective

Herbert Smith Freehills LLP have published an article in Butterworths Journal of International Banking and Financial Law (JIBFL) on Russia’s default on its foreign currency sovereign debts from the perspective of potential disputes and litigation.

Russia’s default on its foreign currency sovereign bonds is unprecedented and likely to lead to bondholder litigation as well as derivatives disputes. The article highlights the reasons for Russia’s default and explores the scope of potential bondholder litigation, together with some of the obstacles which bondholders may face in bringing claims against Russia. The article then considers the ripple effect on the derivatives market, where it is possible that investors in products linked to Russian debt may seek to recover losses by bringing mis-selling claims.

The article can be found here: Russian sovereign debt defaults: a disputes perspective and first appeared in the September 2022 edition of JIBFL.

Daniel May
Daniel May
Senior Associate
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Ceri Morgan
Ceri Morgan
Professional Support Consultant
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Nick May
Nick May
Partner
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Susannah Cogman
Susannah Cogman
Partner
+44 20 7466 2580
Minolee Shah
Minolee Shah
Professional Support Consultant
+44 20 7466 207

LIBOR transition risks: the brave new world of RFRs

In previous blog posts, we have considered the risks of LIBOR transition for legacy LIBOR referencing contracts. For new transactions, LIBOR has almost been consigned to history, although there are still some areas relating to the use of near risk free rates where the market has not yet settled.

In this briefing, our colleagues in the Finance team provide a status update for LIBOR in 2022 through a transactional lens, including the current market practice for new USD debt and a helpful explanation of the purpose and proposed use of “synthetic LIBOR”.

Amending legacy LIBOR contracts: how to cater for near risk-free rates

Herbert Smith Freehills LLP has published an article in Butterworths Journal of International Banking and Financial Law on amending legacy loan agreements to replace LIBOR with near risk-free rates.

Following the Financial Conduct Authority’s announcement on 5 March 2021 that all LIBOR settings will either cease to be provided by an administrator or no longer be representative on 31 December 2021 (in the case of all but the most commonly used USD LIBOR tenors), market participants have focused in earnest on the amendment of legacy facility agreements to cater for near risk-free rates (RFRs). The Working Group on Sterling RFRs imposed an interim milestone of 30 September 2021 for conversion of all legacy sterling LIBOR facility agreements to RFRs where possible, and the Loan Market Association (LMA) has published recommended documentation using compounded RFRs which effect the Working Group’s Best Practice Guide for GBP Loans. However, there are a significant number of legacy loans which still refer to LIBOR, so there will be substantial pressure on resources in Q4.

In our article, we examine the various approaches being taken to amending legacy finance documents in the loans market in the context of a market-driven, rather than borrower-requested amendment, and the areas where practice has not yet settled.

The article can be found here: Amending legacy contracts: how to cater for near risk-free rates. This article first appeared in the October 2021 edition of JIBFL.

Emily Barry
Emily Barry
Professional Support Consultant
+44 20 7466 2546

Court of Appeal rejects all claims relating to transfer of property portfolio to lender’s restructuring unit following borrower default

The Court of Appeal has upheld the High Court’s decision to reject all claims arising from the transfer of a defaulting borrower’s property portfolio to his lending bank’s restructuring unit during the global financial crisis. Dismissing the appeal in full, the Court of Appeal refused to imply any contractual terms into the mortgage, and did not accept claims that the bank owed a general duty to act in good faith in relation to the negotiation of the restructuring, or that the bank’s actions amounted to intimidation or economic duress: Morley (t/a Morley Estates) v The Royal Bank of Scotland plc [2021] EWCA Civ 338.

This decision is a reassuring one for financial institutions where borrower default has led to a restructuring and the bank is faced with attempts to rescind, especially where there has been significant market turmoil (such as the global financial crisis or the current COVID-19 pandemic). It highlights the difficulties for claimants bringing claims of this nature in circumstances where the bank’s exercise of its powers under a facility agreement are in line with its commercial interests and the negotiation of the relevant restructuring is between commercial parties with the benefit of legal advice.

The key points decided by the Court of Appeal that are likely to be of broader interest are as follows:

  • Duty to provide services with reasonable skill and care. The Court of Appeal rejected the implication of a contractual term into the original loan agreement under section 13 of the Supply of Goods and Services Act 1982 (the Act). It did not accept that the bank was under any implied contractual duty to exercise reasonable skill and care in negotiating the restructuring with the claimant after his default on the original loan; by then the parties’ relationship was governed by the express terms of the loan and the equitable principles applicable to that relationship. Even if owed, the Court of Appeal commented that this duty was not breached on the facts.
  • Duty to act in good faith. The Court of Appeal did not accept that the bank was subject to an implied contractual duty under the loan to act in good faith in its negotiations with the claimant. All the bank’s actions in any case, in the court’s view, were rationally connected to its commercial interests.  
  • Intimidation and economic duress. The Court of Appeal underlined that the bank had not committed the tort of intimidation and that the restructuring agreement between the bank and claimant was therefore not voidable for economic duress. In its view, the restructuring agreement concluded was the result of a robust negotiation between commercial parties, each of which had legal advice and was well able to look after itself in that negotiation. Also, it was notable that the restructuring agreement concluded was one that the claimant had wanted and had originally proposed.

The decision is considered in further detail below.

Background

The claimant was a commercial property developer with a portfolio in the north of England. In December 2006, he entered into a three year, £75 million loan (the Loan Agreement) with the defendant bank (the Bank). The Bank took legal charges over all 21 properties in the claimant’s portfolio, but had no recourse to the claimant personally. During 2008 the parties discussed restructuring the loan, after the claimant failed to make interest payments, but did not reach agreement. In January 2009, the Bank obtained an updated valuation valuing the portfolio at approximately £59 million. On the basis of the valuation, the Bank: 1) notified the claimant of a breach of a loan to value ratio covenant; and 2) served a separate notice exercising its right to charge interest at an increased default rate of 3%.

In mid-2009, the Bank’s Global Restructuring Group (the GRG) took over the relationship with the claimant. Negotiations continued between the GRG and the claimant into 2010 (primarily focused on a discounted redemption of the loan by the claimant, on the basis that the value of the portfolio had dropped sharply in turbulent times) and the loan expiry date was extended several times, but the claimant was unable to raise sufficient funds.

