High Court refuses interim payment application in Russian sanctions-related litigation

November 28, 2023

In the context of a claim by a Russian company against two banks for failing to pay sums due under on-demand bonds, the High Court has dismissed the claimant’s application for an interim payment under CPR 25.1 for the entire value of its claim into court or a blocked account: LLC Eurochem North-West-2 v Societe Generale SA & Ors [2023] EWHC 2720 (Comm).

This decision will be of interest to financial institutions as it is yet another illustration of the rise in sanctions-related litigation in the banking and financial sector. Please see our previous blog posts on sanctions cases here.

In the present case, the court was satisfied that the company had not established any jurisdictional bases on which the court could make an order for the interim payment. In particular, the court was not persuaded that, if the claim went to trial the claimant “would obtain judgment”, which was the condition relied upon by the claimant in support of its application under CPR 25.1(1)(k).

The court helpfully distinguished the recent decision in Mints v PJSC National Bank [2023] EWCA Civ 1132 (see our blog post), in which the Court of Appeal confirmed that judgments can be entered in favour of Russian sanctioned parties. The court commented that there is a “significant difference” between the position in the present case, where the banks’ defences rely on the very fact of sanctions, and the situation in Mints, where the existence of sanctions themselves do not form part of the substantive defence.

Importantly, in the exercise of its discretion, the court emphasised that it was proper to take into account the risk that the banks could be in breach of EU sanctions, and therefore exposed to criminal penalties, if they were required to make such a payment.

We consider the decision in more detail below.

Background

In 2020, the claimant Russian project company entered into a number of contracts with third-party contractors to design and construct a fertiliser plant in Russia. These contracts required the contractors to provide the claimant with on-demand bonds to protect the claimants against non-performance by the contractors, which were issued by the defendant banks and governed by English law.

In August 2022, following termination of the underlying contracts by the contractors, the claimant made demands under the bonds for payment by the banks of more than €212 million. However, the banks declined to make payment on the basis that to do so would breach international sanctions, because the claimant is part of a major international group which is closely associated with one of Russia’s wealthiest men, now subject to both EU and UK sanctions. Following that refusal, the claimant brought proceedings against the defendant banks in the English courts.

A few months after initiating the proceedings, the claimant filed an application for an interim payment of the entire value of its claim into court or a blocked account, pending determination of the claim at trial, under CPR 25.1(1)(c) (detention, custody or preservation of relevant property), 25.1(1)(k) (interim payment) and/or 25.1(1)(l) (payment or securing of a specified fund), or alternatively using the court’s inherent jurisdiction.

The banks opposed this application, on the basis that: (1) there was no proper jurisdictional basis for making the order sought; and (2) in any event, the court should refuse to make any such order in the exercise of its discretion, in particular because an interim payment would itself constitute a breach of international sanctions and expose the banks to criminal sanctions.

Decision

The High Court found in favour of the banks and dismissed the Russian company’s application. The key points which will be of interest to financial institutions are examined below.

Interim payment under 25.1(1)(k)

The court started by addressing the primary basis on which the application was brought, for an interim payment under CPR 25.1(1)(k) on account of any damages or debt or other sum (except costs) which the court may hold the defendant liable to pay. This rule expressly provides that one of the conditions specified in the rule must be satisfied in order for the court to make such an order. The condition relied on by the claimants required the court to be satisfied that if the claim went to trial, the claimant would obtain judgment in its favour.

The court noted that in defence of the claim, the banks rely on the principle in Ralli Brothers v Compania Naviera Sota y Aznar [1920] 2 KB 28 to the effect that a contract is invalid where its performance is unlawful in the place of performance. The banks’ case is that they have been excused from performing/making payment under the bonds, and/or are obliged/entitled to withhold performance, and/or that the bonds have been discharged/terminated/frustrated, because payment is illegal under EU, French and Italian law.

In the court’s view, the application was not a suitable occasion for an argument on the merits of the banks’ defences, emphasising that there had been no application by the claimant for strike out or summary judgment.

The court considered and distinguished the recent Court of Appeal decision in Mints. It emphasised that the banks’ defences rely on the very fact of sanctions, whereas in Mints, the Court of Appeal held that the entry of judgment in favour of a sanctioned person would not, in itself, constitute a breach of the UK sanctions against Russia. In Mints it was not argued that sanctions extinguished the defendants’ liability and therefore the existence of sanctions themselves did not form part of the substantive defence. This was a significantly different position from the present case.

In light of these findings, the court concluded that it could not be satisfied, on the face of the application, that the claimant would obtain judgment in its favour if the claim went to trial, as required by the relevant condition of CPR 25.1(1)(k).

Alternative bases for the claimant’s application

The court then turned to the alternative bases relied on by the claimant.

