Ukraine Conflict- Energy Sector Webinar

MS: Good morning from London. Thank you very much for joining us for this Ashurst webinar on the Ukraine conflict and the energy sector.

The past two weeks following Russia's invasion of Ukraine have been shocking, full of events that we thought belonged in the history books. The economic consequences pale into insignificance against the scale of human tragedy, but the economic consequences for our sector will nevertheless be profound, that will be long-lasting The economic isolation of Russia as a consequence of its actions has no historical parallel.

This morning we are going to look at some of the implications that we anticipate, focussed on issues of contractual performance and the direct impact of sanctions. I am joined this morning by my partners, Tom Cummins who will address issues of sanctions, Myf Wood and Emma Johnson who will focus on issues of contractual performance.

So without further ado, Tom, over to you

TC: Thank you very much indeed, Matthew. So I am going to start with sanctions and I am not proposing to go into exhausted detail in terms of what we see across the different sanctions regimes that have been imposed on Russia. There is a lot of detail and it would be hard to it justice in the time available. Instead what I propose to do is give a bit of context, setting the scene in terms of sanctions on Russia, provide an overview of the current landscape of sanctions that have been imposed, and end with some practical tips on how energy industry participants can approach sanctions issues when they are dealing with some of the themes that we are going to explore.

So looking at the slide that we have up, this is really the scene selection slide talking about sanctions to date, and to give a bit of context, many people will be familiar with this, but we have had international sanctions on Russia in one form or another since 2014. What do I mean by international sanctions? Well, we are not talking about UN sanctions here, Russia is a permanent member of the Security Council, so there is no scope for imposing sanctions on Russia through that body. What I am really talking about are US, EU and UK sanctions on Russia, the major trade powers in the world that have been very active in terms of responding to the situation in Ukraine. And as I will go on to mention, sanctions issued by other countries like Australia and Canada and Switzerland are also relevant.

And when I talk about sanctions since 2014, what have we seen prior to the recent conflict? Well initially we had sanctions imposed because of the annexation of Crimea back in 2014 and we have seen further rounds of sanctions in response to election interference issues and cyber-attacks.

But bringing the story up to the present day, since February of this year we have seen a staged expansion of sanctions regimes against Russia and has been a response to heightened tensions in the Ukraine region and then a round of sanctions that were imposed as a result of recognition by Russia of Donetsk's and Luhansk's independence days a few weeks ago.

And I should say also that when we are talking about Russia, there are also a round of sanctions that have been imposed on Belarus as a country that is working alongside Russia in relation to Russia's ambitions in Ukraine. I am not going to focus so much on that today, but you should be aware that that exists.

Now there has been a high degree of coordination by the US, EU and the UK when it comes to the sanctions that we are talking about, but there do remain significant differences in regimes, so you just have to be conscious of that when looking at sanctions issues.

So what are the main themes of the sanctions that have imposed over the course of the past month or so on Russia? This is not intended to be an energy specific list, I am really just focussing on some of the macro themes and measures that have been imposed. And I have put five boxes on the slide and I am just going to explore briefly what has been imposed in relation to each of those.

The first category is asset freezes. This is the most restrictive and draconian item in the sanctions armoury. The Americans refer to asset freezes as blocking sanctions, and they block SDNs, specially designated nationals. In the UK and EU we talk more about asset freezes, but these measures have the same effect. Essentially they say to people in the jurisdiction of the sanctions, "You have to comply with the sanctions. You have to freeze all assets belonging to a target of asset freezes, and you can't provide any benefits, any economic benefits to the targets of asset freezes". And in relation to the Russian sanctions, we have seen asset freezes imposed on high net worth individuals, political leaders, some companies, and I think probably most significantly for the commercial world, a lot of asset freezes imposed on Russian state-owned banks like VTB, Otkritie, VEB and Bank Rossiya.

Now something to be aware of in relation to asset freezes, which is a key point, is that the effect of these freezes extends from the targeted entities down to entities that are owned or owned or controlled by asset freeze targets. So the US imposes something called a 50 percent rule whereby if a target of blocking sanctions owns 50 percent of an entity, then that entity is treated as if it was the same as the targeted person. Similarly in the UK and EU, we extend our asset freezes down to entities that are owned as the 50 percent or more or controlled by targets of asset freezes. So a big part of the due diligence exercise in this area is around understanding which companies, which entities are owned by targets of asset freezes.

Looking at some of the other elements of the sanctions regimes that have been imposed, restrictions on equity and debt financing, these are what we refer to as sectoral sanctions. These also have been imposed on Russia since 2014 and have broadly been intended to prevent certain Russian companies accessing new debt capital, new equity capital, new loans from Western financiers. And the target of those sanctions has been Russian state-owned entities in the banking sector, the energy sector, the defence sector. So we have had this concept since 2014, but what has happened over the past week or so or couple of weeks, is that the scope of those sectoral sanctions has been significantly extended.

