Celestial Aviation Services Ltd and anor -v- UniCredit GmbH, London Branch (formerly Unicredit Bank AG, London Branch) [2024] EWCA Civ 628
The Court of Appeal has held that payment under standby letters of credit (LCs) issued in connection with the leasing of aircraft for use in Russia was prohibited by UK sanctions regulations.
In doing so, it took a different view to the Commercial Court as to the interpretation and scope of the relevant statutory provisions.
The decision is an important one for those navigating UK and other sanctions regimes. It highlights that the purpose of UK sanctions legislation is of central importance and that the licencing regime has been adopted to provide exemptions where appropriate.
The Court of Appeal's judgment is also significant for those who deal with LCs, whether as issuing/confirming banks or as beneficiaries.
The background facts
These were two claims raising materially identical issues.
Three Irish-incorporated entities (Celestial Aviation Services Limited (Celestial), Constitution Aircraft Leasing (Ireland) 3 Limited and Constitution Aircraft Leasing (Ireland) 5 Limited (collectively Constitution) acted as aircraft lessors (Lessors) to two Russian airlines. The leases were entered into between 2005 and 2014. A total of 12 LCs were issued between 2017 and 2020 in connection with the leases. All the LCs were denominated in US dollars, governed by English law and incorporated UCP 600. UniCredit, a German bank acting through its London branch, was the confirming bank under standby LCs issued by a Russian bank, Sberbank.
The leases were terminated for default in March 2022. Most of the aircraft have not been recovered. Around the time of the terminations, the Lessors (as beneficiaries) made conforming demands for payment under the LCs. UniCredit contended that payment under the LCs was prohibited by sanctions. The Lessors commenced proceedings, claiming amongst other things the amounts owed to them and a declaration in relation to the sanctions position.
In the meantime, UniCredit applied for licences from the relevant authorities. It obtained licences from the UK and EU authorities. In October and November 2022, UniCredit paid the principal amounts under the LCs. An application for a licence from the US authorities remained outstanding.
The trial of the matter took place before the licences were received and payment made. However, by the time that judgment was handed down, the only remaining dispute between the parties was over interest and costs.
The UK Regulations
The UK Sanctions Regulations introduced in 2019 to replace the EU sanctions regime that had previously applied were amended on 1 March 2022, following the invasion of Ukraine in February 2022.
The amended regulation, Regulation 28(3) of the Russia (Sanctions) (EU Exit) (Amendment) (No. 3) Regulations 2022, provides in relevant part as follows:
"Financial services and funds relating to restricted goods and restricted technology
"(3) A person must not directly or indirectly provide
financial services or funds in pursuance of or in connection with
an arrangement whose object or effect is—
(a) the export of restricted goods to, or for use in, Russia;
(b) the direct or indirect supply or delivery of restricted goods
to a place in Russia;..."
Where the prohibition does not apply, s.44 of the Sanctions and Anti-Money Laundering Act 2018 (SAMLA) nonetheless provides a defence to a party that had a reasonable belief that it was complying with the UK Regulations.
The Commercial Court decision
The Court held that Regulation 28(3) was not engaged and did not relieve UniCredit from making payment to the Lessors under the LCs. In summary:
- The Regulation was intended to ensure that financial assistance was not provided to Russian parties in relation to, among other things, the supply of aircraft.
- The Regulation operated prospectively, not retrospectively. It looked to the time at which financial assistance was provided to the party.
- In this case, the aircraft were supplied when it was perfectly legitimate to do so and before the prohibition came into effect.
- The LCs were issued at the time when it was perfectly legal to provide such financial services to the Russian lessees.
- At the time Regulation 28 came into force, all that needed to be done was to fulfil an obligation under the LCs that was undertaken long before. Doing so benefitted the Lessors. It was entirely collateral that this also discharged the independent obligations of the Russian lessees and the Russian bank towards the Lessors.
- In any event, the Russian bank remained liable to UniCredit. And the Russian lessees remained liable to the Russian bank. Therefore, the Russian parties did not benefit.
- The autonomy principle meant that UniCredit undertook wholly independent obligations under the LCs that were separate to the underlying leases.
- The fulfilment of an independent obligation by a German bank (UniCredit) to Irish companies (Lessees) was not intended to benefit the Russian entities who happened to be involved in other elements of the overall transaction.
