Sanction clauses have gained significant prominence in international trade and finance due to the ever-evolving global regulatory landscape.  Because of the cross-border nature of transactions in shipping and international trade, traders, shipowners, charterers and banks have increasingly relied on sanction clauses to ensure that they do not inadvertently violate international sanctions and embargoes. Notwithstanding the very nature of sanctions being instruments of coercive diplomacy, it would appear that in interpretating sanctions clauses, one should not be distracted by geo-political considerations and factors such that the underlying contractual legal principles become sideline.

This is indeed the position taken by the Singapore Court of Appeal in Kuvera Resources Pte Ltd v JPMorgan Chase Bank, NA [2023] SGCA 28 (“Kuvera’s case”) where the Court of Appeal overturned the decision of the trial judge and provided guidance on the interpretation of a sanctions clause in a letter of credit transaction.

In this edition of Notes from the Bar, we examine the Singapore Court of Appeal’s comments in Kuvera’s case on the interpretation of sanctions clauses and the basic underlying legal principles applicable to a letter of credit involving sanctions clauses.

Facts of the case

Before we summarise the facts of Kuvera’s case, we think that the opening comments of the Court of Appeal’s judgment are illustrative:

“1 Unlike armed conflict or military intervention, the coercive power of economic sanctions is derived not from what they do to entities and nations that do not comply with international laws and policies but what they do not, in the sense that they operate not through a formal declaration and imposition of war, but by way of “material exclusion from the world economy” (Nicholas Mulder, The Economic Weapon: The Rise of Sanctions as a Tool of Modern War (Yale University Press, 2022) (“The Economic Weapon”) at pp 3 and 14). In withholding international trade and commerce from polities and nations, economic sanctions have become a powerful instrument of international diplomacy, and sanctions regimes have, over the course of the past few centuries, been imposed against states and non-state actors as a response to and a means of exerting political influence over their policies and behaviours and enforcing visions of international order. It is therefore unsurprising that economic sanctions have been described as “something more tremendous than war” in that “[i]t does not cost a life outside of the nation boycotted, but it brings a pressure upon that nation which … no modern nation could resist” (The Economic Weapon at pp 1–2; see also Natalino Ronzitti, “Sanctions as Instruments of Coercive Diplomacy: An International Law Perspective” in Coercive Diplomacy, Sanctions and International Law (Natalino Ronzitti ed) (Brill, 2016) ch 1 at pp 9–14).

2 However, while primarily a geopolitical instrument, economic sanctions have found their way into contractual dealings and have thereby assumed a legal dimension. We see this in the present case, where the respondent denied liability to pay the appellant, the beneficiary of two letters of credit, on the basis that the confirmations of the letters of credit bear a contractual clause (the “Sanctions Clause”) which extinguished the respondent’s liability as the underlying commercial transaction was allegedly caught by the sanctions laws of the United States of America (“US”).

3 The court’s task is to interpret such a clause as a term of the contracts which are embedded within the two letters of credit and, in this task, the geopolitical considerations that underpin the deployment of sanctions may not be relevant or helpful. In that regard, the principles governing contractual interpretation must take centre stage with geopolitical considerations receding to the backdrop.”

In Kuvera’s case, the seller in Indonesia contracted with the buyer in the UAE to sell coal to be delivered in two parcels.  Kuvera advanced the funds to the seller to purchase the coal for on-selling to the buyer.  In return, the buyer procured the issuance of letters of credit naming Kuvera as the beneficiary.

The issuing bank was a bank in Dubai and JPMorgan was named as the advising bank.  Subsequently, JPMorgan added its confirmation on the letters of credit.  When it added its confirmation, JPMorgan included a sanctions clause which provides as follows:-

“[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.”

Kuvera presented complying documents under the letter of credit to JPMorgan.  After JPMorgan received the documents, they were subject to the bank’s internal screening process.  It was then discovered that the carrying vessel, MV “Omnia” was named in the bank’s internal list known as the Master List which contains the names of individuals, entities and vessels that the bank determined had some sanctions nexus or concerns.

Unlike the OFAC list which was publicly available, the JPMorgan Master List is not accessible to the public.  While the MV “Omnia” was on the JPMorgan’s Master List, it was not listed by OFAC as being subject to any form of sanctions.

Apparently the vessel was previously named the MV “Lady Mona” in 2015 when it was placed by JPMorgan into its Master List.  There was evidence showing that the beneficial ownership of the MV “Lady Mona” in 2015 was Syrian and thus fell within US sanctions against dealing with Syrian entities.

However, in 2019, the registered ownership of the vessel changed and the vessel was renamed the MV “Omnia”.  There was no evidence available to show who was the beneficial owner of the vessel after the change in her registered ownership.  JPMorgan’s approach was that since it was not possible to ascertain if there was any change in the beneficial ownership, as a matter of their risk management policy, they chose to regard the MV “Omnia” as having sufficient nexus with a sanctioned entity.

