Consider the following, not-impossible scenario. An arbitration in Switzerland, with UK and Iranian parties. The arbitrators are from France, Belgium and India. Do any sanctions apply? Would your answer change if one of the arbitrators were from the US? Such questions were discussed at last year’s GAR Live London, guided by Hans van Houtte, then president of the Iran-United States Claims Tribunal.
“Sanctions, a triangular look” opened last year’s GAR Live London. Its aim: to look at the impact of sanctions on arbitration from the perspective of counsel, arbitrators and institutions.
Van Houtte moderated a panel that included Mercédeh Azeredo da Silveira, of Bär & Karrer, Charles Claypoole, of Latham & Watkins, Jacomijn van Haersolte-van Hof, Director General, The London Court of International Arbitration (LCIA), and Maya Lester QC, Brick Court Chambers.
Notably, it also included Brian O’Toole, a senior member of the part of the US government in charge of sanctions enforcement, OFAC. O’Toole’s full title is Senior Advisor to the Director, Office of Foreign Assets Control (OFAC), US Department of the Treasury.
After a whistle-stop tour of how sanctions have evolved over the years, from “brutal” to collective, van Houtte got down to the nitty gritty and began posing his questions.
The following is an edited transcript of the result. It has five sections:
- When do arbitrators have to take sanctions into account?
- How do arbitration institutions handle sanctions?
- What is the impact of sanctions when arbitrators have to decide the merits?
- Do sanctions affect the enforcement of the award? and
- Audience questions
Hans van Houtte: Welcome to the session on economic sanctions in arbitration. Economic sanctions are the topic of the day. We all have in mind Russia and Iran, but we could also think of Afghanistan, Belorussia, Bosnia and Herzegovina, Burma, Burundi, Central African Republic, Congo, Iraq, Libya, North Korea, Crimea, some embezzlers of funds in Ukraine, Yemen, Zimbabwe and a few other countries. In other words, the world is full of economic sanctions.
Economic sanctions are as old as international trade. Even the ancient Greeks had economic sanctions between one city state and another. However, nowadays economic sanctions are different. They have different features, which go in two directions.
Firstly, economic sanctions have often a wide, horizontal application. They are most often implemented on a collective basis, be it with national variations. For instance, UN sanctions have to be applied by all UN Member States, be it in different ways depending on domestic law. For an implementation within the EU, UN sanctions need to be transposed into the respective domestic regimes. Even when sanctions are not widely taken, they may apply extraterritorially, they are applicable extraterritorially, which means that they have to be taken into account in other countries.
Secondly, economic sanctions became more targeted. In the past, sanctions were rather and not targeted. . For instance, the economic sanctions against Rhodesia many years ago, excluded all trade, and the population at large was hurt. Nowadays sanctions focused often on specifically designated persons and specific sectors. and became more complicated in their application.
This session shall not discuss the political and economic soundness of sanctions, nor enumerate the respective sanction regimes which are presently in force. Instead, we will look to what the extent sanctions are relevant to arbitrators. The debate will be centred around four themes. First, when do arbitrators have to take sanctions into account? Second, how do arbitration institutions handle sanctions? Third, what is the impact of sanctions when arbitrators have to decide the merits? Fourth, do sanctions affect the enforcement of the award?
An excellent panel is prepared to discuss these four aspects.
Hans Van Houtte introduced the speakers.
I would now like to move to the first question: the scope of application. Brian O’Toole, let us start from the following hypothesis: an arbitration in Switzerland between an English and an Iranian company before a Belgian, Indian and German arbitrator. To what extent should the sanctions be applicable and, for instance, would the situation change if one of the arbitrators were a US citizen?
Topic 1: When do arbitrators have to take sanctions into account?
Brian O’Toole: The basic question here revolves around what the US jurisdiction is and, with respect to Iran, you are going to run into a series of different consequences because of the application of secondary sanctions. What I mean by that is that typically the US imposes what we refer to as primary sanctions. Those are sanctions that apply to US persons wherever they are located in the world. That means that if I’m here in the UK, I still have to follow American law. That applies to US lawyers and to people who have certain citizenship classes inside the United States, such as dual citizens. It also applies to anything in the United States. So, if you are in the United States, you technically have to abide by US sanctions even if you are not US citizens. We expect US citizens to follow the laws of other countries when they are in foreign countries: the same goes in reverse.
When it comes to an arbitration decision, for the most part, if you are talking about an Iranian party, an English party and non-US-person arbitrators, the impact of primary sanctions is going to be pretty tangential unless you are paying in US dollars and it gets routed through the United States. That’s probably where you are going to have more of that type of impact.
Secondary sanctions change the equation though and remember, as I said, these are in place for Iran and, presumably, Hezbollah. Secondary sanctions are activities primarily outside of US jurisdiction and undertaken primarily by non-US persons. That means, if you are conducting business with the Islamic Revolutionary Guard Corps (IRGC), you could run afoul of US secondary sanctions and we can cut you off from the United States. It doesn’t matter that you are not a US citizen. It doesn’t matter that you are not subject to US law. It’s effectively a choice between doing business with Iran and doing business with the United States.
