Energy and Resources Disputes: Russia’s invasion of Ukraine – sanctions, contractual implications and the scope for disputes

Tom Cummins:
Hello, and welcome to the latest episode of our Ashurst podcast series on energy and resource disputes. My name is Tom Cummins, and I have with me the following colleagues from our London dispute resolution team: Emma Johnson, Thomas Karalis, and Neil Donovan. Now, as listeners will know, in this series we've been providing key updates and insights in relation to disputes in the energy and resources sector. Our focus in this podcast is on the conflict in Ukraine and the implications for disputes in the energy sector. You are listening to Ashurst Legal Outlook.

Tom Cummins:
Now, just at the start, I think it would be remiss of me not to say that the events of the past week have obviously been a tragedy for those affected. I think as business lawyers, we are wired to be dispassionate and to apply our legal lens to things, but I think we are all very conscious that underlying what we are going to discuss on this podcast is a profoundly difficult situation on the ground, with very real human suffering. And it's right that we don't lose sight of that, and we, of course, fervently hope that that suffering comes to an end as soon as possible.

Tom Cummins:
Turning to what we're going to cover today, there are really three elements. The first is the legal effect of sanctions, which we are seeing being imposed by a number of governments and organisations like the EU on Russia. Secondly, we want to look at the contractual consequences that flow from the situation in Ukraine and in relation to Russia, what sort of disputes may arise from that situation? And finally, what particular challenges arise when it comes to the resolution of disputes that arise from these issues?

Tom Cummins:
Okay. Well, let's move on to our first topic, which is sanctions. Neil, I wanted to start with you on this. I know you've been working very closely with our colleagues who are advising on US, EU, and UK sanctions, and you of course are an expert in the application of sanctions regimes, such as those we've seen implemented in the past week or so. From a pretty high level perspective, what do you think are the key points which energy sector clients need to know about sanctions?

Neil Donovan:
Thanks, Tom. The first point is, who has to comply with sanctions? Let's start with the strictest regimes currently in place, which are the UK, EU, and US sanctions regimes. When it comes to UK sanctions, they apply to all UK nationals, wherever they are located in the world, to entities incorporated in the UK, irrespective of where their activities take place, and to anyone else located within or operating from the UK or UK territories. EU sanctions are in broad terms binding on EU nationals or persons located or doing business in the EU.

Neil Donovan:
And when it comes to US sanctions, it's important to note that there are two types, which differ quite significantly in terms of their scope and application. US primary sanctions generally apply to US persons, including US citizens wherever they're located in the world, non-US persons located or operating within the US, and wherever there is a US nexus, such as US dollar payments clearing through US correspondent banks. US secondary sanctions have very broad extraterritorial effect, and they apply to any non-US person or entity worldwide and their subsidiaries, even if there is no US nexus. There are of course a number of other countries who have implemented sanctions packages in relation to the crisis in the Ukraine, including Canada, Japan, and Australia. However, generally speaking, the UK, EU, and US measures present the most significant risks for businesses operating in this part of the world.

Neil Donovan:
Moving on to who is targeted and what is prohibited, the first point to note is that Western states have had in place complicated and far-reaching sanctions targeting Russia for some time now, notably in response to the annexation of Crimea in 2014. This included sectoral sanctions, which prohibit certain transactions involving new debt or equity issued by targeted Russian entities, and also restrictions on the provision of services or goods or technology to the Russian energy sector. That specifically targeted support of the exploration or production of new deep water Arctic offshore or shale projects that have the potential to produce oil and involve entities in Russia's energy sector. Those restrictions very much remain in force, and must be complied with.

Neil Donovan:
In terms of the recently announced sanctions, they target a large number of individuals, including senior Kremlin officials, members of the Russian elite, senior military personnel, and major Russian contributors to the Russian economy, particularly in the energy, industrial, and infrastructure sectors. Russian banks have also been targeted, and other state-owned entities, in particular, the Russian Central Bank, companies involved with the Russian military, Russian airlines. And we've also seen broader sectoral sanctions targeting the Donetsk and Luhansk regions and the Nord Stream 2 gas pipeline between Russia and Germany.

Neil Donovan:
The sanctions prohibit a very wide range of activity, and whilst there's been coordination between Western governments, it's important to consider the specific rules applicable to the jurisdiction in which you are operating. But to give an idea of some of the key prohibitions that are in place, asset freezes, which in practise prohibit any dealing with funds or economic resources owned or controlled by sanctioned persons or entities. There are export bans that have been introduced for a wide array of goods and technologies. These are aimed at a number of sectors, including energy, oil, gas, minerals, but cover a wide range of goods that may impact other sectors too.