The position that the bank took was that it would rather breach its obligations to pay on the confirmation rather than risk being in breach of the applicable sanctions regulations.  The decision to decline payment was thus part of its risk management approach.

The issue before the Court of Appeal was whether JPMorgan was entitled to adopt their risk management approach when construing the effect of the sanctions clause.

Decision of the Court of Appeal

The Court of Appeal rightly held that the sanctions clause must be interpreted in the same manner as any other contractual provisions without the influence of any of the geopolitical considerations.  In this regard, the sanctions clause must be construed objectively and the question of whether the MV “Omnia” was subject to any applicable restriction should be determined on an objective basis.  The Court of Appeal further noted that the question of the beneficial ownership of the vessel was also an issue that is capable of objective determination.

In this context, the Court of Appeal applied the same approach in determining the beneficial ownership of a vessel in cases involving ship arrests, namely that as a starting point, the registered owner is prima facie the beneficial owner.  If any party claims that the beneficial owner is some other entity due to any sort of trust or other arrangements, it is open to that party to adduce evidence showing that the beneficial ownership belonged to someone else and not the registered owner.

On the facts of this case, the Court of Appeal held that if JPMorgan wished to rely on the sanctions clause, the burden is on the bank to prove that there was no change in the beneficial ownership of the vessel notwithstanding the change in the registered ownership.  As JPMorgan was unable to prove that the beneficial ownership of the vessel was Syrian, and therefore subject to US sanctions regulations, it would not be permissible for JPMorgan to rely on their sanctions clause to avoid payment.

It was notable in that the Court of Appeal recognised that the bank may not have any access to the information regarding the beneficial ownership of the vessel, particularly since the vessel was from a flag of convenience like the Barbados where the beneficial ownership of the vessel was not provided.  The bank’s difficulty in obtaining evidence on the beneficial ownership of the vessel does not assist the bank when it seeks to rely on the sanctions clause.

Was the sanctions clause fundamentally inconsistent with the commercial purpose of the confirmation?

One of the arguments raised was that the sanctions clause was fundamentally inconsistent with the commercial purpose of the confirmation.  It was argued that if JPMorgan’s interpretation of the sanctions clause was correct, it would effectively grant JPMorgan the discretion to refuse payment against complying presentation and such a discretion to refuse payment is against the fundamental commercial purpose of a letter of credit.

If the bank had the discretion to refuse payment if it suspects that it may be in breach of sanctions regulations, or may be at risk of being in breach, it brings into question the irrevocable nature of a letter of credit.

The Court of Appeal opined that if JPMorgan’s interpretation of the sanctions clause was adopted, i.e. that the bank was entitled to refuse payment so long as it finds that on a risk-based assessment, it risked being penalised by OFAC, it would mean that the sanctions clause would be incompatible with the commercial purpose of the confirmation as it would result in bringing about significant unpredictability into the confirmation.  Such commercial uncertainty to the beneficiary runs counter to the commercial purpose of a confirmed letter of credit which is to provide security to the beneficiary that it will receive payment so long as it is able to present complying documents.

Confirmation by a confirming bank is a unilateral contract

The Court of Appeal also took the opportunity to reaffirm several basic principles in the law regarding letters of credit.

The first is the principle of autonomy where the letter of credit operates independently of the underlying sales contract.  The principle of autonomy extends to a situation where a confirming bank adds its confirmation to the letter of credit.  The undertaking by the confirming bank to pay the beneficiary is independent of the underlying transactions, including the underlying letter of credit.

Given that the confirmation by the confirming bank is a separate contract from the underlying letter of credit, the Court of Appeal noted that it is possible for a confirming bank to include additional terms in the confirmation that are not contained in the underlying letter of credit.

The legal effect of a confirmation being a unilateral contract is that a contract is formed and the bank’s obligations under the confirmation, together with all the terms and conditions set out in the confirmation, are brought into existence upon the fulfilment of a specific condition, i.e. the presentation of conforming documents.

Our Comments

In our view, the holding of the Court of Appeal is a highly welcome development from the perspective of traders.

It makes clear that a bank cannot refuse to make payment on a complying presentation of documents merely because the bank’s own risk assessment is that there may be a potential breach of sanctions regulations.  Letters of credit are the lifeline of international commerce and the introduction of any form of uncertainty as to whether a beneficiary will be paid will have the effect of choking the flow of international trade.

The effect of this case does not place the banks in a disadvantageous position either.  If the transaction is actually prohibited by the relevant sanctions regulations, the banks are permitted to refuse payment.  The banks are not entitled to refuse payment if they think that they may be at risk of breaching sanctions regulations.

And from the traders’ point of view, if they choose to charter vessels that are listed on the OFAC sanctions list, and the banks refuse payment on that ground, the trader would only have themselves to blame for not doing their own due diligence.  But a trader, having done his due diligence, should not be penalised simply because his bank was risk-adverse.

Disclaimer: This article is for general information only and not intended to constitute legal advice. We shall not be liable for any errors or omissions, nor shall we be liable for reliance on the contents of this article.

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