The The Commercial Court found in favour of the Bank in the recent summary judgment hearing of DVB Bank SE (DVB) and others v. Shere Shipping Company Limited and others  EWHC 2321 (Comm), confirming that entities designated by EU sanctions regulations cannot use those sanctions as a reason for refusing to repay debts due under agreements made before the EU Regulations came into effect. Dentons acted for DVB.
In 2006, DVB and another bank (which subsequently novated its loan to Melli Bank and Persia International Bank plc (the Syndicate Banks)) advanced US$50 million to four Maltese registered shipping companies (the Borrowers) (the Loan Agreement). The Borrowers' obligations under the Loan Agreement were guaranteed by Woking Shipping Investments Limited and Islamic Republic of Iran Shipping Lines (together, the Guarantors).
The US$100 million made available under the Loan Agreement provided post-delivery financing in respect of the acquisition costs of four vessels.
Between 2009 and 2012 the Borrowers, the Guarantors and the Syndicate Banks all became subject to certain EU sanctions against Iran, most latterly Council Regulation (EU) SI No 267/2012 (the Regulation)1.
Despite being subject to sanctions, the Borrowers continued to perform their repayment obligations under the Loan Agreement for four months until September 2011.
In September 2011 the Borrowers stopped making payments of interest and principal. The Borrowers also defaulted under other provisions of the Loan Agreement (for example, the ownership of the ships was transferred in May 2012 without the consent of DVB and the Syndicate Banks). As agent, DVB served notice accelerating the repayment of the loan in November 2012.
DVB and the Syndicate Banks then began proceedings against the Borrowers, as did the Syndicate Banks. DVB also brought proceedings against the Guarantors in early 2013. The Claimants applied for summary judgment in each of the three actions and they were heard together in June 2013 in the Commercial Court by Mr. Justice Simon (the Judge).
The key elements of the Regulation for the summary judgment applications were:
- Article 23(2) which provides for a freeze of "all funds and economic resources" of entities designated under the Regulation;
- Article 23(3) which provides that "no funds or economic resources shall be made available to" entities designated by the Regulation;
Article 25 provides a derogation from Article 23 where "a payment by a person... listed... is due under a contract or agreement that was concluded… before the date on which that person... had been designated". In these circumstances a "competent authority" may authorise the release of certain frozen funds or economic resources if (among other things) the competent authority has determined that:
- the funds or economic resources shall be used for a payment by a person listed; and
- the payment is not in breach of Article 23(3).
- Article 38(1) provided that, if performance under a loan agreement was prevented by virtue of the Regulation, the designated creditor could not circumvent the Regulation by making a claim under, for instance, a guarantee.
The Borrowers accepted that an Event of Default occurred in May 2012 when they sold the vessels, but submitted that obligations in the Loan Agreement became discharged and/or unenforceable and/or were frustrated and/or were suspended by reason of "supervening illegality" due to the operation of the Regulation. The Borrowers ran four principal arguments, all of which were rejected by the Judge:
The Loan Agreement was "suspended" because it constituted an "economic resource" within the meaning of Article 23(3).
The Judge agreed with the Claimants that the Loan Agreement did not constitute an "economic resource" as it is not an "asset", but a liability. The Judge stated that the purpose of the Regulation was to freeze "the assets of the designated persons… and not the discharge of their liabilities."
Payments under the Loan Agreement were unenforceable because they breached the asset freeze in Article 23(2) or, alternatively, such payments would have made funds available by increasing equity in the vessel, thereby breaching Article 23(3).
The Judge did not agree that payments under the Loan Agreement breached the asset freeze in Article 23(3). The derogation in Article 25 enabled the Borrowers to obtain authorisation from a "Competent Authority" for "the release of certain frozen funds or economic resources" in order to pay sums due under contracts entered into before they were designated. The Competent Authorities (in this case, the German Bundesbank and HM Treasury) gave such authorisations after the Borrowers had become designated entities. There was no evidence to suggest such authorisations would have subsequently not been given.
