Do you take cash? The Court of Appeal provides guidance on sanctions legislation in Celestial v UniCredit

The Court of Appeal has handed down judgment in Celestial Aviation Services Ltd v UniCredit Bank AG (London Branch) [2024] EWCA Civ 628 overturning a High Court decision which sparked significant concern amongst financial institutions and corporates alike as to the scope of a contracting parties’ obligations when faced with the impact of sanctions. In particular, the extent to which payments in cash may be required to overcome a sanctions issue where a party is prevented from making a payment by way of bank transfer.

Amongst other points, the Court of Appeal:

1. decided that Regulation 28 of the Russia (Sanctions) (EU Exit) Regulations 2019, SI 2019/855 (the UK Regulations) prohibited payment under letters of credit because payment was “in pursuance of or in connection with” an arrangement prohibited by the UK Regulations, (in this case the supply of aircraft). The Court emphasised the breadth of the language in Regulation 28 noting that the provision is a “relatively blunt instrument that is intended to cast the net sufficiently wide to ensure that all objectionable arrangements are caught” and that it “risks catching arrangements that may not be seen to be within the overall mischief”. The Court said the solution to mitigate any unintended negative consequences of the UK Regulations is the licencing regime.
2. rejected UniCredit’s reliance on section 44 of the Sanctions and Anti-Money Laundering Act 2018, which it held did not protect a party with the reasonable (but mistaken) belief that sanctions applied from being pursued in respect of interests and costs.
3. found that UniCredit could not rely on illegality under US law. The Ralli Bros rule was not applicable because UniCredit had not taken reasonable steps to obtain a licence from the US authorities.
4. helpfully rejected (albeit in obiter) any suggestion that payment obligations should be performed through payment in cash or alternative currencies with a view to avoiding violations of US sanctions.

We consider the judgment and key takeaways in more detail below.

Background

The dispute initially arose out of a series of letters of credit that were issued by Sberbank Povolzhsky Head Office (Sberbank) in connection with the lease of aircraft by subsidiaries of AerCap to Airbridge Cargo Airlines LLC (AAL) and JSC Aurora Airlines (Aurora), and by Constitution Aircraft Leasing (Ireland) 3 Ltd and Constitution Aircraft Leasing (Ireland) 5 Ltd (together, Constitution) to AAL. Both AAL and Aurora are Russian airlines.

There were 12 letters of credit in total: Celestial Aviation Services Ltd (Celestial), a member of the AerCap group, was the beneficiary under seven and Constitution was the beneficiary under five. UniCredit Bank GmbH was the confirming bank (UniCredit). The relevant letters of credit were each denominated in US dollars, governed by English law, incorporated the Uniform Customs and Practice for Documentary Credits, 2007 Revision (the UCP), and were issued between 2017 and 2020.

In March 2022, each of the leases were terminated for default; Celestial and Constitution made demands for payment under the relevant letters of credit. UniCredit took the position that sanctions prevented it from making payment. Celestial and Constitution each issued proceedings, and in the meantime UniCredit applied for licences from the relevant sanctions authorities. Licences were subsequently granted by EU and UK authorities, such that the principal amounts due under the letters of credit were settled. A US licence application remains pending.

First instance decision

At first instance, the Court found in favour of Celestial and Constitution and considered that the operation of the operation of Regulations 11, 13, and 28 of the UK Regulations did not relieve UniCredit of its payment obligations.

The Court made the following findings (amongst other matters):

• obligations arising under letters of credit should be considered by reference to the principle of autonomy;
• when interpreting sanctions legislation, a purposive approach should be adopted and sanctions are intended to operate prospectively as opposed to retrospectively; and
• where the fundamental obligation is to make a payment, and where it is possible to make a payment by other means, even if in cash so as not to be processed by a bank targeted by sanctions, payment should be made.

The issues at appeal

Four issues were the subject of the appeal (broadly summarised):

1. Whether payment under the letters of credit by UniCredit was prohibited by Regulation 28(3) of the UK Regulations?
2. If it was not prohibited, did UniCredit have a defence under section 44 of the Sanctions and Anti-Money Laundering Act 2018 (SAMLA) on the basis that its belief it was complying with UK sanctions was reasonable?
3. Did the Ralli Bros principle apply in circumstances where effecting payment in US dollars required the involvement of a correspondent bank in the US?
4. If US sanctions were engaged, would payment have been illegal under that regime?

Issue 1: Letters of Credit/the provision of funds or financial services can fall afoul of sanctions, even if the underlying arrangements have been terminated

Regulation 28(3)(c) of the UK Regulations prohibits a person from (directly or indirectly) providing financial services or funds in pursuance of or in connection with an arrangement whose object or effect is to “directly or indirectly making restricted goods or restricted technology available - (i) to a person connected with Russia, or (ii) for use in Russia”. It was not disputed that the aircraft in question constituted “restricted goods”.

The Court of Appeal determined that the judge did not engage properly with the wording of Regulation 28(3)(c) and erred in his assessment of the purpose of the UK Regulations, which it found was to “put pressure on Russia.”