So, that’s the basic construct. In the Iran context, most of the secondary sanctions were lifted on “implementation day” last year, which was 16 January 2016. The only folks that still retain secondary sanctions are those that remain on the SDN list, which is the list of specially designated nationals and blocked persons for Iran. Likewise, anybody who is a designated member or supporter of Hezbollah is also subject to secondary sanctions. They’re on the SDN List. If you go to our website, you can do a search on the party – say the IRGC – and it will bring up a page that describes the IRGC itself, known addresses, aliases and the programmes under which the group has been sanctioned. It’s one of the more heavily sanctioned groups in the world. It will also contain a little note that says, “subject to secondary sanctions”. You can look this stuff up pretty easily.
Coming back to the broad-based question: if this is dealing with the IRGC or a company that might have some IRGC ties, there are a couple of things to bear in mind. Look, you guys are attorneys and advocates; you’re providing a legal service. When it comes to the enforcement of our primary and secondary sanctions, you may be providing – in the secondary sanctions construct – a significant financial service, which is the bar we have to cut you off from the United States. The bar for primary sanctions is a little different. Basically, what you need to be careful of is whether you are providing material support to that target in the primary sanctions context; and then, in the secondary sanctions, that significant financial service.
In this case, assuming that the Iranian entity is not on our SDN list – which it probably won’t be if you’ve got a contract – I have a hard time seeing that there’s going to be much of an application of our sanctions measures. That may be a little confusing; apologies, but this is a complicated set of overlays, particularly with respect to Iran.
Hans van Houtte: Mercédeh, do you have something to add. And Jackie?
Jacomijn van Haersolte-van Hof: I can briefly follow up on the arbitrator point. If an institution has the choice, it will not necessarily involve American arbitrators in sanctions, as we’ll discuss in a moment. As an institution seated here, we always apply EU sanctions, but we are quite conscious that if you create connections with the US – whether through having an American arbitrator, paying in dollars or even having temporary staff seconded by an American law firm involved in a case – you are making life unnecessarily complicated. That’s something we try to avoid.
You cannot always avoid it if somebody is, for instance, nominated. That’s where you may need a discussion as to whether that’s really what the parties want but, luckily, we have not had that situation. It is important to realise that something such as nationality changes the game. It’s not just about where the seat is; it can be either the seat or the law or the currency. Multiple factors may suddenly trigger multiple layers of regulation.
Mercédeh Azeredo da Silveira: Perhaps I can add one or two observations, from a non-US perspective, on extraterritorial sanctions and on secondary sanctions.
US extraterritorial sanctions include, for instance, sanctions that seek compliance from US nationals abroad or from foreign subsidiaries of US entities, and sanctions that prohibit foreign individuals and entities which have imported goods from the US or made use of technologies developed in the US, from exporting these goods or technologies to a target – sanctioned – state.
From a dispute-resolution perspective, it is important to bear in mind that the fact that a sanctions programme proclaims itself applicable extraterritorially does not imply that arbitral tribunals – or domestic courts for that matter – will necessarily give extraterritorial effect to these sanctions.
There are actual cases in which arbitrators and domestic courts have refused to give effect to US extraterritorial sanctions, notably on the ground that these sanctions were incompatible with public international law. For instance, in a 1982 landmark case, a Dutch court refused to give effect to US extraterritorial sanctions that had been imposed to obstruct the construction of a natural gas pipeline from the Soviet Union into Western Europe. In 2015, the Paris Court of Appeals also refused to give effect to US extraterritorial sanctions against Iran in a case between a French company and an Iranian company.
It is also important to remember that in the past, several states and the EU have adopted “blocking statutes” against extraterritorial US sanctions. These statutes made it illegal for persons and entities subject to the jurisdiction of the enacting states to comply with US extraterritorial sanctions and to comply with orders and judgments from US courts giving effect to these sanctions.
If a disputed transaction falls both within the purview of an extraterritorial sanction and within the purview of a blocking statute, it is crucial for arbitrators to weigh the interests that are served by the sanction against those served by the blocking statutes, to determine which one should prevail in a dispute. It is insufficient to merely focus on the threat of penalty under the sanction, knowing in particular that blocking statutes often also threaten with penalties those that would disregard the statute and comply with the sanction.
As to secondary sanctions – whereby the US threatens, for instance, to deny foreign individuals and entities certain commercial or financial privileges if they maintain ties with a target – I am not aware of any case in which arbitrators would have given effect to secondary sanctions and freed parties from their obligations on the grounds that a disputed transaction fell within the scope of a secondary sanction. To my knowledge, the risk of future adverse measures that could be taken by a sanctioning state for non-compliance with a secondary (or tertiary) sanction has not, to date, been regarded by any court foreign to the sanctioning state as an impediment justifying that a party be freed from its contractual obligations.
The future will tell us how they may impact contractual disputes that are arbitrated but, so far, I have not seen any case in which secondary sanctions were deemed a ground for exemption from liability for non-performance.
Hans van Houtte: Thank you. Now, two other sets of facts. Firstly, what about a British company, which has a licence for some technology from an American company? Is it also bound by sanctions?