Further, the Judge viewed the alternate argument as "commercially unreal". The repayment of a loan can only be said to be making funds available to the creditor according to the Judge. In addition, the repayment of a loan can only have a neutral effect since, to the extent that the equity in the vessels might increase, the Borrowers' cash reserves would reduce accordingly.
Since the operation of the Loan Agreement was suspended and not frustrated, the Claimants were not entitled to repayment of sums under the Law Reform (Frustrated Contracts) Act 1943 (the 1943 Act).
If the Loan Agreement had been found to be frustrated, it would have followed that the Borrowers owed the Claimants sums due under the 1943 Act. To circumvent this, the Borrowers argued that, by reason of supervening illegality, the Loan Agreement was suspended, not frustrated. It was argued that, in the past, such suspensions had operated so as to excuse performance.
The case law referred to by the Borrowers was, in the opinion of the Judge, framed "in very different circumstances" as it was set against the backdrop of the Second World War. The Judge did not, therefore, agree with the Borrowers that performance of the Loan Agreement was excused as a result of supervening illegality.
The Judge did state, however, that, if he had found the obligations under the Loan Agreement were incapable of being performed, he would not have found in the Borrowers' favour on this point. He would have, in fact, ordered "a substantial sum" to be paid under s.1(2) of the 1943 Act.
Payment of the claim by the Syndicate Banks was suspended because they are designated legal persons under the Regulation.
The Judge did not see the position of the Syndicate Banks as significantly different to the position of DVB. The Borrowers were not entitled to use the Regulation to circumvent repayment under the Loan Agreement. The fact that the Syndicate Banks were also designated entities only meant that monies received had to be credited to frozen accounts. The Guarantors ran two principal arguments, both of which were rejected by the Judge:
The Guarantors argued that DVB had succumbed to pressure exerted by the United States Office of Foreign Assets Control (OFAC).
Further, the Guarantors argued they had suffered unfair prejudice as a result of DVB failing to nominate an account into which they could make payment.
The Judge did not agree that the Guarantors had been unfairly prejudiced in either case. Firstly, the Judge noted the limits of the defence, stating that there are no examples of instances where "unfair prejudice" has discharged a guarantor of its obligations. Secondly, the Judge did not accept the Guarantors' arguments as a matter of fact, nor did he believe they gave rise to a defence even if the Guarantors were correct as regards the alleged facts.
Supervening illegality in respect of the guarantees.
According to the Guarantors, there were three reasons as to why performance of their obligations under the guarantee would be illegal:
- Payment would subrogate the Guarantors to the Lenders' security rights against the Borrowers, or would result in the Guarantors having a claim in restitution against the Borrowers, which would make funds available contrary to the terms of Article 23(3).
- Payment would discharge the Borrowers' debts to DVB and the Syndicate Banks, which would also constitute making funds available to the Borrowers contrary to Article 23(3).
- Payment would breach the terms of Article 38(1), because DVB would be acting as security trustee for the Syndicate Banks who are both designated entities.
The Judge did not agree with any of these arguments for the reasons set out in relation to the Borrowers' defences, namely that the derogation under Article 25 equally applies. Further, nothing would be added to the Guarantors' economic resources as their wholly-owned subsidiaries would now owe a debt to them instead of to DVB and the Syndicate Banks. With regard to (b) above, if the Guarantors did make payment on behalf of the Borrowers, this would amount to the Borrowers exchanging one debt for another and would not be making funds available under Article 23(3).
As already noted, the Judge did not see the claim of the Syndicate Banks as significantly different to that of DVB. The Borrowers were not allowed to rely on Article 23(3) and Article 38(1) did not, therefore, operate.
The Commercial Court decided the defence of "supervening illegality" had no prospect of success at trial.
The Regulation was not drafted so as to allow the designated entities to suspend or avoid repayment of monies which were advanced before the Regulation came into force.
Further, although the monies might be frozen, debts owed to designated entities like the Syndicate Banks are still payable despite the Regulation.