Recent UK Case Studies: The Impact of US Sanctions on the Contractual Right to Withhold Payment and Key Compliance Takeaways

December 18, 2020
By: Miranda Hearn, Hill Dickinson LLP

Disclaimer: This article does not constitute legal advice. Legal advice should be sought for each individual case taking into account its unique facts and circumstances.

Sanctions can often times be practically frustrating, particularly when dealing with contract wording and how best to protect your institution from unnecessary exposure. Recently, the English Court have passed down several judgments examining the typical language used in sanctions clauses and dealing with the implications that U.S. sanctions may have for payment obligations under contracts.

This article examines two case studies: Lamesa Investments Limited v Cynergy Bank Limited [2020] EWCA Civ 821 and Banco San Juan Internacional Inc v Petroleos de Venezuela S.A. [2020] EWHC 2937 (Comm), as well as some key takeaways for compliance suites.

These cases illustrate the importance of drafting comprehensively and carefully when preparing sanctions clauses – and how beneficial it is to include bespoke sanctions provisions so that a party does not have to rely on doctrines such as illegality or frustration, or shoehorn a sanctions situation into a clause designed to deal with mandatory laws generally or force majeure. All aspects of sanctions laws and enforcement realities should be taken into account when drafting – including the fact that the sanctions environment may evolve during the term of the contract.

Case Study 1: Lamesa v Cynergy

On June 30, 2020, the English Court of Appeal ruled that U.S. secondary sanctions constitute “mandatory provisions of law” in the context of a default clause within a Tier 2 capital lending facility agreement governed by English law. The decision provides much needed English judicial discussion about sanctions compliance.

Lamesa was a Cypriot company wholly owned via another corporate by Viktor Vekselberg.  Lamesa lent £30 million to English bank Cynergy under a facility agreement entered into in December 2017. Three months later, on 6 April 2018, OFAC placed Mr. Vekselberg on its Specially Designated Nationals and Blocked Persons (SDN) List pursuant to Executive Order 13662 Blocking Property of Additional Persons Contributing to the Situation in Ukraine (E.O. 13662). Due to Mr Vekselberg’s indirect ownership, Lamesa automatically became a blocked person pursuant to OFAC’s 50 Percent Rule.

Due to the risk of U.S. secondary sanctions, Cynergy withheld the payment of interest to Lamesa under the facility agreement on grounds that making payment would expose Cynergy to sanctions risk. Lamesa sued for breach of contract.

Defending the claim, Cynergy relied on Clause 9.1 (Non-payment) of the facility agreement, which stated that it would not be in default where non-payment of sums due was: “…in order to comply with any mandatory provision of law…”

Cynergy argued that section 5(b) of the US Ukraine Freedom Support Act 2014 (as amended) (UFSA) constitutes a mandatory provision of law within the meaning of Clause 9.1. The section authorises the President of the United States to impose sanctions extraterritorially (also known as “secondary sanctions”) on a foreign financial institution if it knowingly facilitates a significant financial transaction on behalf of a person who has been blocked under the US Ukraine sanctions regime including under E.O. 13662.

Lamesa argued that section 5(b) of UFSA does not qualify as a mandatory provision of law as it does not expressly prohibit payments, it merely creates a risk of penalty. Lamesa said that Clause 9.1 does not excuse Cynergy’s non-payment where it is to avoid the risk of sanctions rather than to comply with an express prohibition. The risk of being exposed to sanctions is not a provision of law, Lamesa said.

Lamesa also argued that the English court should not construe “mandatory provisions of law” as covering U.S. secondary sanctions as this would be contrary to the U.K.’s policy of not giving extraterritorial effect to U.S. sanctions.

The Court of Appeal rejected Lamesa’s arguments on the basis that the threat of sanctions in UFSA is an effective prohibition even though it does not contain the word “prohibit” or any equivalent word. As to Lamesa’s argument about the U.K.’s policy of not giving extraterritorial effect to sanctions, the first instance judge did not believe that policy was relevant to his interpretation of the facility agreement. The Court of Appeal took a different approach and referred to the E.U. blocking statute (Council Regulation (EC) 2271/96) for interpretative guidance.  The Blocking Regulation treats U.S. secondary sanctions as imposing a requirement or prohibition with which E.U. persons must comply.