We have also seen enhanced export controls, particularly in relation to cutting-edge technologies like those found in aviation, space and telecommunications. I should mention the payment services and correspondent banking restrictions that have been brought in, these have been targeted at banks such as Sberbank and have restricted the ability of Sberbank to access Western payment processing services. And you will also all have heard of the steps that the European Union has taken to require SWIFT, the payment messaging service, to remove certain state-owned banks from its services – banks like VEB, VTB, Otkritie and Rossiya.

And finally we have seen sanctions directly targeting Russia's Central Bank, its National Wealth Fund and its Ministry of Finance. And the purpose there has been to restrict Russia's access to its international reserves, to make it harder to live through this crisis, live through the sanctions that are being imposed by using its very substantial international reserves.

Now I said the EU, the UK and the US is the focus of a lot of their sanctioning activity. We have also seen sanctions from countries like Australia and Canada, Japan -significantly Singapore which historically only imposes UN sanctions, it doesn't tend to go above and beyond what the UN does – and Switzerland, a lot of focus in the European part of the world on Swiss sanctions that have been brought in in conjunctions with and to replicate what the EU has done.

I am now going to say a few words about sanctions on the energy industry, specifically now. When I first pulled this slide together, there was not a huge amount to say because sanctions on the energy industry were fairly limited. But then on Tuesday this week we saw a number of political statements and indeed sanctioning measures by the UK, the US and the EU. So the UK said, "We are going to phase out Russian oil and oil products by the end of the year". The US has actually legislated, with an executive order, to ban imports of Russian energy products into the US and to restrict US energy sector investment in Russia, and there is a licence in place that permits energy products to be delivered pursuant to contracts that have been entered into before that executive order through to April, but the measure is still pretty significant.

And then finally of course we saw the EU, earlier in the week, saying, "We have this aspiration to make the European Union independent from Russian fossil fuels well before the end of the decade". But even leaving aside those specific initiatives, there are a number of other areas that can come into play for energy companies when they are looking at sanctions issues or interactions with Russia. Some of these have been around for a while; some of these are new.

And I just have flagged up some of the issues we have been looking at and have come across on the slide. So the sectoral sanctions, the debt equity related restrictions that I talked about earlier, they target certain Russian oil companies – Rosneft, Transneft and Gazprom Neft, and we have also seen the US, in the course of the last few weeks, extend those debt and equity related restrictions to a very significant gas company, PJSC Gazprom itself, by executive order.

Similarly we have the UK extending its restrictions on providing debt and equity to Russian persons, to persons connected with Russia, so a very broad category of targets potentially albeit those restrictions only apply to persons domiciled in Russia, not to entities domiciled outside the country. We have got export restrictions in relation to technology and services to deepwater, Arctic and shale projects – those have been around for a while – but then you have also seen in response to recent events, the EU and the US seeking to prevent export of goods needed by the Russians to modernise and improve their oil refining facilities.

I should mention the ban on Russian ships entering ports in the UK – that was brought in, I think, last week – and we have also seen dockers at certain British ports taking matters into their own hands and saying, "We are not going to unload Russian source products, irrespective of the sanctions provision".And finally, restrictions on Russian banks that affect payment flows may be very relevant to the acquisition of oil and gas products from Russia, as may restrictions on access to SWIFT, and I am thinking in this context when it comes to payment processing services of restrictions on banks like Sberbank. Sberbank is the beneficiary of a general licence in the UK which relates to energy products that is in place until June 2022, but we would still expect energy companies to face some challenges when it comes to pay for energy related products to the extent those banks are affected. And I have not put it on the slide, but people will of course also notice the US sanction of Nord Stream 2 AG a little while ago, preventing the development of that project.

On this slide I have just set out a roadmap for approaching sanctions issues and this is really something that hopefully assists people in understanding how to approach some of the legal issues that we have been dealing with, and there is no one approach, but I find this quite a useful workflow when it comes to looking at sanctions related questions.

So the first question, I think, when you are looking at sanctions issues sensibly is which sanction do I actually have to comply with as a matter of law? The general approach under sanctions is that if you are a national of a country that is issuing the sanctions or you are in the territory of the country that is issuing the sanctions, then you are obliged to comply. There may be other bases upon which jurisdiction exists but that approach is pretty fundamental. So as a UK national, and somebody in the UK, there are two reasons why I am obliged to comply with UK sanctions.

The second question, I think logically, is are my proposed activities actually contrary to what those sanctions say? So what is the actual restriction? Is what I am doing inconsistent with it? To the extent it is, is there a licence in place? Either a general licence that is available to everybody or a specific licence that I can seek from an authority that would permit me to do what I want to do.

Thirdly, I think, a question to ask is, is your counterparty or your JV partner targeted by an asset freeze or is it an entity that is owned or controlled by somebody that is targeted by an asset freeze? So there is a due diligence exercise there.

Fourthly, do sectoral sanctions affect my activities that are debt and equity restrictions that we have been looking at. Does that come into play with the way that I am structuring my transactions or providing financing to a Russia related counterparty?