Neil Donovan:
There are increased restrictions in place preventing Russian companies and financial institutions from accessing the financial markets to raise debt and equity capital, increased restrictions on dealings with Russian sovereign debt, prohibitions in relation to the Nord Stream 2 project, and as we saw last weekend, the decision was also taken to cut off Russian banks from the SWIFT clearing system.

Tom Cummins:
Thanks, Neil. Obviously a very complicated and extensive sanctions picture. This may be an unfair question, and it's obviously one on which it's quite difficult to comment meaningfully, but do you think we could see a further escalation of sanctions on Russia? What remains in the armoury of sanctioning powers?

Neil Donovan:
Yes, I think we very much are likely to see an escalation of sanctions. In many ways, the most extreme restrictions would be import restrictions into the West for Russian goods, in particular oil and gas. This is a key revenue stream for the Russian economy, and restrictions would in effect cut off their access to the Western markets. There's obviously a balancing act here, given the knock-on effects this would have on Western economies, particularly in light of existing pressures on energy prices.

Neil Donovan:
We're also likely to see Western governments take other steps to target Russian individuals and companies. In the UK, for example, on Monday this week the government announced that it will bring forward its Economic Crime (Transparency and Enforcement) Bill before the Easter recess, in response to the crisis. This bill is significant, because it includes a range of new powers intended to tackle perceived flows of illicit money into the UK and will also introduce tools which will make it easier to impose financial penalties against individuals or entities who breach the sanctions that have been introduced.

Tom Cummins:
Understood, thank you. And a related question, I suppose. If a counterparty of yours is targeted by sanctions, and I'm really talking here about asset freezes I suppose, is that the end of business with them or is it possible to get some form of licence or authorization which would permit you to continue to trade with them in some fashion?

Neil Donovan:
Yes, that is possible, Tom. There are a few very limited exceptions to the prohibitions, for example, where the activity is necessary for humanitarian purposes, but it is important to carefully analyse these in order to determine whether they apply. There have been some general licences issued already, which permit winding down of business with sanctioned entities, for example, the Russian banks. But if a general licence does not exist, you have to apply for a specific licence, and this may be quite difficult to obtain in the circumstances.

Tom Cummins:
Yeah. No, well, that is understandable. Thank you very much, Neil. I think the only other point I was going to add here is this one. You touched on the importance of looking at jurisdiction as the first stage of a sanctions analysis. In other words, with which sanctions does the party have to comply as a matter of law? And I completely agree with that. The other piece of the picture is, have I agreed to comply with sanctions that otherwise I might not have to comply with in contracts that I've entered into? That's certainly something I've spent quite a lot of time looking at over the course of the past few days.

Tom Cummins:
International contracts, of course, often have sanctions provisions. They have representations, warranties, undertakings, maybe restrictions on what you can do with particular products, and they could have the effect of committing parties to comply with sanctions which otherwise they would not have an obligation to comply with. I think sometimes commercial parties forget about that when they're looking at the effect of sanctions and which jurisdictional rules apply. So I do think that's the vital point of the exercise. Look at your contractual exposure when it comes to dealing with potentially sanctioned persons.

Tom Cummins:
I think that point is probably a good segue to our next subtopic, which is the scope for contractual disputes to arise out of the present situation. I think this issue probably comes into play on a number of different levels. Firstly and obviously, you have the situation where sanctions directly affect the performance of obligations under a contract that a party's entered into. But then, of course, you have the broader question of what happens if the situation on the ground, for instance the realities of the conflict, the disruption of supply chains that come out of that, what happens if they impact the performance of obligations under a contract? That's clearly a separate issue to the one which arises directly from the imposition of sanctions.

Tom Cummins:
Emma, I wanted to turn to you on this one. I think this question of contractual disputes is particularly acute for the energy industry, because, of course, Russia is the world's third largest crude oil producer. It's the world's second largest gas producer. It's a massive player in the international energy industry. Are you able to take us through some of the issues that arise here?

Emma Johnson:
Sure. You've rightly touched on the point, Tom, that the most obvious impact here in terms of contractual performance is parties finding themselves unable to perform their obligations to sanctioned parties, or on the other side, sanctioned parties themselves being unable to honour their contractual commitments. But the conflict itself, distinct from sanctions, will also have a negative impact on contractual performance. In the last week, we've seen instances of petroleum plants and gas pipelines being blown up, of Ukrainians fleeing the country in search of safety, of nationals taking up roles alongside the army and the police force, of international airspace being closed, curfews imposed, and Russian planes being excluded from European airspace.

