The year of sanctions – some lessons learnt

Sanctions have been imposed against Russia since the invasion of Crimea in 2014. However, the full scale invasion of Ukraine in February 2022 has led to unprecedented sanctions being imposed by various authorities, not only in those jurisdictions most commonly associated with setting the agenda on sanctions. Tools never used before are now being applied for the first time. International trade is becoming increasingly difficult and cumbersome, particularly in areas such as energy, transport and commodities.

Violations of sanctions can lead to a wide array of adverse consequences, including civil and in some cases criminal liability: vessels being sanctioned, seized or delayed, or termination of credit facilities or key services such as insurance. The list of trading restrictions seems ever expanding. Needless to say, many operators have a rather low risk appetite when it comes to sanctions, but on the other hand, losing key business streams or ending up in legal disputes by adopting an unnecessarily restrictive approach is also undesirable.

Risk-based triggers are preferable

Sanctions clauses are essentially specialised ‘change of circumstances’ clauses, in the same family as force majeure, hardship, change in laws, and price revision clauses. Their purpose is to provide a framework for the parties to respond to certain events. As such, they tend to have two main components – a trigger telling you when the clause applies, and an operative part providing for the consequences, usually suspension and/or termination of the contract, but more nuanced provisions can also be used in certain cases.

The trigger will typically include a list of events, such as the designation of a party or its owner on a sanctions list, and/or a more general provision triggering the clause if performance of the contract would lead to a breach of sanctions (for example, the import of a prohibited commodity).The latter provision, i.e., sanctions events which do not amount to designation of a party, can be particularly important. Sanctions do not always fit into pre-defined categories, and in our experience a carefully worded trigger provision can be invaluable to avoid disputes.

In a dispute, a court or tribunal will start by analysing the applicable sanctions laws and jurisdiction, and then make a decision as to whether the clause applies to the relevant factual matrix (or if there is an ‘at law’ rule to follow), based on the preponderance of the evidence available. These cases frequently present evidential difficulties. For example, it may not be possible to establish whether one person should be ‘deemed’ to control another for sanctions purposes, because such an arrangement will likely have been put in place secretively and with a view to circumvention (as we note below). More generally, it can be difficult to obtain materials from certain closed corporate registries to evidence ownership, or it may be necessary to seek expert guidance as to whether certain products fall within the scope of what is prohibited under trading restrictions.

In simplified terms, the court or tribunal will assess whether it is more likely than not that a trigger event took place, and the natural interpretation of the clause governing the parties’ response to that trigger. If it is found that the relevant activity does not breach sanctions, or there is an appropriate contractual remedy that ought to have been adopted, then a terminating or suspending party may themselves be at risk of being in breach of contract. Our experience is that most corporations would rather risk a breach of contract than a violation of sanctions if forced to take a choice in this respect, given the potential severity of consequences of a sanctions violation.

A good contractual solution, particularly for longer-term contracts or those that may be exposed to geopolitical risk, is a risk-based trigger, rather than a trigger requiring an actual sanctions violation. In our experience, proving that performance of an activity “exposes” a party to “risk of sanctions violation” or even “may/could” breach sanctions, is significantly simpler than proving that performance actually breaches sanctions. It would in such cases usually be reasonable to act based on an independent legal opinion indicating the relevant risk, even if the position is not wholly certain.

Designations

Many of the sanctions directed against the Russian Federation after the full-scale invasion of Ukraine have targeted wealthy individuals said to be close to and/or to have benefitted from President Putin’s kleptocratic regime, also known as oligarchs. The US Treasury Department in 2018 published a list of 114 senior political figures close to Putin and 96 oligarchs with a net worth of USD 1 billion or more. Many of these oligarchs have been sanctioned by various authorities since February 2022 or earlier.

Sanctions against oligarchs typically take the form of asset freezes, which in respect of EU and UK sanctions means that all funds and economic resources belonging to, owned, controlled or held by the designated individuals (directly or indirectly) must be frozen. Further, no benefit should be provided to designated individuals, directly or indirectly. These provisions are drafted and interpreted widely. This effectively prohibits trade with both the designated individual, and any companies which they control or have majority ownership in.

