Imposition of Economic Sanctions: An Embargo on International Commercial Arbitration?

Author: Charvi Krishna*

I. INTRODUCTION

It is accepted that with the rise in global economic growth, there is also a rise in geopolitical issues. Owing to these issues, one or more countries impose economic sanctions and financial penalties against a particular state. These stem from targeted nations indulging in unfair trade practices, terrorist activities, the proliferation of nuclear weapons, or violation of international norms, among others. In order to condemn such actions, other countries implement a decision against the targeted state in the form of sanctions. This can be seen in instances such as the U.S. and the E.U. imposing sanctions on Russia following the events in Ukraine in 2014 and 2022. Though this instrument is primarily a diplomatic and economic decision,[1] it does have strong implications for the trade and commerce between these countries. Thus, this invariably affects the business community comprising corporations, organizations, and private individuals.

Private individuals tend to stray away from international decisions and policies. However, the imposition of economic sanctions creates a setback when these parties aim to resolve their disputes through arbitration. An arbitration process intrinsically reflects flexibility, neutrality, a consensual approach, and speedy disposal of cases. With the imposition of sanctions, these fundamental principles of arbitration are undermined. It impacts not only the parties involved but the entire process of arbitration—ranging from initiation of claims, substantive issues in the dispute, and consequently, the enforceability of the arbitral award. This article will analyze the effects of economic sanctions at each stage of an arbitration proceeding by referencing various case laws and provisions prevalent in common and civil law jurisdictions.

II. FIRST STAGE: DETERMINING ARBITRABILITY OF THE DISPUTE WHEN CLAIMS ARE INITIATED

Arbitrability essentially involves determining the kind of dispute that can be resolved through arbitration or those that fall exclusively in the national courts’ domain.[2] This is also reflected in the Convention on the Recognition and Enforcement of Foreign Arbitral Award, 1958 (“New York Convention”), along with the UNCITRAL Model Law on International Commercial Arbitration. It states that enforcement of an arbitral award can be denied if courts conclude that the nature of the conflict cannot be settled through arbitration. Moreover, arbitrability can also be divided into objective arbitrability (ratione materiae) and subjective arbitrability (ratione personae).

1. Objective arbitrability refers to cases that can be validly submitted to arbitration.
2. Subjective arbitrability refers to the capacity and competence of parties to enter into an arbitration agreement that is valid and binding.

In situations where economic sanctions have been imposed, the objective arbitrability of a dispute plays an imperative role. This is due to the simple fact that arbitration is a private proceeding with public consequences. At the stage of initiation of claims, courts and other tribunals consider the basic principle of party autonomy and the doctrine of separability. It is possible that the main contract is rendered invalid or the contractual obligations cannot be performed owing to the imposition of sanctions. However, the arbitration clause’s validity will remain unaffected, as has been held by various courts and tribunals, which are discussed below. National courts have further accepted that disputes involving sanctions will be arbitrable since, in most cases, it is uncommon that the resolution of a dispute arising from a commercial transaction would have a huge impact on public law and policy.[3] Allowing the tribunals to proceed with the arbitration proceeding has preserved the core tenet of Kompetenz-Kompetenz.

A. Arbitrability of Dispute: What the Courts have held

In Fincantieri v. Ministry of Defence of Iraq[4], a contract entered for the sale of military goods to Iraq between two Italian shipbuilding companies and a private individual from Syria came into conflict with the imposition of sanctions on Iraq by the U.N. Security Council. Arbitration initiated against the two Italian companies raised the issue of arbitrability of the dispute owing to the sanctions. An interim decision was granted by the arbitral tribunal, which differentiated between the dispute’s inarbitrability and the effect of sanctions on the merits of the dispute. Even if the sanctions regime impacts the law related to the substantive issues of the dispute, it will not render the dispute inarbitrable. Though the Swiss Federal Tribunal further confirmed this, it did caution the parties that the dispute’s arbitrability can contravene Switzerland’s public order. This would pose a threat at the time of enforcement of the award. Nonetheless, the sanctions regime did not have any influence on the arbitrability of the dispute.

A similar approach was taken in La Compagnie Nationale Air France v. Libyan Arab Airlines[5]. An international embargo imposed by the U.N. Security Council affected the contract entered between the Parties. Notably, the wording of the U.N. Resolution specifically denied any claims at the behest of any Libyan national or undertaking concerning a commercial contract or operation. Consequently, Air France claimed inarbitrability of the matter. The Québec Court of Appeal, while rejecting the claims of Air France, gave discernments regarding the nexus between the sanctions regime and the dispute’s arbitrability. After paying heed to the language of the Resolution, the Court created a distinction between the claims arising before and after the Resolution. By doing so, the temporal nature of sanctions was established wherein the tribunal must determine issues arising before and after the Resolution without violating public order and established rules of public international law.

