As geopolitical tensions continue to have profound implications for the maritime sector, Fiona Rafla, senior lawyer at Wikborg Rein, outlines how innocent parties can seek to unwind troublesome contracts when dealing with a sanctioned party.
The maritime industry and global trade have been at the sharp end of risk considerations due to a rapidly evolving and unpredictable geopolitical landscape over the last 18 months. The international nature of the industry, together with often multi-party financing and contractual structures has meant that some businesses have unexpectedly found their operations severely hampered by the sanctions regime, despite being the “innocent party”.
Contracts, entered into in good faith, may become unworkable, leaving innocent parties scrambling for contractual levers and legal precedents to protect their investments, assets, operations and reputations. Ship owners and operators may find that valuable assets have to be laid-up as insurance policies are revoked, causing loss of revenue and potential breaches of charter contracts that otherwise would not have occurred; yards may decide to cease vessel construction or repair if there is any hint of a sanctioned entity’s involvement; and thorny issues of obligation and ownership can arise between the ship owning company and financiers.
It is vital that our industry take lessons learned from ongoing case work to proactively address these concerns and safeguard against the risks involved. Collectively, we must ensure the sector – international by its very nature – is sufficiently agile to operate effectively in an increasingly complicated and unpredictable world.
Assessing risk
With sanctions, the potential loss of legitimate rights over financed assets is an immediate risk, with the potential threat of insolvency, operational events that may impact on the ability to meet contractual obligations, and reputational harm. In a recent case, Norwegian owners Havila, found themselves in a commercial ‘Catch-22’ situation where they had funded the construction of four new build vessels via GTLK, an asset financing arm of the Russian state, and found that the financing (and consequently the shipbuilding) contracts wound to a halt upon the imposition of sanctions.
The sanctioned financier could not advance any further funds to shipyards to complete any remaining vessels, and Havila was unable to follow through on repayments per contractual obligations due to sanctions terms. This then allowed for the sanctioned entity, GTLK, to declare Havila in default of its obligations, allowing GTLK to attempt to exercise various security measures in the contracts, including calling for full repayment in exchange for an unwinding of the contractual relationship or full possession of the vessels themselves.
Establishing new routes
Fortunately, our recent success in court arguing for the Havila Group has allowed us to set key precedents that will mitigate future risk. Firstly, with Wikborg Rein’s assistance, our client was able to effect a unique Norwegian ship arrest – the first of its kind before the Norwegian Courts – that allowed for ‘forced use’ of the vessel by the Havila Group. This then allowed them to reinstate insurances and continue trading the vessel under licence, while refinancing and divestment of the sanctioned debt took place. This is a crucial step for asset preservation and continued commercial operations, and clears a path for future commercial operators in similar circumstances.
At the same time we progressed the matter through the Commercial Court system in London setting a new precedent that in such circumstances, an innocent party may discharge a debt under a contract by paying into a non-contractual frozen account. This way innocent parties can divest themselves of sanctioned debt, while remaining compliant with the international sanctions regime. The legal route through the problem was now cleared, and Havila had to raise refinancing funds in order to complete the transaction. In order to do so, both Havila and potential financiers had to be sure that they could make these payments within the confines of the sanctions regime.
In order to ensure compliance, we engaged with both the UK’s Office of Financial Sanctions Implementation (OFSI) and the US Office of Foreign Assets Control (OFAC). These institutions are tasked with helping to ensure financial sanctions are properly understood, implemented, and enforced in the UK and USA respectively.
After scrutinising the facts of the Havila case, both regulators rapidly issued the requisite licenses which allowed Havila and potential investors to raise funds and pay those funds into the frozen account in order to discharge the debt. This secured the route for our client to recover clear title to their assets and secure them against hostile enforcement by the sanctioned financier. OFAC and OFSI’s speedy decisions to uphold the ship owner’s commercial operation indicates its understanding of the detrimental impact of an extended timeline on commercial operations.
As a result, there is now a precedent whereby businesses impacted by sanctions will be able to pay monies owed to a sanctioned financier into non-contractual frozen accounts, which will be held and not released to the financier while the sanctions regime remains in place. Parties can thus lawfully extract themselves from their contracts, without reneging on repaying the termination sums demanded by the financier – a key risk consideration when pitching to candidate investors.
This has wider impact in the industry as the European arm of GTLK is known to have funded at least 19 vessels and 70 narrow-body aircraft. It is very likely that other innocent parties, across multiple industrial sectors, have found themselves caught between the contractual obligation to repay investors, banks and finance houses and the risk of breaching sanctions and incurring commercial and reputational damage.
OFSI has since issued a licence covering payments to liquidators of sanctioned entities. This is a prudent measure as GTLK’s European arm has recently been dissolved in what is likely to be the largest liquidation in Irish legal history — making extrication from these financial contracts far simpler to navigate. That said, businesses whose financing comes from the Hong Kong or Dubai branches of GTLK will still need to pay close attention to the express terms of the contracts and the exact sanctions framework of the jurisdictions involved.
Looking forward
While we have been successful in setting a legal precedent that paves the way for businesses seeking to divest themselves of sanctioned debt, we believe that there are a number of risks posed by sanctions that have yet to be foreclosed in shipping’s contracts. Although the Havila matter has gone a long way to setting important precedents and providing a blueprint for commercial interests in similar situations, there still remain a few unanswered questions which the court will need to decide.
Due to the particular facts of this case and the way in which GTLK sought to enforce termination rights under the contracts, Havila was able to obtain an injunction from the courts preventing GTLK from taking possession of the very valuable underlying assets (state of the art cruise ships). While the courts will try to assist innocent parties in trying to find a commercial solution within their contracts which stays within the bounds of the sanctions regime, what they will not and cannot do, is completely eradicate the rights of the sanctioned entity. This has to be correct in order to uphold the rule of law.
However, the following issues arose which the court ultimately did not have to address in this instance:
- Is a sanctioned party entitled to benefit from that fact, or to exercise contractual rights which have arisen purely as a result of that sanctioned status? and
- Is a party which is sanctioned, entitled to cause the innocent counterparty to sustain detriment because that innocent counterparty has complied with its obligations under the international sanctions regime (and perhaps in doing so, breached the contract)?
Wikborg Rein’s position (as argued in order to gain an injunction restraining GTLK from taking possession of the unfinished hulls) is that unless the law prevents parties like GLTK from benefitting from their sanctioned status, the sanctions regime would be both incoherent and self-defeating because it would strongly disincentivise innocent parties from complying with the sanctions regime.
For now, there is a blueprint which may help many commercial parties in similar circumstances seek a cut through to refinance similar contracts and divest themselves from sanction “taint”. In addition, there are now license precedents for seeking refinancing which should assist future parties to divest themselves in an efficient manner. However, there is no doubt that the court will have to address the remaining issues before too long.