First, the claimant contended that the sums claimed from the banks were a “relevant property” for the purposes of CPR 25.1(1)(c)(i) and it could therefore seek an order for detention, custody or preservation of that relevant property. However, the court said that sums claimed by way of debt or damages that are not identifiable or distinctive (ie not segregated) could not be considered as a “relevant property”, which envisages an asset that is in some way identifiable.

Second, the claimant asserted that its claim related to a “specified fund” to be secured per CPR 25.1(1)(l). Again, the court found that there was no identifiable or ring-fenced fund in the hands of the banks, and that there was thus no specified fund to be secured.

Finally, the court said that it was not appropriate or necessary to order an interim payment, in particular because the order would have minimal utility to the claimant, and there was no “unjust enrichment” of the banks as they were not accruing any interest on a fund in their hands.

Most importantly, the court acknowledged that in the exercise of its discretion it was also proper to take into account the risk that the banks would be in breach of EU sanctions, and therefore exposed to criminal penalties, by making a payment into court or a blocked account, if ordered to do so.

Accordingly, the court found in favour of the banks and dismissed the claimant’s application.

Herbert Smith Freehills LLP acts for Société Générale SA in the proceedings brought against it by LLC Eurochem North-West-2.

Rupert Lewis

Partner

+44 20 7466 2517

Ceri Morgan

Professional Support Consultant

+44 20 7466 2948

Nihar Lovell

Professional Support Lawyer

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Romain Dupuis

Associate

+44 20 7466 2439

Court of Appeal confirms judgments can be entered in favour of Russian sanctioned parties but leaves uncertainty in relation to the “ownership and control” test

October 13, 2023

The Court of Appeal has confirmed that UK sanctions do not preclude the entry of judgments in favour of Russian sanctioned parties: Mints v PJSC National Bank Trust [2023] EWCA Civ 1132.

The court also held that the Office of Financial Sanctions Implementation (0FSI) is entitled to license a sanctioned party to pay an adverse costs order, security for costs or damages on a cross-undertaking in damages. It can also licence payment of a costs order in favour of a sanctioned party.

Significantly, although obiter (in light of the findings summarised above), the court also considered the “ownership and control” test under the UK sanctions regime, which sets out the circumstances in which companies which are not themselves designated persons must be treated as subject to asset freeze restrictions on the basis of their ownership or control by such persons. The court concluded that, contrary to the High Court’s finding, there was no carve-out to the ownership and control test for control exercised through political office and, accordingly, it could be said that Mr Vladimir Putin (Russian President and a designated person) may be deemed to control “everything in Russia” for the purposes of the regulations.

Although obiter, the court’s comments on this issue will plainly give rise to additional uncertainty for UK businesses dealing with Russian counterparties, particularly state-owned entities and government bodies (as well as businesses in other jurisdictions where UK sanctions have been imposed on political organisations and leaders).

It is unlikely that the UK government can have intended for all Russian companies to become subject to restrictions by virtue of Mr Putin’s designation, in circumstances where only 160 businesses were listed as designated at the time of the first instance decision, and a Foreign Office press release issued at the time of the designation of the governor of the Central Bank of Russia, Ms Elvira Nabiullina, stated that the government did not consider that she controls the Central Bank of Russia for the purposes of the sanctions regime. In addition, although the court heard submissions on the interpretation of the relevant regulation, it was not asked to determine whether Mr Putin does in fact control every company in Russia and the court cannot be taken to have made a factual finding in these terms.

Nonetheless, it would likely provide clarity if the government would review the wording of the regulations in order to make its intentions clear. In the meantime, clarification from OFSI as to the basis on which it will (or will not) take enforcement action based on this theory of control is likely to be welcomed by the market.

For a more detailed analysis of this decision, please see our Litigation Notes blog post.

High Court grants order for payment into court enabling company to redeem loan notes held by sanctioned entity

May 23, 2023

The High Court has granted an order for moneys to be paid into court in circumstances where a company wished to redeem loan notes before their maturity date due to a proposed refinancing, but had been prevented from paying the sums to the holder of those notes in light of UK, EU and US sanctions: Fortenova Grupa D.D. v LLC Shushary Holding & Ors [2023] EWHC 1165 (Ch).

The claim concerned loan notes issued by an EU company and held by the subsidiary of a well-known Russian bank, which is subject to sanctions as a result of the war in Ukraine, including in the UK, EU and US.

Due to a proposed refinancing, the company wished to redeem the notes held by the Russian subsidiary before their maturity date in September 2023. However, the company could not pay the sums to the Russian subsidiary to redeem the notes because of the sanctions in place. The company obtained relevant licences from the relevant authorities to make a payment into court, and then applied to court to make such a payment. The court granted the company’s application for: (i) an order that moneys be paid into court enabling the company to redeem the loan notes and for the company to take the necessary steps to release the security in the Russian subsidiary’s favour, with the intention that the Russian subsidiary could apply for the moneys if and when sanctions are lifted; and (ii) a declaration that the company is not liable for default interest on the notes.