B. Concerns: Parties Evading Applicability of Sanctions

While most courts have held that disputes affected by sanctions are arbitrable, certain courts have also alluded to their reservations. In cases where it is evident that the agreement’s purpose was to evade sanction regulations and mandatory rules, the arbitration agreement will be struck down.[6] Thus, as long as parties are not attempting to escape the mandatory regulations, the arbitrability of a dispute tainted by economic sanctions will be arbitrable.

Apart from this, subsequent Security Council Resolutions have adopted the same wording as in the Air France case. Even though courts and tribunals would confirm the arbitrability of the dispute, the substantive issues might be inadmissible owing to the language of the sanction regulation. Hence, the arbitrability of a dispute apropos of sanctions would depend on three factors: 1) the language of the regulation, 2) the law governing the seat of arbitration. and 3) the law of the arbitration agreement.

III. SECOND STAGE: ADDRESSING SUBSTANTIVE ISSUES AMIDST HARDSHIP AND FRUSTRATION OF CONTRACTS

The imposition of economic sanctions has a considerable bearing on the substantive issues of a dispute. A contract riddled with economic sanctions would lead to parties seeking to extricate themselves from contractual obligations. The invalidity of the contract or the impossible performance of the contract are the consequences of a prevalent sanction regime. In situations where sanctions do not apply to the substantive law of the contract, the arbitral tribunal will have to analyze three conditions. Firstly, sanctions must apply to the matter as per the wording of the requisite legal instrument. Secondly, a jurisdictional link between economic sanctions and contractual obligations should exist. Lastly, the arbitrators should consider sanctions only when all elements of the case have been scrutinized.[7] This brings in the issue of the parties’ right to end the commercial relationship by terminating the contract to reduce their liabilities and damages. Both common and civil law jurisdictions have mechanisms in place regarding the avoidance of a contract.

A. Common Law versus Civil Law Remedies

In English common law, the frustration doctrine can discharge contractual obligations when an unforeseen event renders the contract impossible. English law governing the contract can terminate it if some event occurs post the formation of the contract, which renders it commercially impossible to perform.[8] Recent case laws depict that parties affected by sanctions would not automatically frustrate the contract. In a case wherein a license was sought from the relevant authority for the performance of the contract instead of sanctions, the contract cannot be frustrated.[9] Where no application was made to procure a license, the Court has to be satisfied that obtaining a license would have been inconsequential.[10] To successfully claim the frustration of the contract due to sanctions, it must be proved that obtaining a license was impossible even after several attempts.[11] Hence, the courts narrowly construed the doctrine of frustration by allowing parties to fulfill contractual obligations.

In civil law jurisdictions, the hardship concept has replaced the frustration doctrine. This refers to instances where once the contract has been concluded, a drastic change in the circumstances renders its performance impossible and burdensome.[12] Civil law countries include hardship provisions in their civil codes which become applicable for international contracts governed by their laws, especially in sanctions-related matters. For instance, the Swiss Code of Obligations allows for a contractual obligation to be relinquished when the performance becomes impossible in situations not imputable to the obligor.[13] Similarly, the Russian Civil Code states that the impossibility of performing contractual obligations would lead to its termination in situations where neither party was responsible.

Additionally, the obligation would be terminated when performance becomes impossible due to an act by a State or local authority.[14] In June 2020, the Commercial Procedure Code was amended in response to Russian sanctions.[15] This amendment established exclusive jurisdiction of Russian commercial courts in matters involving a sanctioned Russian entity. These sanctioned parties can also seek anti-suit injunctions against foreign courts or arbitral tribunals, rendering sole jurisdiction to the Russian courts. Thus, it allows sanctioned Russian entities to contravene mutually agreed contractual terms for dispute resolution through arbitration. The consequences of such a decision are yet to be seen.

