Letters of Credit & Sanctions

A principal characteristic of letters of credit (LCs) is their autonomous nature. For those LCs that incorporate the ICC’s Uniform Customs and Practice for Documentary Credits Publication No. 600 (UCP 600), Articles 4 and 5 emphasize the autonomy principle by stating that banks deal with documents only, not with good or services to which the documents may relate, and that the LC is a separate transaction from the underlying contract. A further characteristic of LCs, particularly those that incorporate UCP 600, is the irrevocable nature of the undertaking given by the bank (issuing bank and confirming bank (if any)) to the beneficiary of the LC. There has been concern for many years amongst trade finance practitioners and corporates dealing with LCs that both the autonomy and irrevocability of LCs are at risk of being undermined through the increasing use of a varied range of sanction clauses.

As we know, sanctions are essentially tools used by governments to achieve political and economic ends. Sanctions regulations are complex, they come in many shapes and forms and the penalties for breach are severe. Sanctions may prohibit or restrict dealings with specific countries, persons or property by imposing restrictions on travel, dealings with specific individuals or entities subject to economic sanctions. There is no doubt that financial institutions (FIs), particularly those with a wide geographic footprint, are under a heavy burden to ensure that the restrictions imposed by sanctions are complied with. Those FIs may be impacted by different sanctions regimes in the different jurisdictions in which they operate, as well as sanctions relating to the country of the currency or the place of payment and jurisdiction whose laws govern the LC transaction.

It is accepted, certainly as a matter of English law, that sanctions (if they apply) override obligations under LCs, such that the FI may be prevented from making payment regardless of the terms of the LCs. For that reason, there are two key questions to be considered when considering the impact of sanctions on an LC transaction, namely[1]:

1. Do the sanctions prohibit the issuance, confirmation, extension or payment under the LC[2]?

2. Is the issuing or confirming bank bound by those sanctions?

The first question entails consideration of the wording of the sanctions, as clarified or further expounded by national regulators or administrative agencies or the courts. However, FIs may seek to limit the scope for debate on both questions and so manage their legal risk through the increasing use of sanctions clauses.

There is no standard for these sanctions clauses; rather, there is a range of differently worded clauses in use by FIs. Some of the clauses are seen as “merely informational” in that they simply state that an FI will respect such sanctions law as is applicable to it[3].

Others go further by allowing an FI a level of discretion as to whether or not to honour a complying presentation, beyond the statutory or regulatory requirements applicable to it. It is these later category of sanctions clauses that are seen as particularly problematic. The key issue of concern is that such discretion may bring into question the independent nature of the LC and its irrevocability and, worse still, whether the bank has in fact assumed a legally binding obligation in the first place. In response to the concerns raised in the market regarding the use of sanctions clauses, the ICC Banking Commission first published a guidance paper on this issue in March 2010[4]. In that paper, the ICC recommended that FIs refrain from including such clauses that bring into question the bank’s commitment or the irrevocable nature of the transaction.

The ICC published a revised guidance paper in 2014 (“2014 Guidance”) on the use of sanctions clauses in instruments subject to ICC Rules (and so including LCs)[5]. In its 2014 Guidance, the ICC discourages the use of sanctions clauses which give the bank a discretion whether or not to process or honour the LC, where there is in fact no prohibition under the applicable regulations[6]. In other words, an FI’s concern that there may be some connection with sanctions (and any internal policies of the FI that may have been formulated to address the sanctions risk) should not be the basis upon which the FI determines whether or not to process or honour the LC. The ICC also seeks to dissuade FIs from using sanction clauses that are “informative” only, as it considers that these may be unnecessary, lead to confusion and, in some circumstances, may run foul of mandatory laws in some countries that prohibit the use of such clauses on grounds of discrimination.

