This case involved a security for costs application where an escrow agent (a law firm) and an account bank (a third-party account bank) refused to release escrowed funds to an OFAC sanctioned entity. The judgment highlights the key risks for escrow agents and account banks, including when:

• sanctions impact their respective contractual obligations under an escrow agreement or a banking agreement (as applicable); and
• an escrow agent refuses to make payment to a sanctioned party (to avoid the escrow agent breaching sanctions).

This case arises in a shipping context – where law firms more often act as escrow agents – however the decision is of significance to parties in the aviation industry (particularly for any escrow agent which holds escrow funds with a third-party account bank) where escrow arrangements are common in facilitating closings.

 

Background

In July 2022, Virgo Marine (“Virgo”) and Kibaz Shipping LP (“Kibaz”) entered into a memorandum of agreement (the “MOA”) for the sale and purchase of an oil tanker. Reed Smith UK (“RS”) acted as legal counsel to Kibaz.

To facilitate the payment of the purchase price of the vessel by Virgo to Kibaz, Virgo and Kibaz entered into an English law escrow agreement with RS as escrow agent (the “Escrow Agreement”). The escrow account was RS’ client account, a US Dollar account held in the name of RS with Barclays, London (the “Escrow Account”). Virgo paid the purchase price into the Escrow Account. Shortly before the sale and purchase was scheduled to close, Virgo became subject to US Office of Foreign Assets Control (OFAC) sanctions for its alleged involvement in the transportation of Iranian petrochemicals. The claimants argued that Nixie Marine Inc. (“Nixie”) had replaced Virgo under the MOA, however RS disputed this and argued that its only contractual relationship was with Virgo. In October 2022, Kibaz (via RS) notified Virgo that the MOA was being terminated for repudiatory breach because of Virgo being subject to sanctions. This triggered an obligation for the escrow funds to be returned by RS to Virgo.

 

Dispute

RS initially believed it qualified as a “US person” under OFAC regulations and was therefore subject to US sanctions. RS contacted Barclays informing them that Virgo had been added to a US sanctions list and requested that Barclays “block all amounts received from Virgo”. Subsequently, however, RS informed Barclays that it no longer considered itself a “US person” and RS instructed Barclays to repay the balance of the purchase price to Virgo. Barclays refused to follow RS’ instruction on the basis (among other things) this might cause “US persons to violate US sanctions”.

Virgo and Nixie brought a claim for breach of contract, duty of care and fiduciary duty against RS, as escrow agent, for instructing Barclays to freeze the sums in the Escrow Account. Virgo and Nixie argued that RS was under an absolute duty to pay the balance of the purchase price.

RS denied liability, saying the escrow agreement provided that RS “shall not be liable to the Parties for any mistake of fact, error of judgement or act or omission of any kind unless caused by its gross negligence, fraud or reckless disregard of its obligations under the terms of this Escrow Agreement” and RS “shall not be in breach of its obligations or otherwise be liable to the Parties, or any other party, as a result of any act, omission, failure, fraud, delay, negligence, insolvency or default of any bank, financial institution, clearing or payments system, or regulatory, governmental or supra-national body or authority..”. RS therefore argued that (i) its only liability under the escrow agreement was to give the instruction to Barclays to make payment, which RS had done, and RS’ liability under the escrow agreement was excused or limited by the terms of the Escrow Agreement itself, and (ii) if RS had indeed acted in breach of any legal duty, Barclays’ refusal to follow RS’ instructions was an intervening cause in the chain of causation for losses incurred by Virgo and Nixie.  RS sued Barclays for its refusal to release the balance of the purchase price following RS’ request to do so.

 

Security for Costs Application

RS applied for security for costs against Virgo and Nixie to cover RS’ and Barclays’ costs to trial. Virgo and Nixie argued that an order for security for costs was not necessary as RS already had adequate security (some US$13 million in the Escrow Account). Mr Justice Foxton agreed with the claimants and refused RS’ application saying it would not be just to order additional security. Mr Justice Foxton was not satisfied that Barclays had demonstrated there was proper cause for Barclays to refuse making a payment from the funds in the Escrow Account to RS for the purposes of satisfying a potential costs order.

 

Key Takeaways

• Sanctions Risk: Escrow agents and account banks may face material legal and operational risks when a party to an escrow agreement becomes subject to sanctions. Escrow agents should ensure they are clear on which sanctions will apply to their business. The background to this decision provides a practical illustration of liability disclaimers in escrow agreements.
• Contractual Protections: Even where escrow agreements include liability carve-outs, escrow agents may still be exposed to litigation and must carefully assess their obligations to sellers, buyers, and account banks.
• Relationship with Account Bank: Escrow agents should choose their account banks carefully and ensure the terms of any escrow agreement align with the terms of the existing banking agreement the escrow agent holds with the account bank.
• Decisions of the Escrow Agent matter: An escrow agent’s legal interpretations (even if cautious) can have significant implications for a purchaser’s funds – so funds that parties would assume are held safely can quickly become out of reach.

We will provide a follow-up article addressing the substantive decision once this is available.