Sanctions in international arbitration

June 2023  |  SPECIAL REPORT: INTERNATIONAL DISPUTE RESOLUTION

Financier Worldwide Magazine

June 2023 Issue

The selection of international arbitration as the preferred forum has long been common for contracting parties located in different jurisdictions. The popularity of arbitration has only further increased for such contracts as parties look to avoid possible disadvantages when litigating in foreign courts and seek out the benefits of global enforcement under the 1958 New York Convention on the Recognition and Enforcement of Arbitral Awards. However, recent global events have thrust sanctions into the spotlight, and it is increasingly common that arbitral proceedings, once seen to be rather immune to geopolitics, are impacted when a party to the proceedings becomes the subject of sanctions. This article covers some of the practical implications to arbitral proceedings when a party is the subject of sanctions.

As an initial matter, parties should always be mindful of the possible counterparty risks associated with sanctions when entering into agreements outside of their home jurisdiction. Such risk is only ascertainable with a comprehensive understanding of the counterparty’s business and ownership structure, which is often difficult to determine conclusively. Further, the obligations and terms of the contract should be carefully considered. What currency will be used to effect payment? Sanctions imposed by the US typically target the use of the US dollar, even outside the jurisdiction. What is the place of performance and is it possible that one party will be restricted from access? Is shipping of the goods required? International shipping companies may refuse to deal with a party that is the subject of sanctions. Is there a sanctions clause in the contract? The parties can seek to mitigate the effects of sanctions if they are imposed on one, or both, parties during the lifespan of the contract.

What is the legal position of the contract’s force majeure clause? Most contracts contain some form of force majeure clause, but the scope will be dependent on the terms of the clause and the applicable law. Even without a force majeure clause, different legal systems treat the impact of sanctions on the obligations of the parties differently.

Forum selection should be carefully considered; in particular, the seat of the arbitration may be relevant to the treatment of any award.

Taking these factors into account during the negotiation of the contract can help negate some of the issues associated with disputes where a party becomes subject to sanctions and may well prevent the need for costly dispute resolution altogether.

Settlement negotiations with sanctioned parties

In circumstances where one party to a contract is designated for sanctions, one or both parties typically find themselves in a situation where performance of the contractual obligations becomes contrary to laws applicable to them or performance becomes factually impossible. The natural impulse for parties to such situations is to seek a commercial resolution or some other form of negotiated settlement of the contract. It is also likely to be a recurring theme as a dispute progresses; the parties will seek to limit their exposure through an amicable settlement. Particularly in the context of international arbitration, which has widely adopted the English common law practice of ascribing costs consequences to “without prejudice save as to costs” offers, the need to make settlement offers for costs protection is further pronounced.

However, parties should ensure they take specific sanctions advice as to whether the settlement agreement they intend to enter into allows them to comply with applicable laws. Even the forfeiture of rights under a contract may constitute a breach of applicable sanctions legislation. Any settlement negotiation and agreement should be carefully scrutinised by sanctions specialists to ensure compliance. In some cases, it may be necessary to request authorisations in the relevant jurisdictions in order to negotiate or agree a settlement. Parties should therefore not automatically count on the availability of a commercial settlement as a resolution to a dispute that arises either due to, or in the context of, sanctions.

Payment of arbitration fees

The bodies that administer arbitral proceedings, such as the International Chamber of Commerce (ICC), the London Court of International Arbitration (LCIA), the Singapore International Arbitration Centre (SIAC) and the Hong Kong International Arbitration Centre (HKIAC), require various payments for their administration services and payment of arbitrator fees, typically referred to as the advance on costs. The parties are typically responsible for these fees on an equal share basis. In circumstances where the claimant to the proceedings is not the subject of sanctions, this causes limited issues, other than additional financial exposure to the claimant, as, if the proceedings are to continue, the claimant can always advance the (sanctioned) respondent’s share of the advance on costs if the respondent refuses to make payment (or is unable to).

