Sanctions clauses in international contracts with a Russian nexus

German Zakharov
ALRUD, Moscow
gzakharov@alrud.com

Tarkhova, Ksenia
ALRUD, Moscow
ktarkhova@alrud.com

Belova, Alisa
ALRUD, Moscow
abelova@alrud.com

Over the past few years, there has been an obvious trend towards strengthening and expanding the sanctions restrictions which foreign countries have imposed on Russia. In some cases, foreign regulators introduce sanctions with great legal uncertainty in terms of their practical application as an immediate response to changes in the geopolitical and economic environment.

As a result of the above, and the overall tightening of sanctions and countersanctions regimes, counterparties often face difficulties in fulfilling their obligations under international commercial contracts (and sometimes cannot even fulfil them at all) or in developing long-lasting relations with partners in the absence of legislative stability. Moreover, sanctions-related risks may also arise when a person is working with a non-sanctioned counterparty and products are subsequently supplied to such party for projects whose implementation is also restricted.^[1]

Despite the geopolitical environment and challenges in fulfilling contracts, a recent survey^[2] involving 5,172 representatives of foreign companies showed that 34 per cent of companies continue to operate in Russia. Only seven per cent of companies left the Russian market. Most of the respondents have confirmed that they remain in Russia and do not intend to exit the Russian market due to the available purchasing capacity, a comfortable tax regime and other benefits.

Thus, since Russia remains attractive for foreign investments as a sales market and given that goods may still be delivered to the Russian market, including through third countries and even beyond a supplier’s knowledge, certain peculiarities of the current sanctions and countersanctions legislation should be considered when doing business.

In this regard, many companies believe introducing a system of sanction compliance and the screening of counterparties and transactions could be key methods to reduce the risks of holding companies being liable for violations or imposing secondary sanctions.

Meanwhile, a sanctions clause is another instrument that could not only mitigate the risks of liability, but also provide relief from liability should it prove impossible to fulfil a contract due to restrictive measures. When properly drafted, a sanctions clause adapts the contract to the current conditions and helps to manage sanctions risks and minimise any related consequences.

From a legal perspective, the clause itself serves as a condition for exercising civil rights and fulfilling obligations upon the conclusion or execution of a contract. In this regard, a sanctions clause is a contractual provision that is drafted to address certain relationships and aspects of interaction with a particular counterparty and considers the needs and interests to be covered within the sanctions policy framework and the risk map embedded in it.

A sanctions clause is dispositive in nature and should ensure the balance of interests of the parties to the contract and reveal their attitude to possible risks. It would be impossible to formulate a standard clause that could be included in any international contract and meet the needs of both parties by default. As such, to formulate an efficient sanctions clause, the following questions should be asked each time when drafting a contract with a Russian nexus:

• What activities is our company engaged in and what markets do they concern? Who are the counterparties?
• What information do we have about the counterparty? Does it have international connections, or does it work only in the Russian market? Who are the third parties with which the counterparty interacts?
• What risks do we want to manage (eg, risks of secondary sanctions, criminal prosecution, negative consequences for our counterparties, etc)?
• What jurisdictions are in question?
• What are the risks of the sanctions clause being unenforceable?
• Is the conclusion of the contract conditional upon consent to be bound by the sanctions clause?
• What are the consequences for failing to comply with the sanctions clause?
• What is the validity term of the drafted clause?

Generally, a sanctions clause may impose various obligations on a counterparty, including, inter alia, obligations to disclose information (on partners of the counterparty, the end user of the goods, circumstances arising in the course of the fulfilment of the contract that trigger sanctions risks, etc) and to ensure compliance with sanctions restrictions by third parties with which the counterparty interacts. Some standard examples of these obligations are provided below:

• To the Party’s best knowledge, the Party is not a party to any agreement, understanding, instrument, contract or transaction with: (1) any person on the sanctions list; or (2) any person owned or controlled by a person or an entity that is on the sanctions list.
• The Party confirms that the company, its owners, controlling persons and officers are not included in the sanctions lists as of the date of the contract.
• The Party shall not conclude agreements and/or transactions with persons included in the sanctions lists.
• The acquired products shall not be used directly or indirectly in projects prohibited by the sectoral sanctions/sold to persons on the sanctions list or prohibited jurisdictions.
• The Party shall not dispose of the acquired products to any persons on the sanctions lists or to the prohibited jurisdictions without the seller’s approval.
• The Party shall conduct due diligence when selecting counterparties.
• The Party shall ensure compliance with the sanctions regime by third parties: suppliers, contractors, members of the Party’s group of persons etc.

