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The Court of Appeal, in Lamesa Investments Ltd v Cynergy Bank Ltd [2020] EWCA Civ 281, has found that a party in an English law governed “Tier 2 Capital” subordinated facility agreement with contractual language addressing illegality of

Can You Withhold a Payment of Interest to Comply with U.S. Secondary Sanctions Law?

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The Court of Appeal, in <a target="_blank" href="https://www.bailii.org/cgi-bin/format.cgi?doc=/ew/cases/EWCA/Civ/2020/821.html">Lamesa Investments Ltd v Cynergy Bank Ltd [2020] EWCA Civ 281</a>, has found that a party in an English law governed “Tier 2 Capital” subordinated facility agreement with contractual language addressing illegality of borrower obligations, was justified in refusing to pay interest in order to comply with U.S. sanctions law. This alert discusses the key findings of the judgment, and it will be of interest to international businesses seeking to monitor their risk to U.S. secondary sanctions.<h4>BACKGROUND</h4>Lamesa Investments Limited (Lamesa), a Cyprus company, was a subsidiary of Lamesa Group Incorporated, which was wholly owned by the Russian billionaire Viktor Vekselberg. Vekselberg was <a target="_blank" href="https://home.treasury.gov/news/press-releases/sm0338">designated </a>by the Office of Foreign Assets Control (OFAC) as a U.S. Specially Designated National (SDN) in April 2018 under <a target="_blank" href="https://www.treasury.gov/resource-center/sanctions/Programs/Documents/ukraine_eo3.pdf">Executive Order No. 13662</a>.Cynergy Bank Limited (Cynergy), a UK retail bank, entered into an English law governed facility agreement with Lamesa on 19 December 2017 (the Facility Agreement) for the purpose of meeting its Tier 2 capital requirements. Under the Facility Agreement, Lamesa lent Cynergy £30 million and Cynergy was contractually obliged to pay interest on this amount.When Vekselberg was named a SDN, Lamesa became a “blocked person”, subject to the same sanctions as Vekselberg due to Vekselberg’s beneficial ownership of Lamesa. Under section 5(b) of the U.S. legislation, <a target="_blank" href="https://www.congress.gov/113/plaws/publ272/PLAW-113publ272.pdf">Ukraine Freedom Support Act 2014</a> (UFSA), as amended, non-U.S. financial institutions may face secondary sanctions if they facilitate significant financial transactions on behalf of a SDN. The sanctions that may be imposed include a prohibition on the party maintaining a correspondent account in the U.S.; Cynergy maintained such an account with a U.S. bank.  When Lamesa became a blocked person, Cynergy refused to pay interest to Lamesa and relied on clause 9.1 of the Facility Agreement to do so:“[Cynergy] shall not be in default if during the 14 days after [Lamesa's] notice it satisfies [Lamesa] that such sums were not paid in order to comply with any mandatory provision of law, regulation or order of any court of competent jurisdiction.”The key question in the High Court and the Court of Appeal was whether the provision above allowed Cynergy to withhold payment of interest in order to comply with UFSA.<h4>WHAT HAPPENED IN THE HIGH COURT?</h4>In his <a target="_blank" href="https://www.bailii.org/ew/cases/EWHC/Comm/2019/1877.html">judgment</a>, HHJ Pelling QC (the trial judge) found that Cynergy was entitled to withhold payment to Lamesa “in order to comply” with UFSA, as it was a “mandatory provision of law” for the purposes of the Facility Agreement. The trial judge ordered that Cynergy would not be in default of the Facility Agreement for non-payment for as long as Lamesa remained a blocked person.When making his decision, the trial judge applied the English law contractual principles that the relevant words of a contract should be assessed in their documentary, factual and commercial context.On that basis, the trial judge found that there were no territorial restrictions on the meaning of “regulation”, and that “mandatory” meant a provision of law that the parties cannot vary or dis-apply, rather than a law that requires a party to comply. This meant that the High Court found that UFSA was a mandatory provision of law under the Facility Agreement.On the meaning of the phrase “in order to comply”, the trial judge found that clause 9.1 of the Facility Agreement was drafted widely to mitigate risk, and that the meaning of the phrase included situations where a party acts, or refrains from acting, to avoid the possibility of being subject to a sanction or penalty.<h4>WHAT DID THE COURT OF APPEAL DECIDE?</h4>In the Court of Appeal, the Chancellor, Sir Geoffrey Vos, Males LJ and Arnold LJ unanimously affirmed the High Court’s decision; however, the Court of Appeal did not entirely agree with the trial judge’s reasons.The Chancellor, who gave the leading judgment, found that the High Court overlooked the fact that clause 9.1 of the Facility Agreement was a standard form clause, in common usage at the time. However, like the High Court, the Court of Appeal found that it was important to look at the broader commercial context when interpreting the clause. While the Court of Appeal did not accept the High Court’s meaning of the term “mandatory”, instead finding that it meant “compulsory or required”, it did find that the parties would have been aware of the EU Blocking Regulation (<a target="_blank" href="https://eur-lex.europa.eu/legal-content/EN/TXT/HTML/?uri=CELEX:31996R2271&from=EN">Council Regulation (EC) 2271/66</a>). This regulation describes U.S. secondary sanctions (albeit, not UFSA) as requirements with which EU parties are required to “comply”.While the Court of Appeal accepted that U.S. legislation could not prohibit a payment between two EU based entities, it found that the risk of sanctions is an “effective prohibition”, and that Cynergy’s reason for non-payment was to comply with it.Arnold LJ expressed his reservations on the Chancellor’s analysis, stating that the risk that Cynergy would actually be sanctioned by paying interest to Lamesa should be taken into account, referring to <a target="_blank" href="https://www.treasury.gov/resource-center/faqs/Sanctions/Pages/faq_other.aspx#542">OFAC’s guidance</a> on this matter. Ultimately, however, Arnold LJ agreed with the Chancellor’s judgment. <h4>COMMENT</h4>The Court of Appeal’s decision will provide some comfort to international businesses seeking to comply with U.S. sanctions, but note that the case turns on wording that, firstly, was not designed with sanctions in mind and, secondly, is not common in ordinary investment grade and leveraged finance loan agreements where the relevant illegality provisions are protective of illegality for performance by lenders, not borrowers. Therefore a borrower faced with a similar situation under e.g. a Loan Market Association-style English law loan agreement may need to turn to English law principles of impossibility and frustration of contract.The decision does show that, in certain contexts, U.S. secondary sanctions may amount to a “mandatory provision of law”, which could in any event be useful in excusing a party from performance in a commercial agreement if that would put them at risk of being sanctioned either under express contractual language, for example a lender under a standard contractual illegality provision, or absent such language, in forming a case of impossibility or frustration under the common law.Taking into account the importance that the High Court and the Court of Appeal placed on the interpretation of the words in the Facility Agreement, parties to such agreements should exercise caution when drafting clauses that are intended to provide for sanction risks. Those parties may also wish to consider including clauses in their commercial agreements that explicitly set out the consequences when a party’s performance of an agreement would put it at risk of being sanctioned.Dan Alam, London Trainee Solicitor, contributed to the drafting of this alert.

Can You Withhold a Payment of Interest to Comply with U.S. Secondary Sanctions Law?