The judgment will be of interest to financial institutions following case law developments involving sanctioned entities. The court appears to have taken a sensible and pragmatic approach to dealing with the difficulties caused by sanctions and has provided guidance on the approach to take where an obligor wishes to exercise its right to redeem.

We discuss the decision in further detail below.

Background

This was an expedited Part 8 trial of a claim concerning loan notes with a face value of approximately €400m issued by Fortenova Grupa d.d. (the Company), which is part of the Fortenova Group, a major food producer in Central and Southeastern Europe. The notes are held by the first defendant, LLC Shushary Holding (Shushary), a subsidiary of the Russian bank VTB Bank PJSC (VTB).

Pursuant to a 2019 Subscription Agreement, governed by English law and subject to the exclusive jurisdiction of the English court, the Company had issued a total of €1.157 billion worth of senior secured floating rate notes. Shushary held approximately 37.9% of the notes. The fifth and sixth defendants, as holders of the remainder of the notes, were joined to the proceedings so that they could be bound by the court’s decision. In accordance with the terms of the Subscription Agreement, the loan notes were secured against various assets of the Company and other companies in the Fortenova Group.

During 2021, the Company began exploring options for refinancing the notes. Due to the proposed refinancing, the Company wished to redeem the notes held by Shushary before their maturity date in September 2023 (as permitted under the Subscription Agreement). In line with a Payment Direction Letter, which post-dated the Subscription Agreement, the Company was to pay any sums due in respect of the Shushary notes to certain bank accounts with VTB and VTB Bank Europe SE, in the names of Shushary and VTB (the VTB accounts).

However, in February 2022, as a result of Russia’s invasion of Ukraine, the UK, the US and the EU imposed sanctions in respect of Russian individuals and entities, including VTB. As a result, it became unlawful for the Company to make payments to Shushary or VTB and so the Company could not redeem the Shushary notes, despite being contractually entitled to do so. This made it impossible for the Company to proceed with the proposed refinancing and was causing it serious prejudice.

Accordingly, the Company applied for an order that moneys be paid into court to enable the Shushary notes to be redeemed, and for the security in Shushary’s favour to be released so that the refinancing could proceed. It would then be for Shushary to apply for the moneys to be released from there, when and if sanctions are lifted. The Company also sought a declaration that it was not liable for default interest on the notes, because it has been unable to pay interest to Shushary in accordance with the Subscription Agreement while the sanctions are in place.

Decision

Payment into court

In granting an order for the payment of moneys into the Court Funds Office bank account, the court recognised that the Company must comply with the sanctions legislation in the UK, the US and the EU, and therefore the Company needed the relevant licences from the relevant authorities in order to pay the Shushary moneys into court. Importantly, the court remarked that “the court order itself is not sufficient protection” for the Company and its advisers. The court noted that the Company had sought and obtained various licences and mentioned, in respect of UK sanctions, that the Office of Financial Sanctions Implementation (OFSI) had recently, on 28 March 2023, issued a new general licence which “UK persons involved in the transactions should be able to rely upon to pay the Shushary moneys into court and which may render a specific licence issued further to the OFSI pre-licence unnecessary”.

In considering the nature of the equity of redemption, the court referred to the authorities which emphasised that the policy of the courts of equity was always to ensure that there is nothing to prevent redemption, or rather that there are “no clogs” on the equity of redemption. The court noted that there was no dispute as to the clearly established principles in this area and held that:

“The court will fashion a remedy to ensure that a debtor is able to rid their property of encumbrances and that will include directing that security be released upon payment into court of the sums required to redeem.”

As it was not lawful for the Company to make payment to the VTB accounts in accordance with the Subscription Agreement and the Payment Direction Letter in light of the various sanctions, resulting in the Company being prevented from exercising its right to redeem the Shushary notes and obtain a release of the security, the court held that an order permitting the Company to pay moneys into court, in the event of the Company exercising its right of redemption, was a “perfectly proper and sensible route” in the circumstances. Moreover, without the relief, the court noted the Company and the Fortenova Group more widely faced a real risk to their financial stability.

The court held that the possibility of Shushary being unable to receive funds for a potentially lengthy period of time was no reason to refuse redemption. Indeed, the court held that this was precisely why the court should make the order, as otherwise the Company would be left in a state of paralysis.

It was submitted that Shushary would have preferred payment to be made to a blocked account in its name within the EU, or in rubles to a Russian account. Payment to Russia would clearly be unlawful and unacceptable. Therefore, the court held that, as no suitable account in the EU was identified, there appeared to be “no alternative” but for the moneys to be paid into court.