Five, I think, is really important point, and actually one that generates a lot of questions in our direction. What about my contractual obligations? What if I am an energy company that has signed up to a facilities agreement or a reserve-based lending facility with an international bank and that contains extensive representations or warranties or undertakings in relation to sanctions compliance. Does that mean that although I am outside the scope of US sanctions, jurisdictionally for instance, I have agreed contractually but I will act as if I am a US person and only do things a US person will do. And I think that can give rise to quite complicated questions of interpretation, effective, considering yourself to be subject to sanctions regimes that you are not obliged to comply with as a matter if you are under a contract.

Point six is also one that has generated a lot of attention recently. This concept of market sanctions or derisking, commercial parties going beyond what is actually required by sanctions regimes because of apprehension about the risk of future sanctions or the risk of current sanctions being tripped inadvertently - and of course also the reputational moral concerns associated with doing business with Russia – and I think that particular issue crutches into the whole ESG agenda that we were focussed on in a big way before our focus turned to Russia and big companies not merely being concerned with making money but also thinking about the broader social impact of what they are doing and the reputational impact of what they are doing.

US secondary or extra-territorial sanctions – I just wanted to explain this point. So this is a category of sanctions that operates a bit differently to the other things we have talking about. These are not sanctions where the US says, "You are a US person, you have to comply with these sanctions. If you do not, we will put you in prison or fine you". These are sanctions where the US says, "We want non-US persons to comply with our sanctions, and if you don't do that, we recognise that we can't actually enforce against you, because you are not within jurisdiction, but we may put you on a sanctions list yourself. We may make you subject to blocking sanctions. We may restrict your entry of your executives into the US. We may, for instance, stop you opening a bank account in New York". That is really significant. A lot of focus on that in the context of Iran, also part of the Russia sanctions landscape. So something to think about.

The final point, don't forget export controls. It is a different legal landscape to that applicable to financial sanctions – different authorities, different concepts in many ways, but also really important to be aware of. There are areas where export controls and financial sanctions coincide. I am thinking, for instance, of restrictions on providing insurance or re-insurance in relation to exports, but they are quite distinct things albeit they have to be considered in terms of managing risk when you are dealing with a country like Russia.

Now, I have come to the end of my section. I do have a slide on enforcement, but I am not going to get into the detail of that. I will leave it to you to read in your own time, and with that I will hand back to Matthew.

MS: Thanks Tom. We have had a few questions coming in whilst Tom was speaking, and if I could just encourage anyone who has any questions to key them into the chat box and we will take them at the end, if that is okay?

So what I wanted to talk about are the consequences for supply and sale agreements of price volatility. And skipping onto the next slide, this is what we are talking about. We are talking about volatility, not necessarily always prices increasing. And this is an example of what has happened with the Urals-Brent differential where the Russian crude benchmark Urals has gone through the floor, a very real consequence of this. Last week we were asked to look at the implications for a price structure, price formula for a processing agreement where Urals features as an element in that price formula. The effect of what you can see on the slide is that the project is now in tremendous difficulties. So that is an example of volatility, not simply prices increasing and the very real consequences that that can have very, very swiftly.

Next slide please. Here is one that everybody will be familiar with. This is the, I think, three month forward for a Dutch title transfer facility, LNG Futures, and this from our assessment is probably the area where we are most likely to see disputes arising. It is the gas price, natural gas. Probably here we would anticipate LNG being the area where we are most likely to see legal disputes emerging as a consequence of the sort of volatility and the sort of price increases that they were seeing here. We anticipate repercussions in terms of what the UK and the US have done in terms of embargo on Russian oil, that it does happen, and it's this graph that we would anticipate is most likely to react and most likely to lead to legal consequences and labour disputes.
Next slide. And this is one everybody will be familiar with. Again, we are talking about volatility. I think at least according to the Today Programme at 7.00 a.m. this morning, Brent had fallen slightly. So again, the emphasis from us is on volatility, not simply prices increasing.

So looking at the gas sector, is the area that we anticipate being most likely to produce disputes as a result of what we see. Some of the ingredients there that appear likely to produce that result – firstly, something like 40 per cent of gas used in the European Union is Russian gas that is exported from Russia, and I think a fair amount of it was starting to stop, but Russian gas, around about 40 percent of what EU uses. But that hides quite a spread of different levels of reliance; in the UK, something below 5 per cent; in the Baltic States, something like 100 per cent. So the repercussions of problems with Russian supply are felt very differently across the European Union, an already constrained global energy supply. Anybody familiar with energy spot prices will know that they are already at record high levels as a consequence of the COVID recovery and general tightness of the supply market. So these events are happening in a time when we already have constrained global energy supply.

A compounding factor is the fact that in terms of seeking alternatives to natural gas piped from Russia, certainly Europe has limited alternatives, very limited regassification facilities, some challenges in terms of onward transmission. One of the repercussions of the 2008/2009 Russian and Ukraine gas wars, which we will look at shortly. One of those repercussions were EU energy packages in which one of the aims was to ensure a great deal more flexibility in terms of gas transmission networks within Europe. So the position is improved in the sense that there is two-way flow available on more pipeline networks than there were a decade ago, but still difficulties in onward transmission. Pipeline structures are intended essentially to move gas from East to West not West to East, as far as Europe is concerned.

