Sanctions clauses and the insurance of Iranian entities

Both Europe and the US are imposing stricter and stricter economic sanctions against Iran and Iranian entities, with financial and criminal penalties for non-compliance. Increasingly, the provision of insurance is being regarded as a prohibited activity, and insurers, reinsurers, brokers and traders need to be aware of and understand the implications.

On 25 May 2011, the English Court of Appeal issued judgment in Arash Shipping v Groupama Transport [2011] EWCA Civ 620. The dispute was over the validity of the cancellation of a marine policy under an Iran sanctions clause, but also discusses the scope for renewals and extensions to policies to be prohibited under existing EU sanctions against Iran.

The decision has implications for all classes of insurance and reinsurance business as the scope of the EU sanctions on Iran may be significantly wider than previous market guidance might suggest.   

Council Regulation (EU) 961/2010 (Regulation 961) imposes economic sanctions on Iranian persons and entities. Regulation 961 has direct effect in the UK and came into force as from 27 October 2010. 

Article 26 of Regulation 961 prohibits insurance or reinsurance to, and the renewal or extensions of existing contracts of insurance or reinsurance for, Iran, Iranian governmental organisations, Iranian or Iranian-controlled companies as from 27 October 2010.  There are limited exceptions for compulsory third party insurance, personal lines (where the individual is not subject to an asset freeze) and insurance of vessels or aircraft chartered by an Iranian entity (so long as that entity is not subject to an asset freeze). Article 26(4) states that the sanctions “do not prohibit compliance with agreements concluded before” 27 October 2010 (with limited exceptions).

In October 2010, HM Treasury issued guidance as to the effect of Article 26 of Regulation 961, indicating that whilst existing insurance arrangements to Iranian entities entered into before 27 October 2010 could run their course, such that claims could be paid, the Regulation banned the renewal or extension of insurance and reinsurance agreements after that date.

However, many insurance contracts - particularly aviation and marine fleet policies, binding authorities and obligatory treaty reinsurance - contain automatic attachment, endorsement, extension or renewal provisions. There has been some uncertainty as to the precise extent to which these were caught by the sanctions.  

Both the IUA and Lloyd’s Market Association (LMA) issued some advice to insurers in January 2011, apparently based on communications with HM Treasury, which suggested that in certain circumstances automatic arrangements would not be caught by the prohibition in Article 26.  

LMA Market Bulletin Y4463 (the content of which had been reviewed by HM Treasury) stated that HM Treasury “has confirmed that this [prohibition] applies where the extension to an existing contract is outside the terms agreed when the contract came into force and which would therefore alter and increase the scope of re/insurance coverage that was agreed. Such requests to extend would be seen as optional or at the discretion of the underwriter and would not be permitted. In some cases, however, the terms of a contract agreed may oblige a re/insurer to accept additional risks or extensions to an existing contract i.e. without any option. There may therefore be policies where a re/insurer is legally bound to underwrite any risk falling within the terms of an existing contract, such as under obligatory treaty insurance. In this case, even if the risks incept after 27 October 2010 they are permitted”.

The IUA guidance included a question and answer format which illustrated how the sanctions were understood to operate by a hypothetical example in relation to a 12 month excess of loss treaty insurance contract incepting on 1 January 2010 with a renewal clause at the option of either party, under which a claim was notified on 31 December 2010. The guidance stated:

“[The reinsurer] is permitted to pay the claim notified on 31 December 2010 because the claim falls within the policy period and is deemed to be compliance with agreements concluded before the Regulation came into force…

[Regulation 961] expressly catches renewals except where these are pursuant to existing obligations. Since the renewal is not “automatic” because it is at the option of either party, such renewal would not be permitted except, possibly, where the renewal was pursuant to a clear and unambiguous contractual obligation contained in the contract [of (re)insurance]”.

Based on this guidance it might have been thought that automatic renewals to contracts which incepted before 27 October 2010 and which involved no independent exercise of underwriting judgement were outside the scope of Regulation 961.

In light of the increasing application or potential application of international sanctions to the provision of insurance, many policies (whether in connection with insurance to Iranian or other entities) contain sanctions clauses, such as the LMA 3100 Sanction Limitation and Exclusion Clause.

Some clauses are worded so as to provide insurers with a right to terminate the contract should the insurance be rendered illegal by sanctions or if the insured exposes the insurers to a risk of being subject to any sanction. Others provide that the insurance will effectively be suspended or shall not operate so far as to do so would be rendered unlawful by any sanctions legislation. There is often scope for debate as to whether or not these clauses take priority over any “automatic” renewal or extension provisions, such as can be found under review clauses.

In its judgment in Arash Shipping v Groupama Transport [2011] EWCA Civ 620, the Court of Appeal has considered how Regulation 961, an automatic renewal clause and a sanctions clause interact.

The contract of insurance was a composite policy of marine insurance covering hull and machinery risks on the NITC fleet of Iranian oil tankers, and the co-assured included a Cypriot operating company, Arash Shipping Enterprises Co. Ltd, which was owned or controlled by Iranian nationals. The policy incepted in May 2010, before the imposition of EU sanctions.   