The second component that needs to be included in a sanctions clause is the legal consequences that may arise for a breach of the obligations set out in the sanctions clause. For instance, a breach of an obligation under a sanctions clause or the emergence of/substantial increase in the risk of being included in the sanctions list if the contract is executed may grant the party the right to unilaterally repudiate the contract, the right to suspend the counter performance of obligations (eg, if the breach/risk is temporary and can be eliminated), the right to demand the early fulfilment of the obligation, as well as the right to claim damages and compensation for losses.

Moreover, a sanctions clause might be structured using other legal institutions. For instance, from the standpoint of Russian law, the sanctions clause may be formulated through the concept of indemnities^[3] (when a party who gave misleading information is obliged to compensate the other party for damages) or representation and warranties^[4] (when a party is obliged to reimburse the other party’s losses arising from the occurrence of the circumstances specified in the contract and not related to a breach of a party’s obligation).

In practice, parties sometimes refer to sanctions as a force majeure circumstance when seeking their exemption from liability for the failure to execute a contract due to sanctions. However, according to Russian civil law, a circumstance may only be recognised as force majeure if it, inter alia, meets the criteria of an emergency (exclusivity of the circumstance in the usual conditions). In this regard, since sanctions have been extensively imposed on numerous Russian individuals, Russian courts may not accept the qualification of sanctions as force majeure. Thus, a more reliable solution may be to include a contractual provision that a party is not liable for the failure to perform its obligation in the event of difficulties due to external factors beyond its control. This is possible by virtue of the principle of freedom of contract and may therefore be more willingly accepted by courts.^[5]

Moreover, when drafting a sanctions clause in a contract with a Russian nexus, the specifics of the relevant legislation should be taken into account. In particular, if an entity holds a dominant position in the relevant market (or operates as a natural monopoly), a sanctions clause may, in certain cases, entail the risks of violation of Russian antitrust legislation as abuse of dominance by way of: (i) contractual tying (imposition of unfavourable or economically or technologically unjustified contractual terms on the counterparty); or (ii) the economically or technologically unjustified refusal to conclude a contract or evading the conclusion of a contract.^[6]

Although contractual tying is generally associated with products being tied, the concept of tying under Russian competition legislation has a broader interpretation and may include the imposition of almost any terms that are unfavourable for the counterparty or are not related to the subject of the contract. The imposition of obligations on a counterparty within the sanctions clause may be regarded as tying unless it is economically or technologically justified or explicitly prescribed by Russian laws and regulations or court decisions. References to sanctions regimes or foreign regulations are insufficient for the Russian competition authority to conclude that no abuse of a dominant position has taken place.

As for the unjustified refusal to conclude a contract or evading the conclusion of a contract, if the sanctions clause allows the counterparty that holds a dominant position in the relevant market to unilaterally withdraw from a contract or to suspend the fulfilment of its obligation due to the imposition of sanctions, the authority may regard such a provision as an abuse of a dominant position. As a result, economic justification should also be provided to mitigate the risks of a violation of Russian antitrust legislation.

One more important factor to consider is that a sanctions clause explicitly referring to a specific sanctions regime or restrictive measures adopted by foreign regulators might be unenforceable in Russian courts. In this regard, as recommended earlier, for contracts with a Russian nexus, it would be better to provide a basis for economic or technological justification, rather than solely referring to compliance with sanctions.

Conclusion

In conclusion, a sanctions clause is an efficient instrument to manage sanctions risks within international commercial contracts and can be used to stipulate various obligations for the counterparty, as well as to envisage the legal consequences of their breach. However, there are certain issues to be considered when drafting the relevant contractual provisions. In particular, when embedding a sanctions clause into a contract with a Russian nexus, special attention should be paid to justifying the obligations imposed on the counterparty and providing a rationale for how sanctions may impede the fulfilment of the obligations under the contract, while avoiding a sole reference to sanctions regimes.

As we can see, counterparties are increasingly wary of secondary sanctions, and any scheme that is in the ‘grey’ zone may raise concerns. Meanwhile, improper risk management could lead to the disruption of transactions and delayed payments, while overcompliance could also result in stagnation in business. As such, in order to properly manage risks, it is crucial to pay proper attention to compliance checks and adapt contractual obligations to the current situation and geopolitical environment.

Since Russia is still an attractive jurisdiction for conducting business despite the current geopolitical situation, reliable compliance, checks and due diligence when concluding contracts with counterparties, consideration of export control provisions and preparing effective instruments, such as sanctions clauses, could help to ensure that business functions properly identify and respond to risks in due time, and mitigate negative consequences in the event that they are inevitable.