06 Jul 2020

The Court of Appeal has upheld a judgment that a borrower was justified in its refusal to make payments under a Facility Agreement where the ultimate beneficial owner of the lender was an OFAC SDN.

The facts

Cynergy Bank (a UK bank) (Cynergy) had borrowed £30m from Lamesa Investments Limited (Lamesa) under a Facility Agreement (the Agreement) of December 2017, as Tier 2 capital. The Agreement provided for English governing law and exclusive English jurisdiction.

Lamesa is a Cypriot company, and the wholly owned subsidiary of a BVI company which, in turn, is wholly owned by a Russian national. Three months after the Agreement was signed, this individual was designated by OFAC as a Specially Designated National (SDN) under the US financial sanctions regime. As a result Lamesa became a “blocked person”. This meant that all persons dealing with Lamesa became subject to US secondary legislation.

Cynergy does not operate in the US but maintains a USD correspondent account with a US bank.

Cynergy's case 

Clause 9.1 of the Agreement provided that:

"In the event that any principal or interest in respect of the Tier 2 Loan has not been paid within 14 days from the due date for payment and such sum has not been duly paid within a further 14 days following written notice from [Lamesa] to [Cynergy] requiring the non-payment to be made good, [Lamesa] may institute proceedings in a court of competent jurisdiction in England for the winding up of [Cynergy] and/or prove in its winding-up and/or claim in its liquidation or administration; provided that [Cynergy] shall not be in default if during the 14 days after [Lamesa's] notice it satisfies [Lamesa] that such sums were not paid in order to comply with any mandatory provision of law, regulation or order of any court of competent jurisdiction. Where there is doubt as to the validity or applicability of any such law, regulation or order, [Cynergy] will not be in default if it acts on the advice given to it during such 14 day period by its independent legal advisers."

"Regulation" was defined in the Agreement as " a "regulation" includes any regulation, rule, official directive, request or guideline (whether or not having the force of law) of any governmental, intergovernmental, or supranational body, agency, department or of any regulatory, self-regulatory, or other authority or organisation"

Cynergy refused to pay Lamesa, claiming that the proviso in the Agreement meant its refusal was justified on the basis of compliance with a “mandatory provision” of law. The relevant provision was in the US Ukraine Freedom Support Act (UFSA) which would allow the US to ban a foreign financial institution from opening or maintaining a correspondent account, if it has “knowingly facilitated a significant financial transaction” on behalf of an SDN. Ability to have a correspondent account with a US bank is key to Cynergy's business.

First instance judgment

At first instance, the judge said the UFSA was a mandatory provision of law. He said a mandatory provision is a provision of law that the parties cannot vary or disapply and is not the less so simply because the provision creates a risk of a penalty or sanction rather than actually requiring or prohibiting an action. He said English law had long recognised that a contract could be prohibited by implication, and that the fact that a statute imposes a penalty for breach that would be treated as an implied prohibition.

The judge had also noted that the parties were both aware of the possibility of the SDN designation at the time of signing the Agreement, and the significant impact that imposition of US secondary sanctions would have on Cynergy. Of course, they would also have known that only secondary sanctions were relevant (rather than primary), so it would have been strange to intend the wording to address a risk that did not exist. He also said the parties would have had no reason to believe either that the payments under the Agreement would not constitute a "significant financial transaction", nor that there would be any possibility that secondary sanctions would not be imposed on Cynergy under the relevant provision.

On this basis, he held that Cynergy could rely on the cause and would not be considered in default so long as Lamesa remained a blocked entity.

On appeal

Lamesa appealed. It said the relevant section of the US legislation did not include an express ban on payment, and therefore did not purport to bind Cynergy to act in a particular way, hence Cynergy could not say it had to refuse to pay in order to comply with it. Also, Lamesa said that clause 9.1 of the Agreement was a standard industry clause and the judge should not have treated it as an individually negotiated provision. Its Counsel said the wording was "at best" ambiguous. Lamesa accepted that, in relation to past payments, Cynergy had properly relied on independent legal advice, and therefore was not in default under the clause, but wanted to clarify the situation for the future.

In response, Cynergy originally submitted that the judge's reasoning at first instance was right, that "regulation" included a broad range of official measures even if they did not have the force of law, and that the fact that clause 9.1 was a standard wording did not preclude the judge from looking at the specific facts of the particular case. Its counsel then, however, argued that the real question should have been to address the conduct of the individual, rather than the reaction of the authorities, and that it was for this reason that Cynergy's non-payment was to comply with a mandatory provision of the law, rather than being because of the potential penalty. She drew parallels with the language in Article 5 of the EU Blocking Regulation, which states that " [n]o person … shall comply, whether directly or [indirectly] with any requirement or prohibition … based on or resulting, directly or indirectly, from the laws specified in the Annex or from actions based thereon or resulting therefrom". The Annex did not specify the Ukraine Freedom Support Act but Cynergy's Counsel said parties using language similar to the Article 5 language should be interred to reasonably conclude it applied to US legislation in a similar form.

Court of Appeal

Sir Geoffrey Vos, in his judgment, set out the basic principles of contractual interpretation, which the parties did not dispute. He also cited a judgment relating to the interpretation of the ISDA Master Agreement, noting a statement in that case that, given the nature of standard wording "particular care is necessary not to adopt a restrictive or narrow construction which might make the form inflexible and inappropriate for parties who might commonly be expected to use it". The court also called on another case that emphasised the need to consider a contract as a whole, so that where there are "rival" meanings, the court can consider which construction is more consistent with business common sense, as well as the quality of the drafting of the clause.