At a meeting on Thursday 8 July 2010, the GRG sought the claimant’s consent to transfer the entire portfolio voluntarily to the Bank’s subsidiary, West Register (Property Investments) Limited (West Register). The GRG’s representative warned that if the claimant refused, the Bank would do a pre-pack insolvency and appoint a receiver on Monday 12 July 2010. The claimant did not agree to transfer his portfolio, but continued to negotiate. A few weeks later, the claimant’s solicitors wrote to the GRG threatening injunction proceedings if the appointment of a receiver went ahead. In August 2010, the parties executed an agreement  under which the claimant repurchased five of the properties for £20.5 million and surrendered the rest to West Register and in return the Bank released its security and the claimant was released from his obligations under the loan (the Restructuring Agreement).

The claimant brought proceedings against the Bank on the basis that in concluding this Restructuring Agreement, the Bank acted in breach of a duty owed to him pursuant to section 13 of the Act to provide banking services with reasonable care and skill and in breach of a duty of good faith, and seeking damages for breach of these duties. The claimant also contended that he was coerced into concluding the Restructuring Agreement by unlawful pressure placed upon him by the Bank, and that as a result of this coercion, the Bank committed the tort of intimidation and the Restructuring Agreement was voidable for economic duress.

High Court decision

The High Court dismissed the claim in full. The High Court’s reasoning is summarised in our previous blog post here. The claimant appealed.

Court of Appeal decision

The Court of Appeal found in favour of the Bank and upheld the High Court’s decision to dismiss the claimant’s claim. We consider below some of key issues considered by the court.

Issue 1: Duty to exercise reasonable skill and care in providing lending services

The claimant argued that the Bank was: (i) subject to a duty under the Act to provide lending services with reasonable care and skill (such a duty operated as an implied term of the original Loan Agreement); and (ii) in breach of duty because, in negotiating for the transfer of the properties to West Register, the Bank was acting as a buyer (i.e. seeking to obtain the properties with a view to medium or long term capital gain) rather than as a lender (i.e. seeking to recover the money which it had lent).

The Court of Appeal did not accept that the Bank was under any implied contractual duty to exercise reasonable skill and care in negotiating the Restructuring Agreement with the claimant after his default on the original Loan Agreement in December 2009. The Court of Appeal underlined that by then the parties’ relationship was governed by the express terms of the Loan Agreement and the equitable principles applicable to that relationship; an implied term in the original Loan Agreement therefore did not have any part to play in the parties’ relationship in the circumstances.

The Court of Appeal commented that even if the Bank did owe a relevant duty under the Act, it had committed no breach of duty; throughout the Bank’s only objective was to recover as much as possible of the amount which it had loaned to the claimant, but even if the Bank had mixed motives that would have made no difference – it was unnecessary that a mortgagee should have “purity of purpose”, i.e. that its only motive is to recover in whole or part the debt secured by the mortgage.

Issue 2: Duty to act in good faith

The claimant argued that the Bank was under an implied contractual duty under the original Loan Agreement to act in good faith, or not to act vexatiously or contrary to its “legitimate commercial interests”.

The Court of Appeal did not accept that the Bank was subject to such a duty in its negotiations with the claimant and noted that all the Bank’s actions in any case were rationally connected to its commercial interests.

The Court of Appeal highlighted that the High Court had already made a factual finding rejecting that the manner in which the negotiations were conducted were acts done in order to vex the claimant maliciously.

Issue 3: Intimidation and economic duress

The claimant argued that the High Court’s finding that he had not been coerced was wrong.

The Court of Appeal disagreed and highlighted that, on the facts of the case, there had been no coercion. The Court of Appeal said that the Restructuring Agreement concluded was the result of a robust negotiation between commercial parties, each of which had legal advice and was well able to look after itself in that negotiation. The Court of Appeal noted that the claimant: (a) was not above making threats (such as walking away from the properties to cause serious damage to the Bank’s security); (b) was prepared to exert political and public relations pressure on the Bank (by enlisting his MP and by engaging public relations consultations); and (c) was prepared to threaten an emergency application to a court for an injunction.

The Court of Appeal also commented that the claimant did not submit to the Bank’s demand and that the Restructuring Agreement concluded was one that the claimant had wanted and had originally proposed; it was the claimant’s successful persistence in the negotiations (e.g. in not being coerced) which enabled him to achieve his object and he therefore had entered into the Restructuring Agreement with the Bank of his own free will. The Court of Appeal said the fact that claimant did not take any steps to set the Restructuring Agreement aside until 5 years later was significant, as it not only demonstrated his affirmation of the Restructuring Agreement but also negated any finding of coercion. The Court of Appeal underlined that any doubt was dispelled by a submission document prepared by the claimant or on his behalf in August 2010 for a separate bank, in which the virtues of the deal with the Bank was extolled and described as a consensual deal which was driven by the claimant.

Accordingly, the Court of Appeal dismissed the appeal in full.

Natasha Johnson
Natasha Johnson
Partner
+44 20 7466 2981
Ceri Morgan
Ceri Morgan
Professional Support Consultant
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Nihar Lovell
Nihar Lovell
Professional Support Lawyer
+44 20 7374 8000

US Sanctions and the right of borrowers to withhold repayment: Commercial Court signals return to orthodoxy

The Commercial Court has granted summary judgment in favour of a bank seeking to recover payments under Credit Agreements entered into with the Venezuelan state-owned oil and gas company, Petroleos De Venezuela SA (PDVSA), finding that the defaulting borrower had no real prospect of successfully defending the claims on the basis of certain US Sanctions imposed on Venezuela which post-dated the execution of the Credit Agreements: Banco San Juan Internacional Inc v Petroleos De Venezuela SA [2020] EWHC 2937 (Comm).

The court rejected all of the arguments put forward by PDVSA as to why it was prevented from making repayments as a result of the imposition of US sanctions (PDVSA is now a US Specially Designated National (“SDN”)). In particular, the court made the following findings, which will be of broader interest to global lenders with exposure to borrowers facing sanctions risk:

  1. No “normal course” to suspend payment obligations where there is a risk of US Sanctions

In interpreting the sanctions clause in the Credit Agreements, the court rejected the suggestion that the Court of Appeal’s recent decision in Lamesa Investments Limited v Cynergy Bank Limited [2020] EWCA Civ 821 demonstrated that it is perfectly normal and sensible in commercial agreements to suspend payment obligations where payment would otherwise be in breach of US sanctions (see our banking litigation blog post). It found that this authority (and others) were simply decisions on their (very different) facts. On the facts of the present case, the court concluded that the relevant clause provided no basis for a suspension of the repayment obligations (and in any case it was not clear that it would in fact be a breach of sanctions for PDVSA to make payment).