Emma Johnson:
All of this will really have an impact on day-to-day business. It'll be very difficult to get anything or anyone into or out of Ukraine, and goods and people moving to and from Russia will not be able to do so with the same ease. Businesses might be forced to operate with reduced workforces or will shut down altogether. Stockpiles might be damaged or even destroyed, and imports into countries around the world will no doubt fail to arrive as and when planned. Really, these supply chain disruptions will impact individuals and businesses around the world.

Emma Johnson:
And so what can those parties do? The answer, really, to that question depends on what is in the contract. If there are provisions which can be relied upon to reduce performance obligations, for example, long term gas supply agreements which have volume flexibility provisions, it might be that those are invoked in order to provide a period of reprieve. Force majeure clauses, which can typically be used to suspend contractual performance obligations, might also be invoked. And it's worth noting here that from an English law perspective at least, there's no entitlement to claim force majeure unless there's a force majeure clause in the contract. It's not a standalone doctrine under English law, and so the extent to which you can suspend contractual performance on the basis of force majeure really depends on whether there's a clause in the contract and exactly what it says.

Emma Johnson:
If you've got a clause and there's an express reference to sanctions or embargoes as constituting force majeure events, then that would probably put a party on the right footing to bring a claim. But clauses are often drafted much more generically than that, and even if sanctions, embargoes, armed conflict are things that are expressly mentioned in the clause as force majeure events, there'll usually still be a need to prove a link between those events and the party's inability to performs its side of the bargain.

Emma Johnson:
So invoking force majeure, as we've seen previously when various geopolitical events have happened, is fraught with difficulties. Notice might be required. Other preconditions can kick in. It might be that a sustained period of force majeure results in the contract terminating altogether. Parties will really need to think very carefully about whether they want to go down that route and whether the outcome, if it is termination of the contract, is something that's commercially desirable.

Emma Johnson:
The position will be different where the force majeure clause is contained in a civil law-governed contract, and that's because the standard applicable under civil law is often a much higher one, and an impossibility might have to be proven as opposed to impediment or hindrance. There'll likely be a body of law which applies to impose additional requirements on the party seeking to claim force majeure, and so what that means is really taking full account of not just what is in the contract but also what the applicable law says will be really, really important.

Tom Cummins:
Okay. Well thank you, Emma, and I'm sure I'm not alone in having flashbacks to those early months of the pandemic when we were looking in so much detail at force majeure clauses. Now tell me this, is force majeure the only option under a contract to consider? What other legal concepts do we need to be giving thought to?

Emma Johnson:
Well, Tom, if English law applies, the other obvious thing people might look to is the doctrine of frustration. This would result in discharge of the contract in its entirety, but only if events relied on could be proven to render performance impossible or radically different to what was originally envisaged. It won't be enough that performance simply becomes more expensive or more difficult. Neil mentioned licences earlier, and the point there really is that if a licence to do business with a sanctioned person or entity could be obtained, it's unlikely that frustration will apply.

Emma Johnson:
This is all fraught with difficulty and really a recipe for dispute. Parties will run the risk of claims that they have breached the contract if they fail to perform where they could and should have obtained a licence to do business with the sanctioned party, but instead they simply just seek to rely on a force majeure clause or doctrine of frustration.

Tom Cummins:
Understood. Thank you. And you've teased this concept of the difference between the common law position and the position that may prevail in the civil law world. What if a contract is governed by a civil law legal system? Are there other things we have bear in mind other than what we've been discussing from an English law perspective?

Emma Johnson:
Yeah, absolutely. If the contract's governed by a civil law, there may be additional remedies that can be relied on. Concepts like hardship, doctrines of failed assumptions might be said to apply. Again, performance must normally have become impossible, and so demonstrating that a licence could not be obtained or that an alternative means of performance was not available will be crucial if these types of remedies are to be relied on.

Emma Johnson:
I think the other point to note here is that even if your contract is not expressly governed by a civil law, there may well be an argument that the place of performance gives rise to an argument that the civil laws should apply on a mandatory basis. So even if your contract is governed by English law, if you're performing in a civil law country, then that law may well apply and provide additional remedies. And so really, parties need to think about all of the potentially applicable laws to their relationship and not just what the contract says.