Cast Study 1: Compliance takeaways

  • Sanctions should be addressed explicitly in contracts. It doesn’t appear that the facility agreement even mentioned sanctions.  In this situation it’s almost inevitable that counterparties will disagree over their respective rights and obligations in the event that one of them becomes sanctioned or the sanctions environment changes.
  • Apply a risk-based approach. The judgment says that Cynergy knew at the time of entering into the facility agreement that there was a risk that Mr Vekselberg could be sanctioned by OFAC. At the time, Cynergy’s business was largely U.S. Dollar denominated and its correspondent account in New York had a balance of US$ 15 million. Also, it had entered into a number of U.S. Dollar denominated foreign exchange swap contracts and had committed to long-term service contracts with US companies. A transaction in such commercial context and in circumstances where one of the parties was at risk of becoming sanctioned would generally be assessed as presenting a moderate-to-high sanctions risk making it appropriate to negotiate a standalone dedicated sanctions clause explicitly addressing this.
  • Use robust language. Cynergy had to rely on the words “mandatory provision of law” and a contractual definition of “regulation” as there was no sanctions-specific wording in the facility agreement. Ideally, any contract should contain a comprehensive definition of sanctions (or any preferred equivalent term such as “trade restrictions” or “restrictive measures”) stipulating the sanctions regimes and types of restrictions captured by it. For some transactions it may be appropriate to go even further and expressly state whether or not the term will cover U.S. secondary sanctions. To avoid disputes down the line, parties should negotiate and agree detailed provisions.
  • Make the position regarding payments clear. If it is the parties’ position that the obligation to make payment for interest accrued, goods delivered, services rendered and so on is to be suspended but not extinguished in the event of a sanctions issue, it is helpful to state this clearly. The clause might also deal with whether late payment interest shall accrue on payments which are suspended for sanctions reasons.
  • Standard form clauses are not always fit for purpose. Clause 9.1 of the Lamesa/Cynergy agreement was a standard form wording designed for finance agreements, so it was not unreasonable of Lamesa and Cynergy to use it. However where a transaction presents specific sanctions risks, a tailored clause should be used. The clause should provide appropriate controls managing the particular sanctions risk. The controls may typically include representations and warranties, obligations relating to alternative modes of performance, and suspension and termination rights.
  • “Exposure to the risk of sanctions” probably is not the same as “exposure to sanctions”. Sanctions bodies have a prosecutorial discretion not to pursue enforcement against persons who breach sanctions laws and therefore there is never certainty that a person in breach will be sanctioned. Lamesa argued that in the absence of certainty of penalty, Cynergy’s reason for withholding payment was to avoid risk and this is not the same as complying with laws. The Court rejected this argument, finding that Cynergy’s reason for withholding payment was to comply with UFSA, not to avoid sanctions risk. It should be noted, however, that one of the judges, whilst not dissenting, expressed doubts about this reasoning as he did not believe it could clearly be said that Clause 9.1 is to be relied on where there is no certainty that any sanction would be imposed.

The issue of possibility versus certainty of sanctions was also discussed in the 2018 case Mamancochet Mining Limited v Aegis Managing Agency Limited and Others [2018] EWHC 2643 (Comm) albeit in a slightly different context. In Mamancochet, the issue was whether or not the payment of a marine cargo insurance claim by defendant insurers Aegis was prohibited by U.S. laws and, even if it is not, whether Aegis were nonetheless excused from performance on the basis that there was still a risk that OFAC would view them as being in breach. The contractual clause on which Aegis sought to rely said that an insurer would be excused from paying a claim where doing so would “expose [it] to any sanction, prohibition or restriction…”. The judge said that this language would only assist Aegis if the subject payment would fall foul of sanctions laws. The clause expressly addressed exposure to sanctions and this is not the same as exposure to risk of sanctions, the judge said. He further stated that if Aegis wanted the protection under the clause to extend to the mere risk of sanctions, the clause should have stated that non-payment shall be excused where the payment would result in “exposure to the risk of being sanctioned” or would be “conduct which the relevant authority might consider to be prohibited”.

When comparing the reasoning of the various judges in Lamesa and Mamancochet it is difficult to reconcile their respective views on whether exposure to the risk of sanctions should be conflated with “exposure to sanctions”. The safest approach is to negotiate and draft comprehensive language dealing with all eventualities.

