The English High Court has given effect to the terms of a loan agreement relieving a financial institution of the obligation to make interest payments, where to do so would risk the imposition of restrictions under the US secondary sanctions regime.

In December 2017, UK-registered bank Cynergy Bank Limited (Cynergy) entered an English-law loan agreement with Lamesa Investments Limited (LIL), by which LIL lent £30 million to Cynergy. Cynergy agreed to make interest payments to LIL twice a year through the life of the loan.

LIL was, and at the time of the judgment apparently still is, part of a group ultimately wholly-owned by Mr Viktor Vekselberg. In April 2018 (that is, a few months into the life of the loan), Mr Vekselberg was designated as a "Specially Designated National" or "SDN" by the US authorities – meaning he became a target of the US sanctions regime. In consequence, LIL became a "blocked person" under that regime because of its indirect ownership by Mr Vekselberg. Once Mr Vekselberg became a SDN, US law prohibited any US citizen anywhere in the world, anyone dealing with property subject to US jurisdiction, and anyone operating in the US from dealing with him (as an SDN), or with LIL (as a blocked person); the so-called primary sanctions regime.

Importantly for Cynergy, US law also penalises foreign financial institutions (or other foreign entities) that knowingly facilitate a "significant financial transaction" with an SDN or blocked person, even if there is no US nexus and the transaction would not be prohibited by primary sanctions. These so-called secondary sanctions can result in foreign financial institutions being cut off from the US financial system, including being prevented from opening or maintaining a correspondent bank account in the US, subject to an exception where the US President considers the prohibition is not in the US national interest or US national security interest.

So, if the act of making interest payments under the loan was considered to be a "significant financial transaction", and unless the US President considered that engaging secondary sanctions against Cynergy was not in the US national interest or national security interest, by making interest payments to LIL Cynergy risked a commercially disastrous prohibition on maintaining a US correspondent account. Cynergy needed such an account to carry on banking business denominated in US dollars, and the Court heard that the balance in its US correspondent account was c.US$15 million. In Cynergy's words, the impact of the imposition of secondary sanctions on it would be "obviously ruinous".

Cynergy stopped making interest payments to LIL (reportedly totalling £3.6 million to date). It relied on clause 9.1 in the loan agreement which provided (in part):

"[Cynergy] shall not be in default if...such sums were not paid in order to comply with any mandatory provision of law, regulation or order of any court of competent jurisdiction."

Specifically, Cynergy argued that the US secondary sanctions regime was a "mandatory provision of law" within the meaning of this clause 9.1, and it was refraining from making interest payments in order to comply with that mandatory provision.

LIL brought proceedings in England, asking the Court to rule on the proper construction of clause 9.1 and whether Cynergy continued to be obliged to make interest payments under the loan.

LIL argued that the word "mandatory" only excuses a default where a provision makes it compulsory for Cynergy to refrain from paying – and that the US secondary sanctions regime did not have this effect. Rather, LIL contended, Cynergy was refraining from making payments in order to avoid the risk of a sanction being imposed on it. LIL further argued that the words "provision of law" mean a law that applies to a "UK party, acting in the UK, that has agreed to make a sterling payment pursuant to a contract governed by English law." It further contended that the orthodox English common law position should prevail, namely that (without more) English law will not excuse contractual performance by reference to foreign law unless that law is the law of the contract or the law of the place of performance.

The Court disagreed. His Honour Judge Pelling QC held that, on its proper construction in the factual context of this agreement, clause 9.1 meant that Cynergy was not in default for declining to make interest payments to LIL while LIL remained a blocked person:

  • The US secondary sanctions regime was a "mandatory provision of law" within the meaning of clause 9.1 because it was not something one or both of the parties could elect to vary or disapply.
  • There was nothing in the wording of clause 9.1 to suggest the parties intended its effect to be limited to English law.
  • The English common law position could be varied by the parties' express contractual agreement.
  • Compliance with mandatory provisions means acting – or refraining from acting – so as to avoid the possible imposition of sanctions, and the words "in order to comply" should be understood in that light. The possibility that LIL would become subject to US sanctions was known or assumed by the parties at the time of entering the loan, and in this factual context the parties must have intended clause 9.1 to address the risk that US secondary sanctions might bite against Cynergy, in the event LIL became a blocked person. Further, on the facts, Cynergy's dealings with LIL would not in any event put it at risk of breaching primary sanctions – so clause 9.1 would serve no purpose if it only excused payments that would contravene primary sanctions.

What does this mean?

The Court's ruling means that Cynergy can rely on the contractual protection afforded by clause 9.1 of the loan agreement to refrain from making interest payments to LIL, at least while LIL remains a blocked person for the purposes of US sanctions.

While every case will depend on the specific contractual wording and the particular factual circumstances, this judgment does afford some comfort to non-US financial institutions that, with the right drafting, the English Court is prepared to recognise and give effect to the parties' bargain anticipating and allocating the risk of a future US sanctions designation, including secondary sanctions – and that "mandatory provision of law" is capable of being interpreted to include the US secondary sanctions regime.

Next steps

Financial institutions will already be aware of the significance of the US secondary sanctions regime, and the importance of caution in dealing with SDNs or blocked persons, even where a transaction has no US connection. This case reflects the commercial pragmatism of the English Court in giving effect to the parties' bargain, but each case will turn on its own factual context and contractual wording. Financial institutions will want to consider whether terms they have in place with counterparties that might be affected by sanctions are wide enough to protect their position but for now the decision lends support to the argument that US secondary sanctions also have teeth.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.