REUTERS | Maxim Shemetov

Beware of a Russian torpedo: the impact on arbitration agreements of sanctions-related amendments to Russian procedural law

It is no secret that for the past 20 years, international arbitration has been a popular method of dispute resolution for Russian parties and companies ultimately controlled by them.

However, sensitivity around foreign sanctions targeting certain Russian individuals and companies has resulted in amendments to the Russian Arbitrazh Procedure Code (APC amendments). The amendments came into force on 19 June 2020. This blog considers the effect that they may have on the enforceability of arbitration agreements involving sanctioned parties in the light of three recent Russian court decisions.

APC amendments

The APC amendments are significant because they mean that new and existing arbitration agreements involving parties targeted by sanctions may be rendered unenforceable if a Russian court finds that they have become “incapable of being performed” due to foreign sanctions. They give Russian courts the power to refer a dispute to the exclusive jurisdiction of the Russian commercial (arbitrazh) court.

The APC amendments also permit the grant of an anti-suit injunction (ASI) prohibiting foreign court or arbitration proceedings. Notably, this is the first time specific provisions providing for the possibility of an ASI being granted by the Russian court have been introduced in the Arbitrazh Procedural Code.

When the APC Amendments were passed into law, a number of practitioners expressed concerns about inherent ambiguities in the provisions and how they would be interpreted by Russian courts. Those concerns include:

  • The definition of foreign sanctions draws no distinction between sanctions that result in assets of a sanctioned person being blocked or frozen either in the US, EU or UK, (for example by virtue of being included on the US Office of Foreign Assets Control’s Specially Designated Nationals and Blocked Persons List (OFAC’s SDN List)) and sectoral sanctions, which prohibit certain finance, insurance, services and technical dealings with specific Russian companies and banks, that do not result in asset freezes.
  • The meaning of the phrase “incapable of being performed” is unclear, creating the risk of an arbitration agreement being rendered unenforceable even where sanctions make it more difficult, but do not prevent a targeted persons from participating in arbitration proceedings.

Recent application of APC amendments by Russian Courts

Given these concerns, recent examples of application of the APC amendments by the Russian courts are of particular interest. Two of the cases involve the same parties, Uralvagonzavod v Pesa Bydgoszcz.

The first set of proceedings (Case No А60-62910/2018) was commenced in the Arbitrazh Court of Sverdlovsk Region by Uralvagonzavod, almost two years prior to the APC amendments coming into law. The claimant sought a declaration that an arbitration agreement referring disputes between the parties to SCC arbitration was unenforceable because the claimant was affected by foreign sanctions introduced by the EU and US. The most recent judgment published on 5 October 2020 was rendered after the case was remitted back to the Court of First Instance by the Court of Cassation, which ordered reconsideration of the claimant’s arguments in respect of the unenforceability of the arbitration agreement in light of the EU sanctions.

Having applied the APC amendments, the court emphatically rejected the claimant’s arguments that the arbitration agreement was unenforceable:

  • First, the court held that the arbitration agreement was set out in an agreement for sale of tramway cars, which in itself was not affected by the EU sectoral sanctions to which the claimant was subject.
  • Second, the court noted that sectoral sanctions introduced in respect of the claimant by the EU did not prevent it from participating in the arbitration proceedings on foot.
  • Lastly, the court held that the claimant did not demonstrate any obstacles to justice, given that it had actively participated in the SCC arbitration proceedings, which were commenced by Pesa Bydgoszcz to recover an outstanding debt under the sale agreement. Its active participation included: engaging Polish and Russian legal representatives; nominating an arbitrator; and submitting detailed pleadings and expert reports.  Moreover, the court took into consideration that the claimant was not prevented from making payments of arbitration fees to the SCC, which was factually confirmed by the SCC Secretariat.

In the second set of proceedings (Case No А60-36897/2020), Uralvagonzavod applied for an ASI to prohibit Pesa Bydgoszcz from continuing with the same SCC arbitration proceedings referred to above. The proceedings were commenced after the APC amendments became law. On 24 November 2020, the Arbitrazh Court of Sverdlovsk Region rejected the ASI application on the basis that the claimant failed to prove the unenforceability of the arbitration agreement and did not demonstrate that there were any barriers to access to justice that prevented them from participating in the SCC proceedings for the same reasons set out above in respect of the first set of proceedings.

The approach adopted by the court in Uralvagonzavod v Pesa Bydgoszcz can be contrasted with the Russian Supreme Court’s decision dated 12 October 2020 in Instar Logistic v Neighbours Drilling International (Case No A40-149566/2019) that confirmed earlier decisions of the lower Russian courts.

In Instar, the court held that the inclusion of a party on the OFAC SDN List is likely to result in the Russian courts finding an arbitration agreement between the parties unenforceable.  The Supreme Court upheld the lower courts’ earlier judgments, holding that the applicable US sanctions prevented the claimant from commencing an ICC arbitration and making bank transfers outside of Russia, which created barriers to access to justice as the claimant was unable to make payments towards arbitration fees or for legal representation outside the territory of Russia. The Supreme Court confirmed that, as matters stood, the arbitration agreement was unenforceable.  However, it noted that, should the sanctions in respect of the claimant be no longer applicable in the future, the defendant would be able to rely on the arbitration agreement being enforceable.

Conclusion

It remains to be seen whether the judgments rendered in the proceedings involving Uralvagonzavod will be confirmed by higher courts and, in particular, the court’s interpretation of what may constitute a barrier to justice under the APC amendments, as well as any distinction to be drawn between sectoral and asset-freezing sanctions.  It is also unclear how much enthusiasm  the  Russian courts will demonstrate when granting ASI applications in reliance on the APC amendments and, in particular, whether those ASI will be enforced outside of Russia by foreign courts.

That said, the decisions are a sign that the Russian courts may be reluctant to find that arbitration agreements are unenforceable in the absence of clear evidence of barriers to justice that prevent a party from participating in the arbitration.  This could be taken as a welcome indication that concerns over how the amendments would be applied by the courts were misplaced and that the risk to the enforceability of arbitration agreements may not be as significant as some may have feared.

Nevertheless, there remains a risk that arbitration agreements concluded with Russian parties targeted by foreign sanctions may be open to challenge before Russian courts on the basis that they are incapable of being performed. The risk applies to currently sanctioned entities and to entities that may be affected by sanctions in the future.  It also opens the door for sanctioned persons to apply for an ASI from the Russian courts.

These risks can be mitigated when drafting an arbitration clause by choosing a seat of arbitration and an arbitral institution located in a country that has not introduced any anti-Russian sanctions.

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