Russia/Ukraine conflict: implications of sanctions for financing transactions
For background and discussion of some of the options available to the UK Government as a matter of law and policy, please see the first article in the series, the podcast which accompanies it and this update on the UK’s legislative basis for sanctions against Russia. We have also written separately on the implications of sanctions for derivatives.
With the UK, EU and US preparing to respond to any potential Russian invasion of Ukraine, the implications of any financial sanctions they impose, and any counter from Russia, for existing and prospective financing transactions is a key concern of those with commercial interests in the region.
For a good number of parties to these transactions, the issue is less whether they or one of their counterparties, or a director or other person connected to either, is specifically targeted with sanctions (though this could well be the case for some transactions) and more whether the breadth of the sanctions which are threatened will trigger provisions in contracts that are wider in scope.
Relevance of sanctions
With increased use and complexity of national and supranational sanctions against recalcitrant state actors over recent years, those participating in international financial markets have grown accustomed to considering the actual or potential impact of these deterrent measures on the business of a prospective borrower of a loan or issuer of debt securities. It is a due diligence matter – generally approached on a proportionate and risk-sensitive basis, with reference to the geographical connections of the business being financed.
Whilst sanctions concerns are not confined to particular financial products, loans made to businesses on the basis of cash projected to be generated, or the value of assets situate, in countries which are (or are at risk of becoming) subject to sanctions receive close attention. This is perhaps reflective of the private and highly negotiated nature of many cross-border loan financings. The loan product is flexible and very much a creature of the individual contract agreed to document it. This provides borrowers and lenders with the opportunity to structure and document a transaction that balances a lender’s need for protection from sanctions (whether biting on the borrower and its connected parties or on the lender in its interactions with them) with the borrower’s freedom to conduct legitimate, non-sanctioned business in a country within which certain persons (natural and legal) or specific sectors are the subject of sanctions.
Something of a contrast can be drawn with international public bond markets – for which sanctions are more of a binary matter, with arrangers and the investor base driven by whether a threshold risk of detrimental sanctions has been established in respect of the issuer group. Generally, there is less structuring and documenting of bond deals to cater in bespoke fashion for sanctions concerns attaching to a specific issuer. Confirmations regarding compliance with sanctions are often also sought by listing authorities and exchanges before bonds are listed and admitted to trading.
Lenders contemplating the sanctions risk of a prospective loan transaction are usually concerned to ensure that:
- no borrower or guarantor (or any other member of a wider corporate group) is a designated sanctions target or otherwise a subject of sanctions (or an agent of any such person);
- each borrower and guarantor (and any other member of a wider corporate group) is in compliance with sanctions and has policies in place to ensure compliance with sanctions;
- the proceeds of loans are not (directly or indirectly) used for purposes prohibited by sanctions or that are contrary to the lenders' sanctions policies, or for any sanctionable activity (a US concept to capture activity by non-US persons which is not prohibited but could result in them being designated a US sanctions target); and
- payments to lenders are not sourced from the proceeds of activities involving sanctioned territories or persons.
Towards this end, in all but domestic financings patently unconnected to a sanctioned territory, lenders will likely seek sanctions related representations and undertakings from the borrower group – to be included in the loan facility agreement. How these are worded will depend on the borrower group’s business and the parties to the transaction. There is no settled market standard: the Loan Market Association (LMA) does not, and does not intend to, recommend sanctions provisions in a particular form (beyond its offering of optional sanctions related definitions in its recommended forms of facility documentation for developing markets transactions).
Many lenders have their own (granular) requirements, which sometimes jar with what a borrower can feasibly sign-up to. Private equity sponsors that routinely seek leveraged finance for portfolio companies (whether on acquisition or subsequently) have increasingly developed "house" views as to the contractual comfort they are willing to provide to lenders in relation to sanctions. In a continuing borrower-friendly market, these can hold significant sway in negotiations.
Whilst, as a foreign policy device, sanctions have proliferated in recent years, the contractual provisions which address them in loan documentation have become fairly settled. Generally speaking, they are not as hotly negotiated as they were between five and ten years ago. Whether any further measures in relation to Russia will change this remains to be seen.