Accordingly, the court ordered that moneys be paid into court to enable the Shushary notes to be redeemed and for the security in Shushary’s favour to be released so that the refinancing could proceed. It would then be for Shushary to apply to court for the moneys to be released to it, or to such other person as it nominated, with the application showing that such payment would be lawful and not in contravention of any applicable sanctions regime.

The court commented that the application for the payment of moneys into court was a “relatively straightforward way” of dealing with the “unfortunate situation”, and notably the application was “not strenuously opposed” by Shushary. The court also considered that the Company bringing the claim on its own behalf and pursuant to CPR 19.8(1) on behalf of the companies within the Fortenova Group that had granted security for the notes was a “sensible way to have proceeded”.

Default interest

The court also held that, in the circumstances, the Company was not liable to pay default interest under the Subscription Agreement. The relevant default interest clause stated:

“If an obligor fails to pay any amount payable by it under a finance document on its due date, interest shall accrue on the overdue amount from the due date up to the date of actual payment.”

It was argued that the clause presupposes that it is lawful for the obligor to pay the debt. However, the Company cannot be said to have failed to pay sums due to Shushary, in circumstances where the Company was willing to pay those sums, but was not permitted to do so as a result of international sanctions which prohibited the Company from paying Shushary. Having been referred to a series of cases decided during wartime (notably NV Ledeboter and Van der Held’s Textielhandel v Hibbert [1947] KB 964), where it was held that the debtor cannot be in default if performance of the obligation would be unlawful, the court held that the situation with the present case was analogous and so the correct construction in the circumstances was that the Company was not liable to pay default interest.

In reaching its conclusion, the court agreed with a previous judgment in this case handed down on 5 April 2023 (Fortenova v Shushary [2023] EWHC 970 (Ch)), where the court had expressed a preliminary view that it would be a “harsh construction” if the Company was fixed with default interest, when it was at all times willing and able to pay but was prevented from doing so by sanctions.

Although the court held that it was not necessary to consider the Company’s argument on the default interest being an unenforceable penalty in the circumstances, the court considered that the argument was “quite compelling” and added to the construction argument.

Rupert Lewis

Partner

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Ceri Morgan

Professional Support Consultant

+44 20 7466 2948

Sarah McCadden

Professional Support Lawyer

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High Court considers impact of Russian sanctions regimes in UK, EU and US on payment obligations under standby letter of credit

May 10, 2023

In the recent decision of Celestial Aviation Services Ltd v UniCredit Bank AG (London Branch) [2023] EWHC 663 (Comm), the High Court has considered two Part 8 claims heard together which concerned the impact of UK, EU and US sanctions on payment obligations under several standby letters of credit (LoC).

In a first instance decision that will be of significant interest to parties to transactions which are impacted by sanctions issues, the court considered a factual scenario involving a refusal to make payment by UniCredit Bank AG (London Branch) (UniCredit), the confirming bank under several LoC issued by the Russian bank Sberbank Povolzhsky Head Office (Sberbank), in relation to leases of aircraft to Russian companies. The LoC were governed by English law, all payable in USD, and were issued in favour of the claimant beneficiaries, based in the EU.

On the facts of the present case, the court held that Russian sanctions imposed by the UK in response to the conflict in Ukraine (specifically Regulations 11, 13 and 28 of the Russia (Sanctions) (EU Exit) Regulations 2019 No. 855) did not suspend UniCredit’s obligation to pay under the LoC. In particular:

Regulation 28. The purpose of Regulation 28 is to ensure that financial assistance is not provided to Russian parties (including the supply of aircraft). The court held that the provision of “financial assistance” in this context occurs when an LoC is issued. As the LoC in this case were issued before Regulation 28 came into force (which does not have retrospective effect), UniCredit was not relieved of the obligation to make payment to the beneficiaries. In reaching this conclusion, the court dismissed UniCredit’s arguments that paying under the LoC would extinguish the obligations of the Russian company lessees and Sberbank towards the beneficiary, thereby providing financial assistance to them. The court considered that this was a wholly collateral matter and noted that the payment under the LoC still meant that Sberbank remained liable for reimbursement to UniCredit. The court considered each limb of the trade finance transaction to impose separate and distinct contractual obligations. In this regard, the court placed particular emphasis on the principle that LoC are to be regarded as autonomous instruments. The court also considered it important to take a step back and ask whether the fulfilment of an independent obligation – owed by the UK branch of a German bank to Irish companies – could be said to be intended to benefit the Russian entities who happened to be involved in other elements of the overall transaction. The court considered the answer to this question was clear – it could not.
Regulation 11. The purpose of Regulation 11 is to prevent a party dealing with funds or economic resources owned, held or controlled by a designated person. The court held that Regulation 11 did not come into force until after the date on which the obligation to make payment under the LoC matured, and so did not prohibit payment by UniCredit to the claimants. However, in obiter commentary, the court suggested that such payment would not amount to “dealing” with Sberbank’s property in any event, because UniCredit was satisfying its own independent contractual obligations and “Sberbank’s property was not in any way interfered with”.
Regulation 13. The court also held that Regulation 13, which prohibits making funds (including financial benefits) available to a sanctioned entity, did not come into force until after the date on which the obligation to make payment under the LoC matured. Again on an obiter basis, the court suggested that payment by UniCredit would not amount to a financial benefit for Sberbank, because it would not discharge its obligations under the LoC and would remain liable to repay UniCredit.

