Guidance on drafting and interpreting contractual sanctions clauses
In this article, we discuss the first UK case dealing with the scope of a sanctions exclusion clause in the context of the re-imposed US sanctions on Iran and the EU Blocking Regulation. We also provide some pointers for in-house counsel drafting sanctions exclusion clauses.
In Mamancochet Mining Ltd v Aegis Managing Agency Ltd & Others  EWHC 2643 (Comm), the English High Court has considered the wording “exposure to sanctions” and ruled that the underwriters of a marine insurance policy could not rely on that wording to avoid a claim on the basis of a “risk of exposure” to the US Iran sanctions. For the clause to bite, there would need to be an actual prohibition on paying the claim in question. As with any clause that exempts a party from what would otherwise be its contractual obligations, sanctions exclusion clauses must be clearly worded and provide for the consequences of breach. This judgment deals with a number of key points for drafting effective sanctions exclusion clauses in commercial agreements.
The basic facts
The case concerned whether or not the defendant underwriters (“Underwriters”) could avoid a claim made by Mamancochet Mining Ltd (the “Claimant”), on the basis of a sanctions exclusion clause.
The Claimant was the assigned beneficiary of a policy of marine cargo insurance (the “Policy”). This policy included cover for theft. In August 2012, two cargoes of steel billets, valued at around US$3.8m, were stolen from bonded storage in Iran, following a fraudulent presentation of documents.
An insurance claim was made in March 2013. Whilst it was accepted by the Underwriters that the claim was of a type and nature covered by the Policy, payment was resisted on the basis of the following wording in the sanctions clause of the Policy (the “Sanctions Clause”):
“…no (re)insurer shall be liable to pay any claim…to the extent that the provision of such cover…would expose that (re)insurer to any [UN, EU, UK or U.S.] sanction, prohibition or restriction”.
US Sanctions Summary
The US sanctions against Iran have a long and complex history. For more information, please see our previous articles. Details relevant to this case are below.
In October 2012, the US Iranian Transactions and Sanctions Regulations ("ITSR") were extended, adding section 560.215. This effectively prohibited entities established outside the US that are owned or controlled by a US persons ("US owned or controlled foreign entities") from knowingly engaging in any transactions with Iran that would be prohibited if engaged in by a US persons. Nine of the eleven Defendant Underwriters fell into this category. When the claim was submitted in March 2013, these Underwriters would have been prohibited by US sanctions from paying the claim.
The regulatory landscape changed again following the conclusion of the Joint Comprehensive Plan of Action ("JCPOA"), which, among other things, involved the US relaxing and lifting certain sanctions against Iran from 16 January 2016. Among others, the US issued "General License H", which authorised US owned or controlled.
Interpretation of the Sanctions Clause
The Sanctions Clause is a standard wording for the London insurance market, developed by the Joint Hull Committee. The key question was whether “exposure” to sanctions in that clause meant (i) an actual breach that would expose the insurers to sanctions, or (ii) the risk that a sanctions authority might conclude that there had been sanctionable conduct (without having to show that payment was prohibited as a matter of law).
The Court found that the first interpretation was correct. The Court’s interpretation is consistent with other cases dealing with contractual interpretation as the English Courts are generally extremely reluctant to stretch the ordinary meaning of a negotiated clause. This is especially so when it comes to broadening an exclusion of contractual liability. It was open to the parties to provide for the risk of sanctions, but they did not do so. Accordingly the Court followed the ordinary meaning of the Sanctions Clause.
There was also a question of the impact and duration of the Sanctions Clause. If triggered, would the clause suspend obligations that would otherwise arise under the Policy (i.e., prevent payment of the claim until such time as the sanctions were lifted), or would it extinguish them (i.e., allow the insurers to avoid the claim entirely)? Again, absent wording to the contrary, the Court found that “to the extent” meant that the claim was suspended rather than extinguished. This accords with our usual advice on drafting sanctions provisions, which is that the consequences of breach must be clearly specified, for example, providing a termination right or provision for alternative performance (such as a change in the payment currency).
Applicability of US sanctions
The next question for the court to determine (as a matter of foreign law) was whether payment of the claim fell within the General License H “wind-down” provision, so as being permitted if paid before 4 November 2018.
The Court held that the wind-down provision not only applied to transactions entered into during the currency of, and in reliance upon General License H, but also to transactions entered into before its effective date of 16 January 2016. This included the claim in the present case.
As a result, the court concluded that until 11:59 pm EST on 4 November 2018, payment of the claim would not be prohibited under the US sanctions regime i.e. the payment would not “expose” the insurers to US sanctions within the meaning of the Sanctions Clause.
