Impact of international sanctions on arbitral proceedings

Introduction

The extensive sanctions imposed following the Russian invasion of Ukraine have led to many companies reassessing business relationships.

Companies have ceased performing their contractual obligations, and in many cases have taken steps to terminate contracts, often making decisions quickly in a high pressure situation. This environment has not always allowed companies the time fully to consider their contractual termination rights prior to exercise, or sanctions risk has been seen to outweigh disputes risk, and there is consequently the potential for a significant volume of commercial disputes to arise in the near future. In many cases the parties will have provided for such disputes to be determined by arbitration.

Sanctions legislation will impact on the parties' ability to conduct an arbitration (e.g. in the contractual jurisdiction) and to enforce any award.

This article considers some key issues in relation to the termination of commercial contracts and identifies some of the logistical and legal difficulties parties will have to face when seeking to arbitrate a dispute impacted by sanctions legislation.

The right to terminate – sanctions clauses, force majeure clauses and frustration

Parties seeking to extricate themselves from contractual relationships because of new sanctions should carefully examine their contracts to identify when the right to terminate or suspend performance arises. Apart from obvious sanctions related provisions, illegality or force majeure clauses may provide the right to terminate. The specifics of such clauses will be key and we would recommend parties take sanctions advice if there is any ambiguity as to the applicability of the clauses. Whether a force majeure clause can be relied on in the context of sanctions legislation is a matter of contractual interpretation and the particular wording used in the clause. Some clauses may expressly refer to the imposition of sanctions as a force majeure event; whereas others will specifically exclude this. Some force majeure clauses use broader class-based language, and the different types of force majeure events specified in the clause are likely to be of importance in determining whether the clause covers the introduction and/or impact of sanctions.

In the absence of express contractual provisions, the doctrine of frustration in English common law (or the equivalent concept in other legal systems) could apply to terminate the contract if the sanctions legislation makes the contract impossible to perform or makes performance radically different from what was contemplated.

Even in the absence of a clear contractual or legal termination rights, parties may still seek to terminate contracts to mitigate the risk of breaching sanctions legislation given the stringent penalties that may follow.

As a result, parties may find themselves in disputes over the interpretation of contractual provisions and facing claims for repudiatory breach of contract. They may turn to arbitration to resolve such disputes. The arbitration proceedings may in turn be affected by sanctions, as explored below.

Impact on Arbitration

When a state or international body introduces sanctions legislation, it must generally be complied with by all persons within the state/body’s territory and all nationals of the state/body, wherever those nationals may be. Some sanctions legislation has extraterritorial effect. An arbitration may therefore be impacted by the sanctions regimes applicable owing to:

• the nationality or residence of a party or arbitrator;
• the location in which any relevant business was to be conducted;
• the sanctions applicable to the seat of the arbitration; and
• any legislation that has extraterritorial affect.

The arbitration process

Appointment and payment of arbitrators

Sanctions which operate to prevent the provision of services to sanctioned entities may potentially prevent an arbitrator from acting or accepting payment in an arbitration.

This is likely to arise where one of the parties is a sanctioned entity and the arbitrator is a national or resident of a sanctioning state. For example, a non-UK arbitrator will need to comply with UK sanctions when the arbitration is seated in London. A UK national sitting as an arbitrator will need to comply with UK sanctions whether the arbitration is seated in London or abroad. Extraterritorial sanctions may also be relevant. Parties and institutions seeking to appoint an arbitrator should be mindful of existing restrictions and any such restrictions that are likely to arise in the foreseeable future.

Many sanctions regimes provide a carve-out to the asset-freeze restrictions for the purpose of providing legal services or payment of legal fees. Such carve-outs usually require an application to the relevant authority for the grant of a licence before any payment can be made. These applications to pay an arbitrator’s legal fees may delay the start of arbitral proceedings as the processing of licences is likely to take several weeks. Further, applications may not always be successful. Both the sanctioned entity making the payment and the arbitrator receiving the payment will need a licence. This gives rise to the possibility that multiple licence applications to different national authorities will be required and applications may be required on more than one occasion during the arbitration if the licence is only for the payment of a specific amount.

Even where a licence application has been successful,

a sanctioned entity may face practical barriers to paying an arbitrator.