The second situation: what, when the designated person has filed court actions to get his name removed from the SDN list? Should the sanctions still be applied? Also, to what extent is it possible to get a licence and become exempted from the sanctions?
Brian O’Toole: The question of US technology is an interesting one. What we prohibit when we impose primary sanctions is this blocking prohibition. You end up on the SDN list: your assets and property in the United States are blocked. What it means is that nobody in the US can import or export goods, services or technologies to, or from, the SDN.
When we say “goods”, that means the standard kind of export controls compliance carries with it. So, exports of goods from the United States, including US technology, are prohibited to those foreign persons who are designated. That includes re-export, which is typically done in coordination with the Department of Commerce, our export control infrastructure. Regarding the composition of goods: the percentage that trips that threshold in the US-origin goods is, I believe, typically about 25%. In the Iran context, in the Cuba context – I think those are the only two – it’s 10%.
The most relevant current example I can give is the prohibition on the export of goods from the United States to Iran. That’s retained even under the Joint Comprehensive Plan of Action relief. Because Airbus has planes that use US navigation systems – among other US parts – Airbus planes are still controlled goods. Airbus has to get a licence from us to sell planes to Iran.
On delisting: if you seek delisting – because we’ve designated you as a terrorist, we’ve designated you under our Ukraine sanctions or under any of our programmes – there is a general licence put in place for every one of our programmes authorising representation against the US government. If you’re a US person, there’s a hurdle you have to get through. You can represent the person but, as a US person, you have to get a licence from us to receive payments. Those are granted as a matter of course. It’s just the way that we do it is to ask folks to come and get a specific licence. We try to give SDNs legal recourse.
Maya Lester: Just a couple of comments. Obviously, if you have an EU national arbitrator and an EU national party, there is an issue of EU sanctions, as well as US sanctions. There’s no issue of extraterritoriality because EU sanctions apply to EU nationals wherever they are: any portion of work or business done in the EU; and also EU-incorporated companies, wherever they are. EU parties and arbitrators generally have to be aware of EU sanctions.
So, one of the issues is: is one of the parties to the proceedings designated? Even that phrase is complicated because it means different things. Obviously, there’s a question about which authority has done the designating: the UN, the US, the EU or a number of other countries that impose their own sanctions? What most people mean by the phrase is that there is an asset freeze on that party, meaning it’s a criminal offence in a number of countries to make funds or resources available to that party.
What does that mean? Well, number one, it might mean lawyers need authorisations from the relevant national authority to be able to work for that person and, in particular, to be paid by that person. It may also mean that the arbitrators themselves need to obtain licences in order for the arbitration process to take place. Again, this is a complex question. It depends whether resources are being made available to designated parties or not.
Designation, however, can also mean different things. If you are dealing, for example, with Libya sanctions, you might have parties where there is no prohibition on making resources available, but there are prohibitions on dealing with resources, which means that any moving around or use of funds is not allowed. That might matter, for example, because banks and financial institutions – even if you don’t have an asset freeze, SDN lists – might be simply unwilling to deal with transactions involving certain countries. That would certainly be the case in a UK/Iran arbitration. If there’s any question of payments of awards, even sometimes with licences, it’s likely to lead to difficulties trying to persuade financial institutions to accept those transactions, largely because the impact of US sanctions can be very difficult.
On the issue of a designated person – which includes someone controlled by a designated person – if you have an Iranian entity, you have to ask not just if they are on a list, but if they are controlled by someone else on the list. That involves a bit of due diligence. Then, what if they have challenged their designation, as Hans posits, in one of the courts where you can do that? The short answer is it doesn’t really make any difference because, unless and until they are removed from a sanctions list, they’re still on a sanctions list; but it will mean that you need some kind of licensing arrangement.
We’ll come back to this when we talk about enforcement. Just to say it’s not always straightforward to say we will obtain a licence. There are regimes, Russia being one, where court judgments which make funds available to designated persons can be licensed. But arbitral awards, which come into force after parties have been sanctioned, do not seem to be licensable under the relevant regimes. Even obtaining a licence in an arbitration context might not be straightforward.
Hans van Houtte: Charles, I heard that arbitration in Singapore pursues a sanction-free policy. Does that work?
Charles Claypoole: Because there have been so many touchpoints in which sanctions might be relevant, including the location of the seat of arbitration or the location of the arbiter institution appointed in an arbitration clause, the South East Asian arbitral institutions – SIAC and HKIAC – have used sanctions very aggressively to market themselves, particularly to Russian businesses, saying: “Don’t put LCIA in your arbitration clause; put SIAC, because we’re sanctions-free.”
Now, there are a number of points in response to that – some made in a joint paper published together by the LCIA, ICC and SCC in 2014 – which emphasise that these institutions are perfectly capable of dealing with arbitrations for sanctioned persons, albeit with a number of administrative steps that might be necessary. That’s one issue.
The other issue is that the location of the arbitral institution is just one of the many touchpoints whereby sanctions may become applicable. One is obviously the identity of the parties and, equally, the identity of the arbitrators. Then there’s the issue of counsel – could they act in it – and is the law applicable to the contract? So, there are different ways in which sanctions might be applicable but, just by using SIAC as opposed to the LCIA, will not mean that your arbitration is sanctions-free.
