When will sanctions frustrate an agreement?

A recent judgment of the English Commercial Court has highlighted the issue of the effect of new sanctions legislation upon contractual obligations, and in particular the importance of considering applications for available licences before seeking to rely on the doctrine of frustration.

In the case of Melli Bank plc v Holbud Limited [2013] EWHC 1506, the Commercial Court ("Court") granted summary judgment to Melli Bank plc ("Bank"), regarding commitment fees said to be owed to it by a customer, Holbud Limited ("Customer"). The commitment fee was in regard to a facility that went unutilised after the Bank was designated under the prevailing EU sanctions regime and had its assets frozen. The Court ruled that this did not amount to frustration, as the Customer could have applied for a licence from the UK competent authority ("HM Treasury") allowing payment to be made.

Facts

The contract

The Bank and the Customer had entered into an agreement ("Facility Agreement") allowing the Customer to obtain payment prior to the maturity date of letters of credit and other financial instruments of which it was the beneficiary. This arrangement involved the Bank purchasing the various letters of credit and financial instruments. The Bank then charged certain fees for this service; including a commitment fee for the period during which the funds to make the purchase ("Facility") were to be available.

The Facility Agreement included representations and undertakings giving the Customer responsibility for executing all further documents and taking further action required to give effect to the purchase and complete the assignment.

On 25 April 2008 the Customer informed the Bank under the Facility Agreement that it wished to utilise the Facility and it was duly made available up to 30 June 2008.

The EU sanctions

Two months later on 24 June 2008, Council Decision 2008/475/EC designated the Bank under EU sanctions (amending Regulation (EC) No 423/2007, since superseded by Regulation (EU) No 267/2012). This subjected the Bank to an asset freeze implemented in the UK under the Iran (European Community Financial Sanctions) Regulations 2007 (also now superseded by the Iran (European Union Financial Sanctions) Regulations 2012, as amended).

On the same day HM Treasury published a Financial Sanctions Supplement which contained guidance relating specifically to the implications of the asset freeze in respect of the Bank, and the relevant licensing arrangements. In particular, the Supplement noted that HM Treasury intended to allow payments under prior contracts, including letters of credit, where it was satisfied that certain conditions were met (e.g. that they would not contribute to proliferation-sensitive nuclear activities).

There was no further contact between the Customer and the Bank before 30 June 2008 when the Facility expired. The Bank subsequently contacted the Customer demanding the commitment fee for the unutilised Facility. On 12 August 2008 the Customer replied stating the agreement had been frustrated by the imposition of the sanctions regime.

Frustration or repudiatory breach?

Regarding its failure to apply for a licence, the Customer argued that it would have been impossible for a licence to be obtained before the Facility expired due to the need for HM Treasury to set up its procedures. The Customer also argued that it would need to take various additional steps which risked contravening the Regulation.

In the alternative, the Customer argued that the designation and subsequent asset freezing rendered performance of the agreement either illegal or impossible due the Bank having insufficient funds to proceed with the agreement and that this amounted to repudiatory breach. The Customer claimed it had accepted the breach (by implication), thereby terminating the Facility Agreement.

The decision

The Court dismissed the Customer's arguments and upheld the Bank's application for summary judgment for the full amount of the commitment fees. In particular:

• There was nothing in the Facility Agreement that left it unable to operate if circumstances were to require a licence.
• It was the Customer's responsibility under the Facility Agreement to execute any further documents necessary to give effect to it, which would reasonably include applying for a licence.
• The Customer had failed even to make any inquiries with HM Treasury regarding applying for a licence.
• The evidence suggested that a licence was available and that HM Treasury would have sought to assist.
• There had been no contact between the Customer and the Bank following the asset freeze and as such the Customer could not have been said to have accepted the repudiation (which could not be inferred from silence or a failure to act).

Commentary

This case is a timely reminder of the importance of obtaining advice quickly following extraordinary circumstances such as the introduction of an economic sanctions regime. Importantly, it demonstrates that the designation of an entity or person will not necessarily result in the frustration of the agreement.

While it may seem intuitive to assume that an asset freeze would make performance impossible, in this case the Facility Agreement and the relevant sanctions legislation provided for a licensing regime which anticipated and addressed the circumstances that transpired.

Indeed, specific guidance had been published by HM Treasury concerning the arrangements in question, and the Court considered that all the evidence suggested that the licence "could be expected to be forthcoming". Accordingly, there may be stronger arguments in favour of frustration in circumstances where it is less likely that a licence will be available.

The importance of timing in particular was downplayed by the Court. If ultimately it would have been impossible to obtain the licence in the time available under the contract in order to utilise the Facility, it seems more likely that a frustrating event could have been demonstrated. In this case, however, the Court clearly considered that the Customer should have made enquiries and should have taken steps to ameliorate its position.

More broadly, there are potential implications for other industries and approval processes. The Court specifically stated that this principle could be applied beyond sanctions to the wider banking sector and other heavily regulated sectors due to the broad range of situations where new licensing or other approval requirements could be introduced regulating the receipt of funds.

The judgment serves to emphasise the importance of considering applications for available licences before seeking to rely on the doctrine of frustration, which will not lightly be invoked by the courts.

For further information, please contact Daniel Hudson, Partner, Andrew Cannon, Senior Associate, Jeremy Sher, Associate, or your usual Herbert Smith Freehills contact.