TRADITIONAL ARBITRATION INSTITUTIONS IN TIMES OF ANTI-RUSSIAN SANCTIONS
There has been discussion in recent months about a potential shift away from the common preference of Russian companies to refer disputes under their contracts to LCIA (or sometimes ICC) arbitration in London, with English law as the governing law.
The shift is considered to be a reaction against the imposition of sanctions by the United States and European Union in relation to events in Crimea and Eastern Ukraine. Singapore, Hong Kong and Dubai are talked about as places to which the choice of arbitration seat and institution might move.
Our understanding here in the UK as to why Russian companies chose English law and arbitration was that they had confidence in the system and service provided in the UK. This note discusses whether there are good legal or business reasons for shifting away from London. It concludes that there are limited reasons to move, but recognises that this needs to be proven in practice, in the era after the imposition of the sanctions.
WHAT ARE THE SANCTIONS?
Sanctions relating to events in Crimea and Eastern Ukraine have been issued by the US, EU, Norway, Canada, Australia, Japan and Switzerland. Russia has issued its own retaliatory embargo on the import into Russia of food from countries which have issued sanctions against Russia.
There seems to be a perception within Russia that the sanctions are wide-ranging and have the effect of blocking most or all business between Russian and EU/US businesses. This is absolutely not the case, as the following very brief overview of the sanctions shows (careful review of, and advice on, the meaning and effect of the latest version of each of the sanctions is essential[1]).
US SANCTIONS
There have been four major sectoral directives impacting Russia in 2014. Directive 1 issued on 16 July 2014 was a prohibition on “new debt” and equity directed at Russian state-owned banks including VEB and VTB.
Directive 2 issued on the same day was a prohibition on “new debt” and equity in the energy sector against Rosneft, Gazprom Neft, and Novatek.
Directive 3 on 12 September 2014 prohibits “new debt” in the defence sector against Rostec.
Directive 4 issued on the same day in September is a prohibition of provisions of goods, services and technology for exploration and production of deepwater, Arctic offshore or shale oil against Gazprom, Lukoil and Rosneft.
The US has also listed numerous individuals and entities said to have been involved in events in Crimea and Eastern Ukraine as “Specially Designated Nationals” and “Blocked Persons”. The effect of these sanctions is to block the property and travel of the listed persons and entities.
EU SANCTIONS
The EU sanctions prohibit:
- loans, sale or purchase of bonds, and equity to/from named Russian banks including Sberbank, VTB, Gazprombank, and VEB;
- export of “dual use” (i.e. items which can be for both a military and non-military use) and purely military items;
- the supply of goods and services for exploration and production of deep water, Arctic offshore or shale oil in Russia.
The EU sanctions also impose an asset and visa freeze on named individuals said to have been involved in events in Crimea and Eastern Ukraine.
These sanctions extend to places favoured by Russian business like Cyprus (because it is a member of the EU) and the BVI (because it is a UK Overseas Territory, and so subject to the same sanctions the UK is bound by).
WHAT THE US & EU SANCTIONS ARE NOT
The sanctions imposed on Russian companies and banks are not a “blanket” or an indiscriminate ban on all business between Russia and US or EU. They apply only to the listed companies, persons and entities and only in the manner briefly described above. Outside the banking, defence and oil productions sectors, their effect should be limited.
Nor are they a perpetual ban – for example, the EU sanctions apply for only one year, and their extension will require unanimity amongst EU member states.
Nor are they completely inflexible – for example licences have been granted:
- under EU sanctions, where solvency of Russian subsidiary banks in the EU is at risk, and
- under US sanctions, to permit the orderly winding down of existing oil operations affected by sanctions.
There is also some confusion as to whether it is official Russian policy that Russian companies should not arbitrate in London. Conflicting messages have emerged from state-owned companies. Nevertheless, one very significant Russian state-owned company (Rosneft) has demonstrated that it still has at least some faith in the English legal system, as it has taken action in the English court challenging the legality of the EU sanctions.
