Starting in late February 2022, the European Union, the United States, the United Kingdom, and others have imposed far-reaching sanctions against Russia and Belarus. The measures imposed include, among others, the freezing of assets of individuals and companies, the banning of transactions with various entities, restrictions or bans on the import of Russian gas, oil, and coal, and the stoppage of shares of Russian companies from being listed on stock exchanges, with additional measures almost certain to follow.

These measures are certain to have a major impact on international commercial relationships and will likely lead to an uptick in disputes, many of which will be referred to arbitration. However, there remains much uncertainty around dispute resolution in light of the constantly changing economic and geopolitical landscape. This article will not detail the sanctions that have been imposed, but rather provides general answers to questions that may arise for parties whose contractual counterparty is subject to sanctions, or whose contract relates to a sanctioned matter.

Readers should note that, in light of the constantly changing sanctions landscape, this article merely serves to provide a high-level, general overview.

1.   What happens if contractual performance is no longer possible or legal?

The economic measures imposed may lead to situations in which contractual performance becomes impossible. Certain contracting parties may look to the sanctions imposed to justify their non-performance. In many legal systems, the determination of whether non-performance can be justified on this basis will be subject to the legal doctrine of force majeure.

Force majeure, or “higher power” in French, means that unexpected external circumstances falling outside of the parties’ control prevent the performance of contractual obligations. Many commercial contracts contain force majeure clauses that excuse contractual non-performance in cases of certain defined events, often including terms such as “war”, “invasion”, “hostilities”, “strikes”, and “industrial disturbances”. Whether or not contractual non-performance can be justified due to the Russia sanctions, as well as what the consequences of such non-performance are, may thus depend on the scope of the force majeure clause contained in the contract. It is advisable to thoroughly analyze the specific wording of a force majeure clause.

While some legal systems (e.g. France) recognize the concept and consequences of force majeure in domestic legislation (e.g. France) or case law (e.g. Austria), others do not (e.g. England). In the latter case, absent a contractual force majeure clause, parties would not be able to rely on the doctrine to justify non-performance.

For parties in contracts for the international sale of goods, the United Nations Convention on Contracts for the International Sale of Goods (CISG), if applicable, sets out the consequences of non-performance due to force majeure. The seller may not be liable for damages if, pursuant to Article 79 (1) CISG, he can show that his failure to perform was “due to an impediment beyond his control and that he could not reasonably be expected to have taken the impediment into account at the time of the conclusion of the contract or to  have avoided or overcome it, or its consequences.”

Sanctions may also lead to situations where contractual performance has become illegal. In such cases, the contract may be argued to have become frustrated. The doctrine of frustration, depending on the legal system in question, generally comes into play when a circumstance occurs after the formation of the contract that renders fulfillment impossible or unreasonable. Such circumstances may include, for example, physical and legal impediments. In English law, the doctrine of frustration is a well-established, albeit narrow exception to the principle that the party who fails to perform is liable for damages. Austrian law knows a similar concept (Wegfall der Geschäftsgrundlage) in Section 901 of the Austrian Civil Code.

The doctrine of hardship may be incorporated in a contractual clause or may have a legislative basis in certain jurisdictions. Hardship clauses protect parties against the risk of hardship due to unforeseen changes arising from external circumstances.

Parties may have regulated material impacts to their rights and obligations due to unforeseen circumstances by including material adverse change (MAC) or material adverse event (MAE) clauses in their contract, which may provide for the right to change prices and conditions and/or rights to rescind a contract. Whether the required threshold triggering MAC/MAE clauses has been met may be a topic of intense dispute and can only be determined on a case-by-case basis.

2.   Can disputes with sanctioned parties be settled via arbitration?

Sanctions may have a significant impact on whether it is possible to settle a dispute via arbitration.

Sanctions prohibiting the provision of services or freezing assets may extend to the activities of arbitrators or preclude an arbitrator from accepting payments from a sanctioned party. Whether arbitrators are capable of acting also depends on their nationality and residence, as well as the seat of arbitration. When it comes to institutional arbitration, situations may arise in which payments to or from the arbitral institution are not legal.[i] This may be the case, for instance, when the institution refunds a portion of the advance on costs paid.

Arbitral institutions may ask the parties and arbitrators about the involvement of sanctioned parties in the arbitration and perform their own sanctions checks and due diligence on parties and their beneficial owners. Institutions may refuse to administer arbitrations if the arbitration agreement deviates fundamentally from, or is incompatible with, its rules[ii] or may be forced to obtain a license before administering an arbitration.[iii]

There may be carve-outs for the provision of legal services that allow arbitrators to receive payments from sanctioned parties. Exceptions are subject to a corresponding license being obtained.

