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Court of Appeal confirms EU Iran sanctions preclude sanctioned party’s entitlement to interest under arbitration award

News / 11-03-2020 / London

Ministry of Defence & Support for Armed Forces of the Islamic Republic of Iran v. International Military Services Limited [2020] EWCA Civ 14 

In a judgment handed down on 12 February 2020, the Court of Appeal has confirmed that the intention of EU Regulation 267/2012 extends to preventing a sanctioned party from claiming interest under an arbitration award for the duration that its contractual counterparty was prevented from making payment pursuant to the arbitration award as a result of the sanctions.

The background facts

On 2 May 2001, the Ministry of Defence & Support for Armed Forces of the Islamic Republic of Iran (“MODSAF”)  obtained two ICC arbitration awards against International Military Services Limited (“IMS”) concerning the balances payable under two military equipment supply contracts that were terminated following the Iranian Revolution. IMS was ordered to pay damages to MODSAF plus costs and interest to the date of payment.  

MODSAF commenced enforcement proceedings before the English Court that were stayed due to IMS’s challenges to the awards in the Dutch Court. The consent order to stay the enforcement proceedings was contingent on IMS paying into the Court sufficient funds by way of security. The requisite funds were paid to and held by the English Court and continued to accrue interest.

In the Dutch proceedings that ended on 24 April 2009, IMS’s liability under one award was reduced, whilst the other aspects of the awards including liability to interest were upheld.  However, by that time MODSAF had been added to the list of entities subject to the EU’s sanctions regime relating to Iran. As a result, IMS was and has been unable to lawfully pay MODSAF anything under the awards.

MODSAF, therefore, applied to the English Court in 2012 to obtain a declaration that the funds in Court should at least be held for its benefit. One of the principal issues to be determined was whether IMS was liable to pay interest on the awards during the sanctions period.

The reference to the Court was concerned with Article 38 of Council Regulation (EU) No 267/2012 ("the EU Regulation") which prevents claims made by designated persons "in connection with any contract or transaction" whose performance has been affected by the sanctions imposed by the Regulation, from being satisfied.

The EU Regulation

 

  1. 38 of the EU Regulation provides as follows:

(a)  designated persons, entities or bodies listed in Annexes VIII, IX,  XIII and XIV;

(b)  any other Iranian person, entity or body, including the Iranian government;

(c)  any person, entity or body acting through or on behalf of one of the persons, entities or bodies referred to in points (a) and (b).

2. The performance of a contract or transaction shall be regarded as having been affected by the measures imposed under this Regulation where the existence or content of the claim results directly or indirectly from those measures.

3. In any proceedings for the enforcement of a claim, the onus of proving that satisfying the claim is not prohibited by paragraph 1 shall be on the person seeking the enforcement of that claim.

4. This Article is without prejudice to the right of the persons, entities and bodies referred to in paragraph 1 to judicial review of the legality of the non-performance of contractual obligations in accordance with this Regulation."

(emphasis underlined)

By Article 1(c), “claim” means “any claim, …, under or in connection with a contract or transaction, and includes …: … (v) a claim for the recognition or enforcement, …, of a judgment, an arbitration award …”.

By Article 1(d), “contract or transaction” means “any transaction of whatever form and whatever the applicable law, whether comprising one or more contracts or similar obligations made between the same or different parties; …”

The Commercial Court decision

The Commercial Court interpreted Article 38 of the EU Regulation (i.e. the so-called “No Claims” clause) and found as follows:

The Commercial Court, therefore, held that MODSAF was precluded from enforcing the interest element of the relevant award for the sanctions period by virtue of Article 38 of the EU Regulation.

MODSAF appealed against this decision.