Hans van Houtte: To move to the second question: Jackie, can you describe how the LCIA handles sanctions?
Topic 2: How do arbitration institutions handle sanctions?
Jacomijn van Haersolte-van Hof: The LCIA is an example of an institution that fits somewhere in the middle of the range of what institutions do. Those of you in Switzerland last year will recall that some of the Swiss were very stand-offish and felt it was imprudent to get involved in any way: that you might be breaching all sorts of confidentiality obligations, as an institution or arbitrator, if you got involved in any potential sanctions issue. At the other end of the range you have the ICC, which is intensely involved in vetting.
To some extent, this reflects the make-up of the cases of those institutions. For the LCIA, which has between 20-30% of Russian cases, you might think that sanctions are extremely important. Realistically, numerically, very few cases have triggered, for instance, licence procedures, but it has meant that the LCIA developed a fairly stringent procedure on how to flush out potential issues, such as: is the vice-president or president involved in this matter an American – because that might trigger the application of US sanctions. So, even if you’re an institution based in Singapore, you could suddenly find yourself connected to the US.
So, we look at the case: we run all the names through the sanctions lists, in particular American and European; and if any red flags go up, we then take steps. What we also do is flag to the stakeholders (let’s put it that way) that sanctions are an issue that we need to deal with. It need not be fatal, but we need to be alert: we don’t want one stakeholder making it exclusively the problem of the other stakeholder. There’s also a bit of responsibility for the arbitrators themselves, or the parties. What we find is the more transparent we are about this, the easier it is to deal with. If you are an American law firm, you will have done similar checks. It will be in your interest to make all this work.
What we find with the practicalities is that it’s not just the diversity of rules and regulations (and people have thought long and hard about them); but very few people who set up the rules know anything about arbitration, let alone the administration of arbitration. For instance, the workstreams, the payment streams, don’t neatly fit in the various scenarios that underlie the applicable regulations.
Let me give you an example. In the LCIA system, you typically pay multiple deposits during the course of the arbitration. That’s one of our unique selling points. You don’t pay one huge sum upfront. In a licensing system that’s an absolute nightmare because, as much as authorities try to do their best, it takes quite a while if you really need a licence; and, if you imagine that you’d need to do that every three months, that’s just not going to work.
Then, if you try to explain to the relevant authorities how your system works, you find yourself explaining that typically you would ask for maybe this small chunk of money, but that you propose asking a larger deposit to make things workable both for the authorities and the institution. That doesn’t always work super smoothly. You also need to think about, for instance, the need to return payments. Typically, sanctions regulations deal with the situation where somebody needs to pay somebody else but, if you’re a party paying a depositor for arbitrator fees, there may well come a moment when some funds need to be returned. It can be as little as US$1,000, but then you have reverse payments and all of a sudden you find the rules don’t really match reality any more.
A final example is the situation where the respondent is a sanctioned entity. Clearly, by the time of dispute, it is the least likely to cooperate. What we tend to do when a respondent doesn’t pay its share of the deposit, is we typically ask the claimants to make a substitute payment.
The question then arises: can you do that in a situation where it is a sanctions provision that prevents the respondent from paying? We have had different discussions about this, certainly with the English authorities, who initially said: “No, the sanctions prevent that party from making a payment.” And we explained, well, not necessarily. Every respondent at some point has an interest in trying to be difficult and the system systematically allows for the claimant to take over the payment obligation.
So, for a while the substitute payments were no problem and the latest news from the English authorities is that they think: “Well, actually, maybe there should be a problem.” Then the problem becomes implementing it because, if you then seek a licence for a substitute payment, you find that none of the forums work because the party that will be paying the money is not sanctioned at all. So, it becomes a complete, well, Alice in Wonderland type of discussion.
The final piece to the puzzle is getting the banks to help you accommodate this. Banks have a commercial interest in taking on certain clients, making certain transactions, and the paradox is: you are sometimes better off with a licence than in the current situations where fewer licences are needed. It has become even more difficult to persuade banks that they should allow for certain payments from certain countries to be made – or payments to be returned to those countries – and you are stuck as an institution.
What we try to do is make sure that this is not uniquely a problem only for the institution. We warn arbitrators that, if they start working before there are funds, they will end up with a problem. The more transparent you are about that, we find, the easier it is ultimately to accommodate most of the issues.
Topic 3: What is the impact of sanctions when arbitrators have to decide the merits?
Hans van Houtte: Thank you. Now, we move to the third question. The arbitrators are sitting. They have to decide on the merits and to what extent they have to apply sanctions. Mercédeh, can you please describe very briefly the different possibilities.
Mercédeh Azeredo da Silveira: The prevailing view, today, is that disputes involving economic sanctions are arbitrable: arbitral tribunals have the authority to give effect to economic sanctions, whether imposed by the state of the applicable law or by another state.
What remains a debated question is how sanctions should be characterized by arbitrators, from a private law perspective – whether a sanction should be given effect as fact or as law.