An illustration of the limited regas position, Germany at the moment has no regassification facilities, no ability to turn cargos of LNG into gas that could be piped through its networks. It is, I think, accelerating the construction of a regas facility which was to be done at Tesla's, mirroring the two-year timeframe for the construction of Tesla's factory in Germany. We will see what happens there.

We already have stratospheric gas and energy price rises, as I said, as a function of COVID recovery in general types of supply Also an implication that has received relatively little coverage, interestingly, certainly in the UK press and the international financial press, is the change over recent years to a focus on spot and short term pricing in Europe. Compare that to the relative stability enjoyed in Asia Pacific where long term contract pricing in terms of 15, 20, 25 years, continue to prevail, particularly with Japanese and Korean customers. So the move to spot pricing, the move to the EU's benchmark pricing, encouraged by the EU as a way of facilitating competition. Well now we see some of the implications of that in terms of short term volatility.

Tom mentioned the repercussions of sanctions on Russian owned and flagged persons, but has a significant impact in certain specialist markets, and one of them is the LNG carrier market, and we are also seeing the impact of dockers simply refusing to unload cargos where they believe that those cargos are Russian gas as far as the UK is concerned, anyway.

What all of this means from our perspective, is that we are likely to see a much greater focus on use of volume flexibility mechanisms, price reopener clauses and perhaps the creation of, to some extent an incentive, an economic incentive not to perform and an economic incentive to find a basis for not performing as longer term contracts which are significantly out of the way compared to where the current spot price is. So an incentive perhaps to, or to not use cynical language, to seek flexibility in the performance of contractual obligations.

So what does pricing volatility mean in terms of legal consequences? Well what we anticipate is a particular focus on the application of liability caps and volume flexibility mechanisms. A real question mark around how far contractual liability caps will work. Limited availability of price reopen clauses, particularly in short and medium term gas supply agreements. How are parties going to react if there is no price reopen clause, perhaps look for alternatives. We have seen in the past attempts to bring competition law in and civil war hardship doctrines in to introduce flexibility with regard to pricing in gas sales agreements.

And in particular we are likely to see challenges around the use of force majeure mechanisms and force majeure clauses, last seen in the aftermath of the global financial crisis, and we recon "here we go again". Attempts to expand traditional force majeure coverage into difficulties in performance because of price, because of cost, historically that has not been available in force majeure clauses. Emma and Myf will take a look at this later on.

A quick reminder in terms of how price reopen mechanisms operate. Essentially they exist in medium and long term gas sales agreements, also in cold sales agreements and other entity sales agreements. They provide the opportunity to review price on a 3 or a 5-year cycle. Occasionally one finds one-off Jokers available which could be deployed at once in a contractual lifespan of 15, 20, 25 years. What these clauses allow is for the resetting of a price by reference to changes in the market in circumstances where it is no longer possible to market gas economically. So obviously likely to be highly relevant if prices stay high and long term contracts on a 3 or a 5-year review cycle are significantly out of the market. In terms of how these mechanisms operate, well we start with a trigger event, normally movements in price that regas cannot be marketed economically. That requires a notice to be served as a period of negotiation for this and we end with an arbitrational concern, worthwhile noting what is happening here ultimately is that an arbitration tribunal is resolving this fundamental and economic issue, not a legal issue. We will come onto the significance of that in terms of how the arbitration process operates in a second.

Some lessons that we take from a decade or so of very significant numbers of price reopener arbitrations taking place in Europe. As a result of significant legal consequences of the global financial crisis and EU energy packages leaving to go into competition in the European natural gas market. Firstly, notice provisions are important. Do not play with them. They may well have a pre-contractual effect, and if there are pre-conditions, you need to pay close attention. Obligations to negotiate – again, these can operate as preconditions, take it seriously. Look carefully at the language of the trigger event and structure the responses, structure the notices to accommodate the trigger event. It is important that the language tracks what the trigger event is in the contract. Close attention needs to be paid to confidentiality issues of privilege, particularly given the importance of economic expert witnesses in this area, how they are instructed, the materials they are given, the instructions that they are asked to operate under, expect close attention to be paid to those. It is important that there is maximum confidentiality and privilege protection. Also very important that the right accomplices are identified early on. Very few experienced and able players in this market. Important to get the best people early on.

Also important is select the right tribunal. You have the ability to select your arbitrator. What the arbitrators are doing is significantly not a legal question, it is an economic one and we all know how universally humorous the legal profession is, so it is important to find arbitrators who are comfortable with economic analysis, comfortable with figures.

And lastly, not forgetting that although there is now pretty much an established modus operandi in terms of how these arbitrations run, the arbitration tribunal is not brilliant in determining a legal dispute, it is settling an economic one, and in certain parts of the world the end award may still to a degree be challenged.