HOW ENGLISH LAW DEALS WITH SANCTIONS
EU sanctions are incorporated into English law. The EU sanctions expressly say:
“No claims in connection with any contract or transaction the performance of which has been affected, directly or indirectly, in whole or in part, by the measures imposed under this Decision, …, shall be satisfied, if they are made by: (a) [any sanction list entity] (b) any other Russian person, entity or body; or (c) any person, entity or body acting through or on behalf of [an entity] referred to in points (a) or (b)…”[2]
This will be the first line of defence for any EU company which is party to a contract with a Russian entity or person on the sanctions list, where the Russian party makes a claim for non-performance of the contract.
FRUSTRATION/ ТЩЕТНОСТЬ ДОГОВОРА.
Under English law, an illegal contract is void and unenforceable. If performance of an existing contract becomes illegal or impossible because of the introduction of sanctions, it may be suspended or even “frustrated”.
The law of frustration has developed over the years to provide a legal solution to the situation where there has been a fundamental changes in the circumstances surrounding a contract. The Russian translation of the concept of frustration is “тщетность договора”. Civil law systems have developed analogous solutions, including force majeure and rebus sic stantibus (as reflected in Art 451 Russian Civil Code).
The leading UK appeal court decision[3] says:
“Frustration occurs whenever the law recognises that without default of either party a contractual obligation has become incapable of being performed because the circumstances in which performance is called for would render it a thing radically different from that which was undertaken by the contract.” [my emphasis]
The English courts have said that the purpose of doctrine of frustration is “to give effect to the demands of justice” but it is not to be “lightly invoked.”[4]
Even though a contract could be “frustrated”, it does not mean the arbitration clause will vanish. Ordinary principles of separability mean that the arbitration clause will survive and so disputes about the effect of sanctions will be referred to in arbitration. This is what English law says, and the doctrine of separability of an arbitration clause is near to being universal.
SUPERVENING ILLEGALITY
A contract can be perfectly legal when entered into, but can become illegal to perform as a result of a later change in law. This is referred to as “supervening illegality”. When applied to sanctions, the legal logic is that, when performance of contract becomes illegal because of sanctions introduced post-contract, it would not be just to penalise the party prevented by the sanctions from performing its side of the contract.
“Supervening illegality” may provide legal justification for non-performance of a contract. It does not necessarily frustrate the contract entirely. It may only suspend performance – for example, for the period sanctions remain in force. It is not automatic and not easy to come within the doctrine; it certainly should not be used just as an excuse not to perform. An affected party must try to find a way to perform the contract legally.
EXAMPLES OF WHAT DOES OR DOES NOT CONSTITUTE SUPERVENING ILLEGALITY
- A sanctions law contains provisions allowing applications to be made for a licence to perform otherwise prohibited actions – if a party does not use its best endeavours to obtain a licence, it will not be able to use “supervening illegality” as a defence[5].
- A contract provides for payments in USD. All electronic USD transactions go via New York banks, which may block payment because of US sanctions. If a party does not try to find a way to pay in another currency, it will not be able to use “supervening illegality” as a defence.
- Suppliers of goods and services to a (non sanctions-listed) Russian company anticipated getting financing from US banks, but US banks now prove unwilling to provide finance. If a party does not use its best endeavours to obtain finance from elsewhere (e.g. China) it will not be able to use sanctions as a defence.
- Russian buyer of Italian fruit is barred by Russian sanctions from taking delivery; English law governs the contract. Russian party in principle can rely on “supervening illegality” as a defence to claim by Italian fruit supplier for refusal to take delivery of the fruit.
WHAT IF THE CONTRACT IS PARTLY PERFORMED
A law passed by the UK in 1943[6] (to deal with wartime cases) says that where a contract has been frustrated:
- sums due before the frustrating event cease to be payable
- sums already paid are recoverable.
- a party which has incurred expenses may retain or recover money to cover what it has spent
However, even making a claim under this legislation may be blocked by the provision in the EU sanctions referred to above, which bars claims in respect of the consequences of the imposition of sanctions.
FORCE MAJEURE
There is no self-standing concept of force majeure under English law. Force majeure has to be defined in a contract. Typically it includes events like, war, riots, and natural catastrophes, which are outside a party’s control and are unavoidable, preventing the performance of contractual obligations. Sanctions are not usually mentioned expressly in these clauses; sanctions may be considered to constitute force majeure within typical contract wording, but this is very much open to debate.