This represents a move back to orthodoxy in cases of this kind, emphasising the importance of the contractual construction of the particular wording of the clause in each case. Lamesa v Cynergy was a surprising decision in part because the party with the payment obligation in that case was (if payment was made) only at risk pursuant to US secondary sanctions. Here, US primary sanctions were in play to some extent, given that the payment was to be made in US dollars and to a US account. Nonetheless, the court found that PDVSA’s payment obligation was not suspended. As such, it appears that the outcome in Lamesa v Cynergy does not have broader application – instead, as the court itself observed in Lamesa, each case will turn on the  interpretation of the particular contract in question.

2. Impossibility vs impracticability of repayment

On an obiter basis, the court expressed the view that it was merely impracticable and not illegal for PDVSA to make payments in USD to a US bank account, because: (i) it was not illegal for PDVSA (a non-US entity based outside the US) to initiate payment; and (ii) it was possible for the parties to vary the Credit Agreements and make payment in euros to a bank outside the US. Accordingly, the court doubted that PDVSA could rely on the “very narrow gateway” in Ralli Bros v Compania Naviera Sota y Aznar [1920] 2 KB 287 (providing that English law governed contracts are unenforceable where performance is prohibited in the place of performance).

3. Burden of proving that US Sanctions prevent contractual performance

Even if the US Sanctions prima facie rendered the performance of PDVSA’s payment obligations necessarily illegal at the place of performance, the court found that PDVSA had an obligation under the Credit Agreements to apply for a licence from the US Office of Foreign Assets Control (OFAC) in order to make the payments, which it had failed to discharge. As an important point of general application, the court stated that (absent any contractual provision to the contrary or a statutory reversal), the legal burden to obtain the necessary licence to effect the repayments was on PDVSA (as the debtor and the party bound to perform).

The decision is considered in more detail below.

Background

PDVSA is a Venezuelan state-owned oil and gas company, exclusively operating the Venezuelan oil and gas reserves, which are among the largest in the world. In 2016 and 2017, PDVSA borrowed sums under two Credit Agreements that it entered into with the Puerto Rican bank, Banco San Juan Internacional Inc (the Bank). On PDVSA’s case, this was part of a broad trend by which Venezuelan business interests were moved away from the mainland US financial system to Puerto Rico (an unincorporated territory of the US) as a result of political pressure from the US on Venezuela.

PDVSA defaulted on payments under both Credit Agreements, which contained English law and exclusive jurisdiction clauses in favour of the courts of England and Wales.

The claims

The Bank brought two claims in debt against PDVSA in this jurisdiction:

  1. 2016 Credit Agreement: A claim for US$48 million comprising overdue principal and accrued default interest and costs; and
  2. 2017 Credit Agreement: A claim for US$38 million comprising the loss of anticipated profits under the agreement, accrued default interest and costs. By way of brief explanation, following PDVSA’s payment defaults under this agreement, the loan was accelerated on 3 December 2018 and monies in certain trust accounts were used to discharge the overdue principal and interest then owed under the agreement. The liability under this agreement therefore rested on Clause 3.04(c) of the 2017 Credit Agreement to compensate the Bank for “the loss of anticipated profits equal to the Present Value of all fees and interest payable to [the Bank] through the Final Maturity Date of each Loan“.

The Bank applied for summary judgment on both claims. PDVSA argued that it had a real prospect of successfully defending the claims, primarily because of the effect of certain US Sanctions imposed on Venezuela which post-dated the execution of the Credit Agreements (in particular Executive Order 13850 and Executive Order 13884, detailed below). In the alternative, PDVSA argued that the sum claimed under the 2017 Credit Agreement was a disproportionate penalty, and that the sums claimed by way of costs and expenses under the terms of the Credit Agreements were not reasonable and within the scope of the indemnity.

Decision

The court granted summary judgment in favour of the Bank on both claims. We consider below the principal grounds of defence rejected by the court that are likely to have broader application.

Imposition of US Sanctions

PDVSA said that it wanted (and had the funds) to repay the Bank under the Credit Agreements, but that this was not possible because of the US Sanctions imposed on Venezuela.

PDVSA relied in particular on Executive Order 13850 (issued by President Trump on 1 November 2018, implementing blocking sanctions against persons operating in the gold sector of the Venezuelan economy, and creating an executive power for further sectors of the Venezuelan economy also to be blocked in due course) and Executive Order 13884 (issued by President Trump on 5 August 2019, a general blocking sanction freezing all property held by the Venezuelan government, including PDVSA).

As a consequence of the US Sanctions, PDVSA argued as follows (set out together with the court’s response):

1. The terms of the Credit Agreements, properly construed, suspended PDVSA’s payment obligations

The issue here was whether the sanctions clause in the Credit Agreements operated as a condition precedent to PDVSA’s liability (such that, if it was triggered, it would suspend PDVSA’s payment obligations – PDVSA’s case), or whether it was a negative covenant for the Bank’s benefit, but did not impact PDVSA’s liability to make payment (the Bank’s case). PDVSA relied on the decisions in Mamancochet Mining Limited v Aegis Managing Agency Limited [2018] EWHC 2643 (Comm) and Lamesa v Cynergy to argue that it is perfectly normal and sensible in commercial agreements to suspend payment obligations where payment would otherwise be in breach of unilateral US Sanctions.

The court found that these authorities were simply decisions on their (very different) facts.

The specific clause of the Credit Agreements relied on by PDVSA (Section 7.03), stated as follows:

“Sanctions. [PDVSA] will not repay Loans with the proceeds of

(a) business activities that are or which become subject to sanctions, restrictions or embargoes imposed by the Office of Foreign Asset Control of the U.S. Treasury Department, the United Nations Security Council and the U.S. Department of Commerce, the U.S. Department of State [sic] (collectively, ‘Sanctions’); or

(b) business activities in/with a country or territory that is the subject of Sanctions (including, without limitation, Cuba, Iran, North Korea, Sudan and Syria) (‘Sanctioned Country’)”.

