Court Cautious on Sanctions and Letters of Credit
The Court of Appeal has delivered a decision in Celestial Aviation Services Ltd. V. UniCredit Bank GmbH, London Branch[1] in relation to whether UniCredit could withhold payment under certain letters of credit in light of international sanctions imposed on Russia and many of its institutions by the United Kingdom, the United States and the European Union (the Sanctions) following Russia’s invasion of Ukraine – a decision which will be of interest to the aviation finance community.
Background
The claimant lessors (the Lessors) had delivered aircraft to two Russian companies pursuant to leases that were secured with standby letters of credit (the Letters of Credit) issued by Sberbank Povolzhsky in Russia and confirmed by UniCredit.
Upon termination of the leases in March 2022, the Lessors demanded payment from UniCredit under the Letters of Credit. UniCredit claimed it was unable to pay on the basis of the Sanctions and, as a result, the Lessors issued proceedings in the UK, claiming the amount owed in debt (or alternatively in damages), interest, a declaration in relation to the Sanctions position and costs.
The UK Regulations
Following Brexit, the UK introduced its own sanctions regime to replace the EU sanctions regime, which were amended on 1 March 2022 as a reaction to Russia invading Ukraine. The amended Regulation 28 (3) of the Russia (Sanctions) (EU Exit) Regulations 2022 (Regulation 28) prevents financial services being provided “in pursuance of or in connection with” an arrangement, the “object or effect” of which captures the supply of restricted goods (including aircraft) to Russia or their making available for use in Russia, without a specific licence. The licencing framework allows exceptions if the party demonstrated that the financial transaction was necessary to fulfill pre-existing obligations under contracts signed before sanctions were imposed.
Commercial Court Decision
The first instance case was heard at the Commercial Court in which the court ruled in favour of the Lessors, holding that:
- the Sanctions could not apply retrospectively to the Letters of Credit (which were issued prior to the applicable Sanctions);
- the Letters of Credit were autonomous, stand-alone obligations separate from the leases and were not caught by the Sanctions;
- the payments by UniCredit under the Letters of Credit were to benefit the Lessors and were not intended to benefit the Russian entities; and
- UniCredit could not rely on section 44 of the Sanctions and Anti-Money Laundering Act 2018 (SAMLA), which could have provided a defence to payment if UniCredit could show it had a reasonable belief that it was complying with the Sanctions when it was withheld payment from the Lessors. The court found that UniCredit held this belief subjectively but it was not reasonable for it to hold this.
Court of Appeal Decision
The Court of Appeal overturned the Commercial Court’s ruling and interpreted Regulation 28 broadly, holding that payment under the Letters of Credit would have constituted the provision of “funds” that facilitated arrangements benefiting Russian airlines. Even if the funds were paid to parties unconnected with Russia, they would have been paid “in connection with” Russian interests, which fell under the broad scope of the Sanctions. The court emphasized that the Sanctions are intended as a “blunt instrument”[2] to broadly prevent objectionable arrangements.
Given its conclusion on Regulation 28, the Court of Appeal did not need to consider in detail whether the SAMLA defence applied but concluded that UniCredit had established a reasonable belief that its actions complied with the Sanctions, noting that “UniCredit was required to form a view about new legislation at short notice”[3].
No Enforcement of Illegal Contracts
It is of note that the Court of Appeal also referred to the principle of English law[4] that holds that English courts will not enforce a contract that requires performance of an act which is illegal in the place of performance. Given the involvement of U.S. banks in processing dollar payments, UniCredit argued that such payments would breach U.S. sanctions, making performance illegal in the place of execution. When considering the principle, the Court of Appeal considered whether UniCredit had made “reasonable efforts” to avoid illegality, such as obtaining a licence from the sanctions authorities allowing it to complete performance.
However, the court concluded that, although UniCredit had submitted a licence application to the U.S. Office of Foreign Assets Control, the application was narrowly focused on processing a payment by Sberbank. This limited scope fell short of constituting a “reasonable effort”, meaning that UniCredit would likely not have been able to rely on the principle.
Key Takeaways
The judgment is significant for financial institutions navigating overlapping sanctions regimes – it reminds us that UK sanctions will be interpreted broadly by the UK courts, aiming to ensure compliance even at the risk of catching some unintended arrangements.
Although outside the scope of the initial case, the Court of Appeal decision highlights that the prohibition on enforcement of illegal contracts cannot be used as a blanket defense where other avenues to comply with the contracts are available, such as securing a licence – as Regulation 28 is interpreted broadly, the response needs to be suitable applications for any relevant licences for exemptions.
In line with expectations in the market, the Court of Appeal’s interpretation of the SAMLA defence continues to support the adoption by business of a cautious approach when interpreting and complying with sanctions prohibitions.
