Protecting your business: Is your sanctions clause robust?
Once considered as a “nice to have”, the sanctions clause has become a highly negotiated “must have” contractual clause in recent years. Any business that engages in activity relating to or in connection with high-risk jurisdictions, or involving high-risk goods or services, should incorporate clear and robust sanctions clauses in its contracts. These clauses should include a degree of flexibility to ensure that they stand up to frequently changing geopolitical circumstances and sanctions regimes. Parties must also remember that sanctions clauses which suit one transaction may be very different to what is acceptable to parties in another transaction.
In other words, there is no one-size-fits-all position so it is vital for businesses to understand the key elements of a sanctions clause to be able to assess any “non-negotiable” points.
Broadly speaking, a sanctions clause should have the following key elements:
- Sanctions regimes that should be captured
- The type of sanctions restrictions that should be within scope
- The party that has the right to exercise the remedy
- The remedy
Which sanctions regimes are captured?
This is usually a key point of negotiation. At first instance, determining what sanctions regimes should be included requires an analysis of a business’ operations and place of incorporation, the nationality of the employees involved in the transaction, and the location where contractual performance is envisaged. Separate but also important consideration should be given to a business’ separate contractual obligations – for example, the sanctions covenants in relation to the business’ financing agreements would be relevant where funds relating to that financing are deployed or generated from a particular business transaction. More importantly, is a sanctions regime, while included in the contract, relevant only to the extent that it is “applicable” to a party? In such instances, an in-depth analysis on the jurisdictional nexus of each sanctions regime is highly important when assessing whether that sanctions regime is “applicable”, such that a party may rely on it to trigger the sanctions clause.
Readers should note that, especially since 2022, the number of disputes or potential disputes centred around this issue of “applicability” has grown considerably, particularly in the context of the extraterritorial nature of U.S. sanctions (and EU/UK anti-boycott laws), suggesting that this is a key learning point that should be factored into sanctions clauses going forward.
What type of sanctions restrictions are within scope?
The following are the general categories of restrictions:
- Trade sanctions – these involve prohibitions on the import, export, transfer or movement of goods and technology.
- Financial sanctions – these include restrictions on designated persons, such as freezing their financial assets, as well as wider restrictions on financial services and investment.
- Transport sanctions – these involve restrictions on the ownership, registration or movement of ships and aircraft.
- Immigration sanctions – these include travel bans.
- Export controls – although not technically “sanctions”, parties should also consider addressing export controls in their sanctions clauses.
Whilst most descriptions of the types of sanctions restrictions in industry-standard sanctions clauses would likely capture all of these restrictions, it remains important for businesses to consider this when reviewing any sanctions clauses.
Who has the right to exercise the remedy?
Will this be the party who is not in breach of sanctions or any party to the contract? Can a party rely on the sanctions clause if, in its reasonable (or absolute) discretion, there is a risk of a breach of sanctions? Or will this need to be an objective test? Can the party who is breaching sanctions use termination provisions to improve its commercial position?
What is the remedy?
This could include an immediate right to terminate, suspension or the accrual of interest on suspended payments. It is also important to consider the relevant timings to exercise rights under the sanctions clause. For example, are these rights exercisable with immediate effect upon providing notice and, if so, what is considered “deemed delivery” of a notice under the notices provision? For some sanctions regimes, including U.S. sanctions, regulator authorisation is required prior to terminating an agreement with a sanctioned party.
Interpreting sanctions clauses
As mentioned in our previous client alert, appreciating how courts interpret sanctions clauses is fundamental for commercial parties to understand how to both (a) assess their legal rights under existing sanctions clauses and (b) draft appropriate contractual protection for the future. In Lamesa Investments Ltd v. Cynergy Bank Ltd, the English Court of Appeal considered the proper interpretation of a sanctions clause within a loan agreement and the extent to which the clause in question protected a party from the risk of U.S. secondary sanctions, concluding ultimately that it did so. The decision is an example of the courts applying established principles of contractual interpretation to sanctions clauses, and highlights the factors that may influence the court’s interpretation of a sanctions clause, including extraterritorial risk.
Contractual definition of “Sanctioned Person” (or equivalent)
The implications of an entity being “owned or controlled” by a person subject to asset freeze restrictions is that the entity will also be subject to similar asset freeze restrictions. Accordingly, understanding how the “ownership” and “control” tests are applied is vital when interpreting a sanctions clause and determining whether the concepts of “Restricted Party” or “Sanctioned Party” (or equivalent) are adequately worded to capture all asset freeze targets.
In Mints & Others v. PJSC National Bank Trust & Another and Litasco SA v. (1) Der Mond Oil and Gas Africa SA (2) Locafrique Holding SA, the English courts examined the meaning of “control” in the context of the Russia (Sanctions) (EU Exit) Regulations 2019, arriving at different conclusions based on their respective facts. We discussed this further in our previous client alert.
Conclusion
There are complex issues that businesses face when drafting and interpreting sanctions clauses, requiring an analysis of, amongst other things, the business intent, the business’ ancillary obligations, its global footprint and its concerns about reputation. These issues are even more complex where the sanctions restrictions that are being promulgated by certain governments are rapid and potentially unclear – which, based on our experience, leaves businesses in a “Catch-22” situation, caught between being exposed to contractual repudiatory breaches on the one hand, and potentially violating relevant sanctions laws.
Client Alert 2024-080