So that is a quick canter through price review processes, as I said, of application beyond the gas sector to some extent. And lastly, just a what if? What happens and what might the legal consequences be if one of the responses that we see from the Russian government to oil embargos from the West is to limit or stop the supply of gas to Europe. Well, it is worthwhile noting that historically Russia was a very reliable supply of gas to Europe from the 1980s onwards, really until the 2008/2009 gas wars. Gazprom Russia was a reliable supplier. What happened in 2008/9 perhaps gives an indication of what might happen in the coming weeks or months. It was not a cessation of supply, it was a reduction in pressure, a reduction in pressure in the main pipelines crossing Ukraine. The effect of that was non-supply to small users, particularly the end of pipeline and smaller users, particularly Eastern European, former Soviet ROC States suffered a lack of supply. So that's in the play book, we know that.

Nowadays with 40 per cent of European gas usage coming from Russia, we could anticipate an epic scale of supply substitution being acquired and the sort of legislation leading to back that up would probably involve the invasion of emergency powers legislation. It is two years ago that we looked at some of this legislation for the first in the context of COVID regulations. Maybe we ought to be looking at it again just to remind ourselves as to what powers government have in circumstances where there is an eminent emergency. We would anticipate energies that use gas as feedstock, fertiliser, cement – those are likely to be the first industries that have to close and other high usage industries, steel, perhaps closing. Obvious impacts are upon the energy transition, already talk of continued use of coal fired plants in Germany and some discussion about how to start has been put one side, and continued usage of nuclear power plants.

So perhaps at the minimum, keeping online as a standby mode, fill power plants across Europe and the UK. Undoubtedly, further pressure to move or transition to renewables and perhaps government subsidies to support that. History shows that subsidy regimes, when they become too generous, tend to be withdrawn. That is what underpins the dozens of investment treaty arbitration claims against Spain in relation to its solar subsidies, it was withdrawn and left a lot of investors in the lurch. So keep an eye on that.

And lastly, impact on friendly suppliers. We have talked a lot about the impact on usage of gas in Europe, but anticipate a significant amount of pressure from European governments on friendly suppliers against Australia, the Gulf, Nigeria, the USA, but then how much regas capacity does Europe have in terms of making up for natural gas being turned off in terms of Russian supply. So there is a little bit of looking into the future and perhaps there is some steps we might usefully take here in terms of reminding ourselves what the legal mechanisms are that would play out.

So that's it from me, Myf over to you in terms of contractual clause issues.

MW: Thanks very much, Matthew. Now given what has just been discussed, the impact of the conflict in Ukraine, it seems inevitable that parties will be looking at ways in which they can suspend performance of their obligations under existing contracts, vary their performance or even terminate their obligations. So in this part of the webinar, Emma and I will discuss how this can be affected both under common law and under civil law.

So the starting point for many at common law is force majeure. Now the first thing to note here is that force majeure at common law, which is English law, is not a standalone doctrine. It is very much a creature of contract. So in short, this means that the availability of force majeure will depend upon (a) whether there is a force majeure clause in your contract and (b), what that clause provides for. So when we look at the conflict in Ukraine we might think about what event is impacting your contract. Now if it is the conflict directly it might be that you look at your force majeure clause and there is a shopping list of various events that qualifies as force majeure events. If that list contains something like armed conflict or war, declared or undeclared, then the matter is quite straightforward. However, it might be that that event is not listed or it is not the armed conflict itself which is the event impacting performance of your contract. And we saw this a lot in the context of the pandemic, where it was not the pandemic itself which affected performance of the contract, but it was an ancillary event such as a change in law or regulation of government. Now in terms of the events in Ukraine, as we have heard from Tom, it might be that sanctions is what is actually affecting contract. So in that case, again, look at whether sanctions is included as a force majeure event. If it is not, consider whether that event can be shoehorned into any other wording. So it might be that you have wording about government action or you might have a more general term which is something such as circumstances not within reasonable control of the parties.

Now the next piece to look at, which is very important, is how has the performance of the contract been impacted? Now more often than not a force majeure provision will stipulate that it is not enough that the contract has become merely inconvenient to perform or more expensive to perform. It is often the case that something else is required. Now again, this depends on the wording of the contract. This might range from impossibility of performance, whether in whole or in part, or it might be just mere hindrance of performance or it might be a delay of the performance. The other important thing to remember is that more often than not there needs to be a direct cause or link between that event and the impact of performance.

Now if we move on, I want to talk about the practicalities of invoking force majeure, and a lot of what I will talk about here is things that we saw during the Coronavirus and the lockdowns, and one of the biggest pitfalls we saw, and Matthew eluded to this, were preconditions not being met. And preconditions, if they are not met, can invalidate the implication of force majeure. So preconditions were often included within notice requirements, so we had issues about how much detail to include in the notice. What form that notice must take? Does there need to be an estimation of the duration of the force majeure event? And importantly, what time periods apply and how are they calculated? Is it after you are aware of the event? Is it after the event has started? All of these considerations might constitute a precondition to the right to invoke force majeure. So it is very important to consider these.

The other important consideration to take into account is what is the consequence of invoking force majeure? Now typically, a force majeure clause will suspend the performance with affected parties obligations whilst the effects of that event are ongoing. And the aim then is, where possible, the contract can be resurrected when the event is over and the parties can perform their obligations as originally intended.