Economic sanctions have traditionally been regarded as elements of fact, and a party has been considered to be facing a factual impediment whenever a sanction had the power to compel it to withhold performance, usually via threats of enforcement measures or of penalties.
This factual approach is increasingly regarded as an unsatisfactory shortcut to the extent that it compels arbitrators to give effect almost mechanically, as elements of fact, to measures which are in reality deliberate instructions issued by states, directed to the achievement of a given political purpose, detrimental to one of the contractual partners, and which have at times been condemned by states, if not by the international community.
Another approach has therefore emerged, according to which a sanction should be given effect only if the party requested to withhold performance is legally bound to comply with the sanction, either because it forms part of the applicable law or because it is applicable as a foreign overriding mandatory rule.
Just a word about overriding mandatory rules. These are rules that purport to respond to essential needs and therefore proclaim themselves applicable to all situations falling within their purview, irrespective of the law governing these situations. This is precisely the case of economic sanctions. Trade sanctions, for instance, typically prohibit all trade-related transactions between individuals and entities acting within a sanctioning state, and individuals and entities located in a target state, irrespective of the law governing these transactions.
In most case scenarios, the factual and the legal approaches lead to the same result: very often, sanctions are given effect, and whether a sanction is characterised as an element of fact or as an element of law ultimately matters for procedural purposes. This being said, it is important to note that the legal approach affords arbitrators a degree of flexibility that they do not enjoy under the factual approach. As a legal norm, a sanction that forms part of the applicable law may be disregarded by arbitrators if they find that giving it effect would lead to an outcome which would be in conflict with principles of transnational public policy, that is, with fundamental principles or essential values that are common to most or all nations. Also, a sanction that is external to the applicable law may be disregarded if it does not meet all the conditions that must be satisfied for a foreign overriding mandatory rule to be given effect. Arbitrators may thus have the ability to disregard, for instance, a sanctions programme that was condemned by the UN General Assembly; or a sanctions programme that was imposed in breach of the sanctioning state’s international obligations, for instance, under the GATT or the European Convention on Human Rights; perhaps even sanctions whose extraterritorial scope violates public international law. None of these sanctions could easily be disregarded under the factual approach.
Hans van Houtte: Thank you. Charles, do you have something to add?
Charles Claypoole: All these issues play into the tactics of a respondent if you are facing a claim that relates to an obligation incumbent on you that would be prohibited under either EU or US sanctions: there might be a question as to which sanctions might be applicable to you. In that case, you look at the tension between your contractual obligations, which the other side might be trying to enforce and your legal compliance obligations. It may be that that tension will not be resolved by a force majeure clause. Maybe it won’t be resolved by principles of the governing law, whether it’s frustration or force majeure.
There may be legal defences that you can look to. In many EU Council regulations – which contain the main rules of EU sanctions – there are provisions which indicate that a failure or refusal to carry out obligations because of the wording of that sanction shall not give rise to liability. Then there’s a question as to whether or not the arbitral tribunal might take into account those provisions.
You also need to think tactically. If you invoke sanctions as a defence, could that preclude you from making a counterclaim in the arbitration? There’s also the risk of your obligations vis-à-vis the relevant sanctions authorities. Are you risking an investigation by participating in the arbitration? One of the difficult questions we have is: if you’re dealing with, for example, a European company owned by a US parent, it may be that the US parent does not want the EU company to comply with the contractual obligations – even though, as an EU company, it may be able to – because of US sanctions. That’s the sort of tension that can give rise to disputes.
It’s not just sanctions you need to worry about. There are money laundering considerations, and these might go to issues for the arbiters of the institution and the arbitrators. If there is payment to be made, then it may not just be sanctions obligations you need to be thinking about.
One final comment: let’s say you are dealing with EU sanctions in the courts of an EU member state. One of the big problems we all deal with is what is the meaning of the content of Council regulations. There’s a huge amount of ambiguity. Well, the courts of EU member states can refer those questions to the EU Court of Justice, which is the final and binding arbiter on the meaning of Council regulations. That will not be open to you if you are in an arbitration, so you may have real issues regarding the meaning of the actual sanctions that you are trying to invoke.
Hans van Houtte: Thank you. That reminds me of an arbitration I had where the different member states of the EU had implemented the EU sanctions in completely different ways. The arbitrators then had to select the sanction regime of one of the related EU Member States it would apply: was it the regime of the seat of arbitration; the one of the law of contract or the one of the nationality of the EU party?
An issue, which frequently arises in arbitration is the effect in time of economic sanctions upon the contract. After how much time do contracts become terminated instead of merely suspended by economic sanctions? Moreover, what is the position of the contracting parties when the economic sanctions are lifted? For instance, the Iran- United States Tribunal, which I preside, is already for 30 years unravelling the impact of the sanctions imposed in the 1970s and 1980s between Iran and the United States.
My question is: when does suspension turn into a termination of contract; and how do you undo the impact of sanctions when the sanctions are lifted?
Mercédeh Azeredo da Silveira: We have to look separately at the time period during which a sanction is in force and the time after it has been lifted. The question of what happens with a contract once a sanction is lifted is most interesting if the sanction has not led to the termination of the contract while the sanction was in force.
