This article was originally published in Thomson Reuters Regulatory Intelligence here.
Payments and interest owed to sanctioned entities
Two recent cases shed light on these issues.
Occurrence of interest on sums owed to sanctioned entities
In July, the High Court gave judgment in Ministry of Defence and Support for Armed Forces of the Islamic Republic of Iran (“MODSAF”) v. International Military Services Limited (“IMS”). This decision focused on whether, under EU regulation 267/2012, interest continues to accrue on payments to entities while they are sanctioned. It raises wider implications for companies that have payment obligations to sanctioned entities under any formal commitments, provides reassurance to commercial creditors, and offers important guidance to debtors involved in payment disputes that are impacted by the imposition of sanctions.
The dispute arose out of two contracts concluded in the 1970s, prior to the Iranian Islamic Revolution pursuant to which IMS (an English company, majority-owned by the UK Ministry of Defence) agreed to supply Chieftain tanks and Armoured Recovery Vehicles to MODSAF. The contract, dated 6 February 1979, created a dispute between the parties as to the balances payable.
This led to two ICC arbitrations. The first was commenced by MODSAF in 1990 and the second by IMS in 1996. In May 2001, the ICC tribunal rendered final awards in both: awarding in favour of MODSAF in the first (“7071 Award”) and dismissing IMS’s claim under the second (“9268 Award”). The 7071 Award was later adjourned pending a decision from the Hauge and the Supreme Court of Netherlands. IMS was eventually ordered to pay MODSAF £127,651,823 plus costs and, as part of its claim, MODSAF seeks interest at LIBOR +0.5 from 28 July 1984 to the date of payment.
In June 2008, prior to a payment being made, MODSAF was subject to sanctions imposed against Iran by EU Council Regulation 423/2007 (presently Regulation 267/2012). The parties agree that the sum due under the award cannot be paid to MODSAF while it remains under sanctions. IMS argued that MODSAF is not entitled to enforce the interest component of the 7071 Award in respect of the period from the date of sanction listing of MODSAF.
To facilitate payment, MODSAF made a licence application under Article 25(a) of Regulation 267 to enable payment of sums due under the Awards to the Central Bank of Iran (“CBI”), which had been delisted in January 2016. IMS does not accept that this licensing route is available to MODSAF and the application outcome was unknown when the judgment was made.
The ultimate question was once sanctions imposed upon MODSAF are lifted and payments permitted, will IMS have to pay interest on the amounts it owes under the arbitral award for the period since MODSAF became a designated entity in 2008? In his judgment, Phillips J carefully considered Article 38 of Regulation 267, which provides that no claims made by sanctioned entities, in connection with any contract or transactions, the performance of which has been affected by the Regulation, shall be satisfied.
MODSAF raised arguments against the applicability of Article 38, including that the original dispute and Award pre-dated the imposition of sanctions and that the claim was not arising out of a contract or transactions whose performance was impacted by the Regulation.
The English Court did not agree, concluding that protection provided by Article 38 extended to the payment of interest accrued on an arbitration award while the debtor was sanctioned. The Court agreed that although the existence of the claim may not have been based on the sanctions, its content (insofar as it concerns interest) did result from the sanctions. Therefore, MODSAF will not be able to obtain interest on the pending award since June 2008. It does not, however, impact the Award and any accrued interest prior to June 2008 and the question of payment remains an issue between the parties.
Re-payment of monies owed to a US SDN-listed entity
In September, the English Court gave a judgment in Lamesa Investments Limited (“Lamesa”) v Cynergy Bank Limited (“Cynergy”), a claim brought by a Cypriot lender (Lamesa) against an English borrower (Cynergy). It concerned the interpretation of a loan agreement clause which provided that the borrower would not be in default if it refused to make repayments “in order to comply with any mandatory provisions of law.” The Court held that this would extend to US secondary sanctions.
After a few repayments under the facility agreement, the beneficial owner of the lender became an SDN sanctioned entity. The relevant US secondary sanctions provided that the executive would have power to impose sanctions on non-US persons that facilitated a significant transaction with a US sanctioned entity. The Court’s judgment agreed with Cynergy’s arguments in withholding repayments to the lender and that the US secondary sanctions constituted a mandatory provision of law within the meaning of the facility agreement.
Lamesa was unsuccessful in arguing against this interpretation on grounds that there was no US-related connection between the parties and that the US secondary sanctions had no legal effect in England. This judgment raises interesting implications for financial institutions that may not be directly caught by US primary sanctions, but find themselves in a difficult position: at risk of being subject to secondary sanctions for facilitating a significant financial transaction involving a SDN-listed entity.
These judgments, raise important points for financial institutions:
1. The Lamesa judgment reflects the importance of careful drafting of relevant provisions in facility agreements and similar documents - in this case, the relevant term provided for Cynergy to withhold payment to comply with any mandatory provision of law, regulation or order of any competent jurisdiction. The Court upheld what it construed to have been the parties’ intention and a risk that they were entitled to manage by agreement. The Court acknowledged that a significant part of Cynergy’s business was USD denominated, although it had no presence in the US jurisdiction.
2. More importantly, with the wide nature of the US secondary sanctions, which can potentially target non-US banks and financial institutions for providing services to a US-listed entity, many financial institutions are at risk of being caught by them. Consequently, they could, potentially be completely cut off from the US financial system making it impossible for them to clear USD transactions. Therefore, the recent judgment of the English Court provides insight into how financial institutions can use the correct wording in agreements to protect themselves and provide an automatic way out from being caught by US secondary sanctions.
3. Although the issues in the MODSAF judgment related to an arbitration award involving a commercial dispute, Phillips J’s judgment provided judicial comfort to the position stated in the OFSI’s “Financial Sanctions Guidance”. The OFSI’s Guidance states that “If a court has ordered a judgment in favour of a person subject to an asset freeze, under EU regulations, and there are no licensing grounds to allow the payment to be made, the third party cannot be made subject to any further liability (such as accruing interest) for their non-payment while the sanctions continue to apply”. This could equally apply to judgments and orders against financial institutions in transactions involving sanctioned entities.
It clearly highlights the importance of OFSI’s guidance for commercial parties and financial institutions dealing with sanctioned entities. Financial institutions should continue to maintain effective sanction policies to prevent a direct or indirect payment to sanctioned entities without the existence of the appropriate licence. As shown in this case, the OFSI can take an extensive and unpredictable amount of time to decide over licence applications.
4. While the MODSAF case concerned the application of restrictive measures on Iranian entities, most comparable EU measures contain equivalent provisions, including restrictive measures imposed on Russian, Syrian and Venezuelan entities. Similar provisions are likely to continue after Brexit and a comparable sanctions regime is likely to be created under the Sanctions and Anti-Money Laundering Act. Provisions similar to Article 38 are particularly likely as they provide comfort to UK-based businesses (including financial institutions) which would find themselves in a difficult position to honour judgments or arbitration awards due to the imposition of sanctions on foreign entities. Although the judgment provides reasonable comfort in similar cases, each case concerning an applicable provision under a restrictive measure will need to be thoroughly considered based on its surrounding facts.