A note on the EU Blocking Regulation
The EU Blocking Regulation was also discussed in this case. This regulation is, broadly speaking, aimed at reducing the extra-territorial impact of foreign sanctions, including the US secondary sanctions on Iran which targets non-US persons. In the event that Underwriters had been entitled to rely upon the Sanctions Clause to resist payment, the Claimant made the following three arguments, relying on the EU Blocking Regulation:
- Reliance on the Sanctions Clause would constitute “compliance“ with US Iran sanctions in breach of article 5 of the Blocking Regulation (and thereby breach English criminal law).
- The US sanctions were “unlawful” under the Blocking Regulation and the Sanctions Clause only covered an event that “would lawfully expose” Underwriters to sanctions.
- Enforcement of the Sanctions Clause would be illegal and/or contrary to public policy.
Having determined that the Sanctions Clause did not bite, the Court (unfortunately for curious lawyers) did not need to take a formal view on these issues. However, the judge stated obiter that he saw “considerable force” in Underwriters’ argument that the EU Blocking Regulation was not engaged where the insurer’s liability to pay was suspended under a sanctions clause, because it was not an “act” of compliance with the US sanctions. In such a case, the contract simply operates according to its terms and Underwriters would not be “complying” with a third country’s prohibitions.
- The Court distinguished exposure to sanctions and exposure to the risk of sanctions. This is an easy point to clarify in contractual clauses, if the wider effect is intended. Insurers/brokers in particular should not rely on old contract templates, and should ensure that new policies contain both a broad scope and specific consequences. For example, you could include “exposure to the risk of being sanctioned” or refer to “conduct which the relevant authority may consider to be prohibited or sanctionable”. It is worth noting that the BIMCO sanctions clause contains wording that allows owners to avoid contractual obligations where “in the reasonable judgement of the Owners” these “will expose” the owner to sanctions. While this is somewhat more helpful than the provision discussed above (because it affords some scope for owners’ and their P&I clubs to exercise discretion in sanctions matters), in our view it is probably not wide enough to protect owners against a mere “risk” of sanctions liability. It also fails to account for situations that may result in a loss of P&I cover. Plainly, this will be a matter for negotiation. A more balanced clause would include bespoke limitations, including that the party benefiting from the clause should act reasonably and on the basis of cogent information.
- The case is a reminder of the importance of precise contract drafting, even if it is time-consuming. Drafting sanctions clauses carefully is especially important for long-term contracts in countries or with counterparties associated with a high sanctions risk, where the sanctions landscape (and language) can change dramatically over the course of a contract. It is sensible to review the interplay of the sanctions clause with other relevant provisions, including force majeure, payment currency and termination. There will also be special considerations for particular types of contract. For example, long term commodities trading contracts may need provisions that deal with the effect of sanctions on both individual deliveries and on the contract as a whole, and COAs would need similar provisions for individual voyages. Both trading contracts and charterparties may need to include provisions dealing with alternative destinations for unloading cargoes or alternative currencies in the event of sanctions, together with related costs and delays.
- The obiter remarks represent a positive commercially minded interpretation. This may give some comfort to a party who has been careful in drafting and relying on a sanctions exclusion clause that the clause will not necessarily be viewed as contrary to the EU Blocking Regulation. Again, the effect of these kinds of clauses will be highly fact sensitive, including the question of at what time the clause was included and dependent on the particular form of words used.
- It is important to keep in mind that this judgment is a first instance judgment that could in future be reviewed by the Court of Appeal or Supreme Court. It is also possible that other European authorities enforcing the EU Blocking Regulation may take a different view. They may, for example, take the view that reliance on a sanctions exclusion clause defeats the object of the EU Blocking Regulation.
- Because this case depended upon the US sanctions taking effect on 4 November 2018, the judgment, which was given on 12 October 2018, was determined on an expedited basis. This is a positive demonstration of the English Court’s ability and willingness to respond urgently where required, and in particular to respond to the fast moving world of sanctions.
Finally, for readers interested in how this kind of case will be handled after BREXIT, it is worth mentioning that on 12 October 2018, the UK government published guidance on how sanctions will be dealt with in the event of a no-deal BREXIT. Broadly speaking, the guidance suggests that the UK government intends to mirror UN and EU sanctions under domestic legislation, and so we can expect that the status quo will be broadly maintained. For further information on drafting sanctions provisions in commercial contracts, or managing disputes arising from trade sanctions, please contact Kine Bjelke Christophersen in our Oslo office or Eleanor Midwinter in our London office.