Do sanctions excuse a confirming bank from making payment? - the English Court of Appeal has its say

The interaction between international sanctions and contractual obligations is an issue which English courts are increasingly being asked to determine. In the most recent example of this, the Court of Appeal has overturned the High Court's decision by finding that the UK's Russia sanctions regime did prevent a confirming bank from paying out under a letter of credit. 

The facts

Before Russia's invasion of Ukraine, two Irish aircraft leasing companies (the Lessors) entered into various agreements between 2005 and 2014 to lease multiple aircraft to two Russian airline companies (the Lessees). The agreements were supported by letters of credit (the LCs) in favour of the Lessors. The LCs were issued by a Russian bank, Sberbank (the Issuing Bank), and confirmed by the London branch of a German bank (the Confirming Bank). The LCs were denominated in US dollars but governed by English Law.

The Lessees received the aircraft but, in March 2022, after Russia's invasion of Ukraine, they defaulted on their payments and the leases were terminated. The Lessors demanded payment under the LCs. The Confirming Bank asserted that sanctions prohibited it from making such payments.

The High Court judgment

The Lessors issued proceedings in March and April 2022, claiming the amounts owed under the LCs. The High Court found in favour of the Lessors, concluding that UK sanctions were not engaged and therefore the Confirming Bank was not prevented from making payments under the LCs. The High Court also rejected the Confirming Bank's reliance on the Ralli Bros¹ principle which excuses performance under an English law contract if it would be illegal in the place of performance: the Confirming Bank could and should have avoided potential issues with US sanctions by paying in cash or another currency if necessary (read our briefing).

The Court of Appeal judgment

The Court of Appeal had to determine four issues:

1. Would payment under the LCs by the Confirming Bank be "in connection with" an arrangement the object or effect of which was the supply of aircraft to or for use in Russia/to a Russian person, and so prohibited by the UK Russia (Sanctions) (EU Exit) Regulations 2019 (the Russia Regulations)?
2. If such payment was not prohibited under the Russia Regulations, did the Confirming Bank have a defence to the claim under section 44 of the Sanctions and Anti-Money Laundering Act 2018 (SAMLA)? (Read our briefing on the separate first instance judgment on this issue.)
3. If such payment was not prohibited under the Russia Regulations, could the Confirming Bank rely on the Ralli Bros principle to avoid payment on the basis that effecting payment in US dollars required the involvement of a correspondent bank in the United States?
4. If the US sanctions regime was engaged, were payments in accordance with the demands illegal under that regime?

Issue 1: Was payment under the LCs prohibited under the Russia Regulations?

The Russia Regulations prohibit the export of certain "restricted goods" to or for use in Russia. Since 1 March 2022, aircraft have been included on the list of "restricted goods". As a result, the export of aircraft to or for use in Russia has been prohibited since that date.

The Russia Regulations also contain an associated prohibition on the provision on "financial services or funds" (which includes letters of credit) if they are "in pursuance of or in connection with an arrangement whose object or effect is the export of restricted goods"² (emphasis added).

The Court of Appeal concluded that the LCs were clearly "in connection" with an arrangement whose object or effect was the provision of aircraft to or for use in Russia. The Court of Appeal rejected the High Court's purposive interpretation of the Regulation, favouring instead an ordinary interpretation of the words used. 

The Court of Appeal stated that the words "in connection with" required only a factual connection. It was found to be "straightforwardly the case" that payment under the LCs was "in connection with" the leases because a factual connection existed. It did not matter that the aircraft and the LCs had been provided before the sanctions came into effect and so were not prohibited at that time. It also did not matter that the leases had been terminated by the time the demands under the LCs were made. The Court of Appeal acknowledged the "autonomy principle" in relation to letters of credit (which meant the obligations under the LCs were legally separate to those under the leases), but this did not mean the factual connection between the LCs and the leases could be ignored.  

The Court of Appeal accepted that this broad interpretation of the provision created a risk of "catching arrangements that may not be seen to be within the overall mischief" (and in that respect, described the provision as a "relatively blunt instrument" with the aim of "putting pressure on Russia"). However, this risk was mitigated by the statutory exceptions and licensing regime provided for in the Russia Regulations, in accordance with which certain otherwise prohibited activity is either permitted or can be licensed by the Treasury.

Issue 2: Did the Confirming Bank have a defence to the claim under section 44 SAMLA?

Although it was unnecessary to consider this question given the Court of Appeal's decision on Issue 1, the judgment addresses the position under section 44 SAMLA as it raised points of significance which have not previously been considered by the Court of Appeal. The Court of Appeal therefore approached this issue as if payment under the LCs had been prohibited by UK sanctions. Further, the sums in dispute for the purposes of this issue were only the statutory interest on the LC payments and costs arising in the litigation.

