Celestial Aviation Services Limited & Others v UniCredit Bank GmbH, London Branch

DMC/SandT/24/11

England

Celestial Aviation Services Limited & Others v UniCredit Bank GmbH, London Branch

Court of Appeal: Males, Snowden and Falk LJJ: [2024] EWCA Civ 628: 11 June 2024

Judgment Available on BAILII @ https://www.bailii.org/ew/cases/EWCA/Civ/2024/628.html

David Quest KC, Rachel Barnes KC, and James Sheehan KC (instructed by Reynolds Porter Chamberlain LLP) for UniCredit/Confirming Bank

Fred Hobson KC (instructed by Quinn Emanuel Urquhart & Sullivan UK LLP) for Celestial/Lessor Beneficiary

Akhil Shah KC and Leonora Sagan (instructed by Quinn Emanuel Urquhart & Sullivan UK LLP) for Constitution/Lessor Beneficiaries

STANDBY LETTERS OF CREDIT: CIVIL AIRCRAFT LEASES: SANCTIONS: UK SANCTIONS PROHIBITING PROVISION OF FINANCIAL SERVICES “IN CONNECTION WITH” EXPORT OR SUPPLY OF AIRCRAFT TO RUSSIA: WHETHER CONFIRMING BANK OBLIGED TO PAY BENEFICIARIES PENDING LICENCE BEING GRANTED UNDER UK SANCTIONS: RUSSIA (SANCTIONS) (EU EXIT) REGULATIONS 2019

Summary

The Court of Appeal, in allowing UniCredit’s appeal in part, on ground (1) (fn.1), from the High Court judgment, held that UniCredit was prevented from making payments under standby letters of credit (“LCs”) as a result of the imposition of regulation 28(3) of the Russia (Sanctions) (EU Exit) Regulations 2019 (the “UK Regulations”) (fn.2). It confirmed that the UK Regulations were applicable broadly and did not provide any exceptions or grace periods for obligations arising from agreements that pre-existed the sanctions coming into effect.

As a result of the above determination, UniCredit’s payment obligation under the LCs was suspended until the UK licence process was completed.

Case note contributed by Aishwarya Mishra, LLM International Commercial Law (Specialisation in Financial Crime and Sanctions), BA LLB (Business Law Honours), Advocate (Bar Council of India and Odisha), Certificate of Eligibility to requalify as Solicitor in Scotland (The Law Society of Scotland), Trademark and Patent Attorney - Office of the Controller General of Patents, Designs and Trademarks (CGPDTM).

Background

The case involved three Irish aircraft lessors, Celestial Aviation Services and two Constitution Aircraft Leasing companies (collectively “Beneficiaries”), who were the beneficiaries under 12 standby letters of credit (“LCs”), denominated in US dollars, in a dispute against the confirming bank, UniCredit.

The core issue revolved around UniCredit’s refusal to make payments under the LCs, which had been issued by the Russian bank Sberbank Povolzhsky Head Office (“Issuing Bank”), until appropriate licences to make the payments had been granted. The LCs were issued to secure payments due to the Beneficiaries under their civil aircraft lease agreements (“Leases”) made with various Russian airlines between 2004 and 2014.

Under the terms of the LCs, UniCredit was obligated to make payments to the Beneficiaries in the event of any default by the Russian airlines under the Leases. Following the Russian invasion of Ukraine in 2022, the Russian airlines defaulted under the Leases. The Leases were terminated for default in March 2022, although most of the civil aircraft had not been recovered, which led to the Beneficiaries making conforming demands for payment under the LCs. However, UniCredit sought to avoid making payments under the LCs, citing the imposition of sanctions against Russia by the UK and the US.

The UK and the US sanctions restricted transactions involving Russian entities and affected financial institutions, including transactions involving civil aircraft and Russian airlines and banks. The sanctions were designed to prevent financial flows to and from Russia and imposed significant restrictions on banks and other financial institutions operating in the jurisdictions of the UK and the US.

UniCredit argued that the sanctions created legal risks and regulatory barriers that justified its refusal to make payments under the LCs. UniCredit contended that making such payments would expose it to penalties and legal liabilities under the sanctions regimes, effectively rendering its obligations under the LCs unenforceable. UniCredit further argued that, due to the scope and severity of the sanctions, it was prohibited from conducting any transaction that could directly or indirectly benefit a Russian entity, including honouring the LCs.

