18 Sep 23

Sanctions Clauses in Trade Finance Agreements

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Last Updated on: 19th September 2023, 12:44 am

Sanctions Clauses in Trade Finance Agreements

International trade relies heavily on trade finance, which includes financial instruments like letters of credit, bank guarantees, and documentary collections. These instruments help facilitate the movement of goods and services across borders. However, trade finance can become complicated when countries impose economic and trade sanctions on certain nations or entities. Sanctions restrict trade and financial transactions with sanctioned parties. As a result, trade finance agreements often include “sanctions clauses” that outline how sanctions impact the agreement.

This article examines common sanctions clauses in trade finance agreements. It looks at the purpose of these clauses, key legal issues, and the implications for global trade. Let’s dive in!

What are Sanctions Clauses?

Sanctions clauses are contractual terms included in trade finance agreements, like letters of credit or bank guarantees. They address the issue of sanctions compliance. Essentially, sanctions clauses warn that legal sanctions may prohibit banks or other parties from dealing with certain countries, persons, or assets. The clauses clarify that sanctions restrictions can prevent a party from fulfilling its obligations under the agreement.

For example, a sanctions clause might state: “We will not be liable for any failure or delay to honor or negotiate under this letter of credit if such failure or delay is caused by compliance with applicable trade sanctions laws.”

Banks started including these clauses in response to increasingly complex sanctions regimes after 9/11. Governments use sanctions as a foreign policy tool, often imposing them with little warning. Banks must comply to avoid facing penalties themselves. Sanctions clauses help shield banks from liability if sanctions force them to stop payments or seize funds mid-transaction.

Why Are Sanctions Clauses Important?

Sanctions clauses serve several key purposes:

  • They notify parties upfront that sanctions may disrupt the transaction.
  • They reduce legal risks for banks by limiting liability if sanctions block payments.
  • They remind parties of their own duty to comply with sanctions laws.
  • They allocate the financial risks of sanctions between parties upfront.

For banks, including clear sanctions clauses is crucial to manage sanctions risks. The clauses reinforce that the bank must comply with sanctions, regardless of the underlying trade agreement. This protects the bank from becoming entangled in prohibited transactions.

Key Legal Issues

However, sanctions clauses also raise some legal questions:

Do sanctions override contractual obligations?

A key issue is whether sanctions actually override a bank’s existing contractual duties. Banks argue sanctions clauses simply reinforce their preexisting legal duty to comply with sanctions. But the clauses themselves do not create this duty. Opponents argue the clauses improperly allow banks to sidestep contractual liability.

The English High Court recently examined this issue in Mamancochet Mining Ltd v Aegis Managing Agency Ltd. It upheld a sanctions clause excluding liability, finding the clause simply reflected the legal position that sanctions override contractual terms. This affirms banks’ view.

What sanctions are covered?

Another question is what sanctions are covered by these clauses. They often broadly refer to “applicable” sanctions laws. Banks argue this includes primary sanctions by the UN, EU, or United States. But it is less clear whether it also includes secondary U.S. sanctions against non-U.S. parties. The Mamancochet case took an expansive view, encompassing U.S. secondary sanctions. The breadth of covered sanctions remains disputed.

Must the clause be accepted by all parties?

Finally, there are questions around unilateral sanctions clauses. Typically, all parties must agree to a contract term for it to be binding. However, banks sometimes include sanctions clauses in confirmations without agreement from the underlying parties. In Mamancochet, the court enforced a unilateral sanctions clause in a bank confirmation. But expect more disputes on this issue.

Implications for Global Trade

The increased use of sanctions clauses has meaningful implications for global trade and finance:

  • More due diligence on counterparties to assess sanctions risks.
  • Greater transparency around ownership structures and transaction parties.
  • Rise in trade finance costs to account for sanctions uncertainty.
  • Shift towards using local banks to avoid sanctions exposure.
  • Increasing dollarization as parties wish to avoid dollar transactions.

At the same time, sanctions clauses help banks manage their own sanctions risks. This prevents violations that would exclude banks from the dollar system entirely. Overall, sanctions clauses add a new layer of complexity to trade agreements. Parties must proactively address sanctions risks in their contracts going forward.

Designing Effective Sanctions Clauses

Crafting sanctions clauses requires care to effectively manage risks. Here are some tips:

  • Clearly define the specific sanctions laws that apply, rather than relying on general references.
  • Avoid overbroad terms like “applicable” sanctions that create uncertainty.
  • Include carve-outs for preexisting contracts or allow reasonable termination periods.
  • Require notice to the counterparty if sanctions disrupt performance.
  • Incorporate sanctions clauses into the original agreement, rather than unilaterally.
  • Consider narrow reciprocal force majeure clauses tied directly to new sanctions.

Sanctions clauses will likely proliferate as governments increasingly use sanctions. A carefully crafted clause can help mitigate the legal and commercial risks sanctions pose to trade finance transactions.

Managing Sanctions Risks

Sanctions clauses are only one tool to manage sanctions risks. Parties to trade agreements should also:

    • Conduct enhanced due diligence on all transaction parties and their ownership.
    • Review transactions for any links to sanctioned jurisdictions like Russia, even if indirect.
    • Monitor daily changes in sanctions lists and requirements.
    • Get legal advice to interpret sanctions clauses and obligations.
    • Purchase sanctions insurance or explore government guarantees if available.