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Confirming bank had validly included a sanctions clause as part of its confirmation of a letter of credit

In Kuvera Resources Pte Ltd v JPMorgan Chase Bank, NA [2022] SGHC 213, the Singapore High Court confirmed that a confirming bank may include terms in its confirmation to a letter of credit that were not in the letter of credit. This decision also usefully set out limits on what terms can be validly added to a credit and following this decision banks should review their sanctions clauses to letters of credit and confirmations to ensure that they are not so wide as to be unenforceable.

Key takeaways:

  • A confirming bank may offer to confirm on terms that are different from those of the letter of credit as a letter of credit and a confirmation are separate and distinct unilateral contracts. Accordingly, the defendant-bank in this case could rely on a sanctions clause that was part of its confirmation even though the letter of credit did not contain one. 
  • A sanctions clause that would give a confirming bank such a wide discretion to refuse payment that it would make an apparently confirmed letter of credit an unconfirmed letter of credit could not be added. As the sanctions clause here was confined to allowing the defendant-bank to refuse payment on a complying presentation if to do so would cause it to be in breach of applicable sanctions laws, it was permissible. 
  • As a matter of best practice, banks should review their sanctions clauses used in letters of credit and confirmations to ensure that they are not so wide as to be unenforceable. 

In Kuvera Resources Pte Ltd v JPMorgan Chase Bank, NA [2022] SGHC 213 (31 October 2022), the confirming bank had included a sanctions clause in its offer of confirmation that provided that it would not be liable for any delay or failure to pay, process or return the relevant documents or for any related disclosure of information, where documents presented involved a country, entity, vessel or individual that was subject to sanctions restrictions. This sanctions clause was not in the letter of credit. The Court ruled as follows: 

  • A confirming bank to a letter of credit may make an offer to confirm on terms that are not identical to that of the letter of credit; 
  • The sanctions clause was therefore a part of the terms of the confirmation; and
  • The confirming bank was therefore not liable for a failure to pay on against a presentation of complying documents where payment would have caused it to be in breach of sanctions laws that applied to it. 

Facts

The plaintiff, a Singapore-incorporated company, had lent money to a seller of coal in Indonesia. The seller would use the funds provided to purchase coal and on-sell it to a company in Dubai. The buyer agreed to pay for the coal by letters of credit which named the plaintiff as the beneficiary. The buyer procured letters of credit from a bank in Dubai as the issuing bank. The defendant, a bank incorporated in the US and operating in Singapore as a branch, was the advising and nominated bank. 

The defendant subsequently became the confirming bank when it added its confirmations to the letters of credit. Its confirmations contained a sanctions clause in the following terms: 

[The defendant] must comply with all sanctions, embargo and other laws and regulations of the U.S. and of other applicable jurisdictions to the extent they do not conflict with such U.S. laws and regulations (“applicable restrictions”). Should documents be presented involving any country, entity, vessel or individual listed in or otherwise subject to any applicable restriction, we shall not be liable for any delay or failure to pay, process or return such documents or for any related disclosure of information.

As noted, such a clause was not contained in the terms of the letters of credit. 

When the plaintiff presented complying documents to the defendant, the defendant sent the documents for sanctions screening to ensure compliance with US sanctions laws and regulations. The screening process revealed that the vessel on which the goods had been shipped was likely beneficially owned by a Syrian entity subject to US sanctions. The defendant therefore informed the plaintiff that it was unable to make payment against the complying presentation.

The plaintiff accordingly brought a claim against the defendant for breach of contract for its failure to pay. It sought to argue, among other things, that the letters of credit did not have a sanctions clause and accordingly the defendant’s sanctions clause had not become a term of the confirmations. 