  • The English court is willing to give extraterritorial effect to US sanctions – if that is what the contract says should happen. On this point, the Court of Appeal referenced the E.U. blocking statute as guidance on how U.S. secondary sanctions should be treated legally in E.U. countries. The Court’s application of the E.U. blocking statute is interesting given that the EU blocking statute’s purpose is to nullify the effects of the extraterritorial application of third country laws. However what the Court drew from the blocking statute is the fact that it views U.S. secondary sanctions as laws with which E.U. persons would otherwise have to comply.
  • Consider Multijurisdictional Advice. In order to ascertain whether Cynergy was entitled to withhold payment it was necessary to apply English contract law whilst also having to interpret an Executive Order made under a US federal law (the International Economic Powers Act) and another U.S. statute (UFSA). In addition, the E.U. blocking statute was critical to the decision. There are three systems of law at play here. Therefore, guidance from a multi-jurisdictional advisor – or, more likely, a team of advisors – may be needed before entering into contracts.

Case Study 2: Banco San Juan v Petroleos de Venezuela S.A.

In this case, defendant Petroleos de Venezuela S.A. (PDVSA) was the borrower and Banco San Juan Internacional Inc (BSJI) was the lender under two credit agreements entered into in 2016 and 2017 respectively. These agreements occurred prior to the expansion of U.S. sanctions against Venezuela to target the country’s oil sector as later happened when President Trump was in office.

PDVSA failed to pay the US$ 86 million due to BSJI under the credit agreements citing sanctions. BSJI sued. This case differs from Lamesa and Mamancochet as the defendant payor, PDVSA, is the target of sanctions.  PDVSA relied on a clause referenced as Section 7.03 in each of the credit agreements, which states:

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

  • 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,…”

PDVSA argued that as it is a blocked person under U.S. sanctions, all of its business activities are “subject to sanctions” and Section 7.03 has a suspensory effect entitling it to withhold the making of payments whilst the relevant sanctions remain in effect. It further argued that this is the normal course when sanctions affect payment obligations and that Lamesa and Mamancochet are authority for this.

The Court rejected PDVSA’s case and held that it is liable to make payment to BSJI notwithstanding the U.S. sanctions. The Court decided that PDVSA’s characterisation of Section 7.03 was incorrect. Section 7.03 was a negative covenant, not a provision entitling PDVSA to suspend payment. The negative covenant is for BSJI’s benefit only and BSJI can choose to waive (which it did). The judge did not consider that any of the words of Section 7.03 could be read as providing for the suspension of payments.

PDVSA also advanced an illegality defence, which failed as well. The court did not consider that the common law supported PDVSA on this point, but aside from that the credit agreements contained a provision, Section 6.05 in each of them, formulated as an affirmative covenant imposing an obligation on PDVSA to do something, requiring PDVSA to apply to a “Governmental Authority” (the contractual definition of which in this case covered OFAC) for a specific licence where necessary to make payment under the credit agreements. In light of this, amongst other reasons, PDVSA’s illegality case was not made out.

Case Study 2: Compliance takeaways

  • Know the different types of clauses and what rights and obligations they confer on you. PDVSA mischaracterised Section 7.03 as a clause which provided it with protection whereas the opposite was true: it imposed an obligation on PDVSA. It is crucial to know how the different contractual nuts and bolts work (representations, warranties, conditions, statements of rights, affirmative covenants, negative covenants, conditions precedent etc) and to select the one that will serve your interests.
  • Consider whether to include a contractual right or obligation to apply for a licence. This can either be extremely helpful or extremely onerous, depending on the particular circumstances. Either way, bear in mind that licence applications can take time to process and may not fit in with the timeframe in which performance is required under a given contract.

*Miranda Hearn is a Senior Associate (solicitor) in Hill Dickinson LLP’s London office specialising in natural resources, commodity trading and shipping law. She advises on all aspects of sanctions compliance with particular expertise in the oil and gas context. Her sanctions advisory practice covers the interpretation of sanctions laws and analysis of transactions from a sanctions risk perspective. The rest of her practice deals with advising on all aspects of commodity trading and shipping transactions, drafting contractual documentation, and litigation and arbitration. She spent a year seconded to an oil and gas trading house as a sanctions advisor, and previously spent six months seconded as trading floor counsel at the same trader. 

Contact: miranda.hearn@hilldickinson.com.