Navigating the impact of sanctions on commercial contracts: an overview of key cases and trends in England and Singapore

Introduction

Since the Russian invasion of Ukraine, the courts in England and Singapore have had to consider the impact of an ever-evolving sanctions landscape on commercial contracts, offering critical insights through key decisions.

This article summarises certain key judgments of the courts of England and Singapore, illustrating issues that the courts have tackled, notably in the following areas:

• Interpreting sanctions clauses: Appreciating how courts interpret sanctions clauses is fundamental for commercial parties to understand how to both (a) assess their legal rights under existing sanctions clauses and (b) draft appropriate contractual protection for the future. In Lamesa Investments Ltd v. Cynergy Bank Ltd, the English Court of Appeal considered the proper interpretation of a sanctions clause within a loan agreement and the extent to which the clause in question protected a party from the risk of U.S. secondary sanctions (concluding ultimately that it did so). The decision is an example of the courts applying established principles of contractual interpretation to sanctions clauses, and highlights the factors that may influence the court’s interpretation of a sanctions clause, including extraterritorial risk.
• Sanctions and trade finance: The intersection between sanctions and trade finance is particularly crucial in the context of letters of credit, which are pivotal for facilitating international trade. In Kuvera Resources Pte Ltd v. JPMorgan Chase Bank, the Singapore Court of Appeal examined whether a bank was entitled to invoke a sanctions clause in a confirmation added to letters of credit, in circumstances where its internal screening had flagged a vessel as being owned by a sanctioned entity. The case is a warning that even material sanctions risks identified by internal sanctions screening may not meet the contractual test for relief from performance, absent clear drafting of the sanctions clause.
• The accrual of interest whilst sanctions are ongoing: Sanctions can have the effect of suspending substantial payment obligations, leading to significant claims for interest arising if and when those sanctions are lifted. In The Ministry of Defence and Support for Armed Forces of Iran v. International Military Services Limited, the English High Court held that interest did not accrue for the benefit of an EU-sanctioned entity during the period in which sanctions were imposed. This judgment provides important guidance on how obligations around interest may be interpreted in the context of sanctions legislation.
• What is meant by “control” in sanctions regulations: Understanding the test for “control” under UK sanctions regulations is crucial for assessing the sanctions status of current and potential counterparties. In Mints & Others v. PJSC National Bank Trust & Another and Litasco SA v. (1) Der Mond Oil and Gas Africa SA (2) Locafrique Holding SA, the English courts examined the meaning of “control” in the context of the Russia (Sanctions) (EU Exit) Regulations 2019, arriving at different conclusions based on their respective facts. Mints, in particular, led to important clarificatory guidance being issued by the UK government on the meaning of “control” under those Regulations.

Whilst each case will turn on its own facts and their application to the relevant sanctions that arise for consideration, an understanding of the issues that the courts are increasingly grappling with will help parties to anticipate the issues that may affect their own contracts and business.

Ongoing commentary by Reed Smith on developments in sanctions law is available at viewpoints.reedsmith.

1. Interpreting a sanctions clause: Lamesa Investments Ltd v. Cynergy Bank Ltd [2020] CA EWCA Civ 821

This case involved the interpretation of a sanctions clause in an English law-governed Facility Agreement between Lamesa Investments Ltd (Lamesa) and Cynergy Bank Ltd (Cynergy), under which Cynergy was obliged to make interest payments to Lamesa.

Lamesa’s parent company was wholly owned by an individual who was subsequently designated by the U.S. Office of Foreign Assets Control (OFAC), and as a result Lamesa became a “blocked person” by virtue of its ownership structure and was also subject to U.S. secondary sanctions. The central issue raised in the case was whether Cynergy was entitled to refuse to make interest payments to Lamesa on the grounds that to do so might cause it to become the target of U.S. secondary sanctions.

Clause 9.1 of the Facility Agreement provided that Cynergy would not be in default if its failure to pay was “in order to comply with any mandatory provision of law, regulation or order of any court of competent jurisdiction”. Cynergy sought to invoke clause 9.1 to justify its refusal to make interest payments to Lamesa.

Commercial Court judgment

In a first instance judgment of the Commercial Court, the judge (HHJ Pelling QC) held that Cynergy’s failure to pay interest was excused by clause 9.1 of the Facility Agreement, due to the risk that the interest payments could cause Cynergy to become the subject of U.S. secondary sanctions.

In the judge’s view, the words “mandatory provision of law” in clause 9.1 meant “a provision of law that the parties cannot vary or dis-apply” or “that could not be derogated from”, and not only (as argued by Lamesa) a provision of law that directly prohibited a party from taking a particular step, and therefore, in the opinion of the judge, included the U.S. secondary sanctions to which Cynergy was exposed.

The judge had particular regard to what he considered were the parties’ intentions in agreeing to clause 9.1, finding that the parties were aware at the time of the Facility Agreement that it was possible that U.S. sanctions would be imposed on Lamesa and that, in agreeing to clause 9.1, the parties had intended to address the risk of secondary sanctions being imposed against Cynergy. This was particularly the case because Cynergy (as a non-U.S. person) did not face a risk of contravening primary sanctions. The judge held that the parties would not have agreed to a clause that addressed only a risk (i.e., that relating to primary sanctions) that Cynergy did not face.