The continuing and increasing use of a variety of sanction clauses, the uncertainly as to their application and, consequently, the effectiveness of the LCs[7] themselves has caused the ICC to publish, in May 2020, an Addendum[8] to its 2014 Guidance. The ICC recognises that although the guidance is to avoid the use of sanctions clauses, there has been a resurgence in the use of such clauses as a number of FIs see it as an important risk mitigation tool. Whilst restating its primary message that FIs should refrain from using sanctions clauses that seek to impose restrictions beyond those applicable as a matter of law, the ICC has proposed a sample clause and set out guidance for its use.

The ICC sample clause is as follows:

“[notwithstanding anything to the contrary in the applicable ICC Rules or in this undertaking,] We disclaim liability for delay, non-return of documents, non-payment, or other action or inaction compelled by restrictive measures, counter-measures or sanctions laws or regulations mandatorily applicable to us or to [our correspondent banks in] the relevant transaction.”

The further recommendations set out in the Addendum regarding the drafting of sanctions clauses include that:

i. they ought only to be considered in specific transactions, and only after consulting with the customer and counterparties in the relevant transactions;

ii. specific sanctions regulations may be referred to in the clause, provided that those references are limited to those regulations that directly and mandatorily apply to the FIs;

iii. clauses should refrain from including unparticularised references to laws generally;

iv. banks should consider avoiding sanctions clauses when operating in jurisdictions that prevent or restrict their inclusion; and

v. reference to “bank policy and procedure” should be avoided at all times.

As the ICC expressly acknowledges, the sample clause “may not contemplate every conceivable instance of sanctions application or, indeed, exempt the bank abstaining from the performance of its obligations from liability” but it does serve as a helpful guide to FIs seeking to incorporate such clauses and corporates reviewing whether what has been proposed by an FI is acceptable. A further point that needs to be carefully considered in drafting and using a sanctions clause is what effect it has on liability once triggered. It cannot be assumed that any liability of the FI to make a payment under the LC is extinguished once the sanctions clause bites; the clause may simply have the effect of suspending the payment obligation for the period that the prohibition remains in place[9] and limiting consequential liability, e.g. due to delay.

[1] There is of course the preliminary, and potentially complex, issue to be determined of ascertaining which laws and regulations apply to a transaction. As referred to above, an FI may be subject to regulations in a number of jurisdictions as a consequence of its place of incorporation and/or operations, its ownership or corporate structure, the currency or place of payment etc.

[2] “Before a sanction can lawfully be applied there must be conduct which is prohibited” – Teare J in Mamancochet Mining Limited v Aegis Managing Agency Limited and Others [2018] EWHC 2643 (Comm) at paragraph 47.

[3] An example of such a clause is: “Presentation of document(s) that are not in compliance with the applicable anti-boycott, 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.” Cited in ICC 2014 Guidance

[4] https://iccwbo.org/publication/sanction-clauses-guidance-paper-2010/

[5] https://iccwbo.org/publication/guidance-paper-on-the-use-of-sanctions-clauses-2014/

[6] An example of such a clause is: “[Bank] complies with the international sanction laws and regulations issued by the United States of America, the European Union and the United Nations (as well as local laws and regulations applicable to the issuing branch) and in furtherance of those laws and regulations, [Bank] has adopted policies which in some cases go beyond the requirements of applicable laws and regulations. Therefore [Bank] undertakes no obligation to make any payment under, or otherwise to implement, this letter of credit (including but not limited to processing documents or advising the letter of credit), if there is involvement by any person (natural, corporate or governmental) listed in the USA, EU, UN or local sanctions lists, or any involvement by or nexus with Cuba, Sudan, Iran or Myanmar, or any of their governmental agencies.” Cited in ICC 2014 Guidance

[7] As well as other trade finance instruments such as standby letters of credit and demand guarantees.

[8] https://iccwbo.org/content/uploads/sites/3/2020/05/20200504-addendum-to-sanction-clausespaper.pdf

[9] See further Teare J in Mamancochet Mining Limited v Aegis Managing Agency Limited and Others [2018] EWHC 2643 (Comm) at paragraphs 77 and 78