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The world before sanctions clauses
In 1977, as Mr Justice Kerr was coining his often-cited description of the letter of credit as the “lifeblood of international commerce”, the obstruction caused by the use of sanctions in international trade as a weapon of foreign policy would have been difficult to predict. The modern use of sanctions clauses would have been beyond comprehension.
Although John F. Kennedy’s trade embargo on Cuba, established in February 1962, remains one of the longest-lasting trade sanctions in history, the concept of persuading the international trade community as a whole to collectively adopt measures to pursue common foreign policy objectives had not yet emerged at that time. Ironically, while JFK initiated one of the most famous international trade sanctions, he also showed how to avoid them easily. On the eve of the implementation, JFK ordered his press secretary to purchase 1200 Cuban cigars. Before the sanctions even took effect, they went up in smoke.
Indeed, the lack of support, until the late 1980s, from countries such as the US and the UK, for measures such as the anti-apartheid boycott of South Africa, suggested that international adoption of common sanctions measures was a long way off.
The US government actively discouraged American businesses from getting involved in initiatives like the Arab Boycott of Israel by criminalising their participation. This approach was later mirrored in the 1990s by the European Union, which prohibited companies from complying with the US-Cuban sanctions.
Letters of credit under pressure
The world has since changed considerably. Economic sanctions, a preferred policy choice of the US, have become commonplace since the end of the Cold War, complicating the legal and regulatory channels for trade law.
US sanctions invariably seek to hold US persons abroad liable for breaches, even when the underlying transactions barely touch US soil, and the only connection may be the US Dollar currency denomination. The “Weaponization of Trade”, which includes the use of trade sanctions is clearly here to stay.
The system of international settlement of trade payments through letters of credit has, been in steady decline, despite the 2007 revision of the Uniform Customs and Practice for Documentary Credits (UCP 600) breathing some new life into the rules. Despite stricter capital requirements imposed by the Basel Committee on Banking Supervision, the letter of credit has continued to be a foundational tool in international trade.
What makes the letter of credit worth protecting?
For those who are not familiar with letters of credit, their primary appeal lies in the fact that they allow parties with limited trust in each other’s creditworthiness and performance capabilities to engage in trade. This is achieved by establishing an unchangeable commitment from a buyer’s bank to make payment to the seller, thus providing a secure payment mechanism. The seller can rely upon it for payment for goods shipped, provided that it can present the documents which the parties have specified in the letter of credit, which generally provide a degree of third-party assurance of the shipment of the goods.
The issuing bank is only relieved from fulfilling the payment obligation if the seller engages in fraudulent activities. Simple contractual disputes between the parties will not hinder the seller (beneficiary) from receiving the payment they are entitled to.
The letter of credit is autonomous. For additional comfort, the system allows for a second bank, generally the seller’s bank, to “confirm” the letter of credit (essentially repeating the issuing bank’s promise of payment) and thereby provide the prospect of a local settlement of the payment in the seller’s own jurisdiction.
Modern day sanctions and the letter of credit
Over the years, the courts in most jurisdictions have staunchly protected the principle of independence and autonomy in letter of credit transactions. However, the clash between these well-defended principles and the imposition of sanctions and other regulations has added complexity to what is otherwise a straightforward arrangement.
The long reach of modern-day US sanctions, where entire sections of the economy, whole countries or individual companies and individuals can be the subject of sanctions orders, has introduced a new jeopardy in international trade.
Since there are usually two or more banks involved in a letter of credit transaction the scope for a party to a transaction to be affected in some way by a law or regulation outside the place where it carries on business is greatly increased.
Moreover, the actors in an international trade transaction, from buyer and seller to shipowner, charterer, insurer and other third-party service providers can operate in diverse jurisdictions with laws and sanctions which do not necessarily mirror one another.
Economic sanctions carry severe penalties, ranging from large fines to individual loss of liberty. To ensure compliance with US laws, any business operating within the US must take all necessary measures to eliminate the risk of violating US sanctions administered by the Office of Foreign Assets Control (OFAC).