Tom Cummins:
Yeah, absolutely. And that point about having an English law-governed contract and then the argument being made that hardship provisions in the civil law of a jurisdiction where the contract was being performed come into play, I know is one that you faced in an arbitration. I think it is one to think about in this context, because as we will go on to see, there has been Russian legislation, albeit in the field of dispute resolution provisions, which seeks to essentially override contractual choices that the parties have made in the past. Certainly something to bear in mind when you're looking at these issues.

Tom Cummins:
You've talked about disputes arising directly from sanctions. You've talked about disputes arising directly from disruption in the region. Are there any other types of disputes which energy sector clients should be thinking about?

Emma Johnson:
I think there are, Tom, and that really is the contractual disputes that will flow from the resulting turmoil in the energy markets. In the last week or so, we've seen Germany halt certification of Nord Stream 2. We've seen entities involved in the construction of that pipeline being sanctioned. We're seeing Western companies around the world announce their withdrawal from Russian investments and joint ventures. And as you mentioned at the start, a significant proportion of global, and in particular European, oil and gas comes from Russia.

Emma Johnson:
Now, President Putin is in control as to whether that supply continues. Back in 2009, we saw him turning off the taps. We worked on some of the cases that followed from those actions, where gas purchasers in Ukraine, Hungary, other countries were denied their contractual volumes of gas. The impact here is likely to be greater than a failure to meet supply obligations, and it will affect not just parties who are directly receiving gas from Russia or oil from Russia.

Emma Johnson:
Oil prices are currently at highs that haven't been seen since 2014. Gas prices were rocketing across Europe long before this invasion began. And so purchases under long term oil-linked gas and LNG sales contracts will obviously suffer as a result. It might be that they seek to exercise contractual price reopeners. They might seek to get out of contracts altogether as a means of obtaining better security of supply from elsewhere.

Emma Johnson:
We might see situations where sellers look for ways to reduce their exposure to oil-linked contract prices and instead make sales at higher spot market prices. In fact, for some sellers, it may well be commercially better for them not to supply under their contracts, to pay capped damages, and then to sell on those contractual volumes on the spot market instead. All of this, really, to my mind creates the perfect recipe for disputes.

Emma Johnson:
Price reopener negotiations and disputes have got the benefit of there being a body of practise that's developed over the past few years, particularly in Europe, where the Global Financial Crisis and the Third Energy Package in Europe created a perfect storm for parties seeking to rely on contractual price reopeners and ending up in arbitration proceedings. There are lessons that can be learned from that experience, and they can be deployed in the disputes that will arise here, but that's a topic that we are no doubt going to cover in a subsequent episode, so I'll stop there for now.

Tom Cummins:
Okay. Well look, thank you so much, Emma. That is super helpful, and that topic that you ended with is of course one of many topics that we could expand on and talk about in much more detail, but we're trying on this podcast, I think, just to provide listeners with an overview of some of the issues that are likely to be coming down the track.

Tom Cummins:
Okay. Well look, let's move on to our final topic now, which is the resolution of disputes that arise from the types of issues that Emma has been taking us through. Thomas, I want to turn to you on this one. Many of the contracts that come into play in this context in the international energy industry will provide for resolution of disputes for international arbitration. And one of the questions, I think, that inevitably comes up is, how does arbitration work in circumstances where you are seeing sanctions imposed on individuals and companies that stop other companies having any dealings with them?

Thomas Karalis:
Yes. Thank you, Tom. I think there are two broad issues which arise here. The first one is, can you go to arbitration? And the second one is, can you actually enforce your award? On the first point, if it is necessary to commence arbitration against a sanctioned person or perhaps involving a sanctioned person, there are some potential difficulties. If one looks at institutional arbitration, which is the majority of cases, will the institution accept to administer the case? Will you find arbitrators who will take the matter on?

Thomas Karalis:
The current sanctions include asset freezes, which in addition to blocking all property, they usually also prohibit the provision to sanctioned persons of funds, goods, or services. The arbitral institution, as well as the arbitrators themselves, will be receiving fees in return for the performance of various services, such as the rendering and certification of an award. So the question really is, is this permitted? Can you do it? What is possible will depend on the exact wording of the sanctions in question; however, in most cases there are carve-outs for the provision of, and payment for, legal services, subject to different licence requirements and restrictions, depending on whether we're looking at EU, US, or UK sanctions.

