International Trade – Sanctions and the Sanctity of Documentary Credits

It is a sacrosanct rule of international trade that letters of credit are to be honoured if  complying documents are presented in a timely fashion. This time-honoured rule is  based on the irrevocable undertaking given by issuing banks to honour a credit by paying  against a complying presentation of the stipulated documents. Such banks therefore  assume a simple but seemingly absolute obligation towards beneficiaries of letters of  credit. However, banks also have an obligation to comply with the law and this includes  laws in relation to international sanctions. Therefore, a bank may be faced with the  obligation to honour a letter of credit in circumstances where any such payment would  violate applicable sanctions and place the bank in jeopardy of criminal penalties or other  regulatory sanctions. Banks invariably prefer to avoid such liability even if it means facing  a claim by the beneficiary of a letter of credit for failure to honour a complying  presentation. The solution adopted is to include a sanctions clause in the letter of credit  which gives the bank the right not to honour a complying presentation where to do so  would involve the bank in criminal liability for breaching laws on sanctions. 

A case in Singapore considered the efficacy of such a clause and concluded that in  certain circumstances it may be efficacious to protect a bank against contractual liability. The clause in question was inserted by the confirming bank in its confirmation of the  credit to the beneficiary. Although it was not found in the letter of credit itself this was no  barrier to the confirming bank relying on it. A letter of credit transaction is in reality a  compound transaction involving a number of related but discrete contracts, one of which  being the contract between the confirming bank and the beneficiary. The clause in  question read: 

[JPMorgan] 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.

The bank took the view that the ship which carried the coal which was the subject of the  sale contract pursuant to which the buyer applied for and obtained the letter of credit  was the subject of US sanctions against Syria because the bank had information to  suggest the ship was previously registered by a Syrian entity and, therefore, a red flag was  raised internally that the change of registration to a non-Syrian entity may not have  resulted in a change in the beneficial ownership. The US Office of Foreign Assets Control 

(OFAC) appeared to support the bank’s position by stating that payment in these  circumstances would involve violation of the US Syrian sanctions regime. 

On appeal to Singapore’s highest court the bank failed. While the sanctions clause in the  bank’s confirmation was upheld as a valid contractual clause, the court decided that the  evidence before the court pointing to the supposed Syrian ownership of the vessel was  inconclusive. OFAC’s opinion did not change the fact that the objective evidence was not  good enough to meet the standard of proof required by a court. In refusing to pay, the  bank was taking a risk-based decision i.e. that it would rather be sued by the beneficiary  for failing to pay against a complying presentation than to be found by OFAC to have  breached US sanctions. This was rational but not a contractually justified approach and  the sanctions clause did not help the bank. 

Having decided against the bank on the basis of the lack of evidence to show that the  vessel remained in the beneficial ownership of a Syrian entity, the court went on to  discuss the question raised by the beneficiary which was whether the sanctions clause  was compatible with the commercial purpose of the bank’s confirmation. It was argued  that under the UCP 600, a confirmation was “a definite undertaking of the confirming  bank … to honour or negotiate a complying presentation”. A sanctions clause giving the  bank the freedom not to do so because it believed the carrying ship was a sanctioned  entity was contrary to this undertaking. It was all the more unjust because a beneficiary usually had no say in nominating the ship and even if it knew which ship was being used  it would be difficult to determine the beneficial ownership of that ship. 

This remains an open question and the court’s views on it were strictly not necessary. The  court did not find the ICC’s Guidance Paper on the Use of Sanctions Clauses useful as it  simply stated that “if the sanctions clauses in … letters of credit … allow the issuer a level  of discretion as to whether or not to honour beyond the statutory or regulatory  requirements applicable to that issuer, they bring into question the irrevocable and  documentary nature of the letter of credit”. There is no guidance as to when a particular  sanctions clause would cross the line. However, the court was clear that the bank’s  position in the present case (i.e. that its sanctions clause entitled it to deny payment  against a complying presentation as long as it finds that, on a risk-based assessment, it  would prefer to be sued by the beneficiary than to risk being penalised by OFAC) would  result in the sanctions clause being incompatible with the commercial purpose of the  confirmations due to the significant unpredictability such an interpretation would  introduce into the confirmations. 

Beneficiaries must therefore be aware that a sanctions clause may be inserted in the  letter of credit or separately in the confirmation of that credit and this may affect the  irrevocable and documentary nature of the credit. The court’s remedy is to construe such  clauses strictly and to require banks to ensure they have sufficient evidence to meet the  civil standard of proof before they are allowed to deny payment to a beneficiary.

For more information relating to this article, kindly contact Partner, Probin Dass.

Disclaimer: This information is provided for general information and does not constitute legal or other professional advice. Specific advice should always be sought in relation to any legal issue.