Further caution is required when a contract with a sanctioned Russian party contains an arbitration agreement. As of mid-2020, the Russian Arbitrazh (i.e. commercial, not arbitration) Procedure Code contains provisions establishing exclusive jurisdiction of the Russian Arbitrazh courts over disputes involving a sanctioned party or where the dispute has arisen out of sanctions. In December 2021, the Russian Supreme Court adopted an expansive interpretation of the law. As a result, sanctioned parties preferring the jurisdiction of the Russian courts are now able to walk away from an otherwise valid arbitration agreement.[iv]

3.   What are the practical considerations if an arbitration does take place?

As alluded to above, the residence and nationality of arbitrators impact whether they may assume their mandate, as they may be bound by the sanctions imposed by their home state even when sitting in an arbitration somewhere else.

Law firms will need to consider whether they may represent a sanctioned client in an arbitration, or whether the nationalities of specific lawyers within a firm raise sanction concerns and thus preclude them from working on a case. To avoid a misstep, any client, especially Russian or those with possible connections to Russia, should be closely screened to rule out any connection with sanctioned entities and, in the event of a connection, to act only within the legal framework. Precise scrutiny of the client’s corporate structure is essential, however demanding. A list of persons and entities that are on the “blacklist” of the European Union can be found in Council Implementing Regulation (EU) 2022/261 of February 23, 2022,[v] which supplements Council Regulation (EU) No 269/2014 of March 17, 2014.[vi]

Travel bans may present practical barriers to required personal appearances but would be expected to do so less after the COVID-19 pandemic, where the use of videoconferencing and virtual arbitration hearings became widespread.[vii]

Lastly, third-party funding may be more difficult to obtain for a sanctioned entity.

4.   Can an arbitral award against a sanctioned party be enforced?

In most cases, the enforcement of foreign arbitral awards takes place under the New York Convention (“Convention on the Recognition and Enforcement of Foreign Arbitral Awards”). In practice, one of the most relevant reasons for refusing to enforce an arbitral award is if it is contrary to fundamental principles of the legal system in which the award is to be enforced (ordre public). If an arbitral award with the participation of a sanctioned party is to be enforced, this could violate the ordre public if, for example, the enforcement is to take place in a sanctioned country or a country imposing the sanctions. From today’s perspective, it is difficult to assess how the enforcement of arbitral awards in connection with the sanctions against Russia and Belarus will be handled. It will probably depend on the individual case. If enforcement is permissible, there may be certain reservations. It is conceivable, for example, that the amount in dispute will be deposited and only paid out after the sanctions have been lifted. It remains to be seen how this issue will develop over the coming weeks and months.

[i] See also Victoria Clark, “Sanctions and arbitration clauses” (Practical Law Arbitration Blog, 23 August 2019) <http://arbitrationblog.practicallaw.com/sanctions-and-arbitration-clauses/>.

[ii] See, for example, Art 1 (3) of the Vienna Rules 2021.

[iii] See also John Beechey, Jacomijn van Haersolte-van Hof, and Annette Magnusson, “The potential impact of the EU sanctions against Russia on international arbitration administered by EU-based institutions” (ICC, LCIA, and SCC, 17 June 2015) 4 <https://sccinstitute.com/media/80988/legal-insight-icc_lcia_scc-on-sanctions_17-june-2015.pdf>; Konstantin Kroll, “Impact of sanctions on international arbitration involving Russian parties: new developments” (Practical Law Arbitration Blog, 23 June 2020) <http://arbitrationblog.practicallaw.com/impact-of-sanctions-on-international-arbitration-involving-russian-parties-new-developments/>.

[iv] For a more detailed discussion of the Russian Arbitrazh (Commercial) Procedure Code’s new provisions and their interpretation, see Evgeniya Rubinina, “Russian Sanctions Law Bares Its Teeth: The Russian Supreme Court Allows Sanctioned Russian Parties To Walk Away From Arbitration Agreements” (Kluwer Arbitration Blog, 22 January 2022) <http://arbitrationblog.kluwerarbitration.com/2022/01/22/russian-sanctions-law-bares-its-teeth-the-russian-supreme-court-allows-sanctioned-russian-parties-to-walk-away-from-arbitration-agreements/>.

[v] https://eur-lex.europa.eu/legal-content/EN/TXT/?uri=uriserv%3AOJ.LI.2022.042.01.0015.01.ENG&toc=OJ%3AL%3A2022%3A042I%3ATOC.

[vi] https://eur-lex.europa.eu/legal-content/EN/TXT/?uri=CELEX%3A32014R0269.

[vii] For more virtual arbitration hearings, as well as the topic of due process, see, for instance, Sharon Schmidt, “Austria: The Austrian Supreme Court, Due Process and Covid-19: Conducting Virtual Arbitration Hearings Over Party Objections” (OBLIN Attorneys at Law, 22 January 2021) <https://oblin.at/newsletter/austria-the-austrian-supreme-court-due-process-and-covid-19-conducting-virtual-arbitration-hearings-over-party-objections/>.