In the present case, the court also considered the foreign illegality rule in Ralli Bros v Compania Naviera Sota y Aznar [1920] 2 KB 287, pursuant to which the English court will not enforce an obligation which requires a party to do something which is unlawful by the law of the country in which the act has to be done. The question in this case was whether payment under the LoC in USD would engage the US sanctions regime which, given the LoC were payable in USD, would involve a US correspondent bank and therefore potentially US illegality in the place of performance of the contract. The court decided that the US sanctions regime did not apply at the time the payment obligation arose, and did not apply to this payment in any event. However, the court went on to suggest that any impediment to payment presented by the US sanctions regime was capable of being avoided, because it would have been possible for UniCredit to pay in USD by alternative means (such as in cash, rather than through a correspondent bank in the US) which, the court believed, would bring the place of performance within the jurisdiction of the UK.

A consequentials hearing took place on 21 April 2023 and the court held that the claimants were entitled to interest and costs (subject to certain limited disputes): Celestial Aviation Services LTD v UniCredit Bank AG, London Branch [2023] EWHC 1071 (Comm). The court found that UniCredit was not entitled to rely on s.44 of the Sanctions and Anti Money-Laundering Act 2018 (SAMLA), which provides protection from civil liability for acts/omissions done in the reasonable belief of compliance with UK sanctions law. In the view of the court, UniCredit’s belief that payment was prohibited by sanctions was not a reasonable one. We are monitoring this case to see if an application for permission to appeal is made by the bank.

We consider the decision in more detail below.

Background

The dispute related to LoC issued by Sberbank, which were confirmed by UniCredit, the London branch of the German bank.

In 2017 and 2020 Sberbank issued seven LoC to Celestial Aviation Services Limited (Celestial) in relation to leases of aircraft to Russian companies, which were confirmed by UniCredit shortly after issue. Separately, UniCredit was also the confirming bank under standby LoC issued to Constitution Aircraft Leasing (Ireland) 3 Limited and Constitution Aircraft Leasing (Ireland) 5 Limited (Constitution) in 2018 and 2020, which were again confirmed by UniCredit shortly after issue.

In March 2022, both Celestial and Constitution made valid demands (all payable in USD) and it was common ground that, subject to sanctions, UniCredit was liable to pay under the LoC. However, UniCredit refused to make payment on the grounds that it was prohibited from doing so by reason of the operation of sanctions affecting Russia which were imposed by the UK and the EU in response to the conflict in Ukraine, specifically: Regulations 11, 13 and 28 of the Russia (Sanctions) (EU Exit) Regulations 2019 No. 855 (UK Regulations) and of Article 3c of Council Regulation (EU) 2022/328 (EU Regulation). UniCredit subsequently asserted that US sanctions were another reason why it was prohibited from paying USD sums. Subsequently both Celestial and Constitution brought proceedings against UniCredit claiming various forms of relief designed to assist in obtaining payment under the LoC.

In the period between those claims being issued and the hearing, UniCredit applied for licences in the UK, EU and US to permit payment to Celestial and Constitution, on the assumption that payment would otherwise be prohibited under the relevant sanctions. On 13 October 2022, after the date of the hearing but before judgment was handed down, the Office of Financial Sanctions Implementation (OFSI), which administers financial sanctions in the UK, granted a licence under Regulations 11 and 13 and on 12 May 2022, the German Bundesbank granted a licence. A response from the US authority, the Office of Foreign Assets Control (OFAC), was not received before judgment was handed down in this case.

Following the receipt of the licences, the parties reached agreement in relation to the principal amounts owing under the LoC and UniCredit made the payments to Celestial and Constitution. However, the parties remained in dispute on the issues of costs and interest. The parties asked the court to decide a number of underlying matters which would assist the parties resolve the remaining issues. These matters were as follows:

Did the UK Regulations prohibit payment under the LoC? If the answer is “no”, did UniCredit nevertheless have a reasonable belief that it did?
Does US law have the effect of suspending or otherwise excusing non-performance of UniCredit’s obligation to pay in USD under the LoC?
Did the EU Regulations prohibit payment under the LoC? The parties agreed that the analysis in relation to the relevant EU sanctions is materially the same as in relation to the UK Regulations.

