The Court of Appeal has confirmed that a UK bank was justified in refusing to make payments under a facility agreement where those payments may have resulted in the imposition of US secondary sanctions. The facility agreement provided that the UK bank would not be in default where non-payment was “to comply with any mandatory provision of law”. Although the US legislation in question could not and did not purport to prohibit the UK bank’s payments under the facility, the Court of Appeal considered that it effectively did so, and therefore the UK bank’s non-payment was to comply with a mandatory provision of law.

This decision will be of interest to UK financial institutions operating internationally and navigating foreign sanctions regimes.

Background

Cynergy, an English retail bank, borrowed £30 million as Tier 2 Capital from Lamesa, a Cypriot bank ultimately owned by an individual who, during the term of the facility agreement, became subject to US sanctions. As a result, persons dealing with Lamesa also became subject to the provisions of US secondary sanctions legislation.

In refusing to make payments under the facility agreement “to comply with a mandatory provision of law”, Cynergy relied upon section 5(b) of the US Ukraine Freedom Support Act 2014 (UFSA), which provides that the President of the US shall impose a sanction on foreign financial institutions which facilitate a significant financial transaction on behalf of sanctioned individuals or entities. UFSA allowed sanctions to be applied to Cynergy as a non-US person because it carried on its US$ denominated business via a correspondent bank account in the US.

Why was non-payment justified?

At first instance, the High Court found that Cynergy’s non-payment was justified. The Court of Appeal agreed, although for different reasons. In particular, the Court of Appeal noted that the High Court’s analysis had overlooked the fact that the facility agreement was on standard terms, which meant that the factual matrix and the parties’ intentions had a much more limited role to play. It had also overlooked the general considerations that clear words are needed before a payment obligation can be extinguished, and that in construing any contract a court must take into account both parties’ commercial considerations.

The Court of Appeal acknowledged that the clause was capable of two meanings: the first, put forward by Lamesa, that the reason for non-payment must be to comply with a statute which binds Cynergy and directly requires it not to make payments; the second, put forward by Cynergy, that the reason for non-payment must be to comply with an actual or implied prohibition on making payments.

The Court favoured the second reading. In doing so, and in balancing the parties’ competing commercial considerations, Sir Geoffrey Vos considered it was important that the clause in question merely extinguished Cynergy’s default rather than its underlying payment obligation – the consequence of the clause was that Cynergy was not in default for non-payment during the period Lamesa was subject to US secondary sanctions.

There were three other important aspects of admissible context and commercial common sense. First, the clause was a standard clause in loan agreements used for Tier 2 Capital and was intended to be used by international banks. Second, US secondary sanctions would have been at the relevant time one of the potential problems affecting international banks in the EU dealing with Tier 2 Capital requirements and this would have been known to the drafters of the provision. Third, terms used in the EU Blocking Regulation made clear that US secondary sanctions legislation impose a requirement or prohibition with which EU entities must comply, and that also must have been known to the parties and drafters of the clause.

On the other hand, if the clause only referred to mandatory provisions of law that bound the borrower directly, it would have almost no possibility of taking effect. The Court therefore concluded that, “once the US legislation is seen, as it must be, as an effective prohibition, Cynergy’s reason for non-payment is indeed to comply with it”.

What does the Court of Appeal’s decision mean for financial institutions navigating foreign sanctions law?

The Court of Appeal’s decision illustrates the wider emphasis that the courts are placing on banks and other financial institutions in complying with their international obligations, particularly in relation to identifying and tackling financial crime. As always with matters of construction, the decision is heavily fact-specific, and the Court took pains to point out that the loan was not an ordinary one and that the international dimension was important. Institutions concerned about the possibility of exposure to foreign sanctions would be advised, wherever possible, to use clauses which specifically refer to sanctions. All the same, the decision does give financial institutions a level of comfort that attempts to comply with international obligations will be supported by the courts.