Under many civil law systems as well as under several international law instruments, such as the UN Convention on Contracts for the International Sale of Goods and the Unidroit Principles of International Commercial Contracts, a temporary impediment does not affect the existence of a contract. Contractual obligations are merely suspended.
Economic sanctions are, by nature, temporary measures – like strikes and wars. Some are imposed for a predetermined period of time (with possible extensions). And even in cases in which sanctions are imposed for an unspecified period of time, they are not intended to remain permanently in effect, but rather to be lifted once they have achieved their purpose. This is why arbitrators have held in several cases that once a sanction is lifted, the parties must resume performance under the contractual terms.
Now, one must acknowledge that many sanctions remain in effect for years, some have remained in effect for decades. A sanction’s term typically depends on the sanctioning state’s discretionary decision to lift the sanction once its coercive purpose has been achieved, perhaps not even then, if the sanction also serves as a punitive measure.
One may therefore question whether it is fair to systematically and strictly apply the rule according to which if a sanction did not lead to the termination of the contract, performance must be resumed once it is lifted. During the term of a sanction, circumstances may have changed. They may in fact have changed so radically that the contract’s implications are entirely different, once the sanction is lifted, from what was anticipated at the time of the conclusion of the contract.
In this case, the party that is disadvantaged by this change in circumstances should be able to seek some kind of relief, in particular if the applicable law deals with situations said of “hardship,” where performance has become radically more onerous or radically less profitable for one of the parties.
Depending on the solutions offered by the applicable law in situations of hardship, a party may, for instance, have the right to request a renegotiation of the contract; the right to seek a court-ordered adaptation of the contract; the right to seek an exemption from liability for non-performance for an indefinite period of time, on grounds of economic impediment to performance; or the right to terminate the contract. What justifies such relief is no longer the prohibition laid down in the sanction, but rather the fact that circumstances have changed while the sanction was in force and that it is no longer fair to expect the parties to strictly abide by the terms of the contract.
Now, let’s look at the questions that arise before the ones I just addressed – during the term of a sanction. There are a number of conditions that must be met for a party that is prohibited, under a given sanctions programme, from performing its obligations to be able to successfully seek an exemption from liability for non-performance.
Two of these conditions are particularly interesting from a dispute-resolution standpoint: a sanction will be considered an exonerating impediment, first, only if it was “reasonably unforeseeable” at the time of the conclusion of the contract and, second, only if it was reasonably unavoidable or insurmountable.
The question whether a sanction was reasonably unforeseeable must be examined on a case-by-case basis. There is no general answer, although the trade area in which the parties are active is usually relevant. Clearly, one can more easily expect an entity involved in the nuclear or the military sector to have taken into account the risk of future sanctions that may interfere with its business, than, let’s say, a manufacturer of agricultural equipment or educational material.
Also, whenever the UN Security Council or General Assembly had already passed a resolution or adopted a recommendation for the imposition of sanctions prior to the conclusion of a contract, the impediment must be considered to have been reasonably foreseeable even if domestic or community implementation measures only followed the conclusion of the contract.
More interesting is the question of whether a sanction may be avoided or overcome. The condition that the impediment be reasonably unavoidable and insurmountable implies that a sanction may constitute a ground for exemption only if the contract can no longer be lawfully performed. But if, without breaching and evading the sanction, the defaulting party could have performed its obligations, be it at greater costs and with greater effort than anticipated, exemption will be denied.
I was involved in a case in which exemption was denied on the grounds that the sanctions programme in question granted a period of time for the performance of pre-existing obligations. The arbitrators held that the defaulting party could reasonably have been expected to have advanced the performance date so as to perform its obligations within that time period.
The argument could also be made that a party may be expected to adopt an alternative route for the shipment of goods so as to avoid a prohibited transit through a certain state, although this may, of course, not be expected if the itinerary specified in the contract is crucial – for instance if the goods would perish via a longer route or if it is essential that the goods reach their destination by a certain date and this would be made impossible if the goods were to be shipped via an alternative route.
Finally, one could make the argument that a party may be expected to deliver a commercially reasonable substitute so as to avoid the consequences of a trade sanction prohibiting, for instance, exports of goods manufactured through technology developed in the sanctioning state or goods containing materials or parts that originated in the sanctioning state.
In sum, the answer to the question whether a defaulting party should be exempted from liability for non-performance on the ground that a sanction prohibits such performance is not straightforward.
Hans van Houtte: Thank you. Maya, do you have something to add?
Maya Lester: Briefly. This is obviously a matter of applicable law. The English Courts have taken a similar approach in that they will not readily say that a party doesn’t have obligations under a contract, or is relieved of them, because of the existence of a sanctions regime. For example, concepts of frustration and illegality: the courts have said in a number of cases that, only if the imposition of sanctions rendered performance completely impossible – not more difficult – illegality will lead to voidness only highly exceptionally.
One more comment. There are regimes in the EU which expressly say that you cannot satisfy a claim which is connected with a contract or transaction whose performance has been affected by the imposition of sanctions. That’s another one to look out for.