Vedder Thinking | Articles Court Cautious on Sanctions and Letters of Credit
December 18, 2024
The Court of Appeal has delivered a decision in Celestial Aviation Services Ltd. V. UniCredit Bank GmbH, London Branch[1] in relation to whether UniCredit could withhold payment under certain letters of credit in light of international sanctions imposed on Russia and many of its institutions by the United Kingdom, the United States and the European Union (the Sanctions) following Russia’s invasion of Ukraine – a decision which will be of interest to the aviation finance community.
Background
The claimant lessors (the Lessors) had delivered aircraft to two Russian companies pursuant to leases that were secured with standby letters of credit (the Letters of Credit) issued by Sberbank Povolzhsky in Russia and confirmed by UniCredit.
Upon termination of the leases in March 2022, the Lessors demanded payment from UniCredit under the Letters of Credit. UniCredit claimed it was unable to pay on the basis of the Sanctions and, as a result, the Lessors issued proceedings in the UK, claiming the amount owed in debt (or alternatively in damages), interest, a declaration in relation to the Sanctions position and costs.
The UK Regulations
Following Brexit, the UK introduced its own sanctions regime to replace the EU sanctions regime, which were amended on 1 March 2022 as a reaction to Russia invading Ukraine. The amended Regulation 28 (3) of the Russia (Sanctions) (EU Exit) Regulations 2022 (Regulation 28) prevents financial services being provided “in pursuance of or in connection with” an arrangement, the “object or effect” of which captures the supply of restricted goods (including aircraft) to Russia or their making available for use in Russia, without a specific licence. The licencing framework allows exceptions if the party demonstrated that the financial transaction was necessary to fulfill pre-existing obligations under contracts signed before sanctions were imposed.
Commercial Court Decision
The first instance case was heard at the Commercial Court in which the court ruled in favour of the Lessors, holding that:
- the Sanctions could not apply retrospectively to the Letters of Credit (which were issued prior to the applicable Sanctions);
- the Letters of Credit were autonomous, stand-alone obligations separate from the leases and were not caught by the Sanctions;
- the payments by UniCredit under the Letters of Credit were to benefit the Lessors and were not intended to benefit the Russian entities; and
- UniCredit could not rely on section 44 of the Sanctions and Anti-Money Laundering Act 2018 (SAMLA), which could have provided a defence to payment if UniCredit could show it had a reasonable belief that it was complying with the Sanctions when it was withheld payment from the Lessors. The court found that UniCredit held this belief subjectively but it was not reasonable for it to hold this.
Court of Appeal Decision
The Court of Appeal overturned the Commercial Court’s ruling and interpreted Regulation 28 broadly, holding that payment under the Letters of Credit would have constituted the provision of “funds” that facilitated arrangements benefiting Russian airlines. Even if the funds were paid to parties unconnected with Russia, they would have been paid “in connection with” Russian interests, which fell under the broad scope of the Sanctions. The court emphasized that the Sanctions are intended as a “blunt instrument”[2] to broadly prevent objectionable arrangements.
Given its conclusion on Regulation 28, the Court of Appeal did not need to consider in detail whether the SAMLA defence applied but concluded that UniCredit had established a reasonable belief that its actions complied with the Sanctions, noting that “UniCredit was required to form a view about new legislation at short notice”[3].
No Enforcement of Illegal Contracts
It is of note that the Court of Appeal also referred to the principle of English law[4] that holds that English courts will not enforce a contract that requires performance of an act which is illegal in the place of performance. Given the involvement of U.S. banks in processing dollar payments, UniCredit argued that such payments would breach U.S. sanctions, making performance illegal in the place of execution. When considering the principle, the Court of Appeal considered whether UniCredit had made “reasonable efforts” to avoid illegality, such as obtaining a licence from the sanctions authorities allowing it to complete performance.
However, the court concluded that, although UniCredit had submitted a licence application to the U.S. Office of Foreign Assets Control, the application was narrowly focused on processing a payment by Sberbank. This limited scope fell short of constituting a “reasonable effort”, meaning that UniCredit would likely not have been able to rely on the principle.
Key Takeaways
The judgment is significant for financial institutions navigating overlapping sanctions regimes – it reminds us that UK sanctions will be interpreted broadly by the UK courts, aiming to ensure compliance even at the risk of catching some unintended arrangements.
Although outside the scope of the initial case, the Court of Appeal decision highlights that the prohibition on enforcement of illegal contracts cannot be used as a blanket defense where other avenues to comply with the contracts are available, such as securing a licence – as Regulation 28 is interpreted broadly, the response needs to be suitable applications for any relevant licences for exemptions.
In line with expectations in the market, the Court of Appeal’s interpretation of the SAMLA defence continues to support the adoption by business of a cautious approach when interpreting and complying with sanctions prohibitions.