The Beneficiaries contended that UniCredit’s refusal to make payments under the LCs was unjustified and constituted a breach of its contractual obligations. They argued that the LCs were independent financial instruments, and UniCredit was required to honour them irrespective of any external factors, including the imposition of sanctions. They maintained that UniCredit should not use the sanctions as a basis to avoid its obligations, given that the purpose of the LCs was to provide an unconditional financial guarantee.

The Court of Appeal, therefore, had to decide whether the imposition of sanctions on Russia justified UniCredit's refusal to make the payments under the LCs or whether UniCredit remained obligated to honour the payments despite the sanctions, in advance of appropriate licences being granted.

Judgment

The Court of Appeal (“Court”) allowed in part UniCredit’s appeal, on ground (1) (fn.1), from the High Court’s judgment made in favour of the Beneficiaries.

The Court held that UK sanctions should be interpreted broadly to cover all arrangements involving Russian entities, and that the Russia (Sanctions) (EU Exit) Regulations 2019 (the "UK Regulations") did not limit their effect to agreements made after the sanctions were imposed, which was reflected by the use of the wide words “in connection with” in regulation 28.

As such, the Court held that regulation 28 of the UK Regulations did not provide any grace period or exceptions for payments under pre-existing agreements, and applied sanctions to all payments connected with relevant arrangements, such as the lease of aircraft.

The Court also found that making a payment under the LCs constituted the provision of “funds” in connection with a sanctioned arrangement, meaning that the payments were subject to sanctions.

The result was that UniCredit’s payment obligation under the LCs was suspended until the UK licence process was completed.

In the context of US sanctions, the Court further held that, under the Ralli Bros principle (fn.3), in order to rely on US sanctions as a defence, UniCredit needed to show that it had made reasonable efforts to secure a licence from the US’s Office of Foreign Assets Control (“OFAC”). However, the Court found that UniCredit had not made adequate efforts to obtain such a licence, with the result that its defence based on US sanctions was rendered ineffective.

The Court also rejected UniCredit's argument that it could fulfill payment obligations through alternative means, such as in cash or a different currency, noting that the terms of the LCs specifically required payments in US dollars to a designated bank account, and in a context where no demand for alternative payment methods had been made by the Beneficiaries.

Comment

This judgment is significant in its interpretation of UK sanctions and their impact on contractual payment obligations, particularly in the context of LCs.

The case emphasises the complex interplay between sanctions and private commercial agreements, demonstrating how financial institutions must navigate conflicting obligations under both domestic and international law with care, and by taking reasonable and prompt steps to obtain any appropriate licences.

The decision illustrates the broad and evolving nature of sanctions, especially following geopolitical events like Russia's invasion of Ukraine, and highlights the challenges faced by banks and other financial institutions in balancing their obligations to honour contractual commitments, such as payments under LCs, with their need to comply strictly with sanctions imposed by multiple jurisdictions.

Overall, it underscores the need for careful navigation by financial institutions in managing sanctions risks and compliance, emphasising both strict adherence to regulatory requirements and a good faith proactive effort to honour contractual commitments so far as lawfully feasible.

Footnote 1: Whether payment under the LCs by UniCredit would have been “in connection with” an arrangement, the object or effect of which was the supply of aircraft to or for use in Russia, or to a Russian person, and so prohibited by regulation 28(3) of the Russia (Sanctions) (EU Exit) Regulations 2019, SI 2019/855 (the "UK Regulations")

Footnote 2: Regulation 28(3)(c) of the UK Regulations materially states:

“(3) A person must not directly or indirectly provide financial services or funds in pursuance of or in connection with an arrangement whose object or effect is— … (c) directly or indirectly making restricted goods or restricted technology available—

(i) to a person connected with Russia, or

(ii) for use in Russia…”

Footnote 3: Ralli Bros v Compañia Naviera Sota y Aznar [1920] 2 KB 287 – the principle derived from this judgment is that a limited exception exists to the general principle that the enforceability of a contract governed by English law is determined without reference to illegality under any other law where contractual performance necessarily requires an act to be done in a place where it would be unlawful to carry it out