Hans van Houtte: We now arrive at the last topic and then it’s questions from the floor. Enforcement of the award. Charles?
Topic 4: Do sanctions affect the enforcement of the award?
Charles Claypoole: Once you have navigated all of these issues, you want to be in a situation where you have an enforceable award – particularly if you are the claimant – or you may want to think of potential defences if you’re on the receiving end of an award. Once you have an award or arbitration which has involved sanctions issues, there will be questions as to whether it will be open to challenge at the seat of the arbitration, or regarding the enforcement itself.
It’s generally understood that sanctions issues are arbitrable, but there are obviously questions as to whether sanctions might be applied at the seat of the arbitration. You might be in a situation where the award contains a position regarding sanctions that might form part of the applicable law of the arbitration with which you disagree. For example, the EU Court of Justice might have taken a different position. So, there will be issues there.
Regarding enforcement, there could be a number of legal and factual issues you are likely to face. It may be that an award ordering payment to a sanctioned person might be objectionable on grounds of public policy. There may be other aspects of the dispositive of the award that may arise under the New York Convention in the context of enforcement. But I don’t think getting an award is by any means the end of the story.
I would like also to highlight the fact that we talk about US and EU sanctions, but it’s not just in the US, the EU and other friendly countries where you have sanctions. You have sanctions in Russia targeted at western companies and sanctions in the Ukraine targeted at Russian companies. There’s likely to be a proliferation of issues in this general space and, if you have an award against a Russian company where sanctions have been an issue, it’s going to be incredibly difficult to enforce that in Russia.
Hans van Houtte: Brian, does OFAC care about enforcement of awards?
Brian O’Toole: That’s a good question. There are two things to think about here. I would focus on the difference between what is sanctionable conduct and what is actually a violation, because those two things are often misunderstood. If something is sanctionable, that means you get put on our list. So, for example, undermining peace, security and stability, or democratic institutions in Ukraine. That could be sanctionable conduct, right, if you’re a separatist in the east. A violation is something that’s a US person-focused concept. Basically, a violation is something a US person does that’s in contravention of US law.
So, there are two aspects here. The first is: if one of you makes an award to an Iranian party in US dollars and the payment gets routed through the United States, there’s not going to be much of an issue at your end. The payment should be blocked as it goes through the United States and that will be the end of it. It’s not necessarily going to land you in hot water.
From a violation perspective, the only time that OFAC goes outside of the US-person context is when the payment is disguised as it comes through the United States. The most well-known case is BNP Paribas, which had a system where they took the names of Iranian, Cuban and Sudanese parties out of the transaction, and routed it through the United States. It’s a concept known as “causing a violation by a US person”. If you are being transparent – as long as the payment instruction contains the name and information a US party would need to make a determination about whether they need to block or reject the transaction – that’s not going to be a problem.
Sanctionable conduct, I think, is what folks are more worried about. We have the latitude and authority to go after folks in that world, but what I would say is: “Look at what we have done in the past.” When we sanction people for their conduct – providing material support to an SDN or acting for, or on, their behalf – we tend to go after folks who are doing something bad.
Take Russia. We designated several cronies of President Putin, including Gennady Timchenko, and in subsequent rounds of designations went after people who were helping him to avoid sanctions. So, what they’re doing is taking surreptitious measures to pull his name out of things. They’re still operating companies on his behalf and we’ve gone after them for that. So, I would look to that.
In the case where you are enforcing an award and believe there might be a US sanctions nexus or a conflict of laws situation (and I’m talking from the US perspective here), it behoves you to come in and talk about it, whether it’s a licensing process or payment. We don’t want to have more licences, or a proliferation of them. So, come and talk through how you can work out the conflict of laws situation because we do realise that it comes up and we try to help people work through them, especially those who are acting as honest brokers.
Hans van Houtte: Would it be a solution when an award would confirm that an amount is due but only payable when the sanctions are lifted? Technically, such award would not breach the sanctions. On the other hand, many arbitration laws also have a sunset provision which limit the ‘shelf time’ of an award so that actual enforcement cannot be delayed for too long.
Maya Lester: That may not get you home and dry because, depending on the regime, there may be a prohibition on making resources available, or even on settling claims, where there are clauses that say you must not use economic resources to obtain funds. Even a settlement agreement can potentially trigger sanctions issues if it is seen that, having brought the claim in the first place, is using an economic resource. It shows an action to obtain funds.
Two final words. One is that arbitral awards, like court judgments, may need to consider issues of circumvention because, in most EU and US provisions, what you can’t do is structure particular transactions with the object or effect of circumventing the prohibitions. There has been a case that has gone to the higher courts here: is a court – which is itself bound by these provisions – structuring a transaction in a particular way to avoid asset-freezing in the EU itself circumventing provisions? So, circumvention is another issue.
My final comment is that Brexit will have an impact in this area. Like everything to do with Brexit, we don’t know quite how, but there are two consultations concerning what the UK sanctions policy and legal framework will be post-Brexit. One thing that is reasonably likely is that the licensing regime means that, if you obtain a licence and authorisation in one member state, it’s valid throughout the EU. As and when we leave the EU, that will not count for UK licences. It’s almost certain that, even if we follow the EU on sanctions policy broadly, we are going to be talking about the US, EU and UK as major sanctions regimes. It’s going to add an additional layer of headache to an already complicated picture.