Decision

The court concluded that UniCredit was not relieved of the obligation to make payment to the claimants under the various LoC by reason of Regulation 28, 11 or 13 of the UK Regulations. Further, the court was not satisfied that, as a matter of US law, the payment under the LoC would breach the terms of the relevant US sanctions (it was not asked to reach any conclusions as to EU law at this stage). The court’s analysis of the UK Regulations and US sanctions position is discussed further below.

UK Regulations

Before turning to the specific Regulations relied upon by UniCredit, the court confirmed some principles of statutory interpretation. In the court’s judgment, it is important to take a purposive interpretation of the statute, preferring this approach to UniCredit’s emphasis on a literal approach. The court then proceeded to consider each of Regulation 28, 11 and 13 of the UK Regulations.

Regulation 28 (provision of financing for the supply of restricted goods/technology)

The court confirmed that the purpose of this Regulation was clear, namely “to ensure that financial assistance was not provided to Russian parties in relation to, inter alia, the supply of aircraft”.

On the facts of the present case, the court said that the provision of financial assistance to the Russian lessees of the aircraft occurred when the LoC was issued, which served as a mechanism for the satisfaction of the payment obligations of the lessees. The court confirmed that Regulation 28 operates prospectively and not retrospectively, and therefore the provision of the relevant services (i.e. the issue of the LoC) was perfectly lawful at the time provided.

In the court’s view, at the time that the prohibition in Regulation 28 came into effect, all that remained was for the obligation under the LoC to be fulfilled. The court held that the only parties which stood to benefit from this were the claimants. While the fulfilment of payment by UniCredit to the claimants would have the collateral result of discharging the independent obligations of the Russian lessees and Sberbank towards the claimants; Sberbank would remain liable to UniCredit, and the Russian lessees would remain liable to Sberbank. Accordingly, neither the Russian lessees nor Sberbank would benefit from UniCredit’s payments under the various LoC.

The court also confirmed that it is fundamental to the nature of a LoC that it gives rise to autonomous payment obligations which operate independently of the underlying transaction. In consequence, the payment obligations under a LoC are commonly described as equivalent to cash (see Salam Air v Latam Airlines [2020] EWHC 2414). The court regarded the autonomy principle as of importance; and stated that UniCredit’s obligation to the claimants under the LoC was wholly independent from any other elements of the transaction. This meant that the transaction between the beneficiaries under the LoC and UniCredit was not prevented from being performed by sanctions, even if some of the other transactions may be (e.g. UniCredit’s ability to obtain reimbursement from Sberbank).

In addition, the court considered it important to take a step back and ask whether the fulfilment of an independent obligation owed by a German bank to Irish companies can be said to be intended to benefit the Russian entities who happened to be involved in other elements of the overall transaction. The court considered the answer to this question was clear – it could not. This focus on intention, rather than object or effect (which is the language used in the Regulation) may prove to be a controversial aspect of this judgment.

The court did not accept UniCredit’s submission that the UK Regulation should be read broadly, with any vagaries being assuaged by the use of the licensing system. The court commented that guidance suggests that the licencing authorities may take the view that prohibited transactions may nonetheless be licenced if they are thought to be “consistent with the aims of the sanctions”; which in turn indicates that a licence may be granted in relation to transactions even though they are prohibited on a proper reading of the sanctions, not that the sanctions should be regarded as all embracing, subject only to the licencing regime.

Accordingly, the court concluded that UniCredit was not relieved of the obligation to make payment under Regulation 28.

Regulation 11 (dealing with funds or economic resources owned, held or controlled by a designated person)

The court held that Regulation 11 did not come into force until after the date on which the obligation to make payment under the LoC matured. However, the court (on an obiter basis, given its primary finding above) accepted the claimants’ argument that Regulation 11 did not in any event prohibit payment under the LoC by UniCredit.

The court rejected UniCredit’s argument that paying the claimants would amount to “dealing” with “funds” (including LoC) which were “owned held or controlled” by Sberbank (Sberbank retained a legal interest in the LoC), because the payment would change the character of the LoC by extinguishing Sberbank’s obligation to pay/trigger Sberbank’s obligation to reimburse UniCredit.

The court said that UniCredit was not “dealing” with Sberbank’s property when making a payment to the claimants under the LoC, because UniCredit was satisfying its own independent contractual obligations and “Sberbank’s property was not in any way interfered with”.

