Impact of sanctions on payment obligations - Take II

Refusal to pay under letters of credit

UniCredit had refused to pay demands under stand-by letters of credit which it had confirmed, believing that to have done so would be in breach of sanctions against Russia. The letters of credit which UniCredit confirmed had been issued by Sberbank, a Russian bank, and secured obligations arising under leases of aircraft to Russian entities entered into several years before the sanctions came into effect. Both aircraft finance transactions and Sberbank were sanctioned.

UK Sanctions

The UK sanctions prohibit providing financial services or funds “in connection with” an arrangement whose object is the supply of an aircraft to a Russian entity. Celestial Aviation had successfully argued, before the High Court, that confirming a letter of credit in relation to a transaction that had been entered into long before the sanctions came into effect did not fall within the scope of the sanctions. The Court of Appeal rejected this finding. The court stated that the sanctions did bite on transactions entered into before the sanctions came into effect. They were intended to be a “blunt instrument” to catch all potentially objectionable arrangements. Parties could apply for a license to continue with their transaction if they felt their transaction should be allowed to continue. This UniCredit had done, and it was granted a license by the time of the High Court hearing. As a result the dispute was in fact only about costs and interests, though as precedent the impact is wider.

Protection for acts done for purposes of compliance

The UK regime states that a person will not be liable “to any civil proceedings” for an act (or omission) carried out in the “reasonable belief” that it is in compliance with sanctions. Having found that the sanctions did not apply, the High Court had held, alarming many, that UniCredit’s belief that they did was not reasonable.

Since the Court of Appeal found that payment was sanctioned, its observations here are not binding. Nonetheless, it is a relief to those many that the court viewed UniCredit’s belief as reasonable. 

More troublesome, however, are the court’s views on what liabilities are protected. The court said that the purpose of the protection is to ensure that a person is not pressurised into doing something that risks breaching sanctions by a fear of being exposed to civil claims. The provision, the court said, is concerned to protect against a liability which is created as a result of something done (or not done) in the reasonable belief that it is in compliance with a sanctions regulation. The provision is not, the court continued, concerned to protect against pre-existing liabilities.

The result of this analysis was that, even though UniCredit held the requisite “reasonable belief”, it was not immune from an action to recover a debt, nor any associated costs and interest. The example given of what would be protected was a seller concerned that a failure to deliver goods could expose it to claims from the buyer for loss of profit and/or to recover amounts for which the buyer becomes liable to its own customers.

U.S. sanctions

The final point the Court of Appeal had to rule on was whether the potential illegality under U.S. sanctions affected UniCredit’s obligation to pay. The terms of the letters of credit required UniCredit to pay in U.S. dollars to a designated account. The English courts will not enforce a contractual obligation which requires a party to act unlawfully in the required place of performance (known as the rule in Ralli Brothers). Making payments strictly in accordance with the letters of credit would require payments to pass through the U.S. banking system and thereby potentially breach sanctions. The High Court had held that the terms of the letters of credit did not preclude UniCredit from paying in cash, bypassing the need to use U.S. banks. The Court of Appeal disagreed. Whether payment in cash was acceptable was a matter of interpretation. Demands under the letters of credit for cash would not be in strict compliance with their terms and therefore invalid. The rule in Ralli Bros applied in principle. However, the court held that UniCredit had not made sufficient efforts to obtain a license under U.S. sanctions to make the payments and so was ultimately precluded from relying on Ralli Bros.

Take care with sanctions

Care should be taken when dealing with sanctions as their scope will usually be interpreted widely particularly if there is a licensing regime which may permit parties to continue with legitimate business. Sanctions will trump the autonomy principle that makes letters of credit independent from their underlying transaction. Beneficiaries of letters of credit might also want to consider adding provisions to allow alternative methods of payment if they are concerned about their first choice of method of payment becoming sanctioned.

Judgment: Celestial Aviation v UniCredit