Section 44(2) SAMLA provides that "A person is not liable to any civil proceedings to which that person would, in the absence of this section, have been liable in respect of the act". The Confirming Bank argued that it had a defence to the claim as it had a reasonable belief that refusing the payments was in compliance with sanctions.

The Court of Appeal found that the Confirming Bank did believe that it was acting in compliance with sanctions (a subjective question) and that such belief was reasonable (an objective question).  However, the Court found that section 44(2) "is concerned to protect against a liability which is created as a result of something done (or not done) in the reasonable belief that it is in compliance with a sanctions regulation. It is not concerned to protect against pre-existing liabilities". To illustrate the point, the Court of Appeal gave an example of a claim from a customer against a seller for losses suffered as a result of the non-delivery of certain goods (e.g. loss of profit). Section 44 would protect the seller from such claims if the belief that the delivery would breach UK sanctions was a reasonable one. 

In contrast, section 44 could not have protected the Confirming Bank from an action to recover the amount owing under the LC (i.e. a debt ) because that is an existing liability which would be payable in the normal course, nor from liability for statutory interest and costs arising from that debt claim. However the Court of Appeal did not conclude that all interest claims would necessarily fall outside the scope of section 44, noting that a claim for default interest to which a party has an express entitlement under a contract "is much closer both to the mischief at which s.44 is aimed and the language, because the claim is for an amount due as a result of ("in respect of") the failure to pay".  

Issues 3 and 4: US sanctions and the application of the Ralli Bros principle

The Ralli Bros principle is a limited exception to the general principle that the enforceability of a contract governed by English law is determined without reference to illegality under any other law. The exception applies where contractual performance requires an act to be done in a place where it would be unlawful to carry it out.

The Confirming Bank argued that as the LCs required payment to be made in US dollars, US sanctions prohibited it from making the payment. The Court concluded that the Confirming Bank could not rely on US sanctions because it did not make "reasonable efforts" to obtain a licence from the US authorities. Whilst the Confirming Bank did make an application to the US Office of Foreign Assets Control (OFAC), the focus was on authorising the receipt of funds from Sberbank as opposed to the (separate and independent) payments by the Confirming Bank to the Lessors.

Notwithstanding its conclusion, the Court of Appeal made some helpful obiter comments about the application of the Ralli Bros principle. 

• The Court of Appeal did not endorse the High Court's conclusion that the relevant payments could be made in cash or in a different currency, thereby avoiding the US. The terms of the LCs required "strict conformity", and, following this principle, the contract precluded payment in cash and/or in a currency other than US dollars. Payment had to be made in US dollars to the specified accounts in the LCs. The Court of Appeal therefore distinguished this case from the circumstances in the 1989 Libyan Bank³ case in which payment in cash was contractually permitted.
• As a result, the Ralli Bros principle could have been engaged if the act of performance (effecting payment in US dollars) necessarily required the involvement of a US bank. However, the Court of Appeal found that there was no finding of fact on this point from the High Court, and it was unnecessary to form judgment on this point given the Confirming Bank's failure to seek a licence.

Impact of the decision 

The judgment provides clarity on the interaction between obligations under letters of credit and the restrictions imposed by the UK's Russia sanctions regime, though the reversal of the High Court's less literalistic prior decision may come as a surprise to some. It also provides some helpful guidance on the application of the Ralli Bros principle and the circumstances in which it will (or might) be engaged.  Parties who engage in trade finance transactions should review any outstanding letters of credit to ascertain whether their obligations thereunder are impacted by the decision.

Similarly to the Supreme Court judgment in RTI v MUR Shipping  (read our briefing), the judgment also emphasises the "power of contracting parties to agree terms of their choice", and the English appellate courts' willingness to hold parties to those terms. Both judgments, therefore, favour legal certainty over pragmatism or purposive interpretations.

When drafting contracts which might be impacted by sanctions, in particular those denominated in US dollars, parties should therefore consider whether additional drafting is required around payment terms. For example, would the parties be prepared to accept payment via alternative means – by cash or in another currency – and if so, in what circumstances would this be permitted? Parties should be aware that absent clear wording to the contrary, the English court is likely to hold the parties to their contractual bargain.   

Our Russian sanctions tracker provides a summary of all the measures imposed by the UK, EU, Australia and Japan following Russia's invasion of Ukraine in February.

Authors: Tom Cummins, Partner; Sophie Law, Senior Associate; Laura Biggs, Trainee Solicitor.

^{1. Ralli Bros v Compañia Naviera Sota y Aznar [1920] 2 KB 287.}

^{2. Regulation 28(3) of The Russia (Sanctions) (EU Exit) Regulations 2019.}

^{3. Libyan Arab Foreign Bank v Bankers Trust Co [1989] 1 QB 728.}

^{4. RTI Ltd v MUR Shipping BV [2024] UKSC 18.}