In contrast to the approach taken by the High Court, which considered that sanctions were intended to operate prospectively as opposed to retrospectively, the Court of Appeal held that it was clear that the letters of credit were provided “in connection with” the objects/effects stated in the UK Regulations, notwithstanding that all of the leases had been terminated by the time the demands under the letters of credit had become due for payment. The Court of Appeal found that the object of the leases remain unchanged by their termination: “it is and always has been the making available of aircraft for use in Russia or to a person connected with Russia”. As to the principle of autonomy, which generally applies to letters of credit, the Court of Appeal found that although obligations under letters of credit are autonomous in the sense that they are not contingent on whether the beneficiary has a claim or on the position of the issuing bank, this does not mean that “the factual reality of a connection with the leases can be ignored.”

The Court of Appeal considered that the licensing regime under the UK Regulations is in place to capture historical arrangements which might fall afoul of this provision, and that there was no support in the language to construe the regulation as only capturing future arrangements.

Issue 2: Whether a subjective belief is reasonably held is a question to be determined objectively

Section 44 of SAMLA provides that a person is not liable to any civil proceedings for an act done in the reasonable belief that the act is in compliance with regulations made under SAMLA (which include the UK Regulations) or in compliance with a direction given under section 6 or 7 of SAMLA.

Given the Court’s finding on the first issue, it was not necessary to make a determination on the second. Notwithstanding this, given the issue was fully argued, the Court provided its view given the broader significance of the provision. The Court of Appeal did not disturb the judge’s conclusion that UniCredit had the requisite subjective belief that making payment would be a breach of regulation 28(3) of the UK Regulations, such that it was not able do so and remain in compliance with UK sanctions. The Court of Appeal rejected the submission that UniCredit needed to “show its workings” in coming to this view, noting that having established the existence of a subjective belief, the question of whether the belief was reasonable, is to be determined objectively. The Court of Appeal found that even if it had not agreed with UniCredit’s assessment of the application of the UK Regulations, it would have still considered the view to be reasonably held given the need for UniCredit to form a view at short notice on the interpretation of provisions which were not clear at the time. The Court of Appeal accordingly found that UniCredit was entitled to rely on section 44 until it obtained licences from the UK sanctions authorities (the Export Control Joint Unit and the Office of Financial Sanctions Implementation).

The Court of Appeal found that the purpose of this provision is “to ensure that a person is not pressurised into doing something that risks breaching sanctions by a fear of being exposed to civil claims” but that it does not prevent an award of interest on a claim for debt.

Issue 3: Cash-payments and payments in other currencies precluded by the terms of the contract.

Pursuant to the rule in Ralli Bros, where a contract is illegal in the place of performance, the English Courts will not enforce the contract. UniCredit contended that payment in USD required the involvement of a US correspondent bank, such as to make the US a relevant place of performance for the purposes of the Ralli Bros rule. At first instance, the judge said Unicredit could have paid in cash so as to avoid violation of US sanctions.

As the other issues had been determined in such a way as to make this point less significant, the Court of Appeal only made non-binding comments concerning the judge’s finding on the obligation to make payment in cash or in another currency (which the judge had contended precluded UniCredit from relying on the Ralli Bros principle). Notwithstanding this, the Court of Appeal provided welcome clarity as to the position.

After the trial, the parties made submissions following the release of the Supreme Court judgment in MUR Shipping (our previous article is here). The Court of Appeal considered that although the case was of limited relevance, it reinforced the importance of the freedom to contract, including as to the “manner of performance”.

The Court of Appeal did not endorse the judges’ decision that cash could be paid, or the alternative argument that payment could be made in a different currency in circumstances where no demand for payment in cash or a different currency was made, and neither option is contemplated in the relevant contracts. The Court of Appeal found that the letters of credit expressly required that the demand would be for the transfer of US dollars to a specified bank account. The Court found that the term “transfer” does not naturally connote a payment in cash and referred to the principle of “strict compliance” when making a complying presentation, referring to Article 2 of the UCP.

Issue 4: Reasonable efforts to obtain a licence include drafting the licence application in appropriate terms

Notwithstanding the above, the Court of Appeal found that (to the extent US sanctions were relevant), UniCredit was precluded from relying on the Ralli Bros principle in any event because it did not make “reasonable efforts” to obtain a licence from the US authorities because of the way in which it framed its licence application, namely as an application to receive funds from Sberbank rather than to permit the performance required under the letters of credit.

Key Takeaways

• Notwithstanding that the underlying transactions may have completed prior to the imposition of sanctions, corporates and financial institutions should consider the extent to which their activities and future payments may be caught by applicable sanctions prohibitions. For example, staggered or delayed payments concerning a historic transaction may be relevant to consider in this regard.
• Although made in obiter, the Court of Appeal’s unanimous view that payment in cash is not contemplated in this context signifies an important shift in approach, namely that financial institutions should not feel compelled to make payment in cash where the agreement clearly does not contemplate it, and where doing so may give rise to a wide range of other compliance issues.
• In seeking to rely on the Ralli Bros principle in a sanctions context, it will likely be important not only to show that a licence has been applied for, but also that it has been applied for on appropriate terms.