This clause was contrasted with the relevant clause in Lamesa, which expressly provided for non-payment and was part of the payment obligation in the contract (unlike the present case, where there was no express mention of non-payment and the relevant clause was under the “Sanctions” heading). The court also noted that in Lamesa, the court of Appeal found good reasons for the existence of the non-payment provision.

Having found that the authorities did not suggest that it was a normal course for parties to contract to suspend payment obligations where there is a risk of US Sanctions, the court proceeded to consider the debate between the parties as to whether the clause was a condition precedent or a negative covenant. The court agreed with the Bank that the construction of the clause as a negative covenant was clear, in particular from the express wording of the clause and the structure of the agreement (under the “Sanctions” heading and separate from the payment obligations). The fact that the clause did not mention suspending the payment obligation was a notable contrast with another explicit suspension mechanism in the contract (in favour the Bank) and consistent with this construction.

The court therefore concluded that Section 7.03 provided no basis for a suspension of the repayment obligations by the terms of the Credit Agreements.

The court also went on to say that there were considerable doubts as to whether the relevant US Sanctions activated Section 7.03 at all (although it did not need to decide the point, given its primary finding). This will be interesting for those who wish to draft sanctions clauses which will be triggered by payment by a party who becomes an SDN. The doubt expressed by the court was on the basis that (a) the US sanctions against Venezuela were not country-wide; (b) the US sanctions were not such that PDVSA’s “business activities” were “subject to sanctions”, and (c) PDVSA had historical assets derived from its activities before the sanctions came into effect, held outside the US, and Section 7.03(a) would not apply to such assets.

2. By reason of the rule in Ralli Bros, English law governed contracts are unenforceable where performance is prohibited in the place of performance, which in this case was the US

PDVSA relied on the rule in Ralli Bros to assert that it could not perform the Credit Agreements in accordance with US law. Primarily, this was because PDVSA said it could not pay and the Bank could not receive funds into the “Stipulated Account”, which was located in the US. However, even if they could, PDVSA highlighted that the payments under the Credit Agreements were required to be made in USD, and a significant USD transaction would need to clear the US financial system (via a correspondent bank), from which PDVSA was excluded.

The court found that – even if the US Sanctions prima facie rendered the performance of PDVSA’s payment obligations necessarily illegal at the place of performance – PDVSA had no reasonable prospects of success on this ground of defence. This was because the prohibitions in the US Sanctions were qualified and PDVSA could have applied for a licence from OFAC in order to make the payment into the Stipulated Account. The court found that (absent any provision to the contrary in the Credit Agreements, or a statutory reversal), the legal burden to obtain the necessary licence to effect the repayments was on PDVSA (as the debtor and the party bound to perform). Further, in this case the court found that the Credit Agreements explicitly put the burden on PDVSA. However, PDVSA failed to show that it had discharged its obligation to apply for a licence, or that (had it applied) the application would have failed.

Although unnecessary given its finding on the licence issue, the court considered (obiter) whether making payments into the Stipulated Account would have been illegal, and therefore engaged the Ralli Bros doctrine. In this context, the court noted that the rule in Ralli Bros operates as a limited exception to the general rule that illegality under foreign law does not frustrate or otherwise relive a party from performance of an English law contract (see for example, Canary Wharf (BP4) T1 Ltd v European Medicines Agency [2019] EWHC 335 (Ch) and our litigation blog post). The court emphasised that the doctrine offers a narrow gateway: the performance of the contract must necessarily involve the performance of an act illegal at the place of performance and will not apply where the contract could be performed some other way which is legal, or if the illegal act has to be performed somewhere else.

In contrast to these requirements, the court said the issue of making payment to the Stipulated Account in the US was not one of illegality, but rather impracticability: it was not illegal for PDVSA (a non-US entity based outside the US) to initiate a payment, and it was not clear that it was illegal for the Bank to receive it (if the funds were then blocked). In any event, in the court’s view there was plainly a possibility of payment being made in euros to a bank outside the US, by variation of the Credit Agreements, to which the Bank would have been amenable. Accordingly, the court doubted that the “very narrow gateway” of Ralli Bros was engaged.

3. Article 9(3) of Rome I (Regulation No 593/2008/EC) confers a discretion on the court to apply mandatory overriding provisions of the law of the place of performance (here, US law) to a contract governed by another law (English law) and that this discretion should be exercised in this case

The court concluded that there was no real prospect of success on this argument, particularly in circumstances where the Ralli Bros defence covered similar ground to Article 9(3), but operated without any discretionary element.

Penalty argument

PDVSA argued that the sum claimed under the 2017 Credit Agreement was a disproportionate penalty, imposed for breach of the primary sums due under the 2017 Credit Agreement, and despite the fact that the primary sums have already been recovered in full.

The court had no difficulty at all in concluding that the clause was not a penalty and that PDVSA’s argument had no real prospect of success. As this was in essence a question of construction, the court found it was an appropriate issue on which to come to a final conclusion on a summary judgment application.

It was common ground that the leading authority on penalty clauses is Makdessi v Cavendish Square Holding BV [2015] UKSC 67 (see our litigation blog post), which provides that to find that a provision is an unenforceable penalty, it must be: (i) a secondary obligation; (ii) triggered on breach of contract; which (iii) imposes a disproportionate detriment on the contract breaker.

In this case, the court said that the three limbs of the Makdessi test were intertwined. Looking at the contract as providing an overall agreement for a particular return over the lifetime of the contract, the court commented that “…not only does the mathematics inexorably drive the conclusion that the sum involved is in no way disproportionate, but also suggests that the obligation is a primary one and not a sum due (even in substance) on breach.”

The court therefore found that the clause was not a penalty and granted summary judgment in favour of the Bank on both the 2016 and 2017 Credit Agreements.

Susannah Cogman
Susannah Cogman
Partner
+44 20 7466 2580
Ceri Morgan
Ceri Morgan
Professional Support Consultant
+44 20 7466 2948

High Court takes view in test case on breach of statutory duty under s.138D FSMA, in the context of repeat borrowings and an alleged breach of CONC

The High Court has recently considered a test case under s.138D of the Financial Services and Markets Act 2000 (FSMA), in the context of alleged breaches of statutory obligations under the Consumer Credit Sourcebook (CONC) for failing to take repeat borrowing into consideration when making lending decisions: Kerrigan v Elevate Credit International Limited (t/a Sunny) (in administration) [2020] EWHC 2169 (Comm). The court also considered a claim for an order under s.140B of the Consumer Credit Act 1974 (CCA) on the basis that the relationship between the lender and the borrower was unfair to the borrower.