US sanctions rather clinically focus on ownership under the so-called “OFAC 50% rule”. Under EU and UK legislation it is also relevant whether the individual may be deemed to control the relevant entity, a test which is highly fact based and can potentially apply in cases with minority ownership by the designated individual. In the UK, we must also consider if there are reasonable grounds to suspect that a party is owned or controlled by a designated individual, which adds an additional layer of subjectivity to an already complex assessment.

A typical response by companies which have designated individuals as managers or shareholders, is to have the designated individuals resign from relevant positions, and divest themselves of their direct or indirect shareholding positions (to below 50%). While this is done legitimately in some cases, these arrangements can involve attempts to disguise continuing control, for example by (i) ownership through trusts or frontmen, (ii) ownership located in jurisdictions with limited transparency as regards beneficial ownership, and/or (iii) unknown or circular ownership. These have been a rather common method since oligarchs first became targets of US and EU sanctions after Russia’s 2014 invasion of Crimea.

For the counterparty, the challenge is that control may be exercised through other mechanisms than management positions and ownership. New managers and owners may have informal links to the sanctioned individuals, and the new owners’ finance arrangements may ultimately leave control with the former owner. Like in the case of the sanctions clause trigger, the counterparty may end up in an evidentiary dilemma. It is in our experience very difficult to prove your suspicions of hidden means of control. While it is possible, it will often involve a very deep dive into publicly available sources and require assistance from local investigators and experts. On the other hand, sanctions authorities (such as the UK) may require you to suspend trade if you have cause to suspect that the sanctioned individual remains in control.

Change of control

For parties who need to manage the risk of future designations within their counterparty (starting from an assumption that the trade and counterparty is presently not sanctioned), one solution is a ‘change of control’ provision within the sanctions clause. It may also be helpful to add such provisions elsewhere, including with respect to credit support providers or other entities expected to perform activities under the contract. Change of control clauses are common in contracts where the ownership and/or control of your counterparty is essential, and allow a party to terminate the contract in case of a change in control of the other party. (Corporate lawyers will recall searching for such clauses in due diligence with some trepidation!).

In a sanctions clause, the change of control can work in two ways. Firstly, it can be used within a sanctions clause to solve the above evidentiary dilemma – where there is any divestment or change in ownership reported, that can be relied on – rather than seeking to ascertain the full facts of the new ownership or any subjective control issues. This enables termination or suspension based solely on the purported divestment. Secondly, an analogous provision can be used to enable termination or suspension unless there is a change in control, change in management or novation of the contract. That may be appropriate where there is a crucial long-term supply to be maintained, which can lawfully be continued if the involvement of designated persons is removed. There are still risks in this scenario that would need to be considered on a case by case basis, i.e., there may be apparent compliance with the designated person retaining informal control.

What else?

In any consideration of a sanctions clause or of general sanctions risk, it is necessary to consider whether a general clause is sufficient, or whether a more bespoke provision needs to be put in place. Particular industries will also carry their own particular risks (and in some cases have their own standards to work from). For example, industries which involve multiple deal participants or which may operate in more opaque jurisdictions (such as shipping, offshore drilling, and international trade), will usually require greater due diligence. It can be helpful in such cases to place a higher burden on the counterparty in terms of representations and warranties as to their own compliance/reporting, and not rely solely on a trigger becoming apparent.

In addition to updating your sanctions clause, you may want to use the momentum to update your sanctions compliance programme. A fundamental element in this regard is to conduct a sanctions risk assessment that considers the specific risks of your business, including clients, products, services and geographic locations. Mapping and assessing risks – also looking forward – may be particularly useful now in light of the tense world situation, not only due to Russia’s war, but also tensions in China and Iran.

Our sanctions team can help with practical compliance programmes, drafting effective sanctions clauses, and managing sanctions disputes. Please get in touch if you would like further information or assistance.