The legal nature of a letter of credit and a confirmation 

The Court considered at length the legal nature of a letter of credit and a confirmation. It noted that it had long been accepted that a confirmed letter of credit did not involve a single multi-party contract amongst the seller/beneficiary, buyer/applicant, issuing bank and the confirming bank. Instead, there were five distinct and separate contracts: 

  • A contract between the seller and the buyer where they agree to use a letter of credit as the mechanism to effect payment; 
  • A contract between the buyer/applicant and the issuing bank under which the issuing bank undertakes to pay the seller/beneficiary against a complying presentation and the buyer/applicant undertakes to pay the issuing bank any sums which the issuing bank pays the beneficiary; 
  • A contract between the issuing bank and the seller/beneficiary under which the issuing bank undertakes to pay the seller/beneficiary against a complying presentation (referred to here as the letter of credit); 
  • A contract between the confirming bank and the seller/beneficiary under which the confirming bank also undertakes to pay the seller/beneficiary against a complying presentation (referred to here as the confirmation); and 
  • A contract between the issuing bank and the confirming bank under which the issuing bank undertakes to reimburse the confirming bank once the confirming bank has paid the beneficiary against a complying presentation. 

While this has long been the accepted position, how this structure arises under contract law principles has not been settled. For example, how a contract arises between the confirming bank and the seller/beneficiary when they are not in touch with each other until the presentation of documents does not fit neatly into traditional offer and acceptance rules. Some academics have argued that letters of credit and confirmations should be regarded as a special case, falling outside the traditional rules of contract law. 

Letter of credit/confirmation are unilateral contracts 

The Court considered the various legal theories used to explain letters of credit and ruled that a letter of credit was a unilateral contract between the issuing bank and the seller/beneficiary, while the confirmation was a unilateral contract between the confirming bank and the seller/beneficiary. The traditional contract rules apply to such contracts save for one and one only: the rule that offers are revocable until accepted. This is because longstanding precedent has accepted that an offer of a letter of credit/confirmation made to the seller/beneficiary is irrevocable. 

This analysis has several implications which were discussed by the Court: 

  • An issuing or confirming bank is at liberty to make its offer on terms. These terms can include an expiry date after which the offer will expire. Once that date has passed, on ordinary contractual principles, the beneficiary can no longer accept the offer. The bank can also incorporate terms into its offer by reference or expressly.
  • At the time a bank issues or confirms a letter of credit, the only contractual content of the bank’s act is its obligation to the beneficiary not to revoke its offer. This includes by implication an obligation not to alter the terms of its offer. That would amount to revoking the existing offer and making a new offer on the altered terms. 
  • The beneficiary owes no obligations whatsoever to the bank.
  • The bank’s unilateral contract with the beneficiary is formed when, and only when, the beneficiary makes a complying presentation to the bank. It is only at that point that the beneficiary accepts the bank’s offer of a unilateral contract and supplies consideration for the bank’s promise to pay against a complying presentation. Until that point, there is no contract in existence. All that exists is the irrevocable offer of a unilateral contract.

Adding terms to a confirmation that are not in the letter of credit

This analysis of a confirmation means that: 

  • For a confirming bank, it may therefore add terms to its confirmation of a letter of credit which are not found in the letter of credit itself.
  • For the seller/beneficiary of a confirmed letter of credit, it is open to them to consider the terms of the confirmation and do one of the following: 
    • accept the confirming bank’s offer; 
    • bargain with the confirming bank for a fresh offer on improved terms; 
    • reject the confirming bank’s offer and bargain with the applicant and the issuing bank to permit a different bank to confirm the letter of credit on improved terms; or 
    • ignore the confirmation and accept the issuing bank’s offer. 

If the beneficiary chooses to accept the confirming bank’s offer, it makes a presentation to the confirming bank. If the presentation is a complying presentation, a unilateral contract is formed between the beneficiary and the confirming bank. If the remaining terms of the confirmation are satisfied, the confirming bank becomes contractually obliged to pay the beneficiary against the presentation.

Limits to the terms that can be added 

This ability of the confirming bank to add terms to a confirmation not in the letter of credit is subject only to one qualification: the term cannot be fundamentally inconsistent with the commercial purpose of a confirmation, which is to give the beneficiary an alternate paymaster to which it can look to for payment, in addition to the issuing bank. 