The Court of Appeal

The Court of Appeal upheld the Commercial Court’s decision. Focusing on some general principles of interpretation of the EU instruments that lay at the heart of MODSAF’s submissions, the Court found as follows:

Purpose

MODSAF argued that Article 38 should be reconciled with Article 23, which Article does not purport to confiscate funds of a designated person but merely to prevent temporary access. The Court of Appeal disagreed, determining that Article 38 went further than Article 23 and, therefore, does have confiscatory effect i.e. an applicable claim would be permanently prohibited so as to protect a designated person’s counterparties.

Crediting of Interest.

The Court of Appeal dismissed the relevance of Article 29 of the EU Regulation, which authorises a designated person to be credited with interest if it is paid into a frozen account. The Court of Appeal stressed that, although Article 29 could protect counterparties of a designated person where there is a frozen account, a counterparty who is unable to avail himself of Article 29 because the designated person has no such qualifying account needs the same level of protection. In addition, the need to protect IMS was not affected by the fact that the relevant award pre-dated the sanctions.

Language

On interpreting the language of Article 38, the Court of Appeal disagreed with the Commercial Court, and took the view that the word “transaction” is not apt to refer to an arbitration award as an award cannot conventionally be said to have an “applicable law” or to be “made between” the parties. In addition, an arbitration award ought to be regarded as equivalent to judgment for this purpose, but it would be very odd to regard a judgment as a “transaction”.

That said, the original military equipment supply contracts clearly fell within the meaning of “contract or transaction”; given that the awards concerned these contracts, MODSAF’s application to enforce the interest element of the relevant award still constituted a “claim”  “in connection with any contract or transaction”.

Proportionality

When considering MODSAF’s right to property, the Court of Appeal chose to give more weight to the need to protect the counterparties of designated entities because without Article 38 being confiscatory, counterparties like IMS would continue to accrue interest liabilities and be the “ultimate losers” of sanctions, whereas the whole sanctions regime was designed to punish designated persons/entities. A pro-confiscation construction was consistent with the overall scheme of the EU Regulation and, therefore, not disproportionate.

Comment

The judgment of the Court of Appeal will come as welcome relief to parties who are unable to pay a counterparty due to their designation under sanctions and, therefore, face the real risk of an increasing interest bill accruing whilst the sanctions remain in force.

One way to pro-actively protect from such a sanctions issue is to incorporate  an appropriate sanctions clause into contracts. We would advise all parties to consider the inclusion of wording to deal with these issues, particularly as the use of sanctions has become a more prevelant tool for the acheivment by states of their foreign policy objectives and, with the UK leaving the European Union, there may be a divergence in the way sanctions legislation is interpreted.  

It is expected that MODSAF will appeal to the Supreme Court.

    1. No claims in connection with any contract or transaction the performance of which has been affected, directly or indirectly, in whole or in part, by the measures imposed under this Regulation, including claims for indemnity or any other claim of this type, such as a claim for compensation or a claim under a guarantee, notably a claim for extension or payment of a bond, guarantee or indemnity, particularly a financial guarantee or financial indemnity, of whatever form, shall be satisfied, if they are made by:
    • From a language perspective, the Court held that MODSAF’s application for judgment to be entered in terms of the awards was clearly a “claim”  “for the recognition or enforcement … of … an arbitration award” under Article 1(c)(v) of the 2012 EU Regulation; “transaction” was also broadly interpreted by the Court to include the arbitration awards sought to be enforced by MODSAF.
    • The purpose of Article 38 was to “prevent civil claims being brought against a party as a result of the fact that their performance of a contract or transaction was impeded by the operation of the sanctions”, and that “by seeking leave to enforce the interest component of the 7071 Award in respect of the sanctions period, MODSAF is now bringing a claim to hold IMS liable as a result of the fact that IMS's performance of the relevant transaction, i.e. discharge of the debt due under the Award, was affected by the existence of the sanctions. ” This, in the Court’s view, ran contrary to the object of Article 38.
Fionna Gavin

Fionna Gavin Joint Head of Insurance, Partner

James Rose

James Rose Managing Associate

Eleanor Dickens

Eleanor Dickens Associate

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