The decision relates to claims against a payday lender, in which a group of sample claims (reflecting a wider group of claimants) were tried together. The court determined finally the allegations against the lender for breach of CONC, and although no final conclusions were reached in respect of individual claims under s.138D FSMA or s.140B CCA, the court provided some helpful guidance as to the merits of the arguments. The issues considered will be of interest to lenders and financial institutions more generally.

In summary, the High Court held that the lender’s failure to take repeat borrowing into consideration when making its lending decisions resulted in a breach of its obligations under CONC 5.2, in particular, the obligation that a creditworthiness assessment consider both the potential for the commitments under the credit agreement to adversely impact the customer’s financial situation and the ability of the customer to make repayments as they fall due.

On the key question as to whether breach of statutory duty under CONC was actionable under s.138D FSMA, the court emphasised that a borrower must show that damage was caused, both in fact and as a matter of law, by the lender’s breach of duty. The court reflected that it may be harder for a borrower to prove causation in circumstances where it may be said that – following a robust creditworthiness assessment – the borrower would likely have applied elsewhere to a third party lender able to extend the credit.

The court also provided guidance on the s.140B CCA claim, noting that the court will have regard to compliance with the CONC rules, which articulate the consumer protection objective. However, although important, a breach of the rules will not be the only factor considered when assessing fairness. In particular, where a borrower is dishonest in the information they provide as part of the loan application, to the extent it has a direct effect on the existence of the creditor-debtor relationship, this may undermine any claim by the borrower that the relationship was unfair.

For a more detailed discussion of the decision, please see our FSR blog post.

High Court finds proceedings properly served on process agent appointed by lender under credit agreement

In a recent decision, the High Court confirmed that proceedings had been properly served on a borrower where it had failed to comply with its contractual obligations to appoint a process agent and so the lender had appointed an agent on its behalf as permitted by the credit agreement: Banco San Juan Internacional Inc v Petroleos De Venezuela Sa [2020] EWHC 2145 (Comm).

This decision will be welcomed by lenders, demonstrating the willingness of the court to construe service clauses in accordance with their clear and intended purpose, which is to ensure proceedings can be brought efficiently and in a timely manner. 

Background

A dispute arose between the claimant bank and the defendant state-owned oil company under the terms of two credit agreements. Under those agreements the defendant was required to appoint a process agent for service of proceedings in England, which it failed to do. The credit agreements both contained provisions permitting the bank to make such appointment on behalf of the defendant if it failed to do so.

The defendant had failed to appoint a process agent at all under one credit agreement (the 2017 agreement), and under the other (the 2016 agreement) the agent’s appointment had expired and had not been renewed. The bank therefore relied on the contractual provisions to appoint a process agent for the defendant, and served two sets of proceedings on it.

The defendant subsequently challenged whether it had been properly served with the claims.

Decision

The High Court (Foxton J) held that the proceedings had been properly served on the defendant.

The court noted that the general efficacy of clauses permitting service on a process agent had been recognised by a long line of first instance authorities, but that each clause depended on its own particular language. The court described the structure of the relevant clauses in the two credit agreements as follows:

(i) PDVSA is obliged forthwith to appoint a process agent to be an authorised agent for service of proceedings in England.

(iii) If for any reason the process agent ceases to be such an agent, then PDVSA must forthwith appoint a new agent and notify that appointment within 30 days of the previous agent ceasing to be agent.

(iii) If PDVSA fails to comply with its obligation to appoint a new agent for the service of process, the lender may appoint an agent for service of process on PDVSA.

The court said that “authorised” agent must mean authorised under the terms of the credit agreement, and therefore rejected the defendant’s argument that the bank’s appointment could not be an appointment of the defendant’s “authorised” agent for service as required by (i) above. If the bank appointed an agent on behalf of the defendant following its own failure to do so, then by definition that agent was the “authorised” agent of the defendant. To construe the clause otherwise would render the bank’s right to appoint a replacement agent “entirely nugatory and purposeless”.

The defendant tried to argue that it was “unfair” for it to be encumbered with an agent not of its choosing. The court found there was no unfairness, saying:

“if the defendant did not want to be at risk of an agent being appointed who it does not like [or] on terms of appointment that it did not like, all it need do is comply with its contractual obligation to appoint an agent in the first place”.

In relation to the 2017 credit agreement, where the defendant had not appointed a process agent at all, the court noted that the language of (iii) above”might be said to pre-suppose that PDVSA had at one stage appointed a process agent and failed to replace it”, including because of the reference to a “new” agent. However, adopting an “appropriately purposive construction”, that was not how the clause should be construed.

If the defendant’s construction were adopted, it would allow the defendant to frustrate the operation of the clause in the first place by failing to appoint an original process agent. The court said it was:

“clear from the authorities that the courts construe these clauses, so far as possible, in the light of their acknowledged purpose of allowing a speedy and certain means of service, and they seek to avoid a construction which allows the party to be served to deprive the clause of its intended benefit”.

In the court’s view, the better construction was that the bank’s ability to appoint a “new” agent did not require the defendant to have previously appointed an agent. The court likened the situation to one where: “Someone who has never owned a coat may still be said to buy a new coat, notwithstanding the fact that it is not a replacement…”

Rupert Lewis
Rupert Lewis
Partner
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Antonia Brindle
Antonia Brindle
Associate

New Webcast Available: The new Corporate Insolvency and Governance Act 2020 – implications for financial institutions

The Corporate Insolvency and Governance Act 2020 came into effect on 26 June 2020. As mentioned in our previous blog post, it is expected that this Act will have a significant impact on secured and unsecured bank debt.

Our Restructuring, Turnaround and Insolvency team have produced a series of short, informative and user-friendly webcasts focusing on a number of the key aspects to help our clients better understand the implications of the Act and how it may affect their businesses.

The latest webcast looks at the likely implications of the Act for financial institutions and in particular, commercial banks. Natasha Johnson, a partner in our RTI team, considers the new debtor-in-possession insolvency procedure and the new restructuring plan, which includes a cross-class cram down ability and what super-priority to certain pre-moratorium unsecured debts will mean for financial institutions.

