European Union: High Court Confirms Debtor Must Prove Illegality Where Payment Withheld As A Result Of Sanctions

The High Court has allowed a summary judgment application by a lender and guarantor in their claim against a borrower for sums due under various loan agreements following a default, finding that the defendant's reliance on the imposition of European Union (EU) sanctions in its defence of the claim had no real prospect of success: The European Union & Anor v The Syrian Arab Republic [2023] EWHC 1580 (Comm).

The decision will be helpful for financial institutions dealing with the enforcement of contractual obligations where one or more of the counterparties are subject to international sanctions. It provides guidance on which party has the burden of proving that payment under a contract would result in a breach of sanctions under the relevant law, in order to rely upon the doctrine that a contract is unenforceable if performance is prohibited by the law of the place of performance (per Ralli Bros v Compania Naviera Sota y Aznar [1920] 2 KB 287).

The judgment confirms that it is for the debtor to prove that payment would be illegal under the relevant foreign law. Where the relevant sanctions regime contains a dispensation provision, this will include proving that the debtor has made "reasonable efforts" to apply for a licence to make payment from the relevant authority responsible for administering the sanctions regime; or alternatively to prove that, even had such efforts been made, a licence would actually have been refused (per Banco San Juan Internacional Inc v Petroleos De Venezuela SA [2020] EWHC 2937 (Comm)).

We consider the decision in more detail below.

Background

Between 2004 and 2008, the European Investment Bank (EIB) agreed to lend the borrower sums for specific infrastructure and development projects. The borrower's repayment obligations were guaranteed by the EU.

In May 2011, the EU imposed sanctions (which were later consolidated into Council Regulation (EU) 36/2012 (the 2012 Regulation)). The 2012 Regulation provides that all funds and economic resources belonging to, owned, held or controlled by the natural or legal persons, entities and bodies subject to sanctions can be frozen under Article 14.1. The borrower/Central Bank of Syria (the Bank) were included in the list of entities whose accounts were frozen under the 2012 Regulation. The imposition of sanctions made the payment of any further instalments after that date unlawful. Since December 2011, the borrower has defaulted on its repayments under the loans.

Following the imposition of sanctions, the Bank gave instructions to certain banks to make payments under the loan agreements, which those banks likely refused to make on the basis that such a payment might be in breach of the sanctions. In 2014/2015 the Bank sought the help of the EIB to resolve the situation, but the EIB explained that the obligation to repay the loans remained solely with the borrower until the funds were actually received by the EIB, and strongly recommended that the Bank continue to explore the possible alternative means of repayment.

The EU and EIB subsequently brought proceedings against the borrower and applied for summary judgment. The borrower was informed about the summary judgment application against it and hearing date, but did not attend or make representations to the court.

The court determined that it was just and appropriate to proceed to hear and determine the application in the absence of the borrower. However, the court said it would consider all the matters raised in the borrower's defence to ascertain whether they indicated that a different conclusion should be reached on the EU's and EIB's application. The defence was filed but not served and so had no formal status in the proceedings, but was used to understand the borrower's arguments for the purpose of the application.

According to the defence, the borrower's case was that it should not be obliged to make redress for damage that was caused by the EU and EIB's own fault, ie the fact that the EU imposed sanctions on the borrower, freezing its funds and making it impossible for the borrower to pay, or for the EU and EIB, to receive payments from the borrower. Various other arguments were raised in the defence, but the court noted that this was the only defence raised that had any possible substance, and so this is the focus of our analysis below.

Decision

The High Court found in favour of the EU and the EIB and allowed their summary judgment application.

Impact of sanctions

Turning to the authorities, the court pointed out that a similar issue had been considered in The European Union & Anor v The Syrian Arab Republic [2018] EWHC 1712 (Comm) where the court concluded that even if the defendant were to identify any point in relation to sanctions impinging upon its ability to make payment, it could seek derogation in relation to that matter. The 2012 Regulation contains an express derogation whereby EU Member States and competent authorities can authorise the release of frozen funds where a payment was due under a contract concluded before the date upon which the paying party became subject to sanctions (Article 20). The Bank in the present case had not obtained a such derogation.

The court then considered the application of the doctrine in Ralli Bros, which provides that an English law governed contract is unenforceable if performance is prohibited by the law of the place of performance. The court referred to the analysis of this rule in the context of sanctions in Banco San Juan, which confirmed the following principles:

• It is only illegality in the place of performance which provides an excuse under the doctrine.
• The party relying on the doctrine will (in general) not be excused if they could have done something to bring about valid performance and failed to do so.
• Where payment is unlawful as a result of sanctions, lawful performance is possible where the relevant regime contains a dispensation provision, which allows for disapplication of sanctions if a licence is obtained.
• The burden of proof in relation to the possibility of obtaining a license is on the party who has failed to pay (as per Libyan Investment Authority v Maud [2016] EWCA Civ 788) – they must make "reasonable efforts" to apply for a licence, or prove that, even had such efforts been made, a licence would actually have been refused.

The court noted that in Banco San Juan there was specific evidence that licenses could have been obtained and, indeed, an express provision in the relevant agreements that the debtor was obliged to apply for such licenses. However, the court expressly stated that – even in the absence of such factors – a debtor still has the responsibility to prove that they could not make a payment legally under the relevant foreign law because they could not get a license.

The court concluded that it was satisfied that the court's statements in Banco San Juan properly represented the laws of England and, on that basis, at any trial there would be a clear burden of proof on the borrower to establish that the express derogation contained in Article 20 of the 2012 Regulation would not have assisted it, had it sought to obtain a license. There was no suggestion in the borrower's defence to that effect and there was no evidence before the court that would indicate either: (1) that the borrower intended to try to discharge that burden; or (2) that if it did make such an attempt, that there would be any basis upon which it could succeed.

Accordingly, the court found in favour of the EU and EIB and allowed their summary judgment application.

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