Regulation 13 (making funds available to any person for the benefit of a designated person)

The court also held that Regulation 13 did not come into force until after the date on which the obligation to make payment under the LoC matured. Again (on an obiter basis), the court accepted the claimants’ argument that Regulation 13 would not relieve UniCredit of its payment obligation under the LoC in any event.

Regulation 13 deals with making funds (including financial benefits) available to a sanctioned entity. However, in the court’s view, payment by UniCredit would not discharge Sberbank’s obligations under the LoC, because while this would satisfy its obligation to pay the claimants, Sberbank would remain under an equal obligation to reimburse UniCredit, with no overall reduction in liability.

US sanctions

The court was asked to confirm whether US law had the effect of suspending or otherwise excusing non-performance of UniCredit’s obligation to pay in USD under the LoC. In the court’s view, at the moment that the payment obligations accrued, there was no relevant prohibition under US law, as regards Celestial. At the moment the first obligation to make payment to Constitution matured, there was no relevant prohibition. There was, however, a potentially relevant prohibition under US sanctions which came into force on 26 March 2022, which might affect the later payment obligations. This required the court to consider whether US law was relevant to the enforceability of the English law-governed payment obligation under the LoC.

The court confirmed that the governing law of each of the LoC was English law and that there was a well-recognised principle of English law that the English court will not enforce an obligation which requires a party to do something which is unlawful by the law of the country in which the act has to be done, known as the rule in Ralli Bros. The rule is engaged if performance of the obligation would require the performing party to act unlawfully in the required place of performance.

UniCredit argued that, under the Ralli Bros rule, payment via a correspondent bank in New York would be illegal in the place of performance. In particular, it drew the court’s attention to the following factors:

The currency of each of the LoC was USD.
UniCredit’s payment obligation arose only in the event of a demand precisely in the format set out in the relevant LoC.
Each of the demands identified a USD beneficiary account. In addition, those demands which specified a Dublin beneficiary account also specifically identified a correspondent account in the US through which payment was required to be made.
Payment could not be made in accordance with these demands except via a correspondent bank in the US.

The claimants submitted that this case was akin to Kleinwort Sons & Co v Ungarische Baumwolle Industrie AG [1939] 2 KB 678, in which the Court of Appeal held that since payment was to be made in England, the place of performance was England. The Ralli Bros principle was therefore not engaged. The same principle, the claimants argued, was illustrated in Libyan Arab Foreign Bank v Bankers Trust Co [1989] 1 QB 728 (LAFB).

In another obiter section of the judgment, the court concluded that the LAFB case was authority for the proposition that, where a USD payment is required under the contract, the customer is entitled to demand such payment in cash. While the demand made upon UniCredit assumed that payment would be made through a correspondent bank, that did not entitle UniCredit to insist on making the payment in this way, despite the fact that such a payment could not in fact be made (or lawfully made).

The court further found that nothing turned on the fact that the demand in this case did not stipulate payment in cash. In the court’s view, this would confuse the trigger for the obligation (the demand) with the manner in which that obligation (to make payment) may have to be fulfilled. It may be that the demand assumed payment would be made through a correspondent bank, but that did not mean UniCredit could not choose to perform in any other way, including via the tender of cash. Where the fundamental obligation is to make payment, and where it is possible to make such payment, then the bank must do so.

The court proceeded to consider the potential implications of various US sanctions if they were applicable to the claim, but this aspect of the judgment is not considered further in this blog post.

Key Contacts

Rupert Lewis

Partner

+44 20 7466 2517

Susannah Cogman

Partner

+44 20 7466 2580

Ajay Malhotra

Partner

+44 20 7466 7605

Ceri Morgan

Professional Support Consultant

+44 20 7466 2948

Elina Kyselchuk

Associate

+44 20 7466 6448

High Court finds UK sanctions do not preclude entry of judgments in favour of Russian sanctioned parties

February 20, 2023

The High Court has considered the impact of the UK sanctions against Russia on various aspects of litigation involving a sanctioned party: PJSC National Bank Trust v Mints [2023] EWHC 118 (Comm).

The judgment raises important questions of law with wide implications for litigation involving sanctioned entities. The court’s key finding was that the UK sanctions do not prevent the English court from entering judgment on a pre-existing (i.e. pre-sanctions) claim brought by the sanctioned person. There is no need for a licence from the Office of Financial Sanctions Implementation (OFSI) in order to enter judgment. OFSI can, however, license a sanctioned party to (i) pay an adverse costs order, (ii) satisfy an order for security for costs, and (iii) pay damages awarded in respect of a cross-undertaking in damages, which means that ongoing proceedings involving a sanctioned party do not necessarily prejudice the non-sanctioned party.