For more information on the new Act, please see our Latest Thinking and Corporate Insolvency and Governance Act 2020 – soundbite series.

Natasha Johnson
Natasha Johnson
Partner
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FSB Report: Supervisory issues associated with benchmark transition: major LIBOR transition risks

The Financial Stability Board (FSB) has published its long-awaited report to the G20 on supervisory issues related to LIBOR transition. It follows a survey of the state of preparedness of regulators around the globe and presents its recommendations. The purpose of this engagement is to facilitate greater coordination on a global level, to mitigate the impact on financial stability generally and both financial institutions and non-financial institutions specifically: FSB Report: Supervisory issues associated with benchmark transition.

Results of survey on preparedness of global regulators

The results of the questionnaire on supervisory issues strikingly, but unsurprisingly, reveal a wide range across different jurisdictions’ levels of preparedness for LIBOR transition in advance of the expected transition date of end-2021. While some differences in approach and timeline between jurisdictions are to be expected, the report is critical of the differing timelines and supervisory expectations for transition across jurisdictions:

“Jurisdiction by jurisdiction differences in approach and timeline are unavoidable. However, to avoid the greater risk of being unprepared by the end of 2021, there should be no excuses for a ‘race to the bottom’ to move at the pace of the slowest.”

For example, very few jurisdictions have dedicated roll-off timelines or targets to industry, and, where timelines are in place, monitoring is complicated by the varying timelines for different products. The report recommends that authorities in each impacted jurisdiction establish a formal LIBOR transition strategy, which may include interacting with national working groups with a view to set out milestones and a transition roadmap with clearly specified actions that market participants should take. The report also suggests increased international cooperation as a means of mitigating the inconsistency in transition timing and approaches by sharing information on best practices and challenges.

In light of the survey’s conclusion that a considerable portion of financial institutions across jurisdictions are yet to start or are still in the planning stages of their transition, the FSB has highlighted a need to step up the coordination and monitoring effort at an international level. It has accordingly identified a number of areas for strengthened supervisory actions in order to facilitate efforts by individual institutions to progress their transition programmes.

Major LIBOR transition risks identified by the FSB

The FSB has also provided a useful summary of some of the major LIBOR transition risks for financial institutions, which will be very familiar to those who have been following the developments on this topic over the last few years, and which we explained in more detail in our previous article on the risks (LIBOR is being overtaken: Will it be a car crash? (2019) 34 J.I.B.L.R.):

  • Operational/systems risks – Systems and processes must be updated for all products currently referencing LIBOR so that they can instead rely on alternative reference rates and calculate and manage any fallback adjustments in order to prevent any operational disruptions.
  • Legal risks – Contract frustration and counterparty litigation are key areas of concern if institutions do not adequately identify and address affected legacy contracts, especially with regard to cash market products and long-dated contracts. The risks could be compounded by the volume and complexity of potential contract amendments and potential consent required for covenant modifications.
  • Prudential risks – Institutions may find difficulties in managing market risks and calculating embedded gains or losses for margin requirements, and experience a range of capital impact issues in case pricing and valuation inaccuracies arise. Where interest rate models need to be developed and approved, institutions may face capacity constraints or a lack of historical data.
  • Conduct, litigation and reputational risks – The report notes risks around conduct risk identification and management, especially with regard to the fair treatment of clients, potential conflicts of interests, mis-selling and misconduct, which could lead to potential class-action litigation.
  • Hedging risks – Different parts of hedged positions may transition at different times or to different fallback rates, leaving institutions exposed to new basis risks. Market participants may also face increased hedging costs if liquidity remains low in the alternative RFRs.
  • Accounting risks – If work to reform national and international accounting standards is not adequate or completed on time, there may be unintended impacts on accounting (e.g. with respect to hedging or profitability) or taxation.
  • Others – Financial institutions face difficulties in communicating transition-related issues with clients (finding the right informational level, etc.) and in pricing instruments (particularly in the early stages of transition when liquidity in new instruments is low). Further, financial institutions and non-financial institutions face potential resource constraints.

UK CONTACTS:

Rupert Lewis
Rupert Lewis
Partner
+44 20 7466 2517
Nick May
Nick May
Partner
+44 20 7466 2617
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Ceri Morgan
Professional Support Consultant
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APAC CONTACTS:

Harry Edwards
Harry Edwards
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+61 3 9288 1821
Hannah Cassidy
Hannah Cassidy
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+852 21014133
Will Hallatt
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Natalie Curtis
Natalie Curtis
Partner
+65 68689805

Court of Appeal confirms borrower’s right to withhold payment under English law Tier 2 Capital facility agreement where risk of US secondary sanctions

In a recent decision, the Court of Appeal has confirmed that the terms of an English law facility agreement in respect of Tier 2 Capital, allowed the borrower to withhold payment of interest instalments where there was a risk of secondary sanctions being imposed on the borrower under US law. In the view of the Court of Appeal, this result effectively balanced the competing interests of the lender to be paid timeously against the borrower’s ability to delay making a payment where it would be illegal (in a broad sense of the word, and under a different system of law to the facility agreement) and therefore affect the borrower’s ability to conduct its ordinary business: Lamesa Investments Limited v Cynergy Bank Limited [2020] EWCA Civ 821.

English law does not generally excuse contractual performance by reference to a foreign law unless it is the law of the contract or the place of performance (and these exceptions did not apply here). However, parties can contract out of this general rule, which is what happened in this case. Clause 9.1 of the facility agreement permitted the borrower to withhold payment of interest instalments “in order to comply with any mandatory provision of law, regulation or order of any court of competent jurisdiction”.

At first instance, the High Court, applying the usual principles of contractual interpretation, found that the clause covered the relevant US legislation even though it only gave rise to the possibility of secondary sanctions being imposed on the borrower, rather than expressly prohibiting the borrower from transacting with the lender (read our previous banking litigation blog post).

The Court of Appeal agreed with the High Court’s outcome but adopted different reasoning. In particular, the Court of Appeal emphasised that the relevant clause was a standard term and the factual background therefore had a much more limited role to play in the interpretation than that ascribed by the High Court. Whereas the High Court focused on the specific intentions of the parties to the facility agreement in question, the Court of Appeal focused on the more general context of agreements for the provision of Tier 2 Capital within the EU.

