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A coal trader has won an appeal against JP Morgan after the bank refused to make payments under two letters of credit (LCs) out of fear it would result in a violation of US sanctions on Syria.

Last year JP Morgan successfully fended off a lawsuit brought by Singapore’s Kuvera Resources, with a judge finding that the lender was entitled to decline payment for a US$2.4mn shipment of coal because the vessel involved may have been Syrian-owned and subject to far-reaching US sanctions on the country.

But Singapore’s Court of Appeal on September 28 instead decided in Kuvera’s favour, ruling that JP Morgan did not prove to an acceptable standard of proof that the vessel was in fact under Syrian ownership at the time of the trade. Instead, the court found the bank’s decision to reject payment was based on its own risk management calculations due to the presence of “red flags” that suggested a connection with Syrian entities.

The proceedings have been described by the judge in the first trial as a “test case” for the use of sanctions clauses, controversial additions to LCs which theoretically allow banks to reject payment if a transaction could result in a violation of sanctions rules. They have mushroomed in trade finance as sanctions gain wide usage as a foreign policy tool by the US and its allies.

The trade at the heart of the case was Kuvera’s sale in July 2019 of 35,000 metric tonnes of Indonesian coal to an unnamed buyer in Dubai, receiving payment from the buyer in the form of two irrevocable LCs, which were issued by the buyer’s bank.

Kuvera selected JP Morgan as the confirming bank for the LCs. But when the bank submitted the transaction to its sanctions screening process, it found that the ship carrying the coal, the Omnia, was on its “master list”, an internal list of entities that have a sanctions “nexus”. It did not appear on the list of sanctioned entities published by the US Office of Foreign Assets Control (OFAC).

The bank refused to honour the LCs, later saying in court that because of the Omnia’s suspect ownership, the ship was captured by the sanctions clause in the LCs which included vessels “subject to any applicable restriction”.

After being notified of Kuvera’s lawsuit, the bank sent information about the transaction to OFAC, which provided a statement for the bank saying in part that “had [JP Morgan] and its Singapore branch not rejected the trade documents for a non-US person’s sale of cargo shipped via a Syrian vessel, it would have resulted in an apparent violation of OFAC regulations”.

A JP Morgan employee gave evidence in the 2022 trial that the bank decided it was preferable to be sued by Kuvera for not paying out under the LCs than to face enforcement action by OFAC.

But appeals court judge Steven Chong, writing on behalf of the panel of three judges, found: “While [the payment refusal] might have been ‘rational’ from a risk management perspective, we disagree that it was “contractually justified’. There are several difficulties inherent in such an approach independent of the fact that it is not permitted by the text of the sanctions clause.”

Under OFAC sanctions regulations, any entity at least 50% owned by a sanctioned entity is also considered subject to sanctions. According to the judgement, JP Morgan admitted that a vessel did not need to fall under the 50% rule to be added to its internal “master list”, but could be added if there was a sanctions “nexus”

The judges found that JP Morgan’s approach to determining whether the transaction was likely to provoke the ire of OFAC was “unsatisfactory and unfair” and “entirely a reflection of risk management considerations”.

JP Morgan first added the Omnia to its internal blacklist in 2015, when it sailed under a different name and was owned by Syria’s Ali Samin Group. In 2019 the bank was notified of the name change and renewed its due diligence on the ship, finding that it was now owned by a Barbados shell company.

But the lender’s research suggested “possible ownership” by an Ali Samin entity, and that the ship was managed by a UAE entity also owned by the Syrian group. As such, JP Morgan told OFAC it “made a risk-based decision to retain the vessel on its internal filter as a Syrian-owned vessel”.

OFAC has previously published guidance which highlighted the use of shell companies “to disguise the ultimate beneficial owner of cargo or commodities in order to avoid sanctions or other enforcement action”.

But the judges found that JP Morgan could not rely on the existence of red flags, or the involvement of “third parties” such as OFAC, to determine the vessel’s ownership and to refuse to pay Kuvera. “In our view, it is not sufficient to suggest that just because information on her beneficial owner is not available, it must follow that there is some masking or concealment as regards the identity of her beneficial ownership,” Chong wrote.

“In light of the ‘inconclusive’ evidence before the court, we do not think that JPMorgan’s decision based on its own risk-taking calculus to refuse payment to Kuvera was sufficient to establish that the Omnia was subject to ‘any applicable restriction’ under the sanctions clause. As such, JPMorgan was not entitled to invoke the sanctions clause to deny payment to Kuvera upon a complying presentation of documents.”

 

‘Between a rock and a hard place’

Cases involving banks refusing to honour LCs because they fear punishment by sanctions regulators are tipped to become more common after Russia’s invasion of Ukraine prompted thousands of fresh entities to be sanctioned by a global coalition of governments.

One of the only other cases to make it through court so far also went against a lender, when a London judge ruled in March that UniCredit should have made payment to aircraft leasing companies under LCs issued by Russia’s sanctioned Sberbank.

The Singapore case “highlights how banks may be caught between a rock and a hard place in the discharge of their duties – to the regulators, and to the businesses they serve”, says documentary credit expert Tat Yeen Yap. “Banks are conscripts to perform policing for political masters not necessarily of their choosing.”

But Yap, Asia Pacific managing director at fraud mitigation specialist MonetaGo, believes the judgement won’t have a negative impact on the appetite of banks to confirm LCs “because banks have always been aware of the regulatory risks involved in financing international trade”.

He tells GTR: “This case may spur banks to pay more attention to the sanctions clauses they add to their undertakings, and discourage the non-use of sanctions clauses in LCs and confirmations.”

Arvin Lee, partner at Singapore law firm Wee Swee Teow LLP, says that although the judges made clear their findings were not intended to apply to sanctions clauses generally, they “adopted a high evidentiary threshold” which would “certainly be welcome by [LC] beneficiaries in the trade finance market for enhancing certainty of payment”.

Pointing to the judges’ tentative conclusion that there may be “incompatibility” between sanctions clauses and letters of credit, Lee tells GTR the court “was cognisant of the fact that beneficiaries are typically not involved in nomination of the vessels and the beneficial ownership of the vessel might not be apparent from publicly available records”.

In a statement to GTR, Kuvera says: “There should not be an imbalance between mighty banks and less mighty merchants. Kuvera pursued the matter to obtain clarity not only for itself but also for the wider business community. We are grateful that we managed to clear the kinks and the successful appeal is a testimony to our belief that there has to be a level playing field, especially in the area of commerce.”

Mahmood Gaznavi, who represented Kuvera, describes the case as “an interesting brief from a determined client who wished to get the right answers from day one”.

“Kuvera had struggled to understand why it had been denied its dues under the letters of credit through no fault on its part. Despite vigorous efforts, Kuvera was kept in the dark. Any light that was provided came upon the matter escalating to court.”

Kuvera received the bulk of the US$2.4mn direct from the buyer shortly after JP Morgan declined to confirm the LCs, and pursued damages of US$218,068. The Court of Appeal ultimately granted it US$110,215.

Spokespeople for JP Morgan did not respond to questions about the case.