Thomas Karalis:
Most arbitral institutions, which would include the ICC, the LCIA, and the SCC, which we commonly see in arbitrations in the region, have systems in place to identify sanctioned entities and seek necessary approvals for processing of payments. However, practical issues may still arise and may be encountered when seeking to route payments through international banks.

Thomas Karalis:
As far as enforcement is concerned, in the vast majority of cases, when a party tries to enforce a foreign award, that is, enforcing the award in a country other than the seat of the arbitration, this takes place under the 1958 New York Convention. One of the very limited grounds on which recognition and enforcement may be refused is if it would be contrary to the public policy of the country in which enforcement is sought. So in the context of an arbitral award involving a sanctioned person, recognition or enforcement could be seen as contrary to public policy, both in a sanctioned country, if the award gives effect to sanction, but conversely, also in a country that has the imposed sanctions, if the award does not give effect to sanctions.

Thomas Karalis:
So if one looks at the situation in the country that has imposed sanctions, so from our perspective, the competing considerations here are, on the one hand, the national public policy that led to the imposition of sanctions in the first place, and on the other hand, one has to look at the international public policy in favour of enforcement of awards. It will be important to consider the particular circumstances of each case; however, the prevailing view in arbitration-friendly jurisdictions is that enforcement of an arbitral award should be permitted, possibly with appropriate caveats in place. So for example, that could take the form of paying any damages to a blocked account pending approval by the relevant authorities to release that sum, or perhaps pending the lifting of sanctions, whenever that point in time may arise.

Tom Cummins:
Thanks, Thomas. That all makes sense. I wanted to pick up on a point you and I were talking about the other day, which concerned a particular sensitivity when you have arbitration with Russian sanctioned persons. Can you just expand on that?

Thomas Karalis:
Yes. There is a particular sensitivity here. In June 2020, new provisions came into force in Russia, which effectively give exclusive jurisdiction to the Russian arbitrage courts. And to clarify, the Russian arbitrage courts are Russia's ordinarily commercial courts, not to be confused with international arbitration, given their name. These Russian arbitrage courts have been given exclusive jurisdiction to hear disputes involving sanctioned parties, even where there is a dispute resolution clause in the contract providing for arbitration or for the exclusive jurisdiction of foreign courts.

Thomas Karalis:
The sanctioned party may also apply to the Russian commercial courts for an anti-suit or anti-arbitration injunction. There have already been cases decided in Russia applying these new provisions. So far, the Russian courts appear to take a very generous view of the scope of these provisions. So for example, the relevant provisions state that if a foreign arbitration or jurisdiction clause is incapable of being performed by the sanctioned party due to sanctions that impede its access to justice, the Russian courts may grant an anti-suit or anti-arbitration injunction.

Thomas Karalis:
The Russian courts have taken the position that there is no need to even prove that the sanctioned party is actually prevented from access to justice in the contractually agreed forum. As long as the party's a sanctioned person, they can apply to the arbitrage courts for an anti-suit injunction. However, there has been a case where the Russian courts have refused an anti-arbitration injunction which was applied for after the final award has been issued. That is, of course, common sense, in terms of the finality of any injunction. However, what remains to be seen is how the much stronger sanctions now imposed on Russia may change the attitude of the Russian courts and make them even more willing to apply these provisions in a more generous way.

Tom Cummins:
Okay. Well, thank you very much, Thomas. I think this topic, as with all the topics we've touched on, presents a wealth of legal issues to consider. Now, hopefully this podcast has been a useful overview of the points that we've been thinking about and indeed advising clients on. This is, as everyone will know, a very fast-moving situation, and we'll look to follow up with further thoughts in the weeks ahead. It remains for me just to thank all of our speakers. In the meantime, if you have any questions or comments on what we've been talking about, then please get in touch with us directly.

Tom Cummins:
Thank you for listening. To hear more Ashurst podcasts, please visit ashurst.com/podcasts, and to ensure you don't miss future episodes, subscribe now on Apple Podcasts, Spotify, or your favourite podcast platform. And while you're there, please feel free to keep the conversation going and leave us a rating or review. Thank you for listening, and goodbye for now.

Emma Johnson:
If you enjoy Ashurst Legal Outlook, why not check out our other two podcast series as well? Ashurst Business Agenda tackles the big strategic issues that business leaders face, and ESG Matters at Ashurst reveals how business leaders are rising to mounting environmental, social, and governance challenges. You can listen and subscribe to Business Agenda and ESG Matters wherever you get your podcasts.