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03 Dec 2020

Can borrowers rely on sanctions to escape payment obligations? Banco San Juan Internacional Inc v Petróleos de Venezuela S.A.

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There have been a number of recent judgments concerning the effect of US sanctions on parties' payment obligations.  In this case, the Commercial Court granted summary judgment on a bank's claim to recover amounts from a defaulting borrower.  In dismissing the borrower's arguments that US sanctions prevented it paying sums to the bank, the court emphasised the limited applicability of a defence of foreign illegality and the importance of considering the availability of licences permitting performance that may otherwise be contrary to sanctions.

The Claim

The Claimant lender ("BSJI") is an international Puerto Rican banking entity.  The Defendant borrower ("PDVSA") is a state-owned Venezuelan entity in the oil and gas industry.  BSJI brought two claims against PDVSA following its defaults under two credit agreements governed by English law, one dated 2016 and one dated 2017, for USD48 million and USD38 million respectively (the "Credit Agreements").  After the Credit Agreements were signed, the US imposed unilateral sanctions in relation to Venezuela, in particular Executive Order 13850 and Executive Order 13884, as regulated and administered by the Venezuela Sanctions Regulations 31 CFR Part 591 (the "US Sanctions"). See our article on an earlier judgment in the same case here: The purpose of a process agent: Banco San Juan International v Petroleos de Venezuela.

PDVSA sought to defend the claims on the basis of illegality, stating that the US Sanctions blocked "[a]ll property and interests in property that are in the United States, that hereafter come within the United States, or that are or hereafter come within the possession or control of any United States person" of a person determined to operate in the oil sector of the Venezuelan economy and prohibited the receipt of funds in the US from PDVSA.

PDVSA argued that BSJI was prohibited from receiving funds otherwise due under the Credit Agreements because the account into which funds were to be paid was in the US and that any US correspondent bank (or any US person processing instructions on behalf of PDVSA) was also subject to the same prohibition. 

On that basis, PDVSA argued that the payment obligations under the Credit Agreements were unenforceable for three reasons:

  1. Pursuant to a proper construction of the Credit Agreements, a covenant in Section 7.03 suspended repayment obligations;
  2. Ralli Bros v Compania Naviera Sota Aznar [1920] 2KB 287 provided authority that contracts are unenforceable if performance is prohibited in the place of performance, in this case the US (the Ralli Bros defence); and
  3. the court should exercise its discretion pursuant to Article 9(3) of Regulation No 593/2008/EC (the "Rome I Regulation") to give effect to mandatory provisions of the law of the place of performance (i.e. the US Sanctions).

The Decision

Mrs Justice Cockerill ruled in favour of BSJI, and held that the US Sanctions did not suspend PDVSA's payment obligations under the Credit Agreements for the following key reasons:

1) Section 7.03

The wording in Section 7.03 provided that:

"Sanctions. [PDVSA] will not repay Loans with the proceeds of

(a) business activities that are or which become subject to sanctions, restrictions or embargoes imposed by the Office of Foreign Asset Control of the U.S. Treasury Department, the United Nations Security Council and the U.S. Department of Commerce, the U.S. Department of State [sic] (collectively, 'Sanctions'); or

(b) business activities in/with a country or territory that is the subject of Sanctions (including, without limitation, Cuba, Iran, North Korea, Sudan and Syria) ('Sanctioned Country')".

PDVSA contended that pursuant to this clause the parties had agreed that PDVSA would not repay BSJI from funds of business activities subject to US sanctions, which encompassed all of PDVSA's funds.  In effect, it argued that the clause was a condition precedent which, if triggered, operated to suspend PDVSA's payment obligations.  BSJI's position was that Section 7.03 was a negative covenant, only intended for BSJI's own benefit and which BSJI would waive to the extent necessary.

The court agreed with BSJI and held that, on its true construction, Section 7.03 was a negative covenant which did not affect the repayment obligations.  Further, the court did not accept that it was sensible for parties to commercial agreements to provide that repayment obligations would be suspended in the case of imposition of unilateral US sanctions.  It rejected PDVSA's suggestion that recent case law (Lamesa Investments Limited v Cynergy Bank Limited [2020] EWCA Civ 821 and Mamancochet Mining Limited v Aegis Managing Agency Limited [2018] EWHC 2643 (Comm)) had established that this was the "normal course" for parties to take where there was a risk of US sanctions.  The court distinguished the previous decisions, given their "very different" facts.  In the Lamesa decision (see our earlier article here), for example, the crucial point was that the payment provision expressly provided for non-payment in a sanctions context.

