Sanctions have been described as the new economic battlefield and, in recent years, there has been a sharp increase in the imposition of sanctions as a foreign policy tool for effecting political change. This blog post considers some of the practical implications of sanctions for those drafting arbitration clauses. Whilst there is no perfect solution to the problems that arise as a result of the imposition of sanctions, this post highlights some of the key issues to consider and how the choices made by the parties can, in some cases, minimise the impact of sanctions on the conduct of an international arbitration. Whilst this blog focuses on the impact of EU and US sanctions on Russian entities, the points discussed are of general application.
Impact of sanctions on choice of applicable law
Sanctions may form part of the applicable law of the dispute if the seat of arbitration is in a sanctioning country or if the governing law of the contract is the law of a sanctioning country. For example, if the parties have chosen London as their seat of arbitration, or English law as the governing law of the contract, EU sanctions may be applicable to the dispute.
Where sanctions form part of the applicable law, a respondent may potentially rely on sanctions as justification for its failure to comply with contractual obligations, by raising a defence of frustration or force majeure. Whether such a defence is accepted, and whether the relevant sanctions are applicable to the arbitration proceedings, will depend on the terms of the contract, the impact that the sanctions may have on the contract and the treatment of such sanctions under any applicable law.
This is something that parties should bear in mind when choosing the governing law of the contract. However, in practice, it is unlikely to be a determinative factor.
Impact of sanctions on choice of arbitral institution
EU based arbitral institutions are required to have procedures in place to identify sanctioned entities at the outset of an arbitration. This means investigating whether a party to an arbitration, or its ultimate beneficial owner, or any related entity, is subject to sanctions.
If a potential party is subject to sanctions, asset freezing restrictions may prevent the arbitral institution from accepting payment of the registration fee or advance on costs. The nature of the restrictions will depend on the terms of the sanctions imposed.
In some cases it may be possible to obtain an exemption to allow for the payment of arbitration costs. For example, EU sanctions typically include a provision that permits competent authorities in EU member states to license the release of otherwise frozen funds if such funds are “intended exclusively for payment of reasonable professional fees or reimbursement of incurred expenses associated with the provision of legal services.”
However, the procedure for obtaining a licence to release funds can take several months (delaying the arbitration) and the exemption will only apply to a specific amount of money for a specific purpose. If subsequent payments have to be made (for example, if additional advances on costs are requested during the arbitration) separate applications will have to be made.
Another important point to bear in mind is that clearing banks based in a sanctioning country (particularly the US) may be unwilling to handle funds that are linked to sanctioned entities. This may affect the ability to pay institutional fees and arbitrators’ fees.
These are all issues that parties should consider when selecting both an arbitral institution and the seat of arbitration. In transactions involving entities that are subject to US or EU imposed sanctions, one option is to consider choosing an arbitral institution that is based outside of the US and the EU (for example, the HKIAC or SIAC) choosing an arbitral seat in Asia.
Arbitral institutions are very much aware of the potential impact of sanctions on their ability to administer arbitrations. In 2015, the LCIA, ICC and SCC issued a collaborative article explaining the potential impact of EU sanctions against Russia on international arbitration.
Non-EU based institutions have taken the opportunity to promote themselves as alternatives. For example, the HKIAC has taken steps to promote itself as a preferred institution for disputes involving Russian parties. The HKIAC Administered Arbitration Rules are available in the Russian language and 35 Russian-speaking arbitrators are listed on HKIAC’s various panels of arbitrators. The HKIAC operates primarily from a jurisdiction that has not imposed sanctions against Russian entities and Hong Kong does not require visas for Russian visitors. Most recently, in April 2019, the HKIAC became the first foreign arbitral institution authorised to administer arbitrations seated in Russia and arbitrations concerning certain types of corporate disputes in respect of Russian companies.
Impact of future sanctions on choice of arbitral institution
Another issue to consider is how best to deal with the risk that a contracting party might, at some time in the future, become a sanctioned entity. One option for dealing with this is to provide alternative options within the arbitration clause itself. For example, the arbitration clause could provide that disputes be referred to arbitration in London administered by the LCIA unless and until any contracting party becomes a sanctioned entity, at which point the LCIA arbitration would terminate and the dispute would be referred to HKIAC arbitration with a seat in Hong Kong.
Whilst alternative clauses might appear an attractive option, allowing parties to keep their options open, they require very careful drafting. The arbitration clause would have to address how a transfer from one arbitral institution to another should be effected if an arbitration has already been commenced before the imposition of sanctions. It would also need to address the status of any procedural or substantive decisions made in the initial arbitration. There is no procedure for dealing with this in any institutional rules, so the parties would have to agree on how the process would work, either in the arbitration clause itself or by agreement after a dispute has arisen. Any uncertainty as to how the process should work in practice could cause costly delays in the arbitration process.
In view of the complexities of drafting alternative arbitration clauses, parties may prefer to address the risk of a party becoming a sanctioned entity by choosing an arbitral institution based outside the EU or US and an arbitral seat in Asia. Whilst this may restrict the choice of seat and arbitral institution, it will provide greater certainty.
Impact of sanctions on choice of arbitrators
Sanctions may also have an impact on the choice of arbitrators, particularly arbitrators who are resident in or have connections to the US.
Arbitrators who are nationals of (or based in) a sanctioning country may need to obtain a licence or approval from the relevant governmental authorities before agreeing to take on appointments. This process is not straightforward and can be time consuming. Delays in obtaining licences or approvals may mean that arbitrators are reluctant to accept appointments in disputes involving sanctioned entities.
Sanctions may also have an impact regarding whether payments can be made to the arbitrator. Clearing banks based in a sanctioning country (particularly the US) may be unwilling to handle funds that are linked to sanctioned entities. This may affect the payment of arbitrators’ fees and expenses.
There is no perfect solution for the problems that can arise in international arbitration as a result of the imposition of sanctions. However, understanding the impact of sanctions on the conduct of an international arbitration will allow parties to make choices when drafting and negotiating arbitration clauses that may minimise their effect.