What we have seen, however, is that there can be time limits placed on the duration of such a suspension. And after those time limits have expired, it might be that the contract provides for the affected party, or even the unaffected party, the right to source goods or services from elsewhere and in some cases what we have seen is that after a specific period of time, a party can actually terminate contract. Now that is obviously quite a drastic end measure to the use of a force majeure clause, but it is something that you do need to consider before invoking force majeure.

Another point, and Matthew eluded to this as well, which is you may be on the receiving end of a force majeure notice and it might be that that force majeure notice, on the face of it, does not appear to be a valid force majeure event or it may not appear that it has, you know, affected the contract the way that you would expect. What we might see here is a strategic decision to invoke force majeure as a way of stalling obligations, and it might be that this is a strategic decision to take on, you know, the risk of a dispute about the force majeure clause, but that that option might be seen as more advantageous than the alternative which might be liquidation or winding up. So just be aware that force majeure notices are not only used in situations where it is a clear force majeure event, they may be used strategically as well.

Now I have also got on the slide the role of mitigation, and that is just to be aware that there might also be an obligation to mitigate against the force majeure event. So if we move onto change in law, this is also a contractual remedy, it is similar to force majeure in that it depends upon what the contract says as to whether it can be invoked. An important point to note here is also the consequences of a change in law provision. As distinct from force majeure clauses, what we have seen, particularly in supply agreements, is that it might make provision for recovery of increased costs rather than just mere suspension of the contract or even termination of the contract. So really read through the consequences carefully and decide, you know, which is more advantageous in the situation.

The question we are being asked at the moment is obviously whether sanctions that are imposed on Russian entities can constitute a change in law? And the answer to that question is, it depends. It depends what is written into the contract. We have seen contracts recently where sanctions are clearly listed as a change in law event. Now that may not always be the case. And the other point to keep in mind is, again, as with force majeure, look at the impact that sanction has on the contract itself and whether that falls within a change of law provision.

Now the next point here on the slide is frustration. This is a doctrine of common law, it's not a contractual remedy and it is a notoriously high threshold to meet with so much frustration. And the test adopted is whether due to an event performance of the contract has been rendered radically different to the obligation undertaken. Now frustration in English law is covered by the Law Reform (Frustrated Contracts) Act which came into being in 1943. So you can see there just from the date of that Act that war has been used in circumstances as a frustrated event.

The key thing to keep in mind here, two points. The first is if we are talking about the conflict in Ukraine; if the consequences of armed conflict or of war have already been provided for in the contract, such as under a force majeure provision, frustration would not be available. The second point to note here is what it would mean if there is frustration. The parties would be discharged from their obligations and the courts have traditionally applied a rule of "loss lies where it falls".
The next slide here we talk about material adverse change. I just mention that in the context of M&A activity. Often SPAs may provide that a buyer will have the right to terminate prior to completion if the target is materially and adversely affected. I've also put up here variation. It is important to keep in mind variation as a possible solution to any disruption in performance of contract. It can be particularly useful in supply agreements if you can come to an amicable agreement about how the contract may be varied to take into account any adverse effects of what is going on in Ukraine.

Now the final slide we have here is termination. Now termination, again, if we are looking at whether or not to terminate the contract, look at the termination provisions within the contract. Be very careful about how a termination right may occur. It might be a breach of a specific clause or it might be something else. The point here really is to also consider the notice requirements and just be aware that if you do terminate and that termination is not valid, that may end up to a repudiatory breach and you may therefore be liable for damages. So that is the position under common law.

What happens where your contractual relationship is governed by civil law. Generally speaking you are still likely to be able to claim force majeure either because there is a clause risk into your contract or because force majeure applies as a standalone legal doctrine. Many civil laws will have force majeure provisions in their civil code. There will likely be a body of authority and precedent which clarifies the circumstances in which force majeure applies or what might constitute a force majeure event. And generally application of civil law doctrines of force majeure will still result in suspension of the contract. But the difference really, in our experience, is that the threshold claiming force majeure under civil law is often much higher. You have to be able to point to impossibility of performance rather than just an impediment or a delay. And so the fact that a contract becomes more expensive to perform, even if excessively so, is unlikely to trigger force majeure claims under civil law. It is worth noting here that even if your contract is governed by a common law, if you have performance taking place in a civil law jurisdiction, it may well be that there could be an argument made that civil law principles of force majeure or any other civil law remedies should apply on the basis of an application of mandatory application of laws of the pace of performance. We have seen that argued in arbitrations before, and it can and does come as a shock to parties who are not familiar with civil law concepts and the fact that laws comply in that mandatory way. So it is something to be aware of.

Take the next slide. The other potential relevant remedy here from a civil law perspective is that of hardship. It is known in some jurisdictions as excess onerousness. In Scandinavian law countries it's a doctrine without subject, and effectively applies where there is a fundamental change of circumstances, an extraordinary event which is unforeseen and that makes contractual performance excessively bad and more onerous. What this allows for, hardship, is a resetting of the economic equilibrium. So in effect the contractual terms including the pricing provisions might be renegotiated. Now this is another area that can come as a surprise to parties not familiar with the concept and that's because what happens, where the parties are not able to reach agreement on how the contract is to be redrawn, is that a court or tribunal can do it. And we've seen courts and tribunals do that and effectively they rewrite the original bargaining between the parties.