While the High Court decision could be seen as limited to the specific facts of the case, the Court of Appeal’s conclusion that “the balance between the interests of the parties to this type of facility agreement in respect of Tier 2 Capital favours the application of the proviso to clause 9.1 to the standard form of US secondary sanctions legislation” potentially has broader implications for the interpretation of similar clauses in similar agreements. The decision emphasises the need for parties to consider the potential impact of extraterritorial sanctions regimes on the performance of their obligations, to include a clear contractual allocation of risk in this regard and to pay close attention to any standard form clauses which might affect the allocation of this risk.

Many sanctions practitioners were surprised with the first instance decision in this case – and in particular the proposition that secondary sanctions (which may be imposed on a discretionary basis under a legal system which is not applicable to the parties or the contract) amount to a “mandatory provision of law” with which “compliance” is required. Whilst the case turned on the construction of a particular contract, it raised new uncertainty as to the ability of parties to avoid contractual performance in light of secondary sanctions risk, in the absence of clear wording to that effect. In this context, the Court of Appeal judgment is broadly helpful by focusing on the particular backdrop of EU Tier 2 capital requirements – although, as noted above, the emphasis on the fact that this was a standard clause means the case has read-across value in respect of similar agreements.

Background

The claimant, Lamesa Investments Limited, is a Cypriot company whose ultimate beneficial owner is Mr Viktor Vekselberg. On 19 December 2017, the claimant entered into a facility agreement with the defendant, Cynergy Bank Limited, an English company.

Under the facility agreement, the claimant lent £30 million to the defendant as Tier 2 Capital for a term of 10 years, with interest payable on 21 June and 21 December of each year throughout the term of the loan. Clause 9.1 of the facility agreement provided that the borrower would not be in default if sums due were not paid “in order to comply with any mandatory provision of law, regulation or order of any court of competent jurisdiction”. The facility agreement was governed by English law.

On 6 April 2018, the US placed Mr Vekselberg on the list of “Specially Designated Nationals” (SDNs), pursuant to Executive Order 13662 (made under the International Emergency Economic Powers Act). As a result, the lender became a “Blocked Person” by reason of its indirect ownership by Mr Vekselberg.

The US sanctions on Russia (in common with a small number of other US sanctions regimes, including for example the regime applicable to Iran), contain so-called “secondary sanctions” provisions. By contrast to traditional “primary sanctions”, which apply to US persons and to conduct within the territorial jurisdiction of the US, secondary sanctions seek to target non-US persons who engage in certain specified activities that have no US jurisdictional nexus. A non-US party that engages in the specified activities can itself be subjected to retaliatory measures by the US government. For example, pursuant to US/Russian sanctions, knowingly facilitating a “significant” transaction with a SDN is secondarily sanctionable.

This meant that if the borrower knowingly facilitated a significant financial transaction on behalf of the lender, then the borrower could be subjected to secondary sanctions. Under a particular provision of US legislation, namely Section 5 of the Ukraine Freedom Support Act 2014, the borrower could be blocked from opening or maintaining a correspondent account in the US or have strict conditions imposed on the maintaining of such an account.

A significant part of the borrower’s business was denominated in US dollars, and US dollars deposited by its retail customers were deposited in a correspondent account maintained by the borrower with JP Morgan in the US. As a result of the significant risk to its business, the borrower relied on clause 9.1 of the facility agreement to withhold payment of £3.6 million of interest instalments that had fallen due (although it had ring-fenced the funds).

The lender sought a declaration that the borrower was obliged to continue making the payments under the facility agreement notwithstanding the risk that it would be subjected to secondary sanctions.

High Court decision

The High Court held that the borrower was entitled to rely on clause 9.1 of the facility agreement for as long as Mr Vekselberg remained a SDN and the lender remained a Blocked Person by reason of it being owned by Mr Vekselberg.

The High Court reiterated the general position that, unless the contract provides otherwise, English law will not excuse contractual performance by reference to foreign law, unless that law is the law of the contract or the law of the place of performance. The facility agreement was not governed by US law and the US was not the place of performance. The sole issue was therefore whether, on its true construction, clause 9.1 of the facility agreement excused performance by reference to the relevant provisions of US law. The High Court found that it did.

The High Court’s reasoning is summarised in our previous blog post here.

Court of Appeal decision

The lender appealed against the High Court’s decision on the basis that:

  1. The relevant US legislation contained no express legal prohibition on payment and the borrower could not say that it refused to pay “in order to comply with [a] mandatory provision of law”, when the relevant legislation did not even purport to bind the borrower to act or not act in a particular way.
  2. The High Court was wrong to construe clause 9.1 as if it were a one-off negotiated provision when it was in fact a standard form clause.

The Court of Appeal dismissed the appeal. Sir Geoffrey Vos (with whom Males LJ and Arnold LJ agreed) held that the High Court had made the correct order, but the Court of Appeal did not agree entirely with the reasons given at first instance.

The Court of Appeal set out the usual principles of contractual interpretation and noted a number of additional relevant factors that the High Court may have overlooked.

  • Clause 9.1 of the facility agreement was a standard term in common usage at the time. The Court of Appeal referred to previous authority emphasising that standard form agreements should, as far as possible, be interpreted in a way that achieves clarity, certainty and predictability so that the large number of parties who use the standard forms know where they stand. A standard form is not context specific and evidence of the particular factual background or matrix has a much more limited, if any, part to play in the interpretation. The focus is ultimately on the words used, which should be taken to have been selected after considerable thought and with the benefit of the input and continuing review of users of the standard forms and knowledge of the market (Re Lehman Brothers (No 8) [2016] EWHC 2417 (Ch)).
  • The Court of Appeal said that consideration of the context of the facility agreement that led to the inclusion of the standard term, had to be against the background of two more general considerations: (i) that it would take clear words to abrogate a repayment obligation in a loan agreement; and (ii) that, in construing a commercial contract, the court must always take into account the commercial interests of both parties. The Court of Appeal noted that there were indications in the High Court’s decision that it was more focused on the commercial interests of the borrower than those of the lender.
  • The process of interpretation is a unitary exercise. The court starts with the words and relevant context and moves to an iterative process, checking each suggested interpretation against the provisions of the contract and its commercial consequences. The court must consider the contract as a whole and give more or less weight to elements of the wider context in reaching its view as to its objective meaning.

The Court of Appeal went on to consider the relevant context to the facility agreement.

