Fast-changing sanctions environment poses risks for borrowers

This desire to terminate contractual arrangements early, sometimes at significant expense in penalty costs, is likely to reflect a combination of three considerations: a view that further sanctions are inevitable and should be pre-empted; a reflection of investor, customer and employee pressure; and a moral imperative to do something in the light of recent events.

Beyond these considerations, it is important for borrowers dealing with Russian entities to consider a fourth point: could we risk breaching our loan documentation, notwithstanding that the Russian counterparty or activity has not yet been sanctioned?

Loan documents often contain more onerous sanctions provisions than those prescribed by government. This is because financial transactions are particularly susceptible to money laundering and are often cross-border.

Banks and other financial institutions must therefore take care to ensure that they meet regulatory requirements in many jurisdictions, and they will seek to pass this requirement on to borrowers and customers.

Extra-territorial reach

A significant number of loan agreements categorise prohibited transactions by reference to sanctions authorities in a number of jurisdictions. The effect of this is that a borrower agrees to not undertake transactions with persons sanctioned by governments other than its own, or those of its lenders.

Consequently, in the current climate, borrowers need to be aware that the sanctions provisions in their loan agreement could be driven by the most fast-moving of certain western governments, which is not necessarily the sanctions regime that is applicable to the borrower at that time.

A UK borrower could breach its loan documentation by trading with an entity sanctioned by the EU, for example, but not the UK government.

Transactions with sanctioned entities

A borrower’s loan agreement may prohibit any transactions with a person on a sanctioned persons list. The legal position can, however, be more nuanced than that. Entities can be on a sanctions list of a particular country, but this does not mean that all transactions with these entities are prohibited.

Borrowers may however find that carrying out a specific transaction would still put them in breach of their loan agreements, especially as the situation is changing on a daily basis.

For example, until 8 March it was possible for US entities to purchase oil and gas from Russian energy giant Gazprom, even though Gazprom in the US was on a sanctions list prohibiting investment in Gazprom or selling certain technological or mechanical equipment. 

However, under certain loan agreements even this perfectly legal transaction involving oil and gas could have triggered a breach, because Gazprom was on a sanctions list relating to certain other transactions.

It is therefore imperative that borrowers look to their contracts with banks as well as the prevailing sanctions in their jurisdiction, in order to determine whether they should or should not proceed with a high-risk transaction or continue with a high-risk relationship.