What is meant by the words "a mandatory provision of law"?  The English High Court recently considered this question in  Lamesa Investments Ltd v Cynergy Bank Ltd [2019] EWHC 1877 (Comm).  In this case, the Defendant (CBL) argued that its failure to make payments under a facility agreement with the Claimant (LIL) was not a default, relying on wording in the facility agreement which stated that this was the case where "such sums were not paid in order to comply with any mandatory provision of law, regulation or order of any court of competent jurisdiction", on the basis that LIL’s beneficial owner had become subject to US sanctions.  The Court agreed that the wording used in the facility agreement included the risk of being subject to restrictive measures under US secondary sanctions. While the Court gave particular regard to the "relevant documentary, factual and commercial context" of the facility agreement, this judgment serves as a helpful reminder to non-US financial institutions that sanctions clauses in facility agreements and other financing documentation should be drafted in a clear, unequivocal manner.  This Legal Update: (i) sets out the background to the case; (ii) considers the approach adopted by the Court; and (iii) considers the key takeaways for financial institutions.

1.  Background to the case
On 19 December 2017, the Claimant, a Cypriot company beneficially owned by a Russian-Ukrainian citizen named Viktor Vekselberg, loaned £30 million to the Defendant, a UK retail bank, pursuant to a facility agreement under which CBL was contractually obliged to make interest payments on a bi-annual basis throughout the term of the loan.

Under a non-payment clause in the facility agreement, LIL had a contractual right to issue a written notice requiring CBL to make good any non-payment of principal or interest that was due and owing and had not been paid within 14 days unless "such sums were not paid in order to comply with any mandatory provision of law, regulation or order of any court of competent jurisdiction".

On 6 April 2018, Mr Vekselberg was placed on the US list of Specially Designated Nationals (SDN List) by the US Office of Foreign Assets Control, rendering Mr Vekselberg and any entities he owned or controlled Specially Designated Nationals (SDNs) or "Blocked Persons".  As a result, LIL became a Blocked Person under US sanctions.  This had implications from both a primary and secondary sanctions perspective.  From a primary sanctions perspective, it became prohibited for (i) US Persons (broadly, US nationals and green card holders, US companies and persons located in the United States), and (ii) non-US persons where there is an applicable "US nexus" (broadly, a connection with the United States, such as US Dollar payments or the involvement of US Persons) to engage in activity with Mr Vekselberg or any entities controlled by him (including LIL).  

Under section 5(b) of the US Ukraine Freedom Support Act 2014 (UFSA), the US President is required to impose restrictive measures on a foreign financial institution if it were to "knowingly facilitate a significant financial transaction on behalf of… [LIL]."  The only exceptions apply where the President issues a waiver on the basis of either the "national interest" or the "national security interests" of the United States.  Thus from a secondary sanctions perspective, the addition of Mr Vekselberg to the list of SDNs created a risk of non-US persons (including CBL) becoming subject to restrictive measures (e.g. restrictions on access to the US financial system) as a result of engaging with him or entities controlled by him (such as LIL), even in the absence of a US nexus.

Once LIL became a Blocked Person on account of Mr Vekselberg's ultimate beneficial ownership of the company, CBL considered that it faced a risk of being subject to restrictive measures under secondary sanctions.  CBL refused to make payments of interest totalling £3.6 million under the facility agreement and sought to rely on the non-payment clause, arguing that the CBL's non-payment of interest to LIL following LIL becoming a Blocked Person was necessary in order to comply with a "mandatory provision of law", namely the specified secondary sanctions under UFSA.

It was common ground between the parties that neither party was ordinarily subject to US jurisdiction for primary sanctions.  In addition, the facility agreement did not prescribe any specific US nexus as part of the arrangements (e.g. that payments must be made in US Dollars).  However, CBL submitted that since (i) a significant part of its business was denominated in US Dollars, and (ii) it held a number of key long term service contracts with a number of US-based companies, the impact of secondary sanctions on CBL would be "ruinous" as it would no longer be able to deal with those US-based assets and parties.

2.  The approach of the Court
LIL sought a determination from the Court that CBL continued to be obliged to make repayments (including of interest due and payable) under the facility agreement, notwithstanding the fact that LIL had become a Blocked Person under US sanctions. 

It was common ground between the parties that, except where a contractual provision modifies the position, 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.  Thus the issue for the Court was whether the wording the facility agreement did in fact reverse the common law principles that would otherwise apply.

LIL argued that the word "mandatory" meant "a law applying to UK parties, acting in the UK, that have agreed to make a sterling payment pursuant to a contract governed by English law" that prohibits something and did not encompass the risk of actions being taken against the CBL by non-UK authorities.  

The Court, however, rejected this narrow interpretation.  Assessing the "true construction" of the relevant provision by considering the express wording of the non-payment clause in its documentary, factual and commercial context, the Court held that, in the context of the surrounding words, including the reference to "any court of competent jurisdiction", it was clear that no such jurisdictional qualification was made or intended. 

The Court instead accepted submissions by CBL that the meaning of the phrase in the context of the surrounding words and the agreement as a whole was "a provision of law that the parties cannot vary or dis-apply."  The Court noted that this interpretation made contextual sense on the facts of the case since the non-payment clause was concerned with enabling CBL to avoid what would otherwise be a clear contractual obligation to pay under the facility agreement.

The Court noted that, at the time the facility agreement was entered into on 19 December 2017,  the parties were aware that it was possible (but at the time considered it unlikely) that US sanctions would be imposed on LIL.  Since the facility agreement did not foresee a US nexus (such as requiring payments in US Dollars or to a US bank account), the Court considered that neither of the parties could have thought that any question of direct sanctions could arise even if Mr Vekselberg became an SDN and LIL a Blocked Person.  In other words, the risk that arose was exclusively that CBL would be exposed to the risk of secondary sanctions if LIL became a Blocked Person.

Particular attention was given to the effect of the words "… in order to comply…".  The Court considered that this phrase could apply in one of three possible permutations, as follows:

  • compliance can arise only in relation to a statute that expressly prohibits payment on pain of the imposition of a sanction/penalty;
  • compliance occurs whenever a party either acts or refrains from acting in a manner that would otherwise attract a sanction/penalty by statute; or
  • compliance occurs whenever a party acts or refrains from acting in a manner that would otherwise attract the possible imposition of a sanction/penalty by operation of statute.

Having established the meaning of "mandatory" on the basis set out above, the Court considered it highly unlikely that the first and second permutations reflected the intention of the parties since there was no prospect of CBL being subjected to primary sanctions even if LIL became a Blocked Person – rather the only risk the parties may have contemplated was the risk that CBL might become subject to secondary sanctions in the event LIL became a Blocked Person.

In reaching this conclusion, the Court placed reliance on the context around the non-payment clause, the facility agreement and the parties.  Among other things, the Court considered that the non-payment clause was a provision by which the parties chose to manage risk and that the clause could effectively protect CBL from the risk of breaching an express or implied prohibition against payment that exposed it to potentially severe penalties or sanctions as a result of making a payment under the facility agreement to LIL.  Further, the Court noted that the non-payment clause was drafted in wide and unqualified language to ensure that the risk was properly and clearly managed contractually.

3.  Key takeaways for financial institutions
In concluding that CBL was able to rely on the non-payment clause to resist making payments under the facility agreement as long as LIL remained a Blocked Party, the Court placed emphasis on the specific facts and the context in which the non-payment clause should be considered.  In particular, the Court concluded that – in the context of US sanctions – the parties in this case could only have contemplated the risk of CBL being subject to secondary sanctions since there was otherwise no express US nexus in contemplation of the facility agreement.

This approach reflects the fact that the non-payment clause had been drafted by the parties specifically to address a known sanctions risk.  Contractual provisions which deal with the risk of sanctions are commonly drafted on a transaction-by-transaction basis, in the light of the factual and commercial circumstances of the relevant agreement.  For instance, the Loan Market Association generally does not include recommended form sanctions-related provisions in its template documentation, and has issued guidance that the drafting of such provisions will always be fact specific, and will depend upon a number of (factual) variables.  In that context, it is not surprising that the Court paid close attention to the factual circumstances of the facility agreement and the detail of the relevant sanctions regime in interpreting the non-payment clause.

The judgment demonstrates the importance to contracting parties of closely assessing the sanctions risks which will or may arise under the transaction, and taking appropriate steps to allocate those risks under the contract where appropriate.  

This judgment also serves as a helpful reminder to non-US financial institutions in particular to give due consideration to the drafting of sanctions clauses in facility agreements and other financing documentation.  In particular, where the risks being contemplated in the negotiation of a sanctions clause are primarily secondary sanctions, non-US financial institutions should take extra care in drafting clear, unambiguous sanctions clauses into their contracts to guard against any dispute over the interpretation of such clauses further down the line.