Between sanctions exposure and commercial liability: do you have the protection you need?

Many contracts contain clauses excusing parties from performance by reference to international sanctions. The High Court’s very recent judgment in Mamancochet v Aegis & Others should prompt businesses to consider the following questions:

1. What kind of sanctions exposure should excuse you or your counterparty from performance? Some sanctions clauses only bite where it can be shown that performance would result in an actual breach of sanctions. Parties may wish to agree contractual protection that is broader in scope, or which takes account of ambiguities as to the scope or effect of sanctions.
2. Where a sanctions clause is triggered, are rights and obligations to be suspended or extinguished? Where the effect of a sanction clauses is only to suspend a party’s liabilities, this can lead to litigation risk and commercial uncertainty.
3. More broadly, do your existing contracts and business processes do the trick in the face of today’s dynamic sanctions landscape? For example, you may need to be ready to perform (or insist on a counterparty’s performance) during a finite window of time when a payment or other action is not prohibited.

While not reaching a concluded view, the judgment also contains some comments about the application of the EU Blocking Statute. These comments will be of interest to businesses preparing for the forthcoming US sanctions against Iran.

What kind of sanctions exposure should excuse a party from performance?

The sanctions clause in this case was a Lloyds standard clause. The clause excused insurers from paying an otherwise valid insurance claim where “payment…would expose that insurer to any sanction, prohibition or restriction under [UN, EU or US sanctions].”

The parties had made joint requests to a number of authorities for clarification as to whether the payment would be permitted, and had for some months been awaiting a formal response to a reference they had made to the UK Export Joint Control Unit (EJCU). In the absence of a formal response from the EJCU, each party had adduced expert evidence as to whether the payment would constitute a sanctions breach.

The insurers unsuccessfully contended that the sanctions clause applied wherever payment would expose the insurers to a risk of being sanctioned by an authority. The High Court instead found that, in order for the sanctions clause to bite, payment would have to constitute an actual breach of sanctions. The Court said that “clear words” would be required for a clause to excuse a party from performance where there was a mere risk of an authority considering an action to be a sanctions breach.

In the negotiation of some contracts, parties may want to seek to agree a sanction clause that is more developed or wider in scope than the clause in this case, e.g. a sanction clause that provides for obligations to be varied where there is an apparent risk of a sanctions breach and, as happened in this case, the parties cannot obtain a definitive answer from an authority as to the scope or effect of a sanction.

Where a sanctions clause is triggered, are obligations to be suspended or extinguished? 

A key aspect of the sanctions clause in this case was that it began “to the extent that payment…would expose [the insurers]…”. The Court construed these words as meaning that, from December 2012, the effect of certain EU (and later US) sanctions was that the insurers’ liability to make the payment was only suspended – not extinguished. When, in January 2016, the EU and US lifted various sanctions as part of the Joint Comprehensive Plan of Action (JCPOA), the insurers were no longer excused from performance under the contract and the insured had an enforceable right to receive the payment.

The Court rejected submissions that this “suspensory interpretation” of the sanctions clause would lead to confusion and uncertainty. While the Court acknowledged that its interpretation would lead to potentially open-ended liability, it said that this would be qualified by the rules of limitation. The Court envisaged that, where a contractual claim is issued and the Defendant raises a valid defence based on a sanctions clause, the relevant proceedings can then be stayed (seemingly indefinitely), pending any changes to the relevant sanctions regime. During the period of the stay, a defendant would then reflect any suspended liability in its accounts.

In order to avoid prolonged exposure to a suspended liability, parties may alternatively wish sanctions clauses to provide for:

• the application of sanctions to extinguish contractual liability; or
• the application of sanctions to suspend liability initially but then to extinguish liability if, after a certain period of time, there has been no material change to the relevant sanctions regime(s).

The importance of timely performance in light of the dynamic sanctions landscape

The facts of the case highlight the issues of timing that can arise where sanctions clauses only suspend (rather than extinguish) liability. The Court dealt with the proceedings on a highly expedited basis, hearing the case on 2 and 3 October and delivering its judgment 9 days later. The Court’s findings on the application of sanctions were that:

• from December 2012 to early 2016, the insurers were prohibited from making the payment
• from early 2016 to 11.59pm on 4 November 2018, the insurers were not prohibited from making the payment
• from 5 November 2018, the payment would again become caught by US sanctions as part of President Trump’s decision in May 2018 to withdraw the US from the JCPOA.

Accordingly, the Court ordered the insurers to make the payment on the basis that it had no valid excuse at the date of judgment (and up until 11.59pm on 4 November 2018).

Does the EU Blocking Statute prohibit a party from invoking a sanctions clause in the context of US sanctions against Iran? The High Court’s provisional answer was ‘no’…

The EU has taken steps to counteract the sanctions that will be reinstated by the US following its withdrawal from JCPOA. In particular, the EU ‘Blocking Statute’ will prohibit EU nationals and EU-incorporated companies from taking steps (without specific authorisation) to comply with US sanctions against Iran.

In this case, the Court did not need to determine the effect of the Blocking Statute because (as noted above) it found that the US sanctions in place at the date of judgment did not prohibit the insurers from making the payment such that the sanctions clause was not a valid defence. Accordingly, the Court did not need to reach a “concluded view” on the interaction between sanctions clauses and the EU Blocking Statute. However the Court did indicate that, where a party validly invokes a sanctions clause, this is to be regarded as “simply relying upon the terms of [a contract]” and not as complying with US sanctions in breach of the EU Blocking Statute.