By 2014, the international trade market faced a problem related to the inclusion of clauses in letters of credit by issuing and confirming banks. These clauses aimed to limit or nullify the banks’ obligation to make payments in cases where sanctions supposedly affected the underlying transaction or the provided documents. To address this issue, the International Chamber of Commerce (ICC) issued guidance specifically designed to discourage the excessive and unwarranted use of such provisions. It is important to note that this guidance does not have the force of law but serves as a recommendation.
Conflicts in Iraq, Syria, and most recently Ukraine and associated sanctions have made banks even more sensitive to the risk of inadvertent breach of sanctions.
Sanctions clauses receive a boost in Singapore
The recent case of Kuvera Resources Pte Ltd v JPMorgan Chase Bank, NA in the Singapore courts shows that the general counsel of international banks must keep a wide-angled lookout for potential hazards when dealing with international payments.
In the case of Kuvera, one of the required documents to be presented under a letter of credit was a shipping document containing the name of a vessel. However, upon further investigation, it was discovered that the ship had been renamed from its original name, which it had when registered under Syrian ownership. The Singapore branch of JPMorgan, acting as the confirming bank, included its confirmation with a letter of credit issued in favour of Kuvera. This confirmation incorporated JPMorgan’s preferred sanctions clause wording.
The clause (see below) purported to excuse it from payment where an entity sanctioned by US sanctions legislation (including in this case the US sanctions against Syria) was involved in the documents presented. The original letter of credit issued by the issuing bank contained no such provision. JPMorgan refused to pay against the shipping documents, and the beneficiary, Kuvera, sued JPMorgan in Singapore courts.
Singapore courts uphold sanctions clause
Despite a strong legal challenge by the beneficiary, the use of the “sanctions clause” by the bank was upheld, and the beneficiary’s claim failed. The decision was not in itself wholly surprising. The clause was well drafted, and the court held that the beneficiary, a sophisticated business, ultimately had a choice whether or not to accept such a qualified promise of payment as its security for the price of goods shipped when it decided to ship against such a letter of credit.
The ICC guidance warns against the use of sanctions clauses which seek to entitle an issuing or confirming bank to avoid its payment obligations unless such payment would cause it to break the law.
Many sanctions clauses go well beyond that benchmark and entitle the bank to rely on internal policy considerations rather than only strict legal obligations. In a market for letters of credit estimated to be worth over $5 trillion by 2030, any disruption to or devaluation of the letter of credit as a secure payment instrument is therefore unwelcome.
The ICC guidance
An example provided by the ICC that aligns with its guidance is as follows:
“Presentation of document(s) that are not in compliance with the applicable antiboycott, anti-money laundering, anti-terrorism, anti-drug trafficking and economic sanctions laws and regulations is not acceptable. Applicable laws vary depending on the transaction and may include United Nations, United States and/or local laws.”
In fact, the clause does little more than restate the principle that no one can be contractually required to break the law. JPMorgan’s clause in Kuvera was in a similar vein:
“[The beneficiary] must comply with all sanctions, embargo and other laws and regulations of the U.S. and of other applicable jurisdictions to the extent they do not conflict with such U.S. laws and regulations (“applicable restrictions”). Should documents be presented involving any country, entity, vessel or individual listed in or otherwise subject to any applicable restriction, we shall not be liable for any delay or failure to pay, process, or return such documents or for any related disclosure of information.”
During the litigation, OFAC provided evidence that had JPMorgan paid in these circumstances, it would indeed have been in breach of US sanctions. The clause did its job.
The use of sanctions clauses has, as a result of this and similar cases, become a necessary evil in international trade finance. No bank of good standing can risk being in breach of US sanctions, let alone a major US bank. The case shows that a proportionate clause which meets the ICC guidelines will be enforced.
Refusing payment where such a payment would breach sanctions is, a reasonable and lawful position to adopt. No party to a commercial transaction should be forced to break the law in its performance of its obligations.
However, the imposition of sanctions can sometimes catch parties cold. When a confirming bank provides its confirmation, it does so after evaluating the credit risk associated with the issuing bank at the time of confirmation.
An argument has raged in trade finance circles for some time as to whether sanctions clauses should be banned. The argument against sanctions clauses is that the local law will either permit or prohibit the required performance and that ought to be enough.
At least one major international bank takes the position that sanctions clauses add nothing to its legal position in terms of mitigating risk for that reason. For those craving certainty, however, the pressure for a clause to be inserted is sometimes irresistible.