U.S. authorities take an expansive view of their jurisdiction when it comes to sanctions. They cannot, however, directly restrict persons outside U.S. jurisdiction from dealing with sanctioned persons. They therefore exert pressure on persons outside U.S. jurisdiction by threatening to designate them as sanctioned persons if they engage in certain activities contrary to U.S. sanctions policy (“Target Activities”). Sanctions imposed in such circumstances are known as ‘secondary sanctions’, and were the topic of the September 2019 judgment of the High Court of England and Wales in Lamesa Investments v. Cynergy Bank. In a ruling that will surprise many, the Court found that the risk of incurring secondary sanctions could be invoked by a party seeking to be excused from its contractual obligations under an illegality clause. While the Court’s interpretation of secondary sanctions appears questionable in several respects, parties will nonetheless need to take it into account when drafting contractual provisions.
The claimant – a vehicle controlled[i] by prominent Russian businessman Viktor Vekselberg – lent the defendant £30 million in late 2017. A few months later, U.S. authorities introduced sanctions prohibiting persons under U.S. jurisdiction from, among other things, making payments to Viktor Vekselberg or entities in which he owns a majority, including the claimant.
The parties were not required to comply with these sanctions. After all, the sterling-denominated loan had been concluded outside the United States, under English law and between two non-U.S. persons – i.e., outside U.S. jurisdiction.
The defendant nonetheless refused to pay the interest on the loan, arguing that it was not required to make payments to the claimant where to do so would expose the defendant to the risk of secondary sanctions for engaging in a Target Activity (knowingly facilitating a significant financial transaction with a sanctioned person).[ii] In support of this argument, the claimant pointed to the illegality clause in the loan agreement, which excused non-payment where necessary “to comply with any mandatory provision of law, regulation or order of any court of competent jurisdiction”.
The claimant sought payment of the interest on the basis that secondary sanctions should not be considered “mandatory provisions of law” capable of engaging the illegality clause.
Reasoning of the Court
In dismissing the claim, the Court relied on three main strands of reasoning.
- “Mandatory” does not necessarily mean “mandatory under English law”. The Court endorsed the default common law position that, where England is the place of performance, an illegality clause in an English-law agreement may not be invoked by reference to a breach of foreign law. However, the Court found that the loan agreement implicitly displaced this default position, such that the defendant could properly make reference to U.S. law in triggering the illegality clause. In coming to this conclusion, the Court attached significance to the absence of any jurisdictional limitation in the broadly drafted definition of “regulation”: “any regulation […] of any governmental, intergovernmental or supranational body”. As “regulation” had no jurisdictional limitation, the Court ruled it would be inconsistent to read such a limitation into the other elements of the expression “any mandatory provision of law, regulation or order of any court of competent jurisdiction”.
- U.S. secondary sanctions statutes are “mandatory provisions of law” as they implicitly prohibit engaging in Target Activities. Secondary sanctions statutes generally provide that sanctions “may” or “shall” be imposed by the Executive Branch if a person engages in a Target Activity. They do not explicitly prohibit that person from engaging in the Target Activity, and are not enforceable by fine, injunction or imprisonment (indeed, secondary sanctions are premised on the absence of U.S. jurisdiction). The Court ruled, however, that imposition of a penalty (sanctions listing) implied a prohibition (on engaging in Target Activities). As the parties could not vary or disapply this implied prohibition, the Court considered it to be a mandatory provision of law.
- The parties must have intended the expression “mandatory provision of law” to encompass secondary sanctions. The Court considered that the factual circumstances of the loan (described above) strongly suggested that it would not be considered to be within U.S. jurisdiction and that, therefore, the parties could only have been concerned with the risk of secondary sanctions when drafting the illegality clause. As the Court put it, “it is improbable that the parties could have intended the scope of [the illegality clause] to be limited to protecting [the defendant] from the risk it was not exposed to – becoming the subject of primary sanctions – and not to extend to the risk that was apparent – […] secondary sanctions”.
Analysis of the judgment
The reasoning of the Court is surprising for a number of reasons:
- Secondary sanctions are, in practice, political and discretionary, not legal and mandatory. Many secondary sanctions statutes contain language that appears to be mandatory; their provisions describe what the President “shall” do in various scenarios. Yet this deceptively clear-cut language (which is directed at the U.S. Executive Branch and not private counterparties) belies a more complicated reality. For one thing, whether a Target Activity triggering secondary sanctions has occurred is often open to interpretation. For example, where a Target Activity is defined by reference to a “significant transaction”, OFAC somewhat nebulously advises such term be considered in “the totality of the facts and circumstances” (see #542 and #545 here). What is more, secondary sanctions are not self-executing. They are triggered not by a person engaging in a Target Activity, but rather by the President determining that a person has engaged in a Target Activity. If the President does not make such a determination, there is no mechanism to require him to. Accordingly, far from every instance of a person engaging in a Target Activity results in secondary sanctions.
- In the case of secondary sanctions, penalty does not imply prohibition. It seems difficult to argue that secondary sanctions imply a mandatory prohibition on engaging in Target Activities while the very raison d’être of secondary sanctions is to provide the United States with a tool of influence where it has no jurisdiction to impose a prohibition. If the authorities were unable to impose an explicit prohibition, it should be equally impossible to find an implicit prohibition.
- The illegality clause may well have been intended to address the risk of falling within U.S. sanctions jurisdiction, not the risk of secondary sanctions. As it turned out, the absence of any U.S. nexus meant the matter fell outside U.S. jurisdiction and only secondary sanctions were in play. That does not mean that the parties excluded the risk of falling within U.S. sanctions jurisdiction at the time of entering into the contract. On the contrary, the defendant would likely have been alive to the risk of unknown facts coming to light that would bring it into U.S. jurisdiction (its signatory holding an undeclared U.S. passport, for example). It is well possible that the parties intended the illegality clause to manage this risk, and not the risk of secondary sanctions as the Court concluded.
- Allowing the defendant to rely on the illegality clause on the basis of a risk of secondary sanctions is difficult to reconcile with the Court’s October 2018 ruling in Mamancochet Mining v. Aegis Managing Agency. In that case, the Court found that contractual non-performance could only be excused on the basis of a mere risk of sanctions where there were “clear words” to that effect. Which transactions fall within the Target Activity of knowingly facilitating a significant financial transaction with a sanctioned person is far from clear, and, as noted above, not every such transaction results in secondary sanctions. The defendant in Lamesa was therefore confronted with a mere risk of sanctions, yet the Court, in the absence of clear words, found such risk to trigger the illegality clause.
You can read our blogpost about Mamancochet here.
Lamesa stands for the proposition that illegality clauses may be triggered by the risk of secondary sanctions. But, more than that, it illustrates that a court presented with imprecise and over-broad drafting will seek to impute the parties’ intentions, with potentially unpredictable results. Those seeking to avoid this pitfall should take matters out of the court’s hands by setting out in their contracts explicitly whether foreign laws are relevant to contractual performance and, if so, how secondary sanctions in particular are to be dealt with.
[i] According to the factual background set out by the judge.
[ii] See section 5(b) of the Ukraine Freedom Support Act of 2014, as amended.