For example, the recent sanctions aimed at Russian banks and the removal of certain banks from the SWIFT payment system may lead to significant difficulties in processing payments involving Russian entities.

Similar issues will arise in relation to a sanctioned entity seeking to pay its legal representatives and the fees of arbitral institutions.

Appointment of legal representatives

Many international agreements are governed by English or US law. Sanctions may impact on the parties’ ability to instruct legal representatives qualified in these jurisdictions. For example, US law firms are prevented from acting in arbitrations involving US-sanctioned entities under blocking sanctions unless prior authorisation has been sought from the Office of Foreign Assets Control (OFAC), and consent may not be given.

Aside from legal restrictions, international law firms may take their own decision that they will not accept instructions from certain entities or involving certain trade for reputational or other risk related issues.

Arbitral institutions

An arbitral institution based in a particular jurisdiction will need to comply with the legislation of that state/international body. Many leading institutions have previously indicated that they will administer arbitrations involving sanctioned entities. However, as set out above, they will usually need to obtain licences, take additional administrative steps and conduct their own due diligence on the parties. This all adds complexity and time to the arbitration process.

It remains to be seen if arbitral institutions will continue to adopt the same approach to arbitrations involving Russian sanctioned entities following the Ukrainian invasion.

The LCIA Rules are one of the few set of institutional rules that address sanctions.

Article 24A.10 of these Rules provides the LCIA with the right to refuse to act on any instruction and/or make any payment if it determines (at its sole discretion and without the need to state reasons) that doing so may involve a breach of sanctions or may otherwise expose the LCIA to enforcement action from any law enforcement agency.

If an institution is unable to administer an arbitration, it would be open to the parties to choose a different institution outside of the jurisdiction. However, that requires a degree of cooperation that is often absent after disputes have arisen and, in that situation, the issues outlined above in relation to the appointment and payment of arbitrators and transfers of funds may still arise (as well as general satellite disputes with respect to jurisdiction).

Witnesses

Individuals impacted by sanctions may not be able to travel to appear in arbitration hearings in person. While they may be able to appear by video link, if they are significant witnesses this may give rise to concerns about the integrity and procedural fairness of the proceedings. Counsel’s general availability to deal with the witness may also be impacted, depending on the sanctions imposed.

Enforcement issues

Even where the parties are able to complete the arbitration process, sanctions may impact on the enforcement of any award. 

Under the 1958 New York Convention on the Recognition and Enforcement of Foreign Arbitral Awards, a national court may refuse to enforce an arbitral award where to do so would be contrary to “public policy”. Sanctions legislation may be held to constitute public policy. For example, sanctions put in place by the UN and the EU could constitute international public policy and a national court may refuse to recognise and enforce an award on that basis.

Practical difficulties may also arise in enforcing an award against a party which is subject to an asset freeze or blocking sanctions (the most draconian form of sanctions implemented by the UK, EU and US). The possibility of applying to the authorities to release frozen funds to satisfy judgment debts has been previously discussed by the English courts in relation to certain Syrian sanctions. Any licence application may only be permitted where limited exceptions apply under the regulations, and would be subject to certain conditions and a consideration by the relevant authorities of the particular facts.

Impact of Russian exclusive jurisdiction law

Sanctions can also give rise to jurisdictional

issues in any given arbitration. A particularly pertinent example of this is the amendment to the Russian Arbitrazh Procedure Code which came into force in June 2020. The effect of the amendment is that Russian commercial courts can claim exclusive jurisdiction over disputes involving a sanctioned Russian entity (or a non-Russian party which becomes subject to Russia-related sanctions).

The amendment enables a Russian entity to commence proceedings before the Russian courts or, if arbitration proceedings have already started abroad, the Russian entity can apply to the Russian courts for an anti-suit injunction. This means that an arbitration agreement entered into by a Russian sanctioned party providing for arbitration with a seat in a sanctioning country is potentially unenforceable in Russia. Further, the enforcement in Russia of any foreign arbitral award is unlikely.

Key takeaway

Any party involved in a potential dispute arising from the multitude of new sanctions introduced with respect to the invasion of Ukraine should consider the above issues. Any arbitration team should be led by, or include, sanctions specialists.

Should you have any questions regarding sanctions related arbitration issues, we would be happy to assist.