There is apparently growing convergence among the major authorities in the US, EU and UK on the shape of additional sanctions against Russian-connected targets should there be an invasion. US officials have stated that these would be aimed at both new and existing financings. In any event, it will be important for parties to transactions connected to Russia or Ukraine to review and closely consider their contractual terms in addition to the possible operational (for example, supply chain) impacts on the relevant business.
For new deals, it will be just as important for due diligence to capture the effect of any additional sanctions against Russia. And, indeed, to attempt the much trickier exercise of predicting their possible future expansion or unwinding, which the first article in this series flagged as being a consequence of the UK Government’s new legislative powers to bypass the link with actions in Ukraine and implement broader sanctions aimed at the strategic interests of the Russian state as a whole.
Interactions with contract
So how might the broader sanctions planned by the UK (and, we understand, being considered by the US and EU) interact with contractual provisions that commonly appear in loan facility agreements?
It bears mentioning that it can be difficult to construe these provisions with reference to even existing sanctions regimes, which are by their nature fluid and, as a construct of legislative (rather than contractual) drafting, themselves open to differing interpretations. Given that those who drafted and negotiated legacy contractual clauses will not have had sight of even the legislative basis for (never mind the detail of) any further measures against Russia, there is considerable scope for ambiguity.
Whether these further measures lead to:
- misrepresentations being made, or undertakings being breached, by a borrower group (perhaps constituting an actionable event of default); or
- it being unlawful for a lender to fund or maintain, or even enforce, its participation in a loan (perhaps constituting a prepayment event or an actionable event of default),
will require careful consideration in each case.
We imagine the attention of many will be drawn to definitions of “Sanctioned Territory” (or similar), which often refer to the implementation of “territory-wide” or “comprehensive” sanctions in respect of a territory as a threshold for persons located (or incorporated) there to be considered “restricted” for the purposes of the facility agreement – probably triggering a misrepresentation.
Borrowers may contend that this is a materially lower threshold than a person being specifically named on a sanctions list; whilst lenders may seek to justify it on the basis that the breadth of the envisaged sanctions means any dealings with the “restricted person” will pose an unacceptable sanctions risk.
Whether the totality of existing and any additional sanctions against Russia should be regarded as “territory-wide” or “comprehensive” in respect of Russia as a whole will clearly depend on their scope and content, and how they are framed by relevant sanctions authorities. Express reference to “Sanctioned Territories” that are intended to be in scope of the definition is sometimes included within facility agreements by way of non-exhaustive examples. The familiar list comprises Cuba, Iran, North Korea, (North) Sudan, Syria and (most importantly, given its recent annexation by Russia) Crimea.
Based on statements and legislation made to date, it could be expected that the package of sanctions being considered for Russia as a whole will not be as all-encompassing as those applied against these listed territories. Consequently, the sanctions may not be regarded as “territory-wide” or “comprehensive” for these specific purposes, but they are likely to still be extensive. Whether they will result in a triggering of any relevant provisions of a facility agreement will depend on the precise words used, the intention behind them and, most crucially, the detailed business and operations of the borrower group.
The first article in this series raises the prospect, and this update confirms the likelihood, of Russian countersanctions and other countermeasures should the UK, EU and/or US impose additional sanctions in response to any potential Russian invasion of Ukraine. From the narrow perspective of cross-border leveraged loans, countersanctions would appear unlikely to trip contractual provisions which tend to only contemplate measures implemented by the UN, EU, US and UK. However, they could put Russian-connected lenders to European businesses in a difficult spot. And the introduction of a comprehensive “blocking statute” – making compliance with UK, EU and US sanctions by multinational businesses operating in Russia illegal – would pose practical and legal problems for in scope borrowers and lenders alike.
Taking a step back: that many countries (particularly within the EU) rely significantly on Russia would seem to leave considerable scope for effective countermeasures to emanate from Moscow. Of particular concern are restrictions on natural gas supplies should the situation worsen, whether because of damage to pipelines through Ukraine or Russian state control. In relation to the economic and commercial fallout of the Russia/Ukraine crisis: (a) it is not just sanctions that businesses need to worry about; and (b) it is not just those doing business in Russia or Ukraine that need to worry.