The Impact of Sanctions on Contracts with Russian Counterparties

The Effect of the Sanctions

The starting point is to appreciate that the sanctions do not either suspend or terminate a contract simply because there is a Russian counterparty, and nor do they grant a legal right to do so. The trade sanctions impose specific prohibitions and restrictions, described in the Department for International Trade’s ‘Notice to Exporters 2022/04: introduction of new sanctions against Russia’ published on 2 March 2022’ as “a list of critical-industry goods and critical-industry technology which are now prohibited for export, supply or transfer to, or for use in, Russia, along with the provision of related technical assistance, financial services and brokering services”, with those trade sanctions most likely to be relevant to commercial contracts being:

• A prohibition on the sale of critical industry products and technology, including in the electronics, ICT, energy and aerospace sectors, to Russia;
• A ban on the export of military and dual-use products to Russia;
• The removal of key Russian banks from the SWIFT payment system; and
• Bans on Russian flights within UK airspace and on Russian-linked ships arriving or berthing at UK ports.

There are, however, additional sanctions, such as the financial sanctions applied to a number of Russian politicians, officials and oligarchs which prevent them from travelling to the UK and the freezing of associated assets in the UK which, coupled with the general horror and outrage at Russia’s invasion of Ukraine in February 2022, may well cause UK businesses to wish to examine their contractual relationships with Russian entities whether or not those contracts are directly affected by the current trade sanctions.

Given that the sanctions neither suspend nor terminate a contract simply because there is a Russian counterparty, and do not grant a legal right to do so, then the ability of one party to either suspend its performance of the contract or to terminate the contract will depend upon the terms of the contract itself.

Let’s first consider a contract which clearly falls within the scope of the sanctions: for example, a UK company has contracted to supply aviation equipment to a Russian counterparty in Russia. The UK company can no longer supply that equipment without breaching the trade sanctions, so where does that leave it in terms of its contractual obligations?

Are the Sanctions a Force Majeure Event?

Can the UK company claim that the imposition of sanctions is a force majeure event excusing it from performing the contract and absolving it from liability for its non-performance? Certainly, the UK company is legally prevented by the sanctions from performing the contract (supplying the equipment) and certainly the imposition of the sanctions is an event outside of its reasonable control, but that is not the end of the story.

• Whilst the ordinary meaning of ‘force majeure’ is commonly understood – the occurrence of an event or circumstance which was not foreseen and is outside of a party’s control, such that the party should be excused from the performance of its contractual obligations – English law does not (i) define ‘force majeure’, or (ii) automatically insert a force majeure provision into a contract if the parties have not agreed one, or (iii) define the legal consequences of a force majeure event.
• In English law ‘force majeure’ is not a legal doctrine; it is simply the name given to a clause in the contract, agreed between the parties, which is drafted in a way which means that if certain events or circumstances occur which affect one party’s performance of its contractual obligations, then that party is relieved from the consequences of that failure to perform in some manner. But the key aspects of that contract clause, including what events or circumstances are ‘force majeure events’, the procedures to be followed if such an event occurs, and the consequences for each party of that event, are all a matter for agreement between the parties.

Contracts with no Force Majeure Provision

• So, then what happens if there is no such clause in the contract? If one party’s performance is affected by an event that is genuinely outside of its control, is that party granted no relief under the law, and does it simply have to accept the consequences of its failure to perform the contract? Under English law, the answer to that question is basically “Yes”. English law is commonly used as the governing law for both domestic and international contracts because of its basic principle that the words of the contract are paramount: the starting point is that the parties write down what they have agreed, and the words they use mean what they say.  So, if the parties do not include a force majeure clause, then it is assumed that they did not intend to do so.
• Whilst this might, perhaps, seem harsh upon a party which would otherwise perform the contract, but is genuinely unable to do so because it is legally prohibited because of UK Government sanctions, English law looks at this simply as a matter of risk allocation. Sanctions have been imposed, consequences have followed, loss has arisen as a result, and the question is which party to the contract is to bear the liability for that loss – and, unless the parties have agreed otherwise by including a force majeure clause in their contract, then it is simply a question of applying the ordinary contract law principle that the party in breach of contract is the party liable for the loss resulting from that breach. (We consider some alternatives to force majeure below).

Contracts with a Force Majeure Provision

If there is a ‘force majeure’ clause in the contract then the relevant provisions need to be considered to determine the contractual consequences for each party of the event which has occurred, in this case the imposition of Government sanctions.

First, the ‘qualification’ criteria – does the event fall within the definition of force majeure in the contract? Some contracts define ‘force majeure’ narrowly, others widely, and it is a matter for the parties as to whether trade sanctions are to be considered as a force majeure event. In the example under consideration, it is certainly not inconceivable that, in the context of certain sanctions having been in place since Russia’s annexation of Crimea in 2014, the Russian counterparty might have successfully argued during negotiations that additional sanctions are a foreseeable (if not preventable) commercial risk to be assumed by the supplier if it wants its business.

Next, the ‘causation’ criteria – has the relevant event had the impact described in the relevant clause? This is not simply a question of determining whether the event falls within the definition of ‘force majeure’; but whether that event has in fact caused the failure by the affected party to perform the contractual obligation from which it seeks to be excused, in the manner described in the contract. So, for example, does the contract say that a party can only claim force majeure if its performance is ‘prevented’, or does it also apply if it is ‘hindered’ or ‘delayed’ or ‘impeded’? This determination is a matter of fact: the same event or circumstance may have a different impact on different parties and whilst, in a sense, that may seem unfair, the assessment is not what impact would be expected upon a hypothetical ‘reasonable party to the contract’ but what is the actual impact on, and what is to be expected from, the party seeking to rely on the clause.