The main point to note if you are thinking about a hardship claim is to act swiftly because you cannot claim hardship years and years after the event. So civil law, at least in these two respects, can provide additional remedies to what is in the contracts and that is something that is worth being aware of.

The next slide is something that Matthew alluded to earlier which is liquidated damages and liability caps. You may think if you are a seller and you decide that you are going to withhold some supply that you are on relatively safe ground if you have got a liability cap in your contract, and that may well be the case, but you need to proceed with caution and consider very, very carefully exactly what the contract states as regards to liability cap. When does it apply? Are any specific types of losses excluded? And, as Matthew alluded to earlier, will the liability cap hold in circumstances where your breach of contract or your decision to withhold supply is a deliberate choice, specifically because you want to take advantage of higher spot market prices. From an English law perspective, the liability cap should hold but you would need very clear wording to make clear that it applies in these circumstances.

From a civil law perspective the position may be very, very different particularly if there is an obligation either in the contract or in law to perform in good faith, so it may well be that the liability cap falls away and higher damages are incurred at that point. So then again another issue which is fraught with difficulty and requires lots of consideration before action is taken.

Next slide please. One final point in terms of protection available here, and that is treaty protection. For historical reasons Russia is party to an unusually large number of investment treaties. It has signed 83 treaties, 64 of those remain in force. It is also party to the Energy Charter Treaty which gets signed but not ratified. The relevant BITs is that these treaties all provide for a series of protection to investments made by foreign investors within Russia. If the Russian state takes countermeasures, such as expropriated investments of foreign investors in its country, and there have been suggestions in the press just this last week that factories that now are shutdown, standing still may in turn be rationalised. That would appear to us to be a very clear breach of expropriation protections in these treaties. So it may well be that investment treaty claims follow. And so this is another area really just to be aware of when you are considering your contractual rights and remedies. That is about all from us, I think, for now. But we will turn to some questions.

MS: So we have had a series of questions coming in whilst we have been speaking. I will start with one of the first which is about the application of sanctions. And the question is whether sanctions will apply to a company established by a Russian citizen outside of Russia? For example, say a UK company, but the founder of that company is Russian. Tom, I think that is probably one for you.

TC: Yeah I will pick that one up and actually we have had a similar question or a number of similar questions, I will formulate it slightly differently. But conceptually I think there are two aspects of this. The first is, if you have a UK company then that UK company is obliged to abide with UK law in the same way as everybody in this room that are sitting within the UK. You are within the jurisdiction of the sanctions. It is irrelevant who owns you, whether it is a Russian company or a Russian individual or owner from any other jurisdiction. You are in jurisdiction, you have to comply. So that is one aspect.

I think the other aspect when looking at this is if you have a UK company that is owned by a Russian entity or individual who is the target of sanctions, what then are the implications for the UK company? And to some extent it depends on which sanctions we are talking about. As I explained earlier, if we are looking at asset freezes, then if you have a Russian owner who is subject to a UK asset freeze then the ownership and control test means the effect of that asset freeze flows down to the company. The company is treated as being subject to an asset freeze in the same way as the Russian owner. We have seen this week, looking at issues for banks in the financial institution space, concern around UK subsidiaries of banks like VTB or VTB Capital Plc covered by the asset freeze on its parent because it is owned and controlled by VTB.

MS: Okay, thank you. Another question is what can we do where sanctions are excluded from the definition of a force majeure event? Emma and Myf, that's probably one for you. Emma, do you want to start off?

EJ: Yeah, I mean, I think the first question is are sanctions really the thing that are preventing performance? If not, and actually the reason that you cannot perform your contract or you are delayed or in some way have been inhibited, is not sanctions but it is the consequences that flow from sanctions, then it may well not matter that sanctions is not within the definition of force majeure. If it is sanctions that are causing you a problem and you cannot go down the force majeure route then you are left looking at things like frustration. If the contract is governed by English law, and if it is not and you are dealing with civil law, then you are looking at things like hardship and this would seem to us to be sort of classic hardship territory, again noting that you need to be able to show the possibility and not skipping short of that in order to get home on it.

MS: Myf, any thoughts on that?

MW: No I think that is all, thanks Matt, and I think it goes back to that point about looking really at what the clause provides for. Is there wording that you can shoehorn in the consequences for sanctions injury. So look at what the ramifications are. Is there something, an event outside of the control of the parties, that you can fit in the consequences to.

MS: So one of the lessons I would take from this is the drafting of force majeure clauses. The laundry list of 12, 13, 14 specific events invokes Sod's law that what happens will be the 15th or 16th. And a generic approach is perhaps safer if you are the performing party, perhaps not if you are the party receiving performance. But that is the lawyer's joy of being wise after the event.