Court of Appeal judgment

Lamesa appealed to the Court of Appeal. Lamesa argued that the judge had been wrong because:

• the U.S. secondary sanctions to which Cynergy was exposed did not expressly prohibit Cynergy from making payment or bind Cynergy to act or not act in a particular way, such that Cynergy could not say that it had refused to pay “in order to comply with [a] mandatory provision of law” within the meaning of clause 9.1;
• the judge had been wrong to interpret clause 9.1 as if it were a one-off negotiated provision – and thereby having regard to what the judge considered to be the parties’ intentions in agreeing to the clause – when, in reality, the clause was a standard clause that appeared in many finance agreements;
• it would require clear wording to enable a debtor under a loan agreement to escape its fundamental payment obligations, and the wording of clause 9.1 was insufficiently clear to do so; and
• the court had to take account of the commercial interests of both parties in interpreting the contract, and not only those of Cynergy as the judge had apparently done.

Whilst the Court of Appeal dismissed Lamesa’s appeal and upheld the first instance decision, it did so based on somewhat different reasons to those of the judge in the lower court. The Court of Appeal’s reasons as set out in the lead judgment of Sir Geoffrey Vos, chancellor of the High Court, are instructive as to the approach that the English courts can be expected to take to the interpretation of sanctions clauses.

In interpreting clause 9.1, the Court of Appeal applied principles established under the leading authorities on contractual interpretation, which are summarised below:

• The court should construe the relevant words of a contract in their documentary, factual and commercial context, assessed in the light of (i) the natural and ordinary meaning of the provision being construed, (ii) any other relevant provisions of the contract being construed, (iii) the overall purpose of the provision being construed and the contract or order in which it is contained, (iv) the facts and circumstances known or assumed by the parties at the time that the document was executed, and (v) commercial common sense, but (vi) disregarding subjective evidence of any party’s intentions.
• In arriving at the true meaning and effect of a contract, the departure point in most cases will be the language used by the parties, and where the parties have used unambiguous language, the court must apply it.
• Where the language used by the parties is unclear, the court can properly depart from its natural meaning where the context suggests that an alternative meaning more accurately reflects what a reasonable person with the parties’ actual and presumed knowledge would conclude the parties had meant by the language.
• If there are two possible constructions, the court is entitled to prefer the construction which is consistent with business common sense and to reject the other.
• In striking a balance between the indications given by the language and those arising contextually, the court must consider the quality of drafting of the clause and the agreement in which it appears. Sophisticated, complex agreements drafted by skilled professionals are likely to be interpreted principally by textual analysis unless a provision lacks clarity or is apparently illogical or incoherent.

The Court of Appeal confirmed that contractual interpretation is a “unitary exercise”, starting “with the words and relevant context”, before moving “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, against its wider context, before reaching a conclusion on its objective meaning.

The Court of Appeal held that, since the words of clause 9.1 were ambiguous, it was relevant to consider the context to the clause and the question of business common sense.

Four aspects of context that were considered relevant were:

• First, that clause 9.1 used similar language to the EU Blocking Regulation, which regards U.S. secondary sanctions as imposing a “requirement or prohibition”. These terms must be taken to have been known to the parties and to the drafters of this standard clause.
• Second, that the Court of Appeal considered that clause 9.1 was a standard term that was in common usage at the time that the Facility Agreement was entered into. Where this is the case, less weight should be given in the contractual interpretation process to the contextual evidence of the factual background or matrix. Instead, the focus should be “ultimately on the words used, which should be taken to have been selected after considerable thought and with the benefit of input and continuing review of users of the standard forms and knowledge of the market”.
• Third, that, at the relevant time, U.S. secondary sanctions would have been one potential problem affecting parties to agreements such as the Facility Agreement and, for the reasons the judge gave, far more likely to be a potential problem than U.S. primary sanctions.
• Fourth, that clause 9.1 did not extinguish the entitlement to be paid interest and repaid capital under the Facility Agreement – it merely provided that Cynergy would not be in default for non-payment. Clause 9.1 therefore affected the timing of payments rather than the question of whether payments would ever be made. This was an important factor when considering Lamesa’s submission that clear words were needed to abrogate a payment obligation, because clause 9.1 did not abrogate the payment obligation; it abrogated only a default and merely delayed the payment obligation.

On the application of business common sense to the construction of the clause, the Court of Appeal held that clause 9.1 was intended to be used by international banks, which faced the risks of dealing with the prospect of U.S. secondary sanctions. If the words “mandatory provision of law” only referred to a provision that directly prohibited the borrower from paying, it would have almost no possibility of taking effect.

For these reasons, the Court of Appeal dismissed Lamesa’s appeal and held that clause 9.1 was engaged by the risk of U.S. secondary sanctions against Cynergy.

Commentary: The case is a reminder that the risk of a party being subject to secondary sanctions may be brought into the scope of a sanctions clause by appropriate drafting, although the particular words used by the parties in this case were held to be ambiguous and capable of multiple meanings. Ultimately, the interpretation that aligned most closely with the parties’ assumed intentions based on business common sense was preferred.

2. Sanctions and trade finance: Kuvera Resources Pte Ltd v. JPMorgan Chase Bank [2023] SGCA 28