RELEVANCE OF SEAT
Just because the contractually agreed seat of arbitration is London does not automatically result in sanctions difficulties for Russian parties. A Russian party is either subject to sanctions or it is not – the fact that an arbitration is to be held within the United Kingdom does not of itself bring the Russian party within the sanctions regime. A speaker at a recent conference said that a Russian company was denied funds by its Russian bank to pay its London lawyers for an arbitration in London; there is nothing in any of the sanctions that would be a justified cause of the bank’s decision in this case.
IDEAS ON HOW TO AVOID SANCTIONS ON EXISTING CONTRACTS
Some commentators have suggested that Russian companies with contracts providing for arbitration in London could simply ignore the arbitration clause and take their cases to a Russian court (or a Russian arbitration institution). These commentators think Russian courts would accept such cases and disregard both the arbitration clause and any defence based on the effect of the sanctions.
The possibility of using the Russian courts may be alluring, but the other party is likely to counter-attack with an anti-suit injunction. The Russian party may win its case in the Russian court, but is very likely to face difficulty enforcing the judgment outside Russia.
The English courts have decades of experience of dealing with cases arising from sanctions against Iran, Libya and other countries. The courts have a good track record of achieving a fair outcome for both parties. There is little or no evidence of prejudice against the foreign party and therefore no need to take the measures suggested by some commentators.
FUTURE CONTRACTS
If a Russian party is subject to sanctions either by name or sector, no EU or US party will knowingly contract with that Russian party, if to do so would put it in breach of the sanctions laws. A debate about where to arbitrate disputes arising under such contracts then becomes rather academic.
If an EU or US party enters into a contract with a Russian party not knowing it was sanctioned, the contract is likely to be held to be illegal and so void. As already explained, any arbitration clause will probably remain in force, because of the doctrine of separability.
On the other hand if a Russian party is not subject to sanctions, there is nothing to stop an EU or a US party entering into a contract with the Russian party. If this is the case, there will be consequently no reason to stop using English law, LCIA Rules and a London arbitration seat.
FUTURE CONTRACTS – TURNING TOWARDS ASIA
Hong Kong and Singapore are excellent places for arbitration, but simply changing the seat of arbitration does not mean escape from the effect of sanctions. Say, for example, a contract has been entered into between a UK company and a Russian company, and the contract provides that it is to be governed by Singapore (or Hong Kong) law, and all disputes are to be arbitrated in Singapore (or Hong Kong) under the rules of the local arbitration institution. The Russian company was not sanctions-listed by the EU at the time the contract was entered into, but is subsequently added to a EU list, making it illegal for the UK company to perform the contract.
Because the legal systems of both Singapore and Hong Kong law closely follow English law on frustration, the UK party can still use similar defences to those it would use in England – that the contract has been frustrated by supervening illegality, and so the UK company can be excused from performing its obligations. It is quite likely that the UK company could also rely on Article 11 Council Regulation (EU) No 833/2014 referred to above as “the first line of defence”, even though the arbitration was being heard in Singapore or Hong Kong. Another option would be to rely on Article 11 to resist enforcement in the UK of any award made in Singapore or Hong Kong
It also has to be recognised that the circle of UK and US law firms and arbitrators which dominates the arbitration “market” in London also dominates the market in Hong and Singapore.
CONCLUSIONS ON EFFECT OF SANCTIONS
Antipathy towards nations responsible for sanctions against Russians is regrettable but understandable. That antipathy could indeed lead to a move of arbitration away from London. However, the sanctions are not, on a proper analysis, a good commercial or legal reason to move away from English law, and/or arbitration in London. All of us in the UK are confident that Russian parties will still receive a fair hearing and not be discriminated against, and that the features which made London a good place to arbitrate still apply.
[1] Go to http://www.treasury.gov/resource-center/sanctions/Pages/default.aspx for the latest information on the US sanctions
Go to http://eeas.europa.eu/cfsp/sanctions/index_en.htm for the latest information on the EU sanctions
[2] See, for example, Article 11 of Council Regulation (EU) No 833/2014 of 31 July 2014. The same wording appears in other Regulations.
[3] Davis Contractors v Fareham UDC [1956] AC 696
[4] The Nema [1982] AC 724
[5] Illustrated by Melli Bank v Holbug [2013] EWHC 1506
[6] Law Reform (Frustrated Contracts) Act 1943