A confirming bank cannot therefore add a term to its confirmation if the effect of the term is to annul the confirmation, that is, if it renders a confirmed letter of credit no different in substance from an unconfirmed letter of credit. Thus, for example, a confirming bank cannot include a term in its confirmation which entitles it not to pay the beneficiary against a complying presentation unless and until the issuing bank reimburses the confirming bank. 

Application of these principles to sanctions clauses 

A bank may therefore incorporate a clause in its letters of credit and in its confirmations permitting it to not pay against a complying presentation if doing so would breach an applicable jurisdiction’s sanctions laws and regulations.

On the other hand, a bank may not include a sanctions clause if it entitles the bank to refuse to pay against a complying presentation simply because doing so may breach the bank’s own internal sanctions policy, regardless of whether it would breach any applicable sanctions laws and regulations. This is because a bank’s internal sanctions policy is, by definition, internal. Unlike an applicable jurisdiction’s sanctions laws and regulations, an applicant and a beneficiary will not know what the bank’s internal sanctions policy is. The level of discretion that a wide sanctions clause affords to a bank to decline payment might well amount in substance to rendering a letter of credit or a confirmation de facto revocable even if it remains de jure and on its face irrevocable. Further, to the extent that even a nominated bank will not know and cannot know an issuing bank’s internal sanctions policy, a wide sanctions clause can introduce banking uncertainty as against the nominated bank.

Application of these principles to the defendant’s sanctions clause 

The Court then examined the defendant’ sanction clause, which provided that it would not be liable for any failure to pay in the event that the documents of a complying presentation showed that they involved, among others, an entity or a vessel subject to US sanctions laws. The Court ruled that such a clause was permissible as it did not contradict the commercial purpose of the confirmation. 

It then considered the language of the clause and ruled that it had to be construed in accordance with its commercial purpose, which was to mitigate or eliminate the regulatory, reputational and financial risk that the defendant faces if it breaches US sanctions laws and regulations or is found by the US Office of Foreign Assets Control (OFAC) to have breached US sanctions laws and regulations. Thus, although the clause only referred to “laws and regulations”, this had to be understood as encompassing the entire regulatory superstructure and infrastructure of the US sanctions laws and regulations. Accordingly, this included not only the Syrian Sanctions Regulations but also OFAC’s guidelines on the standards it expects US persons to adhere to in order to avoid breaching US sanctions and OFAC’s approach to investigating and penalising breaches of US sanctions. These include the due diligence guidelines and guidelines as to red flags issued by OFAC. 

For the defendant to be able to rely on the sanctions clause, therefore, it was sufficient for it to show that it was likely that OFAC would consider it to be in breach of US sanctions laws and regulations and not that the vessel was in fact owned by an entity subject to US sanctions laws. 

Commentary

This is a welcome decision which clarifies the nature of a confirmation of a credit, as well as the appropriate scope for sanctions clauses in letters of credit generally.

As regards the latter, we note that in the "Consolidated ICC guidance on the use of sanctions clauses in trade finance-related instruments subject to ICC rules", the ICC similarly highlights that where an issuer has "a level of discretion as to whether or not to honour beyond the statutory or regulatory requirements applicable to that issuer, they bring into question the irrevocable and documentary nature of the letter of credit or guarantee. The implementation by a bank of an internal sanctions-related policy that goes beyond what is required under the laws and regulations applicable to that bank is an illustration of that discretion. It may cause a serious problem when considering the role of a confirming bank, a nominated transferring bank, a guarantor or a beneficiary. If the reference to an internal, sanctions-related policy were to allow the bank discretion to honour or refuse payment, one could even question if that bank has in fact assumed a legally binding obligation, a question that of course has to be determined under the applicable law." 

The ICC has therefore recommended that banks should refrain from issuing trade finance-related instruments that include sanctions clauses that purport to impose restrictions beyond, or conflict with, the applicable statutory or regulatory requirements. 

Banks may therefore wish to consider carrying out a review of their standard form sanctions clauses used in their letters of credits or confirmations to ensure that they meet the standard set out in this decision and in the ICC guidance.