The next stage is to check whether there are any procedural or other requirements set out in the contract with which a party needs to comply to claim the benefit of the force majeure provision. There are usually a variety of different requirements on the party seeking to claim force majeure which, depending on the drafting, may include any or all of the following obligations:

• to notify the other party,
• to take steps to mitigate the impact and to resume the performance of the affected obligations, and
• to keep the other party informed.

Particular attention should be paid to any such procedural requirements which might act as a condition to relying, or continuing to rely, on the force majeure event, such as time limits for notifications to the other party. Even if they are not conditions to relying on the force majeure, they are still contractual obligations which must be complied with if the affected party is not to be in separate breach of contract.

Benefits of Force Majeure

• If the party seeking to rely on the force majeure clause can work through and satisfy the various requirements– the ‘qualification’ criteria, the ‘causation’ criteria, and the procedural requirements – then the contract terms will still be relevant in determining what relief is provided. Whilst a force majeure clause typically excuses a party from its contractual obligations where its performance has been prevented by the force majeure event, the contract may or may not provide for any or all of the following:
• (i) relief from liability for non-performance of the affected obligations.
• (ii) the right to delay the performance of the affected obligations.
• (iii) the right for the affected party to suspend its performance of the contract.
• (iv) the right of the affected party to an extension to any stated deadlines or time periods for performance in the contract; and/or
• (v) the right for the affected party, or for the party not affected, or for either party, to terminate the contract, if the force majeure event continues for a specified time period.

Alternatives to Force Majeure

• What if the contract does not contain a force majeure provision or, for whatever reason, the UK supplier is not able to avail itself of the benefit of that provision?

Illegality

• If the performance of the contract (supply of the aviation equipment) would be in breach of the UK Government sanctions then the UK supplier might be able to argue that because its performance would be illegal then the contract, or at least the relevant obligations, should be unenforceable under English law as a matter of public policy. The purpose of the public policy (the sanctions) is to prohibit the supply of the stated items to Russia and the law should not condone what would be an illegal act by enforcing the supply obligation under the contract. However, the key difficulty in relying on the ‘public policy’ principle is that it is perhaps best described as “unprincipled”, with considerable uncertainty as to the circumstances in which it applies including which public policies are to be considered and what is a ‘proportionate’ response of the court in the case before it (bearing in mind that ‘punishment’ is a matter for the criminal courts).

Frustration

• The UK supplier may also be able to argue that the contract has been ‘frustrated’ by the sanctions, meaning that the sanctions make the performance of its contract obligations impossible, the sanctions were neither foreseeable nor its fault, and the impossibility of performance of the relevant obligations defeats the core commercial purpose of the contract. The threshold to prove frustration of a contract is deliberately high, to avoid undermining the principle of the enforceability of agreed contract terms; even in our relatively simple example of a contract for the supply of aviation equipment to Russia then frustration may well be a difficult argument because of the possibility, if not the likelihood, that the sanctions may be lifted (and there are a number of case authorities to this effect), whilst more complex arrangements will almost certainly give rise to more complex considerations.
• It should also be noted that the consequence of a contract being ‘frustrated’ is that the contract is automatically terminated, with a right for the parties to recover monies paid under the contract before that time (means that, for example, if the Russian counterparty has previously made any payments under the contract then those payments should be recoverable) but no other rights or remedies, or flexibilities, and so whilst frustration might be a relevant consideration for a contract with no force majeure clause, care is needed to make sure that it is a legally and commercially astute course of action to follow.

Non-Performance of Contracts with Russian Counterparties Not Affected by Sanctions

What if the contract is not directly affected by the trade sanctions, but the UK business is nevertheless deeply uncomfortable about its continuing contractual relationship with the Russian counterparty and wants to end the contract anyway?

The first step in this situation is to review the terms of the contract itself including the term and termination provisions. The nature of the contract may well be relevant to the circumstances in which one party may terminate the contract; for example, sponsorship or product endorsement agreements and similar contracts will usually contain a right for a party to terminate the contract where the continuing association is damaging to its reputation, whereas such a termination provision would be unusual in a standard supply agreement (although is sometimes achieved indirectly by the contract requiring compliance with a supplier code of conduct or similar document, breach of which permits termination of the contract). There have been media reports of the swift termination of high-profile sponsorships and similar arrangements.

Material Adverse Change / Material Adverse Event (MAC / MAE)

If the supplier is fortunate then the contract might contain a helpful ‘hardship’ clause which would typically allow for renegotiation or even for unilateral amendment of the contract, if one party suffers a substantial hardship, whether or not foreseeable at the time the contract was made, or a ‘material adverse change’ clause which would typically allow a party to terminate a contract if there is a material adverse change in the defined circumstances (which might be tightly defined and limited, or might refer broadly to changes which have, say, a material economic impact upon the party with the benefit of the provision).

Public Policy

In the absence of contractual termination rights or other helpful provisions then the UK business’s options are limited. The argument has been advanced that the contract might be unenforceable on the grounds of ‘immorality’ or perhaps as harming good government in relation to foreign affairs (‘trading with the enemy’) or the integrity of the legal system, each as a matter of public policy; but it seems difficult to see the courts permitting a party to walk away from its contractual obligations in circumstances when its performance is both possible and lawful (unaffected by any of the sanctions directed at Russian trade), however much extra-judicial sympathy there might be for its position.

Scope of the Sanctions and ‘Grey Areas’

Should the applicability of the sanctions be uncertain then section 44 of the Sanctions and Anti-Money Laundering Act 2018 may be of assistance as it provides that if a person acts, or omits to act, in the reasonable belief that their act or omission is in compliance with sanctions made under the Act (which includes the current Russian trade sanctions) then that person is not liable to any civil proceedings to which they would otherwise have been liable in respect of that act or omission.