Russia and Ukraine sanctions - Their effect on contracts: Top 10 Tips
The sanctions currently being imposed by the EU and the USA since show no sign of being relaxed – indeed, their nature and scope are increasing. In addition, although previously the sanctions regimes of the EU and the USA have proceeded in unison, the USA is now imposing sanctions which the EU either has not, or will not, be imposing itself, and this trend is likely to continue. Combined, these factors give rise to two simple questions:
- What do you do when you are required to perform a contractual obligation when that performance is illegal as a result of a sanction?
- What do you do when performance of that contractual obligation is legal under the laws of one county (the UK) but illegal under the laws of another country (the USA)?
Even though the situation in relation to Ukraine and Russia is changing almost daily, the imposition of previous sanctions regimes means there is already settled law on many of the questions that are likely to arise now. The basic rules are as follows:
English law contracts void from the outset
1. An English law contract is unenforceable by both contracting parties if its true purpose or ultimate objective is the break the laws of England. So a contractual obligation which on the face of it is enforceable automatically becomes unenforceable if the real purpose of the contract as a whole is to "sanctions bust".
2. An English law contract is unenforceable by both contracting parties if its true purpose or ultimate objective is to break the laws of a foreign and friendly State (here, the USA). This is because it is wrong for an English Court to enforce a contract which, if it had it been an agreement to break the laws of England, would have been void for illegality.
But this only applies if the contract in question has to be performed in that other country – the USA. If the contract is legal under English law, and is to be performed in England, the fact it is illegal in the USA makes no difference to the obligation to perform.
English law contracts which become unenforceable
3. An obligation under an English law contract which was legal in both England and the USA at the time the contract was made can become unenforceable in England if its performance later becomes illegal in the country (the USA) where the contract is to be performed.
But this only applies if that performance has to or could, but need not, be performed in such a way as to result in illegality in the place of performance: what matters is whether performance itself necessarily involves an illegal act. This will be the case if the contract requires performance in a particular (now illegal) way, otherwise the fact that performance is now more difficult than originally anticipated does not matter – before the obligation to perform no longer exists, performance must be impossible except by committing a criminal offence.
4. An obligation under an English law contract which was legal in both England and the USA at the time the contract was made remains enforceable in England even if its performance later becomes illegal in the county (the USA) provided the contract does not need to be performed in the USA.
English law contracts which remain enforceable
5. The usual situation here is that (i) a USA sanction makes performance illegal, (ii) the law of the contract is not US law, (iii) performance does not have to take place in the USA either, but (iv) the party who has to perform has business or assets in the USA. The problem arises because of the "extra territorial" nature of US sanctions (they apply throughout the world so technically, anyone, anywhere, can be in breach of them) and because the US and UK sanctions regimes are no longer identical. The problem will arise when a US company cannot (as a result of the US sanctions) deal with a sanctioned person, but its UK subsidiary can (there is no equivalent UK sanction), and must (there is a contract with the sanctioned person which requires it to perform).
Legally, the principle is that the UK subsidiary must perform, and its parent must face the US sanctions consequences. But in reality this principle is uncertain for two reasons:
- English case law arises mainly from the First and Second World Wars, and the decisions which gave rise to this principle prevented English companies from paying money to hostile countries with whom England was at war where "the courts will give no assistance to proceedings which would lead to enrichment of an alien enemy". The Russian Federation is not an "alien enemy".
- The principle itself is based on public policy. This is a concept which has been described as "an unruly horse, which when you get on it you never know where it will carry you". Here, the public policy of both England and the country where performance is to take place, including their relations with both the USA and the Russian Federation, are relevant and cannot currently be predicted with certainty.
Foreign law contracts
6. The usual situation here is that one, more, or neither of the contracting parties is based in the USA, performance is to take place in the UK, but the governing law of the contract is New York law, and that law says that performance is illegal. Here, the general rule is that the English court will give effect to that law and decide that the contract does not need to be performed.
Claiming "Force Majeure"
7. "Force majeure" typically excuses a party from performing where there is an event beyond the parties' control, and will either suspend performance whilst the "force majeure" exists, or relieve a party completely from further performance. Sanctions might be thought to be a classic case of "force majeure". But under English law "force majeure" does not arise automatically on the happening of an unexpected event, nor is it implied into a contract – it only arises when the parties have agreed a "force majeure" clause in their contract, and when the unexpected event in question is covered by that clause.
8. If there is no express "force majeure" clause, it will still be possible to claim it has arisen if the contract is governed by a law which implies such a provision into a contract, although usually it will be necessary to show that all possible steps were taken to avoid the problem but performance remained impossible.
9. The fact that a counterparty has been made the subject of sanctions (either UK or USA) after the contract was entered into does not mean the contract is automatically frustrated because it is, now, impossible to perform without breaking the sanctions : it is only frustrated if it is impossible to perform in fact. The sanctions imposed to date by both the USA and the UK have a mechanism in place under which permission from the relevant Government Authority can be applied for to e.g. make a payment to a sanctioned person. As such, performance is not impossible unless and until an application has been made for that permission, and has failed.
Impact of Russian law
10. The final situation is where performance is illegal as a result of either UK or US sanctions, but legal as a matter of Russian law. A Russian court, applying its own rules, can decide not only that it has jurisdiction to decide the case (for example because one of the parties is Russian, the subject matter of the dispute is in Russia, or the cause of action arose in Russia) but also that the non-performance (to comply with UK or US sanctions) provides no defence to a claim for breach and an award of damages. Although it would be difficult, if not impossible, to enforce such a judgment in either the UK or the US, that judgment could be enforced against assets located in Russia or, in principle, in one of the countries with which Russian has a reciprocal judgment enforcement treaty.
Simon Moore frequently advises clients on the international recognition and enforcement of judgments and arbitration awards.