The long arm of OFAC: English law contracts and U.S. secondary sanctions

In a recent judgment, the Court of Appeal  confirmed that a provision in an English law facility agreement stating that the borrower would not be in default if “sums were not paid in order to comply with any mandatory provision of law” allowed the borrower to avoid making payments where to do so could result in the imposition of U.S. secondary sanctions.

While the decision of the High Court was upheld, its reasoning was not. The judgment is a useful illustration of the approach to the interpretation of sanctions-related clauses, particularly in financing agreements.

Lamesa, acting as lender, was a Cypriot company wholly owned by a group company registered in the British Virgin Islands. The group company’s owner was added to a list of “Specially Designated Nationals” by the U.S. Department of The Treasury Office for Foreign Assets Control ( OFAC). As a result, Lamesa became a “blocked person” under a U.S. federal law, exposing Cynergy, the English borrower, to secondary sanctions if it made payments to Lamesa.

Cynergy refused to make payments, relying on a clause in the facility agreement allowing it to escape a default if “sums were not paid in order to comply with any mandatory provision of law, regulation, or order of any court of competent jurisdictions.”

The Court of Appeal noted:

• The provision was a standard term in common usage. The focus, therefore, should be on the words used (and not the particular factual background).
• Clear words are required to abrogate a repayment obligation.
• The court must take account of the commercial interests of both parties (the judge at first instance seemed to have preferred those of Cynergy).
• The relevant context:
  • The provision was not just about sanctions.
  • It did not extinguish the entitlement to be paid interest and be repaid capital. Rather, if engaged, Cynergy would not be in default.
  • Ultimately, the provision was an attempt to balance the lender’s need to be paid on time and that of the borrower not to infringe mandatory provisions of law.

The court stated that because the provision was ambiguous, context and commercial common sense were relevant. It held:

• The clause was intended to be used by international banks. A risk facing international banks is the problem of dealing with U.S. secondary sanctions. Tier 2 lending is an EU concept, and the parties were EU financial institutions. If a “mandatory provision of law” only referred to one that directly bound the borrower not to pay, it would have almost no possibility of taking effect.
• The provision must have intended the borrower to be capable of obtaining relief from default if its reason for non-payment was to “comply” with a foreign statute that would otherwise be triggered. The EU Blocking Regulation (which seeks to limit the extra-territorial application of third country laws) was known to regard U.S. secondary sanctions legislation as imposing a “requirement or prohibition” with which EU parties were otherwise required to “comply”.
• Although U.S. legislation cannot prohibit, and does not purport to prohibit, a payment by Cynergy to Lamesa, its effect is clearly one of prohibition as the EU Blocking Regulation makes clear.
• Once the U.S. legislation is seen as an effective prohibition, Cynergy’s reason for non-payment is indeed to comply with it.

One member of the Court of Appeal had doubts about the interpretation of “in order to comply with” and whether this meant in order not to comply with the U.S. legislation or in order to avoid the risk of being sanctioned. However, he did not dissent.

This case is of particular interest to non-U.S. banks that are parties to English law governed contracts, especially where they do not routinely include contractual provisions that expressly refer to U.S. sanctions. This is because the judgment clarifies that a reference to a “mandatory provision of law” may include reference to U.S. secondary sanctions.

Going forward, banks will need to consider carefully the drafting of their agreements to ensure that they are not disadvantaged in circumstances where there is a risk that their counterparty may be targeted by U.S. sanctions or the arrangements may otherwise carry a U.S. secondary sanctions risk.