In MODSAF v IMS  EWCA Civ 145, the Court of Appeal confirmed that an award debtor was not liable to pay interest on an arbitration award where it was prohibited to satisfy this award by international sanctions.
On 24 June 2008, the Ministry of Defence and Support for Armed Forces of the Islamic Republic of Iran (“MODSAF“) first became subject to sanctions imposed by the EU against Iran, which later became part of Regulation 267/2012 (the “Regulation“).
The impact of the Regulation became a feature of a long-running dispute concerning contracts entered into in the 1970s under which UK state-owned company International Military Services Limited (“IMS“) agreed to supply MODSAF with military vehicles. The contracts were terminated following the Iranian Revolution of 1979 and MODSAF and IMS commenced ICC arbitrations resulting in the award of over £140 million (plus interest from 1984) to MODSAF in 2001.
MODSAF applied to enforce the awards in the English courts under section 101 of the Arbitration Act 1996. Due to a pending challenge in the courts at the Dutch seat of arbitration, these proceedings were adjourned by consent, subject to IMS paying £382.5 million into court as security for any sums eventually owed to MODSAF.
By the time the Dutch Supreme Court reduced the principal sum due to MODSAF to around £127 million, MODSAF had already become subject to EU sanctions legislation.
It was not disputed that IMS is, and has been since 2008, prohibited from paying any sum to MODSAF which is a designated entity under the sanctions legislation, but in 2012 MODSAF applied to the English courts for a declaration that the funds paid into court were held for its benefit. In advance of a full hearing on this application, the Commercial Court considered the question whether MODSAF was entitled to interest arising between the start of the EU sanctions in 2008 and the date of payment.
Article 38 of the Regulation provides that “[n]o claims in connection with any contract or transaction the performance of which has been affected, directly or indirectly, in whole or in part, by the measures imposed under this Regulation… shall be satisfied, if they are made by: (a) designated persons, entities or bodies” which include MODSAF.
Justice Phillips considered that Article 38 precluded MODSAF from enforcing the post-2008 interest part of the awards. Based on the language of Article 38, he considered that MODSAF’s application was “in connection with any contract or transaction”, and that the “relevant ‘transaction’ is the arbitration award that MODSAF seeks to enforce”. The purpose of Article 38 was, in his view, to “protect parties against claims brought against them by virtue of their non-performance of a contract or transaction that was caused by the sanctions”.
The Court of Appeal’s Decision
The Court of Appeal unanimously upheld the lower court’s decision that Article 38 of the Regulation prevented MODSAF from claiming interest from IMS for the period during which MODSAF was subject to sanctions.
Justice Phillips had been correct to consider that the purpose of the Regulation was to protect parties who were forced by the sanctions regime not to perform a contract or transaction. In the leading judgment, Lord Justice Newey disagreed, however, with the judge’s finding that the arbitration award was the relevant ‘transaction’ as such a reading was not supported by the Regulation. Instead, MODSAF’s application to the courts was a claim that was “in connection with” a contract (ie, the 1970s contracts) and therefore covered by Article 38 of the Regulation.
In the Court of Appeal’s view, Article 38 of the Regulation was clearly intended to have confiscatory consequences. In fact, to find in favour of MODSAF that Article 38 did not bar its claims for interest would result in financially penalising IMS. As IMS was prohibited from satisfying the award while the sanctions were in force, interest liabilities kept increasing. It could not be correct that the Regulation allowed MODSAF to claim these amounts, as the purpose of the Regulation was to influence MODSAF’s actions rather than to penalise MODSAF’s counterparties.
Counsel for MODSAF had referred to cases in which payments to a designated entity were permissible because the entity had a frozen account in the EU. The Court of Appeal accepted that this could be correct but it was undisputed that in this case MODSAF did not have such an account. Furthermore, where such an account existed, debtors could make payments into them and thereby avoid interest from accruing. But where such an account did not exist, it was the exact purpose of Article 38 to protect those counterparties which were unable to make payments.
IMS had further raised an alternative argument based on the ICC Rules (and other frequently used arbitration rules contain similar wording) which impose a contractual obligation on the parties to carry out and perform an award. On this reasoning, MODSAF’s claims for interest would be barred under Article 38 as they were claims “in connection with a contract or transaction, namely the contractual obligation to perform the award”. Lord Justice Males saw merit in this argument from a literal point of view, but rejected the argument as it would apply to arbitration awards only and not to court judgments. In his view, such a sharp distinction between awards and court judgments could not have been intended by the EU legislature.
In the Commercial Court, IMS had argued that, in the alternative, the ‘no liability’ provision at Article 42 of the Regulation precluded MODSAF from enforcing interest during the sanctions period. Article 42 provides that “the refusal to make funds… available, carried out in good faith on the basis that such action is in accordance with this Regulation, shall not give rise to liability of any kind”. Justice Phillips considered, obiter, that this provision only applied to cases of “incorrect but non-negligent actions taken in good faith”, but not where the relevant liability arose from a correct application of the Regulation (where he considered that Article 38 protections would likely apply). The Court of Appeal did not comment on this part of the judgment.
The Court of Appeal’s decision provides helpful guidance on a rarely interpreted provision commonly found in EU sanctions legislation. It should provide comfort to contractual counterparties of sanctioned entities which are unable to satisfy payment obligations under either awards or contracts. The interest arising in such cases can be considerable, taking into account the principal sums awarded and the potentially lengthy application of international sanctions.
However, the Court of Appeal made clear that this result was based on the specific wording of the Regulation and the outcome could be different under other sanctions regimes. In particular, it remains to be seen whether new questions of interpretation arise as a matter of English law if the Regulation is revoked and replaced by the UK Iran (Sanctions) (Nuclear) (EU Exit) Regulations 2019 at the end of the Brexit transition period.
For more information please contact Andrew Cannon, Partner, Jerome Temme, Associate, or your usual Herbert Smith Freehills contact.