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Bond docs don’t work when sanctions collide

Many bond documents have huge holes in them when it comes to sanctions, which could in theory trap paying agents and other deal parties in civil and even criminal legal action.

Because EU and US sanctions over Russia do not match, US-based firms which perform services for English law transactions might be caught out. Some issuers are already demanding new clauses in their documents to cover this risk, which could become standard in all bonds.

The US’s Russia-related sanctions still do not apply to many of the largest public bond issuers, but they apply retrospectively — there are no grandfathering provisions in place to permit contracts that have already been struck. EU sanctions, on the other hand, only apply to new deals.

So where, for example, a US paying agent was supposed to pay out money for a sanctioned entity in an English law deal, it would violate US sanctions (by handling money for a sanctioned entity) if it made the payments, and breech its contract if it did not.

According to a London-based lawyer working for a US trustee, structured finance deals usually have provisions called illegality clauses, which let the paying agents and other deal functionaries out of their contractual obligation if performing their duties becomes illegal. But these clauses are rare in bond documents.

“In short, bond documents don’t provide much for paying agents and other deal functionaries if performing their duties becomes illegal,” said Simon Hill, co-head of Allen & Overy’s global international capital markets group in London.

Tim Beech, a senior associate who works with Hill at A&O, said that some clients were already trying to fix it.

“Some market participants have already started to insist on specific wording to deal with illegality, particularly focused on sanctions, and I think in general we’ll begin to see a standard provision appear in most DCM documents on this point,” he said. "It’s a continuous task to keep contracts up to date with global developments.”

English law escape

However, paying agents do have another get out which should get them off the hook in English courts — if it is ever tested.

“In the case of a paying agent prevented from making a particular payment by reason of sanctions for example, we think under English law the courts would be likely to hold that the contract is frustrated," said Beech, "[whereby] the parties discharged from their obligations with no liability on either side and no damages payable.”

Hill explained that frustration is an English common law principle which is relevant for situations like the sanctions.

“But you can see that it would give everyone involved much more comfort if provisions dealing with illegality were specifically written into documents,” he added.

In practice, holding contracts together is likely to rely on confidence as much as the courts. If investors or issuers ask for court guidance and an English court declares a contract frustrated, then there is no chance of all parties picking up again once sanctions come to an end — it is permanently dissolved.

So recourse to the courts ought to protect paying agents but it will be better for all parties if they can avoid it altogether.

Other documentation details set out what the other options for trapped paying agents are. In some deals, they may be able to resign their role; in others, issuers may be obliged to replace them if they do not perform.

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