Most English law cross-border finance documents include something that addresses the possibility that an obligation might be unlawful for a party under a law other than English. No English law contractual obligation is enforceable where it would require a breach of English law, but breaches of the laws of any other country are (as a matter of common law) only relevant if that country is the place where performance of the obligation in required to be made. So when US banks got involved in Eurodollar lending in the 1970s, they included an illegality clause to protect them from having to do things that would be lawful under English law and the place of performance, but illegal under US law (a situation known as “double jeopardy”), and so it remains.

The usual illegality clause applies where it would be “unlawful” for a lender to lend, etc. but earlier this month, in Lamesa Investments Ltd v Cynergy Bank Limited, HHJ Pelling had to consider the reverse situation, where an illegality provision had been specifically included to protect the borrower: to be precise, a proviso to the non-payment event of default that declared non-payment would not be in breach where the failure to pay was:

“in order to comply with any mandatory provision of law, regulation or order of any court of competent jurisdiction”.

In this case Lamesa had lent GBP30 million to Cynergy in 2017. 4 months later the US Government designated it as a “blocked person” under the USA’s 1977 International Emergency Economic Powers Act and the individual who owned it, a Viktor Vekselberg, as a “specially designated individual”. This meant that:

  • no US person could deal with Lamesa or Vekselberg, and no non-US person operating in the USA or dealing with US property could deal with Lamesa or Vekselberg – the so-called “primary sanction”, which everyone agreed did not apply in this case because Cynergy was not a US person and the interest was in GBP;
  • if any non-US person “knowingly facilitated a significant financial transaction” with Lamesa or Vekselberg then (subject to a very unlikely possibility) it would be subjected to “secondary sanctions” – and Cynergy had significant business denominated in US Dollars and a US Dollar account with JP Morgan in the USA, and so was at obvious risk of being damagingly sanctioned if it paid interest to Lamesa.

So, Cynergy refused to pay interest, relying on the proviso, and Lamesa issued proceedings, arguing that Cynergy was a UK company and the loan was in GBP, and so the proviso did not apply. This meant looking at what “regulation” meant, and the loan agreement used the standard LMA definition:

“a “regulation” includes any regulation, rule, official directive, request or guideline (whether or not having the force of law) of any governmental, intergovernmental or supranational body, agency, department or of any regulatory, self‑regulatory or other authority or organisation”

Judge Pelling therefore had to decide what a “mandatory” regulation was. He went through the Arnold v Britton principles in the normal way and decided that since the proviso must mean something, and since the primary sanctions could never have applied to Cynergy, the proviso had to extend to the secondary sanctions. Lamesa argued that a “mandatory” regulation had to require someone to do or refrain from doing something, whereas the secondary sanctions did not do that; they just applied if the conditions were satisfied. He rejected Lamesa’s assertion that the UK had a “long-standing policy of not giving extraterritorial effect to US foreign policy as enacted through its secondary sanctions programme” – in his view the only such rule was where the 1996 EU Blocking Regulation applied, and in this case it did not because the US International Emergency Economic Powers Act was not scheduled under it. Here the parties were free to agree whatever they wanted about the risk of US sanctions, and they had put the risk onto Lamesa by including the proviso. Having decided that this is what the contract meant, Judge Pelling upheld it and permitted Cynergy to refuse payment.

This is a finely balanced case that one suspects could have gone either way. Bear in mind that, despite the LMA’s definition and use of the word “regulation” in various places, the standard illegality clause wording (i.e. mandatory repayment) requires unlawfulness.