The policy contained an Iran Sanctions clause, which gave insurers a discretionary right of cancellation “… in circumstances where the Assured has exposed or may, in the opinion of the Insurer, expose the Insurer to the risk of being or becoming subject to any sanction prohibition, regulation or adverse action in any form whatsoever against or in respect of Iran promulgated by ...  the European Union ...”. The clause was slightly (but not materially) amended for the Lloyd’s and IUA markets.

The policy also contained a Review Clause, which stated that the insurers would extend the policy period by 12 months, on an unaltered basis, provided the loss ratio at a specific date did not exceed 50%.

In the light of Regulation 961, in December 2010 certain insurers gave prospective notice of cancellation on expiry under the sanctions clause. Discussions ensued. In January 2011, Insurers subsequently withdrew the notice of cancellation (without prejudice to their rights).

In February 2011, the insured’s solicitors obtained advice from HM Treasury’s Asset Freezing Unit to the effect that it did not consider automatic renewal to be permitted under Article 26(4). This ran contrary to the advice the insured had obtained from its QC, and in March 2011 the insured’s solicitors wrote to the European Commission seeking its views. Certain insurers then re-tendered notice of cancellation in April 2011.

The insured sought to challenge the validity of the re-tendered notice of cancellation on various grounds, including that the notice was premature on the basis of the Review Clause and unreasonable because there was no risk of sanctions being imposed, since Article 26(4) of Regulation 961 did not prohibit the automatic extension of the policy.

On 20 April 2011, the High Court decided that on balance the Regulation should be interpreted as prohibiting the automatic extension of the policy and that the notice of cancellation was valid and effective. On 6 May, the Court of Appeal heard and dismissed the insured’s expedited appeal, delivering a reasoned judgment on 25 May 2011.

The Court of Appeal confirmed that the insurers' notice of cancellation of the policy on expiry of the policy year was valid under the clause and exercised in good faith; it was reasonable in light of the risk of sanctions being imposed by Article 26 of Regulation 961. The wording of the clause did not require an act or omission by the insured to trigger insurers’ rights, rather the trigger was that the insured had become an entity with whom any further dealing by the insurers might expose those insurers to the risk of being in breach of the relevant sanctions.

The Court’s decision on this narrow issue meant that it did not need to decide whether Article 26(4) of Regulation 961 prohibited the automatic extension of the policy. However the Court of Appeal offered the view that the decision of the High Court was “plainly correct”.

There are a variety of sanctions/termination clauses in insurance and reinsurance contracts: some operate by giving a right to terminate. Some clauses are expressed to suspend rather than terminate the insurance, which may lead to increased uncertainty as the Court of Appeal recognised in Arash. Whether insurers have a right to terminate on the grounds of any sanctions legislation will depend on the proper interpretation of the relevant clauses in each individual case.

In policies where each insurer’s subscription is made a separate contract of insurance, it is likely each insurer will have to give separate notice. The effectiveness of any notice may depend upon whether or not the insurers had reasonable grounds for tendering it, and this may depend in turn upon that insurers’ assessment of its exposure to the risk of sanctions. Where market placements involve insurers both inside and outside the EU, the assessment may be different.

Permission to appeal from the Court of Appeal decision was refused. It seems likely that any definitive interpretation of the scope of Article 26(4) of Regulation 961 will have to wait for another day. This question would ultimately be one for the European Court of Justice, but the Court of Appeal cautiously volunteered that the proper meaning and effect of Article 26(4) was indeed to preclude any extension or renewal after 27 October 2010, whether expressed to be automatic or otherwise. The reasoning behind this appears to be that it is implicitly up to the insured to elect whether or not to invoke such “automatic” provisions. The Court was firmly against the review clause in this case being an automatic renewal.

Insofar as any decision by insurers not to renew, extend, accept or bind a contract on the basis of a risk of sanctions is based on a contractual option in the policy, the provisional interpretation of Article 26(4) by the Court may make it harder for an insured or reinsured to argue that the decision was unreasonable.

The comment that Article 26(4) would exclude any extension or renewal is perhaps at odds with the earlier HM Treasury, IUA and LMA guidance. Consequently a more cautious approach to automatic contract renewals or extensions of Iranian business, or indeed obligatory treaty reinsurance of Iranian risks, where the risk incepts after 27 October 2010 may be needed. Guidance can be sought from HM Treasury on any specific instance, but that guidance is not necessarily conclusive (and indeed may be subject to change).  

Insurers who write Iranian risks elsewhere in the EU will also need to consider the same issues. In this context, it may or may not be helpful to record the reported observations of the European Commission. Its response (received on 5 May) to the insured’s enquiry in March was (as the Court of Appeal put it) “in terms that were not entirely helpful”, stating that it appeared the renewal was prohibited by Regulation 961 unless this it could be construed as a mere continuation of the original contract.