The Court also held that it was unreasonable for UniCredit to have concluded that Regulation 28 was in effect retrospective and that it applied to a German bank paying an Irish company. Therefore, the s.44 defence under SAMLA did not apply.
Finally, the Court stated that payment need not have been illegal under the US sanctions regime because payment could have been made in cash rather than through a correspondent bank. Alternatively, payment might have been made in an alternative currency.
The Court of Appeal decision
The Court of Appeal held that Regulation 28(3) was in fact engaged and allowed the appeal on this point. It stated as follows:
- The aim of the UK Regulations was to put pressure on Russia.
- Regulation 28(3) had to be read in context. Whereas Regulation 28(1) and (2) prohibited financial services and funds provided "to a person connected with Russia" in pursuance of or in connection with specified arrangements relating to restricted goods and technology, Regulation 28(3) was not so limited: it could apply to financial services and funds provided to a person who was not connected with Russia. In the Court of Appeal's view, this was an intentional extension.
- The words "in connection with" were broad and when used with "in pursuance of" indicated a clear intention to cast the net more broadly than financial services or funds provided under or in accordance with the terms of the relevant arrangements.
- The amendments to Regulation 28 in March 2022 did not limit their effect to arrangements entered into or after 1 March 2022 or provide any grace period (unlike EU sanctions).
- While the LCs were not caught by Regulation 28(3) when they were issued, making a payment under them was the provision of "funds" and, unlike Regulations 28(1) and (2), it did not matter that the payee was unconnected to Russia. It was sufficient that the funds were provided in connection with a relevant arrangement.
- Payment under the LCs would be "in connection with" the leases. The LCs provided security for performance of the lessees' obligations under the leases, and the leases required either the LCs or some other acceptable security to be in place. Payment under the LCs would have the effect of discharging obligations under the leases.
- Notwithstanding the autonomy principle, the factual reality of the LCs' connection with the leases could not be ignored. The LCs were issued only because of the leases and they were triggered by an assertion of default under them.
- There was no need for a temporal coincidence between the provision of funds and the existence of the relevant arrangement. It was, therefore, irrelevant that the leases had been terminated by the time that the demands under the LCs became due for payment. The object of the leases was unchanged by their termination: it was and always had been to make aircraft available for use in Russia or to a person connected with Russia.
Given its conclusion on Regulation 28, the Court of Appeal did not need to decide whether the s.44 defence applied. However, it took the view that UniCredit had the requisite reasonable belief and could have relied on s.44 until it received the relevant licences. However, s.44 did not protect UniCredit against an award of interest and costs.
As to US sanctions, the Court of Appeal referred to the doctrine of strict compliance and highlighted that the LCs expressly required that any demand would be for (a) the transfer (b) of US dollars and (c) to a specified bank account.
"Transfer" did not naturally connote payment in cash. Further, the LCs referred only to a US dollar amount. A demand for payment in cash or in sterling or euros could not be a conforming demand. The terms of the LCs appeared to preclude both payment in cash and payment in a currency other than US dollars.
If that was correct, then payment under the LCs that required a US dollar transfer to the specified bank account and the involvement of a US correspondent bank to process the transfer would potentially have been illegal. However, the Court of Appeal did not need to decide the point for the purposes of the appeal. It did, however, state that UniCredit was precluded from relying on US sanctions because it had not made reasonable efforts to obtain a licence from the US authorities.
Comment
The Court of Appeal emphasised that the purpose of Regulation 28 is not simply aimed at preventing further aircraft going to Russia by preventing financing arrangements that facilitated that. Rather, it is a "relatively blunt instrument" that is intended to cast the net sufficiently wide to ensure that all objectionable arrangements are caught, such that the overall purpose of putting pressure on Russia is achieved.
Whilst that approach risked catching arrangements that might not appear to be objectionable, the UK government's solution, including the licensing regime, had been adopted to provide for appropriate exceptions.
The Court of Appeal also cited the recent Supreme Court decision in RTI Ltd -v- MUR Shipping [2024] UKSC 18, which re-emphasised the power of contracting parties to agree terms of their choice, including as to the manner of performance. In that case, a party's right to be paid in US dollars was described as a valuable right which would require clear words for it to forego.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.