Hans van Houtte: Thank you. I would now like to open the floor to the audience.
Topic 5: Audience Questions
Monica Feria: Monica Feria, 20 Essex Street. This is for Mercédeh. I am interested in the point you raised concerning the applying of sanctions, particularly when it came to the possibility of a foreign overriding mandatory rule. The question is: would it be that the arbitrator would be looking at a decision by the European Court that has already declared that the sanction was unlawful; or would it be a situation where there hasn’t yet been a decision by the Court but, nevertheless, you are you suggesting that the arbitrator should make his or her own judgment and decide, therefore, that the sanction should not be applied?
Mercédeh Azeredo da Silveira: I will answer this from a dispute-resolution – in particular an international arbitration – perspective.
If you have a foreign overriding mandatory rule – a sanction that is external to the applicable law – arbitrators will look at a certain number of conditions, one of them being: “Does it serve a legitimate purpose?” They have the authority to examine the interests served by one such sanction before giving it effect.
It is perfectly conceivable that no prior decision has been made, by a body other than the arbitral tribunal itself, on the question of the legitimacy of the sanction’s purpose. Arbitrators are nonetheless called to rule of the fate of a contract that falls within its scope. How should the arbitrators then assess the legitimacy of a sanction’s purpose knowing that international arbitral tribunals have no local standard to rely on?
Arguably, arbitrators must examine whether the sanction serves interests that are deemed legitimate by the international community, even if these interests are those of a single state. Thus, for instance, if a sanction is clearly based on discriminatory motives, arbitrators have the authority, arguably also a duty to disregard it if it is external to the applicable law.
Maya Lester: I find it very hard to think of circumstances in which something like that might arise. First of all, the EU Court of Human Rights would not have jurisdiction to consider the validity of a sanctions measure. So, if you are in Luxembourg, they will look at the validity of individual listings, but never declare a sanction overall to be unlawful.
Secondly, the Strasbourg cases on sanctions are few and far between. There have been two cases I know of, both involving Switzerland, which go to very specific issues about the fundamental rights of Swiss nationals being infringed because of the way in which UN sanctions were enforced. I would be very surprised if arbitrators were going around declaring individual sanctions regimes to be contrary to human rights provisions.
Hans van Houtte: Now the very last question for a short answer.
Audience member: Should a state or a state entity be entitled to rely on a sanctions regime imposed against it in order to excuse its own non-performance under a contract?
Mercédeh Azeredo da Silveira: Two questions must be examined here. The first is: Is the sanction applicable? The second is: Have all the conditions of, for instance, a force majeure defence been met?
Considering the latter question first: Depending on the circumstances in which the sanction was imposed and its timing, there may be a problem with the condition that I mentioned earlier, according to which the sanction must have been reasonably unforeseeable to the entity (or state entity) that is seeking exemption from liability for non-performance. The sanction may have been imposed very quickly in reaction to the behaviour of the target state, and it may therefore be reasonable to expect this state to have anticipated the sanctions, in which case the disputing state entity may not be able to seek relief based on force majeure.
You also raised – outside this discussion – the situation in which a state has entered into a contract and then imposed sanctions, following which it tries to get out of the contract based on those sanctions. Here, the argument could be made that the sanctions are within this state’s control and that the state therefore cannot successfully seek an exemption.
As to the first question, the question of the applicability of a sanctions programme – let us consider again the scenario you raised in your question, in which a state or a state entity is trying to rely on a sanctions regime imposed against it in order to excuse its own non-performance under a contract.
If the dispute with that state or state entity is heard by a domestic court of the same state, clearly the forum will disregard the sanction and the state or state entity in question will have to perform the contract. In this case, if, on the one hand, the sanction is external to the applicable law, it will be disregarded by the forum on the ground that it does not serve a legitimate purpose; if, on the other hand, the sanction is part the applicable law, it will be put aside by the forum on the grounds that it is in conflict with the forum state’s international public policy.
Now, if the dispute is heard by an arbitral tribunal, the arbitrators will examine the sanction. If, on the one hand, the sanction is part of the applicable law, arbitrators may disregard it if it is in conflict with principles of transnational public policy. If it is not, arbitrators will likely give effect to the sanction and free the state entity of its obligation to perform. If, on the other hand, the sanction is external to the applicable law, then I would give the same answer as the one I gave before: the arbitrators will have to look at the conditions that must be met for a foreign overriding mandatory rule to be given effect, and may or may not consider that the sanction is applicable. Hence, they may or may not consider that there is, to begin with, an impediment, before even examining the conditions of a force majeure defence.
GAR Live London was held on 15 May 2017 at Freshfields Bruckhaus Deringer. It was sponsored by Freshfields Bruckhaus Deringer, Cooley, BDO, Linklaters, Therium, Maitland Chambers and Geotext Translations.
The next GAR Live London will take place on 10th May 2018. Registration is now open and is complementary for in house counsel.