In circumstances where the claimant is subject to sanctions, this can become materially more complex. The respondent will not wish to bankroll the claimant’s claims against it and so the claimant must ensure payment of its share of the arbitration costs. This will necessitate payments from a sanctioned entity to an arbitral institution, typically denominated in one of the main global currencies that form the basis of many financial sanctions. The arbitral institution will also want to ensure that it is not complicit in any breach of sanctions by receiving payments or handling funds from a sanctioned entity, as this may pose a substantial risk to its broader business. Further, the arbitral institution’s banking partners may be unwilling, or reluctant at best, to process payments from a sanctioned entity.

Ordinarily it will be possible to receive the requisite authorisations to process the payments, as the payment of court and other legal fees is typically exempt from sanctions; however, delays may still jeopardise the process and cause inconvenience.

Foreign court interference and countersanctions legislation

While, in many respects, most modern jurisdictions respect the independence of arbitral tribunals and the final and binding nature of their decisions, recent developments in the sanctions space are cause for concern.

Firstly, some jurisdictions have introduced national legislation to interfere with the jurisdiction of foreign arbitral tribunals when one of the parties is subject to sanctions. For example, Russia has implemented laws to protect individuals and entities that have been sanctioned from the jurisdiction of the courts in countries that have imposed sanctions (or arbitral tribunals seated in those countries). These laws give the Russian courts exclusive jurisdiction over such disputes, even if this may not be recognised internationally, or over any arbitral tribunal properly seized under an arbitration agreement in a contract. The issue for parties in such situations will be that parallel proceedings may be commenced before the Russian courts, potentially resulting in an adverse judgment that may be enforced. Aside from adding the cost and distraction of parallel proceedings, this negates the neutrality benefits that the parties sought by selecting international arbitration as the appropriate forum for the contract.

Similarly, there is an increasing trend to implement legislation that restricts compliance with foreign sanctions regimes to varying degrees. A well-known example of this is the EU Blocking Statute, which prohibits compliance by EU operators with certain foreign sanctions regimes. While challenging in its own right for many international businesses, compliance with these overlapping sanctions rules, bearing in mind the relatively aggressive enforcement of US secondary sanctions, becomes all the more problematic in a conflict of laws or proportionality context.

Enforcement issues

Sanctions may cause material enforcement issues, particularly where a party that is subject to sanctions only or predominantly has assets in its home jurisdiction. Many local courts are likely to be unwilling to enforce a foreign arbitral award against a local party when that party may be perceived to have been prejudiced by foreign sanctions. Further, assets that are frozen in jurisdictions foreign to the debtor are likely to be unavailable for the discharge of an arbitral award. While commercial parties prefer to see their businesses as politically agnostic, the application of sanctions can drastically impact the availability of assets for enforcement along geopolitical lines.

In circumstances where the respondent to an arbitration is not the subject of sanctions and prevails in the proceedings, it may struggle to enforce any costs award issued in its favour. This increases the risks associated with a respondent’s participation in an arbitration, as even if it is the victor, its costs will likely not be recoverable. Further, the claimant (designated for sanctions) will have limited incentive to discharge any costs award when its claims have failed. A respondent faced with this situation should seek an award for security of costs from the arbitral tribunal at an early stage to minimise risk.

Conclusion

It is clear that there are myriad issues that arise whenever sanctions become relevant to a dispute. Businesses are well advised to seek specialist legal advice at an early stage, as very often the most crucial issues are the provisions of the parties’ contract and the initial disputes strategy implemented.

 

Chiraag Shah is a partner and Robin Bachmann is an associate at Morrison Foerster. Mr Shah can be contacted on +44 (0)20 7920 4176 or by email: cshah@mofo.com. Mr Bachmann can be contacted on +44 (0)20 7664 1678 or by email: rbachmann@mofo.com.

© Financier Worldwide

BY

Chiraag Shah and Robin Bachmann

Morrison Foerster

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