EU sanctions prevent the payment of arbitration awards
It is not every day that an English court is asked to interpret the application of an EU sanctions regime. But on 12 February 2020, the English Court of Appeal did just that in the Ministry of Defence & Support for Armed Forces of the Islamic Republic of Iran v International Military Services Ltd.
In its judgment, the Court confirmed that an EU sanctioned entity is precluded from enforcing an interest component of an arbitration award, in respect of the period during which it was sanctioned by the European Union.
The origin of the dispute can be traced back to the 1970s, when International Military Service Ltd (a company which is owned by the UK's Ministry of Defence and Treasury) entered into two contracts to supply tanks and armoured vehicles to the Ministry of Defence and Support for Armed Forces of the Islamic Republic of Iran (MODSAF). Shortly after the Iranian revolution in 1979, the contracts were terminated. IMS refused to complete the contracts, even though MODSAF had already paid towards them. This led to a dispute between the parties about the sum payable under the contracts.
As a result of the dispute, both parties commenced arbitration proceedings under the International Chamber of Commerce (ICC). MODSAF commenced the first arbitration proceedings in 1990 and International Military Service Ltd commenced the second arbitration proceedings in 1996. The tribunal rendered the final awards in both arbitrations in 2001. In relation to the first arbitration, the tribunal found that International Military Services Ltd was liable to pay over £140,000,000 for breach of contract together with interest from 28 July 1984 to payment at a rate of +0.5% and MODSAF's costs. The tribunal dismissed the second arbitration and ordered International Military Services Ltd to pay MODSAF's costs.
Shortly afterwards, MODSAF applied for the enforcement of the awards in the United Kingdom as per s.101 of the Arbitration Act 1996 and International Military Service Ltd paid the sum of £382,500,000 to the court by way of security. However, the proceedings were adjourned pending a determination of a challenge brought by International Military Service Ltd in The Netherlands. By the time a decision had been reached by the court in The Netherlands in 2009, MODSAF had been added to the list of entities subject to sanctions imposed against Iran. As a result, the sum that was due to MODSAF under the award could not be paid. Nevertheless, MODSAF sought an order for judgement to be entered by the English court in terms of the arbitration awards and a declaration that the funds in court were held for its benefit.
The key issue for determination in the current proceedings was whether International Military Service Ltd was liable to pay interest on the awards, during the period in which it was not able to satisfy the awards due to the EU sanctions which took effect on 24 June 2008.
The difference between an arbitration award and interest
An arbitration award is the document that contains the decision of the arbitral tribunal on the substantive issues that were raised before it during the arbitration. Unless otherwise agreed by the parties, an arbitration award is final and binding between the parties and any person claiming through or under them (see s.58 (1) of the Arbitration Act 1996).
The interest component of an arbitration award is an additional sum that is awarded by the tribunal and is more relevant to liability and conduct of the parties. It is awarded from such dates, at such rates and with such rests as the tribunal considers meets the justice of the case (see s.49 (3) of the Arbitration Act 1996). In fact, unless otherwise agreed by the parties, a tribunal may award simple or compound interest, in respect of: a) any period up to the date of the award; and b) any period from the date of the award to the date of the payment.
In this particular case, there was no issue between the parties as to whether International Military Service Ltd can make any payment to MODSAF. It was common ground between the parties that due to EU restrictive measures on MODSAF (in particular those contained in EU Council Regulation 26/2012 (the "Regulation") International Military Service Ltd could not lawfully pay MODSAF anything. The question that the court was invited to rule on related to liability for the interest and not payment.
The English Court Proceedings
The proceedings initially took place in the English Commercial Court and were later upheld by the Court of Appeal. They found that Article 38 of the Regulation precluded the Iranian Ministry of Defence from enforcing the interest component of the awards, in respect of the period during which the Iranian Ministry of Defence was subject to the sanctions imposed by the European Union. Article 38 of the Regulation prevents claims made by sanctioned entities "in connection with any contract or transaction" whose performance has been affected by the sanctions imposed by the Regulation from being satisfied.
Most importantly, the Court of Appeal clarified that while on a true construction of the Regulation, an arbitration award did not amount to a "contract or transaction" within Article 38 of the Regulation, there was no doubt that each of the original contracts between the parties, which were the subject of the arbitration awards, constituted a "contract or transaction" within Article 38. Further, it was held that the Iranian Ministry of Defence's application for judgement to be entered in its favour in terms of the arbitration award also constituted a "claim" within Article 38, which by Article 1(c)(v) of the Regulation included a claim for the recognition or enforcement of an arbitration award that was "in connection with" those contracts. Moreover, it was found that the existence or content of the claim for the interest component of the arbitration awards resulted directly or indirectly from the sanctions; with the consequence that the performance of the contracts was deemed to have been affected in part by the sanctions. Therefore, Article 38 barred the Iranian Ministry of Defence from enforcing the arbitration awards insofar as they related to interest arising during the sanctions period.
It is expected that the Court of Appeal's judgment will provide assurance for companies and individuals that have withheld payments to EU sanctioned entities and/or individuals; on the basis that it would be illegal to transfer funds under the EU sanctions regime.
The judgment will likely be welcomed by practitioners and EU based arbitration institutions, as it provides greater clarity on the language, purpose and proportionality of asset freezing measures. On the other hand, it may only serve to further isolate the State of Iran, as the judge acknowledged: "MODSAF is frustrated that, four decades on from the events giving rise to arbitration awards in its favour and 18 years after those awards were made, it has still received nothing".
It is worth noting however, that the judgment does not provide for a blanket ban on the payment of interest on all arbitral awards enforced by EU sanctioned parties. In fact, Lord Justice Newey held that in some instances interest can still be lawfully paid to a sanctioned entity, subject to that entity having an appropriate EU account. He held:
"a designated person with an appropriate EU account can be credited with interest pursuant to article 29 of [the Regulation]. This has a rational basis in the fact that the money can be frozen once in the account. Further, where such an account exists, a counterparty can avoid liability for future interest by paying what he owes into the account. He therefore needs no protection. If, on the other hand, the designated person holds no qualifying account, the counterparty will be unable to pay and, in the absence of a provision such as article 38, could not escape accruing interest liabilities. It is therefore comprehensible that a counterparty should enjoy protection where the designated person has no relevant account but not where he does".
This judgment highlights the importance for contracting parties of introducing measures in their commercial agreements that specifically deal with the relevant steps to be taken if economic sanctions are imposed on either party. Failure to discuss such measures early on in negotiations could lead to expensive litigation and difficulty in enforcing successful arbitral awards.
The Iranian Ministry of Defence is expected to appeal the decision in the United Kingdom's Supreme Court. While the appeal is likely to extend beyond the looming Brexit deadline, it is not considered likely that the UK's post-Brexit sanctions regime will differ substantively from the European Union's position on this specific point.
  EWCA Civ 145.
  WLR 1 1726.