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Russia Reacts: Impact of Sanctions on International Arbitration Involving Russian Parties

Russia Reacts: Impact of Sanctions on International Arbitration Involving Russian Parties

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Sanctions imposed by the U.S.A, the EU, and other jurisdictions in relation to certain Russian individuals and legal entities have had a substantial impact on international arbitration involving Russian parties. There exist serious concerns as to the ability of sanctioned Russian parties and their contractual counterparts to realize their right to defend themselves in the course of arbitration proceedings. These concerns have led to changes in market practice regarding the choice of the arbitration forum and to some legislative proposals in Russia that, if implemented, would have a dramatic impact on international arbitration involving Russian parties.

Sanctions

Although the format of this article does not allow for a comprehensive review of applicable sanctions, let us set a very broad framework of the key sanctions regimes impacting Russian parties – namely, the U.S. and the EU sanctions.

There are several U.S. sanctions programs targeting Russian entities, including:

  • The Specially Designated Nationals and Blocked Persons (SDN) program, which blocks assets of SDNs within the remit of the U.S. and prohibits any U.S. citizens or resident and any legal entity or organizations registered in the U.S. (i.e., a “U.S. person”) from dealing with an SDN, unless authorized by the Office of Foreign Assets Control of the US Treasury Department (OFAC)
  • The Sectoral Sanctions Identifications program, which targets selected industries and applies to certain financing and equity transactions
  • The Crimea-related sanctions program, which prohibits, with a few exceptions, any dealing involving Crimean assets or counterparties (i.e., individuals residing in Crimea and legal entities either registered in the Crimea or carrying out activities there)
  • The U.S. Countering America’s Adversaries Through Sanctions Act of 2017, which targets, inter alia, non-U.S. third parties entering into “significant” transactions with Russian sanctioned entities.

Any U.S. person, whether individual or corporate, is bound by the U.S. sanctions regardless of their location. Importantly, a non-U.S. person may become subject to the secondary sanctions if such person is involved in, or facilitates, a “significant” transaction with a sanctioned Russian entity or its affiliate. There is no clear criteria to define a “significant” transaction and any such determination would be made by OFAC in its discretion.

The EU sanctions (or “restrictive measures”) can be divided into smart sanctions, which prohibit all transactions with specific entities (“targets” or “EU blocked persons”), and sectoral sanctions, which target sectors of the economy and industries. EU sanctions apply (i) to any national of a EU member state irrespective of his/her location, or to legal entities and organizations registered or carrying out activity in the EU; (ii) any person within the territory of the EU; and (iii) with respect to any business conducted, even in part, in the EU.

The EU sanctions prohibit:

  • Engaging in nearly all types of commerce with “EU blocked persons” (designated by Regulations 208 and 269) and
  • Engaging in the specifically prohibited transactions with “sanctioned entities” (designated by the so-called “sectoral” sanctions set out in Regulation 833)

EU sanctions also prohibit participation in activities the object or effect of which is to “circumvent” the applicable prohibitions set by the EU sanctions.

Impact on Arbitration

While many scholars would argue that the nature of arbitration is a quasi-judiciary function and hence beyond the scope of sanctions targeting commercial activities, there are practical problems that arise in arbitration involving sanctioned entities.

The practical problems may arise at various stages, including, for example, the appointment of arbitrators, instructing legal counsel, involving experts, participation of sanctioned persons as witnesses, payment of arbitration fees, expenses, and costs, and paying legal counsel.

Unless expressly authorized by OFAC, a U.S. person (whether a U.S. national or resident or a U.S. law firm) would be extremely uneasy accepting an appointment to act as an arbitrator, counsel, or expert in an arbitration involving an entity under blocking sanctions. Even a non-U.S. person needs to consider the risk of secondary sanctions if he or she gets involved in such an arbitration as it can be argued that an arbitral award may facilitate a “significant” transaction with a sanctioned entity that is prohibited by the U.S. sanctions.

A significant practical impediment is that banks are likely to block/freeze any payments where either the payee or the payer is a sanctioned entity. This would lead to the possibility that any payment in U.S. dollars or euros under an arbitral award could be blocked. That risk would also apply to the payment of arbitration fees and costs and paying legal counsel and other parties in the arbitration proceedings.

Individuals under blocking sanctions may be prevented from participating in an arbitration in person (e.g., as a witness) as their visa applications are likely to be denied. Even though it might be possible for them to participate via a video link, this raises the question of equality of the parties in the proceedings, which in itself may lead to a risk that the arbitral award could be invalidated.

Such risks have led Russian entities, especially those under state control, to start opting for arbitration venues in Asia – Singapore and Hong Kong in particular – as opposed to more traditional forums in Europe. However, many concerns remain, as sanctions apply to U.S. and EU persons irrespective of their location, so there would still be a risk of secondary U.S. sanctions, and the problem with bank transfers would remain as well.

The most recent development is the Russian Parliament’s July 24, 2019 adoption in the first reading of a draft law which, among other things, entitles a sanctioned Russian party to amend an arbitration agreement/clause unilaterally to switch to arbitration or litigation in Russia under Russian law. If proceedings outside Russia would nevertheless continue, the draft law allows a Russian party to seek damages from its opponent in a Russian court equal to the amount of claims brought in a non-Russian court or arbitration, and also claim a court penalty on its counterpart in the amount of the claim and associated costs.

This means that even if a non-Russian tribunal chooses to disregard the application of Russian law on the subject, the risk in relation to any Russian assets of a non-sanctioned party pursuing a claim against a sanctioned party outside Russia would be significant, and the likelihood of enforcement of a foreign arbitral award in Russia in these circumstances would be close to zero.

To become law, a draft law needs to pass three readings in the State Duma (the lower chamber of the Russian Parliament), be approved by the Council of the Federation (the upper chamber), and then be signed by the President.

Clearly, if the draft law is adopted in its current form, it will limit the ability of most parties, both Russian and non-Russian, to rely on international arbitration as a way to resolve commercial disputes. While at present this appears unlikely to happen, that may well change if new sanctions of significance are imposed on influential Russian entities, which may prompt possible protective and counter measures by the Russian government.

By Konstantin Kroll, Partner, Dentons

This Article was originally published in Issue 6.12 of the CEE Legal Matters Magazine. If you would like to receive a hard copy of the magazine, you can subscribe here.

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