An interesting question about what we might see in terms of the role here of Azerbaijan. So the question is how do we see the role of Azerbaijan in contributing to Europe's energy security. I think timing is right for materialising the Trans-Caspian Gas Pipeline project. Gas supplies from Turkmenistan via the Caspian to Azerbaijan and then onto Europe. Having myself spent a certain amount of time in Baku over the years, absolutely. The reason why gas travels the way it does from the former USSR is to do with the geography and the politics of the USSR. It does not make sense, that is why Nord Stream came into existence in order to take Ukraine transit out of the equation. So, yes, absolutely. As geopolitics change, and it is hard to think of a more significant geopolitical event than what we are seeing at the moment, arguably since the Second World War, then the sense and the appropriateness of certain geography for pipelines changes.

And as I mentioned earlier, I think it has always been the case that a proportion of gas, the gas pump sales, has originated in Turkmenistan. So it would make, I am sure, a great deal of sense for other routes to be considered. It is worth harking back perhaps history and the role of Georgia in the Trans-Caucasus Pipeline along the independence of Georgia, and the determination of the Georgian government, then Georgia would matter, and therefore it is across Georgia that that pipeline travels, not through Russia. And, again, historians might look at that and perhaps then think that Georgia's assessment in the nineties was a correct one.

A further question which is, I think, probably a very pressing one, which is, would we be in trouble paying tax in roubles to a bank suffering an asset freeze where the branch in the EU is tied? So this looks to be a situation where somebody has to pay taxes to government because there is a branch or an office in Russia, but the bank involved, Bank Rossiya, is subject to a freeze. So that sounds like the case of the devil and the deep blue sea. Tom, I shall pass that one to you.

TC: Yeah, and to be honest I think it is one of those questions where we need to get more information, there are quite a lot of elements to that question. I think the point to bear in mind is that there is a reference I think to having a branch in EU. You need to look at what sanctions apply as a matter of law. So if you are a UK company, what is the UK sanctions regime. If you are a EU company, what is the EU sanctions regime. To the extent there are differences, what approach do you follow? I do not really want to get into the detail of that question but I am certainly happy to follow-up with the speaker if they would like some legal advice on that front.

MS: Okay. And there is another question which I think the answer, from a sanctions perspective, will be to say that it is important, because it raises the question of the role of Russian beneficiaries but also Russian banks in the context of trade finance. And that is something certainly that we have seen over the past couple of weeks. The question is what about trade finance facilities, letters of credit and bank guarantees which are given to Russian beneficiaries, have outstanding exposure. Is it possible for banks to not honour them under the force majeure clause? So Tom, we start with you on that.

TC:  Yeah, and certainly back in 2014 when these sanctions were first imposed on Russia we spent quite a lot of time looking at letters of credit and bank guarantees. I think there are a few points to make there and it echoes a point I have made on a few occasions.

Firstly, what are the specific sanctions we are talking about? Are the Russian beneficiaries targeted by asset freezes or owned or controlled by persons who are targeted by asset freezes or are we in the realm of those sectoral sanctions I spoke about, so restrictions on providing credit and loans to Russian beneficiaries? And generally the restrictions that are coming in the sectoral space only apply to credit that is extended after a certain date. So if you have got historic arrangements, and what you are doing now does not involve new credit being extended to a Russian beneficiary, then generally speaking you are okay. So that is quite an important thing to think about.

On the question about force majeure, I mean to some extent I think that flows from the sanctions analysis. If you are an institution, and you are unable to honour a credit facility or a letter of credit or a bank guarantee because sanctions have been imposed of which you must comply as a matter of law, then I suspect there is a good chance that you will yourself near a force majeure provision. As the question of remains now, quite a lot of controversy in the past about putting force majeure provisions and sanctions clauses into some of these instruments that are used for international trade, because it is seen as so important that those instruments just respond when demands are made so that trades take place as speedily and as frictionlessly as possible, so there is always going to be a question as to whether you have a provision of that nature in your instrument. But with all those caveats, yes, I think there is a good possibly of that if you are unable to perform your obligations as a matter of law.

MS: And just before we close, I would like to pick up on of course the transaction that has the trade finance mechanism in it, will very often just be the first in a chain of transactions, and so the territory that Myf and Emma have in terms of impossibility, performance or challenges in performance, the FM issues or the hardship issues, or even potentially the frustration issues, they may occur at any point down the line if the starting transaction, if the first domino has not fallen or has fallen, because of a trade finance problem, the repercussions can be anywhere down the line. I think that is important in a sense that issues of trade finance can kick off a whole chain of events.

So with that note, thank you very much for spending the last hour with us, against what is very obviously a fast-moving, challenging and upsetting picture. We are going to be speaking to our clients an our friends on a regular basis on this topic. If there are issues that you would like us to cover, please do not hesitate to let any of us know. We have got our contact details on screen. We are very keen to know what it is you would like help and guidance with.

There are a couple of quick links here to arbitration hub and our Russian sanctions tracker, where hopefully you will find more useful material – lots of articles and guides going up there at the moment

So thank you very, very much for joining us and please do keep in touch with us. Thank you.