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LOUs Containing a Sanctions Clause

By Felipe Arizon
Arizon Abogados (Spain)
+34 952 211 774

LOUs Containing a Sanctions Clause

For those making use of Letters of Undertaking (LOUs) in the context of ship arrest practice, this is an interesting case for reading as it deals with the inclusion of a sanction clause within the terms of a LOU issued in the context of a collision case.

As regards the use of LOUs in Spain arising from ship arrest, the arresting party is not obliged to accept a LOU to release the ship, therefore it has the upper hand in accepting, or not, the terms of any LOU.

On the other hand, Spanish law is rather strict regarding wrongful arrest, therefore a good LOU might be of great interest for the arresting party in those cases where the maritime claim is disputable on its merits as the release of the ship shall stop the running of any damages arising from a potential wrongful arrest.

In this case, High Court judge Sr. Nigel Teare stated the following: “An arrest of a ship in English law (and in the law of many other maritime nations, though the details may differ) is a means not only of establishing jurisdiction but also of obtaining security for a maritime claim. Where ships collide causing damage the owners of each ship will be concerned to recover that damage from the other ship. Of immediate concern will be the decision as to where to arrest in order to commence proceedings and to obtain security for the claim. However, an arrest may not be the ideal way of founding jurisdiction or of obtaining security. The ship to be arrested may be in a jurisdiction which, for one reason or another, is not regarded as suitable for determining the merits of the claim. The arrest will only provide adequate security if the market value of the ship, when sold, is sufficient to cover not only the claim for collision damage but also the claims of others such as a mortgagee whose claims may have priority to that of the damage claimant. Furthermore, an arrest is costly, not only for the arresting party but also for the owner of the arrested ship. For these reasons the owners of ships involved in a collision will often agree upon a jurisdiction where the claims of each owner against the other will be heard and will also agree to an exchange of letters of undertaking from each owner’s P&I Club (or Hull Underwriters) securing the claim of each owner against the other. A letter of undertaking (“LOU”) from an owner’s P&I Club is preferable to an arrest. It avoids the costs and uncertainty of an arrest and provides a reliable and trustworthy form of security. A LOU is therefore often provided before an arrest takes place…”

Other than the above, the facts of the case extracted from the judgments (High Court and Court of Appeal) were succinctly the following:

Following a collision in the Suez Canal the appellant (the owner of a ship called PANAMAX ALEXANDER) offered to provide security to the respondent (the owner of a ship called OSIOS DAVID) in the form of an LOU from its P&I Club, the Britannia.

Discussions followed as to the amount and terms of the respective security to be provided by each party. While those discussions were continuing, on 5th September 2018, the respondent arrested in South Africa a ship called PANAMAX CHRISTINA, owned by a company associated with the appellant.

On 7th September 2018, the appellant’s P&I Club proposed a draft LOU which it was willing to provide to the respondent. This was based on the standard wording of ASG 1, but with the addition of a “sanctions clause” relieving the Club from its obligation to pay in certain circumstances. The clause was in the following terms:

“We shall not be obliged to make payment under, nor be deemed to be in default of, this Letter of Undertaking if (i) doing so would be unlawful, prohibited or sanctionable under the United Nations resolution or the sanctions, laws, or regulations of the European Union, United Kingdom, United States of America or [the place of incorporation or domicile of your member] or the ship’s flag state (‘the Sanctions’), or (ii) if any bank in the payment chain is unable or unwilling to make, receive or process any payment for any reason whatsoever connected with the Sanctions (including but not limited to a bank’s internal policies). If any such circumstance arises as described in (i) or (ii) herein, then we shall use reasonable endeavours to obtain whatever Governmental or other regulatory permissions, licences or permits as are reasonably available in order to enable the payment to be made.”

The proposed clause relieved the Club from its obligation to pay not only if it would in fact be contrary to sanctions regulations imposed by the United Nations or the laws of any of the specified countries to do so, but also (in very wide terms) if any bank in the payment chain was (rightly or wrongly) unwilling to process a payment for any reason whatsoever connected with such regulations. The proposed currency of payment was the Euro, no doubt because of the difficulties of making US dollar payments through New York banks in the event of United States sanctions applying (cf. MUR Shipping BV v RTI Ltd [2022] EWHC 467 (Comm) at [3] and [4]).

This clause was included because the PANAMAX ALEXANDER had been on a voyage to Iran and the United States had recently announced the re-introduction of sanctions against Iran (see Mamancochet Mining Ltd v Aegis Managing Agency Ltd [2018] EWHC 2643 (Comm), [2019] 1 All ER (Comm) 335 at [10] to [29]). The Club was concerned that it might be unable to pay under its LOU if called upon to do so without being in breach of sanctions regulations or, at any rate, that banks in the payment chain who were known to be sensitive to sanctions issues might be unable or unwilling to handle any payment.

The respondent and its P&I Club were not prepared to accept an LOU with this (or any) sanctions clause, expressing concern that security in this form might prove worthless. They maintained that position, notwithstanding that the wording proposed was approved by the International Group’s Sanctions Committee on 10th September 2018. Accordingly the respondent refused to agree to the release of the PANAMAX CHRISTINA from arrest in South Africa unless security was provided which did not include a sanctions clause. Such security was provided on 10th September 2018, in the form of an LOU from the United Kingdom Club with which that ship was entered. The UK Club LOU did not contain a sanctions clause. It provided for South African law and jurisdiction to govern the LOU. Despite the release of PANAMAX CHRISTINA on provision of this LOU, the proceedings in South Africa have continued because the lawfulness of the arrest is being challenged. We were told that an appeal before the Full Bench of the KwaZulu Natal Local Division is due to be heard this month. On 6th May 2019 the appellant’s P&I Club repeated its offer to provide an LOU in the same terms as before but this time backed by a guarantee from HSBC. The terms of the guarantee were that HSBC would irrevocably and unconditionally guarantee payment of any liability on the part of the appellant to the respondent. It did not include any form of sanctions clause. This offer was said to be made in order to mitigate the appellant’s damages claim and was open for seven days. It was not accepted.

On 15th July 2019 these proceedings were initiated seeking damages for breach of the Collision Jurisdiction Agreement, together with declaratory relief. The damages claimed consisted of fees payable by the appellant to the owners of PANAMAX CHRISTINA for providing security in the form of the UK Club LOU, together with out-of-pocket expenses incurred by the owners of PANAMAX CHRISTINA in connection with the arrest in South Africa.

The High Court judge held that the Owners of PANAMAX ALEXANDER have established that the LOU tendered on 7 September 2018 was in a reasonably satisfactory form to the Owners of OSIOS DAVID. However, the Owners of OSIOS DAVID were not on the true construction of the CJA obliged to accept that security. The claim of the Owners of PANAMAX ALEXANDER must therefore be dismissed.

The Court of Appeal held that the appeal was to be allowed as the Owners of OSIOS DAVID was obliged to accept the LOU that was in reasonably satisfactory form. And accordingly judgment should be entered for the appellant in the sum of €297,000 and US $201,275, and that the appellant will be entitled to recover in respect of such further losses as may accrue between the date of judgment and the conclusion of the proceedings in South Africa.

A copy of both judgments can be obtained here: