What if a surety has an obligation to pay a bond claim, but to do so would place the surety in breach of sanctions? Well, that is precisely what happened in LLC Eurochem North-West-2 & Anor v Société Générale S.A & Ors [2025] EWHC 1938 (Comm) save that it involved banks.
The factual scenario
The defendant French and Italian banks – Société Générale (SocGen) and ING Bank – issued six on-demand performance bonds, all governed by English law. The total value of the bonds was €280m.
The bonds had been issued in 2020 and 2021 in favour of the first claimant, in connection with the construction of a major fertiliser plant in Russia.
Russia invaded Ukraine in February 2022 and, as a result, the EU imposed sanctions on the founder of the claimant group of companies (Mr Melnichenko) in March 2022 and on his wife in June 2022. The EU sanctions Regulation 269/2014 were restrictive measures introduced in respect of actions threatening the territorial integrity, sovereignty and independence of Ukraine.
The first claimant made demands under the bonds in August 2022, but the defendant banks declined to pay on the basis that to do so would be illegal because of the EU sanctions. The reason given by Société Générale was: “… we are unable to honour the claim due to the presence of international sanctions directly impacting the transaction. Paying under the above-mentioned claim will indeed constitute a breach of these international sanctions.”
The bond wordings expressly permitted assignment to a list of named companies and to “any other person or entity to whom the rights, obligations and benefits under the Contracts have been assigned … subject to Issuer’s consent, such consent not to be unreasonably withheld…”
In December 2024, the first claimant assigned the benefit of the bonds to the second claimant.
The issues
The claimants’ case was straightforward: valid demands were made under the bonds which the banks were obliged to pay. It was submitted that neither of the claimants was owned or controlled by Mr or Mrs Mr Melnichenko.
The defendants relied on the EU sanctions and submitted that it would be illegal for them to pay. The assignment could not cure the unenforceability of the bonds, additionally the assignments were invalid. Finally, the banks submitted that the bonds had now expired.
The decision
The burden of proof was on the defendant banks to demonstrate that the bonds were frozen and/or that payment was prohibited.
The Court first had to decide whether the claimant companies were owned or controlled by Mr or Mrs Melnichenko – this required an incredibly careful and detailed analysis of a complex structure of companies and trusts in jurisdictions including Bermuda, Cyprus, Switzerland and Dubai.
If the answer to the first issue were yes, then whether the bonds were ‘funds’ for the purposes of the Regulations fell to be considered. The Judge referred to the definition of ‘funds’ which expressly includes, at Article 1(g)(v), ‘performance bonds or other financial commitments’.
Having decided that the bonds constituted ‘funds’, if they were ‘belonging to, held or controlled by’ Mr or Mrs Melnichenko then they were frozen under Article 2(1). No legal relationship was required for control: de facto control was sufficient, and the Court found this to be the case.
The Court decided that payment under the bonds was prohibited under Article 2(2) because it would make funds or economic resources available to Mr or Mrs Melnichenko. The French and Italian banks were entitled to decline to pay the claimants following their demands on bonds as to do so would be illegal.
Implications for sureties
It is generally understood that the only defence to a claim under an on demand bond is a fraudulent call. We need to add to that: where payment is illegal due to sanctions.
The seriousness of non-compliance with sanctions was highlighted in the decision in the following passage: “It was apparent that all three of the Banks’ witnesses were concerned to comply properly with the EU sanctions. They were conscious not merely that this was an important part of their jobs, but that they, personally, might face criminal prosecution if they did not comply. Mr Colbert, in particular, mentioned the possibility of SocGen facing a fine of 10 times the sum involved, and of individuals facing up to five years in prison”.
Imagine the machinations at the banks; on the one hand faced with apparently valid demands but, on the other, the prospect that payment could breach sanctions and be unlawful leading also to criminal consequences.
In the Judge’s words, “extensive teams of barristers and solicitors” were involved. The hearing took place over 12 court days. An extremely expensive case indeed. Could this cost have been avoided?
Interestingly, the bonds did not contain wording to the effect that the banks were not obliged to make any payment if to do so would place them in breach of sanctions. Would that have put the matter beyond doubt on the face of the documents and avoided the machinations and this litigation? Quite possibly. So, this example admirably demonstrates why wording is included in bonds to the effect that a surety shall not be obliged to pay if to do so would breach sanctions. In this case, there was an attempt to assign the benefit of the bond to the second claimant. The Court did not have to decide whether that was an attempt to circumvent sanctions as the second company was also under the de facto control of Mr or Mrs Melnichenko. What this highlights is the importance of prohibiting assignment to unknown third parties. Permitting assignment while retaining control requires consent and notice of course.
Another interesting point that the Court considered was whether performance of the obligations under the bonds would be unlawful under the laws of the place for performance. For an on-demand bond, it is the location where payment is to be made, so France or Italy in this instance. Payment would be unlawful under the laws of those jurisdictions and was therefore prevented by the operation of the rule in Ralli Bros v Compania Naviera Sota y Aznar [1920] 2 KB 287. Even if the place of performance had been Russia, the bonds should still not be enforced because to do so would be contrary to public policy as outlined in the Hong Kong Court of Appeal case Ryder Industries Ltd (formerly Saitek Ltd) v Chan Shui Woo (2015) 18 HKCFAR 544.