2) Ralli Bros

PDVSA also argued that Ralli Bros provided authority that an obligation under an English law contract is invalid and unenforceable if the contract requires performance in a place where it is unlawful under the law of the required place of performance. Here, the Credit Agreements required payment into BSJI's account in the US and PDVSA argued that such payment would necessarily involve committing an illegal act in the US.

The court considered previous decisions on the Ralli Bros defence. It concluded it has a narrow application and would not apply where the contract could be performed in some legal way.  In the context of the US Sanctions, a licence permitting payment could have been sought from the US authorities (OFAC).  Lawful performance was therefore possible.  The real issue was whose responsibility it was to obtain a licence.  The court held that 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.  In the absence of any provision to the contrary in the contract or statute, the burden was on PDVSA to obtain the necessary licence.  In fact, here, the Credit Agreements expressly placed that burden on PDVSA. 

Although not cited in the judgment, the English courts have previously reached similar conclusions in other cases concerning non-payment purportedly due to EU (i.e. domestic) sanctions, even where the contractual provisions do not expressly refer to sanctions: Melli Bank v Holbud [2013] EWHC 1506 (Comm); and DVB Bank SE v Shere Shipping Company Ltd & Ors [2013] EWHC 2321 (Comm) (Stephenson Harwood represented successful applicants for summary judgment in both cases).  It is not surprising that the same position was reached when considering the effect of sanctions imposed in a foreign jurisdiction. 

While it would have been open for PDVSA to adduce evidence that no licence would be granted, it had not done so.  It followed that PDVSA could not rely on the Ralli Bros defence. 

3) Article 9(3) Rome I Regulation

Article 9(3) of the Rome I Regulation provides that:

"Effect may be given to the overriding mandatory provisions of the law of the country where the obligations arising out of the contract have to be or have been performed, in so far as those overriding mandatory provisions render the performance of the contract unlawful. In considering whether to give effect to those provisions, regard shall be had to their nature and purpose and to the consequences of their application or non-application".

Given the failure of the first and second arguments, the court concluded that there was no real prospect of success on this argument.  The Ralli Bros defence covered similar ground without the discretionary element.  That argument failed because of the licence point, and so it would not be appropriate to exercise the discretion under Article 9(3). 

Commentary

This case is likely to be viewed as a good outcome for lenders, particularly given sanctions clauses are now common in financing agreements – the relevant provision in this case was not particularly unusual.  The decision suggests that borrowers cannot easily escape their payment obligations merely from the imposition of unilateral sanctions. 

Where a defaulting party seeks to rely on sanctions, the non-defaulting party should consider whether authorisation can be sought to permit performance and whose responsibility it is to obtain any such authorisation, whether under statute, contract or the common law.  PDVSA no doubt had its own reasons for not having sought a licence from the US authorities.  However, a defaulting party relying on sanctions should be aware of the risk of summary judgment in the absence of evidence that no authorisation would be granted. 

In this case, BSJI had originally taken issue with the question of whether the US Sanctions made the payment illegal.  As this was an application for summary judgment proceeding without evidence of foreign law, BSJI focussed at the hearing on the issue of licences, which was determinative.  However, the court did comment obiter that PDVSA's case on illegality was "beset with difficulties".  In particular, it doubted that it was illegal for BSJI to receive payment or for PDVSA to make it, or that it was factually impossible for PDVSA to make payment on its own evidence.  Whether such an argument can succeed will depend on the particular sanctions in question. 

The recent decisions regarding the impact of sanctions on commercial transactions make clear that these cases are fact-specific and careful consideration should be given to the interpretation of the sanctions and the relevant contract.  However, it is not surprising that the court has been slow to find an obligation released or even suspended as a result of sanctions. 

Given the prevalence of sanctions (and potential for divergence, which will no doubt only increase following Brexit), it is crucial that parties consider carefully their potential impact when negotiating contracts, especially when the governing law and the place of performance are not the same. Lenders should seek to include clear wording on how to preserve payment obligations, when obligations are and are not suspended and whose responsibility it is to seek licences if sanctions may otherwise prevent payment, while borrowers may wish to include mechanisms to minimise the impact in the event that relevant sanctions are imposed.  

As a final point, it is interesting to see that the court gave short shrift to PDVSA's reliance on a recent US decision dismissing an application for summary judgment against PDVSA on the basis that Executive Order 13850 created an "impossibility of payment" to the US-based creditor applicant.  The argument initially appears quite powerful.  However, the English court disregarded it because it was concerned with domestic illegality and the US court was applying a different test.  The relevant US decision has also been criticised for its apparent failure to take into account the availability of licences, and – as in Holbud and Shere Shipping – that was a hurdle that the defaulting party could not get over in this case. 

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