The UK’s Supreme Court has affirmed that the country’s sanctions regulations can cancel a bank’s obligation to pay a beneficiary in a documentary credit transaction, ending a closely watched case that has raised questions about the use of letters of credit as security.
The court on March 25 dismissed appeals from two Irish aircraft leasing companies and allowed an appeal from the London branch of UniCredit Germany, which had confirmed 12 standby letters of credit issued by Russia’s Sberbank.
The leasing companies, Celestial Aviation Services and Constitution Aircraft Leasing, made payment demands totalling US$69.3mn after two Russian airlines refused to return aircraft after the leases were terminated following Moscow’s invasion of Ukraine. UniCredit declined to make the payments for around six months until it received a licence to do so from UK sanctions authorities.
The lessors, respectively subsidiaries of Irish firms AerCap and Aircastle, successfully sued UniCredit in the High Court in 2022, before a Court of Appeal decision overturned that ruling, finding that UniCredit was entitled to deny payment.
That decision was appealed to the Supreme Court, which today dismissed the lessors’ arguments that because the leases had been terminated, there was no link between the payments being made and Russia receiving a prohibited benefit.
The court found the “net” of sanctions regulation is “cast wide” because it involves vital public interests, and the licensing regime exists to determine exceptions and remedy any unintended consequences of the rules.
Sanctions regulation is deliberately broad, the judges found, partly so that banks are put on alert for transactions that may ultimately benefit a sanctioned country such as Russia.
“Clearly, in this case there was a factual connection between the payments under the letters of credit” and the leasing arrangement, the court found.
“Therefore, payment under the letters of credit was in connection with the arrangements, namely the aircraft leases, whose object or effect is making aircraft available to a person connected with Russia or for use in Russia.”
“The bank was prohibited under [sanctions regulations] from making payments under the letters of credit until licences to do so were obtained.”
While UniCredit ultimately made the payments after it received permission to do so from the authorities, the finding means the bank is not liable to pay interest that accrued between the lessors making compliant presentations in March and April 2022 and the licences being granted in October that year.
Even if the court had found otherwise, the judgment said UniCredit would have had a defence to claims from the lessors because it had a “reasonable belief” that its refusal to pay was in compliance with sanctions regulations.
The Supreme Court decision “has obvious implications for the use of letters of credit as security”, said HFW partners David Savage and Sarah Hunt.
The pair, who are not involved in the case, told GTR the “effect of the judgment is arguably to undermine the autonomy principle and therefore the security offered by standby letters of credit”.
A foundational principle of letters of credit is that banks have a duty to pay when a compliant presentation of documents is made, regardless of the underlying contract or movement of goods. Courts have typically allowed only very limited exceptions to this principle, such as in cases of fraud.
But the HFW lawyers noted that “in today’s judgment, which upholds the Court of Appeal decision, the Supreme Court has held that banks will not be able to pay out under standby letters of credit, even on receipt of a compliant demand, if the purpose of the underlying transaction has a factual link to an activity prohibited by sanctions”.
Industry group the International Trade & Forfaiting Association had intervened in the case due to the impact of the previous Court of Appeal ruling on insurance policies. But the organisation’s chairman Sean Edwards said the court’s answer is clear: “ask for a licence”.
The ruling adds to a growing body of law on the intersection of sanctions and trade finance, including a 2023 ruling against JP Morgan after it refused to make a payment to a coal trader because it believed the vessel carrying the goods was linked to Syria.
The decisions have also fed debate over the use of sanctions clauses in letter of credit contracts. The International Chamber of Commerce advises that sanctions clauses should be drafted narrowly so as not to bring into question the irrevocable nature of the instruments.
UniCredit, AerCap and Aircastle did not respond to requests for comment on the decision.
