Sanctions clauses in letters of credit can cause payment uncertainty for parties involved in international trade. The Singapore Courts recently considered the validity and enforceability of a sanctions clause in a letter of credit.

Facts

The bank advised and confirmed a letter of credit but added a clause stating i. it is obliged to comply with US and other sanctions laws; and ii. if the documents presented involve a country, vessel or individual which is the subject of any sanctions it would not be liable for any failure to pay. As the cargo was shipped on a vessel believed to belong to a Syrian entity the bank relied on this clause to refuse payment to the beneficiary.

High Court Decision

The High Court agreed that the bank was entitled to do so, and the key findings are set out briefly below.

  • The sanctions clause could be inserted in the confirmation even though it was not found in the letter of credit itself.
  • The sanctions clause was not a "non-documentary condition" and did not contradict the fundamental commercial purpose of the confirmation.
  • The sanctions clause was not too widely drafted and did not confer a high level of discretion on the bank.

Court of Appeal Decision

The Court of Appeal found that the bank was not entitled to rely on the sanctions clause as it had failed to prove on a balance of probabilities that the vessel was owned by a Syrian entity. The key findings are set out briefly below.

  • The sanctions clause was to be strictly construed and allowed the bank to decline payment where the country, entity, vessel or individual is (i) "listed in ... any applicable restriction"; or (ii) "otherwise subject to any applicable restriction". It was accepted that "applicable restriction" meant the publicly available OFAC list. The vessel was not on this list but on the bank's internal list. Therefore, the question that remained was whether the vessel was "otherwise subject to any applicable restriction".
  • In the lower court the bank successfully relied on correspondence with OFAC and the unchallenged expert opinion of a US lawyer which suggested that the bank would be in breach of US sanctions against Syria if it paid the beneficiary.
  • The CA, however, took the view that such evidence "merely demonstrated that there were risks that the vessel may be subject to an applicable restriction" and rejected the evidence as being relevant to the burden of proof on JP Morgan to show on a balance of probabilities that the vessel was owned by a Syrian entity.
  • The CA carefully examined the circumstantial evidence which the lower court accepted as sufficient to prove a Syrian connection to the vessel and concluded that such evidence was inconclusive on this question. Therefore, the bank failed to establish that it was entitled to rely on the sanctions clause.
  • The reason the bank found itself in this position was that the bank's approach was "not predicated on an objective yardstick but was likely to have been shaped by risk management considerations. ... such an approach is not permissible as it is not in accordance with the terms of the Sanctions Clause". In other words, the bank assessed that it was less risky not to pay than to potentially breach sanction laws.
  • The CA went on to express its views on whether the sanctions clause was compatible with the commercial purpose of the bank's confirmation of the credit. While leaving the point open as it was not necessary to decide it, the CA expressed concern that sanctions clauses could run counter to the commercial purpose of a letter of credit. This was because of the uncertainty that would confront a beneficiary especially in a case such as this where the beneficiary may not know who the real beneficial owner of the vessel was.

Learning Points

The case demonstrates that the courts will take a very strict approach to the interpretation of sanctions clauses and will hold a bank seeking to rely on such a clause to strict proof that it is entitled to do so.

Banks must be careful to understand the scope of its sanctions clauses and have sufficient evidence that a payment would involve a person, entity, or ship from a sanctioned country. This is a factual matter and an expert opinion would not suffice. As the CA put it, "the question of whether a vessel is "subject to any applicable restriction" should be determined on an objective basis without third-party input from entities such as OFAC."

Issuing and confirming banks should do sufficient due diligence on the parties and the transactions (including the goods and the vessel) to mitigate sanction issues instead of simply relying on sanction clauses which (a) requires the bank to discharge its burden of proof and (b) requires the bank to face the risk that the court may find that the sanction clause runs contrary to the commercial purpose of the letter of credit or confirmation.

Originally published October 05, 2023

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.