  • This was a standard provision in a loan agreement used for the provision of Tier 2 Capital to an international bank. The capital was required under the Capital Regulations including CRD IV (Directive 2013/36/EU). The non-payment provisions in this type of loan are different to ordinary loan agreements. The loan is subordinated and can only be enforced by winding up the borrower and repayment events are controlled.
  • The High Court seemed to have lost sight of the fact that clause 9.1 was drafted to deal with possible future events that went far beyond sanctions in general and US sanctions in particular. The High Court seemed to have treated clause 9.1 as if it had been inserted to deal only with prospective possible US sanctions affecting the lender.
  • It was important that clause 9.1 did not extinguish the borrower’s repayment obligation entirely. It merely abrogated any default so that the lender could not enforce payment by presenting a winding-up petition. The argument was therefore about the timing of the payments rather than about whether those payments would ever be made.
  • The Court of Appeal concluded that the context to clause 9.1 was a balance between the desire of the lender to be paid timeously and the desire of the borrower not to infringe mandatory provisions of law, regulation or court orders.

The Court of Appeal then considered the competing meanings of the clause. In particular, whether the wording of clause 9.1 meant that the reason for non-payment must be:

  1. To comply with a statute that binds the borrower and directly requires the borrower not to pay the sums in question (the lender’s argument); or
  2. To comply with an actual or implied prohibition on making such payments in legislation (or regulation or order) that affects the borrower (the borrower’s argument).

The Court of Appeal followed the unitary process to determine the correct interpretation, accepting that the wording of the clause was ambiguous and it was therefore relevant to consider the admissible context and commercial common sense.

There were three aspects of admissible context that the Court of Appeal considered were of great importance:

  • The terms of the EU Blocking Regulation that must have been known to the parties and the drafters of the standard clause. The EU Blocking Regulation does not apply to the US/Russia sanctions, but in the context of other US secondary sanctions measures (notably in relation to Iran and Cuba) it regards specified US secondary sanctions legislation as imposing, in the court’s view, a “requirement or prohibition” with which EU parties are required to “comply”. The EU Blocking Regulation therefore uses similar language to clause 9.1.
  • The fact that clause 9.1 was a standard clause.
  • US secondary sanctions would have been at the relevant time one (but not the only) potential problem affecting parties to agreements for the provision of Tier 2 Capital within the EU. The drafter of the clause must have intended the borrower to be capable of obtaining relief from default if its reason for non-payment was to “comply” with a foreign statute that would otherwise be triggered.

Taking this context into consideration, the Court of Appeal reflected on the rival meanings of clause 9.1 as follows:

  • The lender’s main argument was that, once one accepted that the clause was ambiguous, the wording could not be clear enough to excuse something so crucial to the agreement as non-payment. That, however, assumed that payment would be abrogated rather than delayed. Adopting the unitary approach, it also needed to be considered that the utility of clause 9.1 would be badly dented if the lender’s interpretation was correct.
  • If a “mandatory provision of law” only referred to one that directly bound the borrower not to pay, it would have almost no possibility of taking effect.
  • While the US legislation cannot, and does not purport to, prohibit a payment by the borrower to the lender, its effect is clearly one of prohibition.
  • As noted above, a compelling argument in favour of the borrower’s interpretation was the drafting of the EU Blocking Regulation. Interestingly, the court dismissed an argument that the wider drafting of the Blocking Regulation was a distinguishing feature (the Regulation refers to persons “[complying]…with any requirement or prohibition, based on or resulting, directly or indirectly, from the laws specified in the Annex…”, rather than persons complying with the laws themselves).
  • It was not certain that payment under the facility agreement would attract the imposition of a sanction on the borrower, but it was clear that (as a matter of US law) the imposition of a sanction would be mandatory, subject to the payment not being deemed “significant” or the President otherwise deciding that it was not in US interests to impose the sanction. There seems to have been little weight ascribed to the practical experience of secondary sanctions enforcement, with the court observing that “what matters here is [the borrower’s] reason for the non-payment, not whether [the borrower] is certain or only likely to be sanctioned if it makes the payment”.
  • The Court of Appeal noted that the competing interests of the parties to a Tier 2 Capital facility agreement including clause 9.1 are the lender’s interest in being paid timeously and the borrower’s interest in being able delay payment if, put broadly, payment would be illegal, not only under English law but under any system of law which would affect the borrower’s ability to conduct its ordinary business. Overall, the balance between the interests of the parties to this type of facility agreement favours the application of clause 9.1 to US secondary sanctions legislation.

The Court of Appeal therefore dismissed the appeal.

Conclusion

It is clear from this decision that parties should consider the potential impact of extraterritorial sanctions regimes on the performance of their obligations, to include a clear contractual allocation of risk in this regard and to pay close attention to any standard form clauses which might affect the allocation of this risk.

The case also raises an interesting Blocking Regulation point. Particularly following the revisions to the Blocking Regulation arising from the US withdrawal from the Joint Comprehensive Plan of Action (JCPOA), EU businesses wishing to contract on terms that require performance not to be conducted in a way which is secondarily sanctionable, have been struggling with how to ensure that such contractual language is “Blocking Regulation compliant”. There is a concern that contracting on such terms (by either party) may amount to compliance with a requirement or prohibition which is based on the Blocked Laws. Here, the relevant sanctions regime was the US/Russia regime, and accordingly the Blocking Regulation was inapplicable. However, the court appears to have considered that a contractual provision that required compliance with US secondary sanctions as well as potentially other foreign law – which must logically include the Blocked Laws under the Blocking Regulation, as well as the US/Russia sanctions – did not itself constitute an infringement of the Blocking Regulation. The enforceability of the clause would no doubt have been impacted if it had been relied upon in the context of the Iran or Cuba secondary sanctions, but it does not appear to have been argued that the clause itself was unlawful because of its implicit coverage of, inter alia, the Blocked Laws. It does not appear that this point was argued, and accordingly one would need to be cautious about placing undue weight upon it, but it adds to the incrementally growing body of judicial observations that will be relevant to the interpretation of the Blocking Regulation, if and when it is finally considered directly in a dispute or enforcement action.

Susannah Cogman
Susannah Cogman
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Chris Bushell
Chris Bushell
Partner
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Ceri Morgan
Professional Support Consultant
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Gary Horlock
Senior Associate
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