As part of an interesting obiter discussion of what constitutes “ownership” or “control” for the purposes of the UK sanctions regulations, the court expressed the view that this does not include control by virtue of a sanctioned person’s political office, as opposed to personally (including through a trust structure) or (potentially) via a corporate officeholding.

In view of the importance of the issues raised, the judge gave permission to appeal the judgment to the Court of Appeal.

For a more detailed analysis of this decision, please see our Litigation Notes blog post.

Rupert Lewis

Head of Banking Litigation

+44 20 7466 2517

Susannah Cogman

Partner

+44 20 7466 2580

Ajay Malhotra

Partner

+44 20 7466 7605

Maura McIntosh

Professional Support Consultant

+44 20 7466 2608

Alexander Gridasov

Senior Associate (Russia)

+44 20 7466 2732

Court of Appeal finds party was required to accept non-contractual performance in exercising reasonable endeavours to “overcome” force majeure event

November 7, 2022

The Court of Appeal has held, by a majority, that a shipowner was not entitled to rely on a force majeure clause in a shipping contract where its charterer’s parent company became subject to US sanctions: MUR Shipping BV v RTI Ltd [2022] EWCA Civ 1406.

Although set in a non-financial context, the decision will be of interest to financial institutions as it turned on the wording of the force majeure clause, which required that the force majeure event could not be “overcome by reasonable endeavors” on the part of the affected party. The High Court had held that, in exercising reasonable endeavours, the shipowner was not obliged to accept anything other than contractual performance (see our post on that decision).

The Court of Appeal disagreed, finding that the clause required the shipowner to accept a proposal involving payment in an alternative currency, which did not extend to full contractual performance, but which achieved precisely the same result as it: (i) fulfilled the underlying purpose of the relevant obligation; and (ii) caused no detriment to the shipowner. However, it was clear that, had these criteria not been met, the shipowner would have been entitled to rely on the force majeure clause.

The court emphasised that each case will turn on the drafting of the relevant clause as applied to the factual matrix. Parties must therefore be cautious in seeking to rely on previous decisions regarding the interpretation of a force majeure clause.

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

Navigating UK sanctions against Russian persons in English court proceedings

September 21, 2022

The UK is one of many countries which have introduced extensive sanctions against Russia, its individuals and entities in light of the military action in Ukraine which began on 24 February 2022. The application of the sanctions is generally limited to the territory of the UK and the conduct of UK persons (as defined) inside or outside the UK, but their practical effect is nevertheless wide-ranging.

An area where the UK sanctions regime may have significant impact, but which is not often discussed, is the effect on proceedings in the English court involving sanctioned Russian parties. Whilst UK sanctions generally do not restrict court proceedings against Russian individuals or entities subject to sanctions, the effect of the overall sanctions regime means that pursuing such claims may involve practical difficulties, such as delays to the proceedings or issues with enforcement. Those who wish to pursue claims against sanctioned Russian persons in the English courts therefore need to understand how to navigate the relevant sanctions in order not to be caught off-guard by such difficulties.

For a background to the sanctions regime and potential difficulties arising from asset freeze restrictions, please see our Litigation Notes blog post.

Party entitled to rely on force majeure clause where counterparty’s parent company became subject to US sanctions

March 21, 2022

The Commercial Court has held that a shipowner was entitled to rely on a force majeure clause in a shipping contract where its charterer’s parent company became subject to US sanctions: MUR Shipping BV v RTI Ltd [2022] EWHC 467 (Comm).

Although set in a non-financial context, the decision is of particular interest as the court allowed reliance on force majeure despite the fact that the sanctions did not directly bite on the shipowners, but rather would be likely to delay US dollar payments which in turn meant that shipowners were not prepared to go ahead with performance of the contract. The two key points arising from the court’s decision are as follows:

In exercising reasonable endeavours to overcome the impact of a force majeure event, a party is not obliged to accept anything other than contractual performance. In this case, for example, the shipowners were not required to accept payment in Euros rather than the contractual currency of US dollars.
There is no requirement that a force majeure event directly prevents or delays performance, without any intervening decision-making process on the part of the party relying on the clause. A party’s decision, taken in reaction to a force majeure event, will not necessarily break the chain of causation between the force majeure event and the non-performance, at least where the decision is reasonable.

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

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

November 23, 2020

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:

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:

2016 Credit Agreement: A claim for US$48 million comprising overdue principal and accrued default interest and costs; and
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

Partner

+44 20 7466 2580

Ceri Morgan

Professional Support Consultant

+44 20 7466 2948

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

July 14, 2020

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:

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.
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:

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
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

Partner

+44 20 2580

Chris Bushell

Partner

+44 20 7466 2187

Ceri Morgan

Professional Support Consultant

+44 20 7466 2948

Gary Horlock

Senior Associate

+44 20 7466 2917

Banking Litigation notes

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Tag: sanctions

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