The effect of sanctions and sanctions clauses in letters of credit on the independent nature of these instruments

Abstract

Two essential principles of letters of credit are autonomy and stringent compliance. Autonomy describes letters of credit as being distinct from and unrelated to the underlying agreement between the parties. The underlying purchase agreement between the parties does not apply to a letter of credit because it is a contract based on the delivery of papers. Therefore, banks are generally only allowed to refuse payment on the submission of fraudulent conforming documents that relate to letters of credit. According to the "strict compliance" principle, banks have the power to reject documents if they do not strictly abide by the terms noted on the letter of credit. Upon presentation of conforming documents, the credit must accordingly be paid. Letters of credit are normally provided by commercial banks that have to protect their interests. Targeted financial sanctions interfere with the aforementioned free flow of money and certainty of payment, since banks may be prohibited from making or processing payments in transactions involving targeted individuals, companies or vessels. As such, targeted financial sanctions are severely detrimental to both international trade and to the interests of the banks. Sanction clauses have emerged as a way for banks to protect their interests when issuing letters of credit and independent guarantees. In protecting their interest, the issuing bank normally makes use of an extremely broad sanction clause, for example: XXX Bank complies with the international sanction laws and regulations issued by the United States of America, the European Union and the United Nations (as well as local laws and regulations applicable to the issuing branch) and in furtherance of those laws and regulations, XXXX Bank has adopted policies which in some cases go beyond the requirements of applicable laws and regulations. Therefore, XXX Bank undertakes no obligation to make any payment under, or otherwise to implement, this letter of credit (including but not limited to processing documents or advising the letter of credit), if there is involvement by any person (natural, corporate or governmental) listed in the USA, EU, UN or local sanction lists, or any

involvement by or nexus with Cuba, Sudan, Iran or Myanmar, or any of their governmental agencies.1 Sanction clauses are designed to protect banks in the event of payment being blocked by targeted financial sanctions. Wording such clauses broadly will have a significant and negative effect on the foundational principles of irrevocability and independence of letters of credit. This would undermine the essential principles of letters of credit. Sanctions are prohibitions instituted by an individual country or a group of countries, or the UN Security Council. Being a United Nations member prohibits Member States from conducting business with countries against whom sanctions have been instituted. Most countries have restrictive legislation that adds to this. The most recent sanctions issued against Russia as a result of its invasion of Ukraine, had a detrimental effect on international trade in such a way that exports from sanctioning countries to Russia have declined by 60% and non-sanctioning countries by 40%.2 A further effect of sanctions against Russia is that certain banks have stopped issuing letters of credit relating to the trade of crude oil with Russia and any sanctions that are specifically focussed on the Russian energy sector could prevent payment in this regard.3 Against this background the research question asks how sanctions and sanction clauses affect the role and status of letters of credit in trade financing, with a special focus on their effect on the independence and the irrevocable nature of these instruments.

This study aims to answer the research question by considering the historic development of letters of credit into the known modern-day letter of credit. Thereafter, the study ventures into modern-day entities that provide for good governance and certainty in international trade relationships. Thereafter this study will venture into the incorporation and application of these entities in the South African legal spere. This study further addresses the historical development of sanctions and how it is applied in modern-day engagements between various parties. This is followed by a consideration of the imposition of sanctions against South Africa and the effect thereof on international trade finance instruments. Then this study provides clarity on the view of the ICC relating to sanctions and answers the research question addressing it within the South African legal sphere.