The Court of Appeal found that the judge at first instance had perhaps overlooked some relevant factors – specifically that the clause in question was a standard term in common usage, so a detailed consideration of the parties’ intention in using it may not have been appropriate. It also noted that, in assessing the commercial interests of both parties, the judge appeared more to consider the interests of Cynergy than of Lamela. The process of interpretation should be a unitary exercise, starting with the words and relevant context, and then an iterative process checking each suggested interpretation against the provisions of the contract and its commercial consequences. The judge now said the “relevant context” in this case was that the court was considering a standard provision in a loan agreement used for Tier 2 capital to an international bank and that the facility agreement made it clear the capital was required under “Capital Regulations” including CRD 4. He said non-payment provisions for loans of Tier 2 capital are not of the kind seen in ordinary loan agreements because the loans are subordinated and repayment events controlled. The original borrower had been the UK subsidiary of Bank of Cyprus Holdings plc, which was subsequently sold to the Cynergy group and, at the time the Agreement was made, only Lamesa and another entity that was a shareholder in the ultimate parent were competing for the business.

It appeared to the Court of Appeal that the relevant clause was drafted, in principle, to deal with possible future events beyond sanctions, but that the judge had lost sight of this, appearing to consider the clause as if it has been specifically drafted to deal with the imminent likelihood of sanctions affecting Lamela.

The key, said the Court of Appeal, was that clause 9 did not extinguish the entitlement to be repaid, but that if the proviso is engaged, there would be no default and therefore the lender could not seek to wind up the borrower. The context to the clause was a balance between the desire of the lender to be paid timeously and the desire of the borrower not to beach any laws etc.

Competing meanings

Next then, the court considered what a “mandatory provision of law” would mean in the context and concluded it was possible to give it different meanings – either compliance with a statute or, more broadly, that it can relate to actual or implied provisions of law. The proviso to the clause could reasonably have either meaning.

The judge said:

  • The black letter meaning of the words could lead to the conclusion that default was excused only where the non-payment was mandated or required by a statute, regulation or order directly binding on the borrower. But, given that the words are ambiguous, it is relevant to consider "admissible context and commercial common sense"
  • On "admissibility", it is relevant to consider (i) that the words of the Blocking Statute should be assumed to have been known by the parties; (ii) that the clause is a standard clause and (iii) that US secondary sanctions would at the relevant time have been one (but not the only) potential problem affecting parties to agreements for provision of Tier 2 capital within the EU – and that secondary sanctions would have been far more likely to have been a problem than primary sanctions
  • That the lender, obviously, would want to be paid timeously, but the borrower would want to delay payment if payment would be illegal not only under English law but under any system of law which would affect its ability to conduct its ordinary business.

Of course, it was not certain that payment would have attracted a sanction, but it was also clear from the wording of the US legislation that the imposition of a sanction was mandatory and the President would have had to impose it unless the payments could be deemed insignificant or it was otherwise not in the US' interests to impose it. Cynergy could not know this, so what mattered was its reasons for the non-payment, not whether it was certain it would be sanctioned for making it. In this particular case, there was no issue as to whether the payments were significant, but had there been it would have been for the borrower to convince the lender they were, or to have independent legal advice on the applicability of US sanctions.

Lamesa had argued that given the proviso was ambiguous, it could therefore not excuse something as crucial as non-payment. But, the judge said, that both assumed the payment would be abrogated rather than delayed, and also he noted that the utility of the clause would be "badly dented" by Lamesa's interpretation. He reverted to the fact that the clause was intended to be used by international banks, for whom the risks of US secondary sanctions are a major issue, and moreover, that Tier 2 lending is an EU concept, and the parties to the Agreement were EU institutions. He said that is "mandatory provision of law" means only one that directly bound the borrower not to pay, it would have "almost no possibility" of taking effect. As a result, the drafters would have known the Blocking Regulation regarded US secondary sanctions legislation as imposing a "requirement or prohibition" with which EU parties were otherwise required to "comply". Although the language ot the Blocking Regulation is broader than the Agreement clause, the judge said the important point is that the language refers to the provisions of US secondary sanctions legislation in substantially the same terms as the UFSA. 

The conclusion

The upshot is that while US legislation could not prohibit one EU entity from paying another, its effect is clearly one of prohibition – and any argument that by refusing to pay Cynergy is complying with the policy rather than the wording of the legislation is a semantic difference. The US legislation should be seen as an effective prohibition and therefore Cynergy's reason for non-compliance is to comply with it.

On that basis, the Court held that the balance between the interests of the parties, given the nature of the agreement and its purpose favours the application of the proviso in the relevant caluse to the standard form of US secondary sanctions. Lord Justice Arnold was not convisnce that it was sufficient for the purposes of the proviso that the reason for non-payment was to comply with the UFSA, but did not dissent.

So, all in all, although the Court of Appeal did not necessarily agree with all the reasoning of the High Court it agreed with the order.

Conclusion

What does this mean? The key message must be that where standard wording is used in agreements which are known to have a particular purpose, it must be assumed that the drafters and the parties should have understood the context of the words in the context of their needs. And, where wording is ambiguous, the commercial context will be critical in interpretation. In this case, although the judges at first instance and on appeal differed in the route they took to their conclusion, a key consideration was the knowledge of the parties of both the purpose of the Agreement and the practical implications of US secondary sanctions.