B. Private Law Instruments & Economic Sanctions

Before delving into the international law instruments that govern commercial contractual transactions, arbitral tribunals and courts have adopted two types of approaches to understanding the applicability of sanctions in a dispute. This comprises, first, the traditional datum approach, which implies that an economic sanction imposed by a nation separate from the state whose law is applicable must be regarded as a datum, i.e., an element of fact.[16] Hence, the law of the contract must be given supremacy in determining the illegality or invalidity of the contract.[17] The second approach, i.e., the legal norm approach, consists of tribunals and courts giving effect to provisions not part of the applicable law, such as economic sanctions.[18] These are considered the “overriding mandatory provisions” applicable in all situations regardless of the law governing the main contract. It is the second approach that tribunals prefer since economic sanctions are considered to override mandatory rules.[19] It provides a more nuanced solution as the tribunal or courts must ascertain the contract’s validity mechanically by scrutinizing the legal and factual circumstances of the case. However, in terms of the performance of the contract, the factual element is considered a better approach without deciding its legal applicability.[20] This dichotomy of approaches has made it difficult to establish a universal and uniform approach.

Other than the domestic laws applicable to a contract, parties also opt for international law instruments such as the United Nations Convention on Contracts for the International Sale of Goods (“CISG”). Article 79 of the CISG states that a party will not be held liable for failure to perform his obligations because of an impediment beyond his control and not reasonably foreseeable. Several arbitral awards have applied this provision to exonerate the liability of a party because of the imposition of sanctions.[21] Similarly, the UNIDROIT Principles of International Commercial Contracts, 2016 (“UNIDROIT Principles”) provide similar provisions under Article 7.1.7 for non-performance due to an unexpected impediment. Liability for non-performance of a contract governed by these legal instruments can be dealt with in two situations: 1) exemption from liability when the sanction is still in force, and 2) adaption in contracts when the sanction has been lifted.

In the first instance, embargos and restrictions made outside the control of private parties would be considered by arbitral tribunals as impediments under the CISG or UNIDROIT Principles, thereby absolving the party from any liability.[22] However, this situation is different when the seller’s supplier is affected by the imposition of sanctions. The seller cannot claim non-performance as they possess the risk of procurement, i.e., their contractual duty is to supply the goods. The party will thus have to look for a commercially viable substitute to evade liability.[23] Concerning the second instance, CISG and UNIDROIT Principles provide for adapting or re-negotiating contracts once the sanction has been lifted. Sanctions, essentially, are temporary. However, for every sanction, the period for which it is effective varies. Only when time is of the essence can the sanctions be viewed as an impediment. In contracts where time is not essential, tribunals have ordered a resumption of performance.[24] After the sanctions are lifted, situations can change so radically that the intention of the contract itself becomes difficult to fulfill. Hence, parties can adapt and alter their contracts as given in Article 6.2.1 of the UNIDROIT Principles. While the CISG does not specifically allow for the re-negotiation of contracts, following the good faith and uniformity principle imbibed in Article 7, parties can alter their contracts to suit their commercial needs and mitigate their losses. Therefore, the imposition of economic sanctions can drastically impact the substantive issues in an arbitration proceeding. Lex contractus and favor contractus are two principles that enable arbitral tribunals to determine the parties’ liability and the contract’s validity.

IV. FINAL STAGE: ENFORCEABILITY OF AN ARBITRAL AWARD AND OBSTACLE OF PUBLIC POLICY

Suppose a dispute affected by sanctions has completed the arbitration process, and an award has been rendered. The next and last stage would be recognizing and enforcing this foreign arbitral award by the requisite domestic court. The New York Convention, 1958, is a leading international instrument for recognizing and enforcing foreign arbitral awards. Article V(2) of the Convention lays down two conditions for which enforcement of an award can be denied. First, if the substance of the dispute cannot be resolved through arbitration as per the law of that country, and second, if the public policy of that country does not allow for recognition and enforcement of the award.

The first condition deals with the issue of arbitrability, which, as discussed above, depicts that courts usually allow for a dispute to be arbitrable irrespective of sanctions. However, at the enforcement stage, the legal regime of the nation where enforcement, if sought, can raise issues regarding arbitrability. Thus, the arbitrators have the duty to ensure that concerns with respect to enforcement and arbitrability are considered beforehand so that no conflict arises later.[25] The subsequent condition of Article V(2) has become a root cause for the non-enforceability of arbitral awards, especially in relation to economic sanctions.

A. Article V(2)(b): Public Policy Concerns

The second condition says that recognition and enforcement of an award that contravenes and violates the country’s public policy where enforcement is sought will be refused. The term “public policy” has been debated regarding its interpretation since it varies from State to State. Even though the wording in the provision is quite broad, it must be interpreted with caution.[26] The imposition of economic sanction raises whether the decision rendered amid a sanction contravenes the concerned State’s public policy. In this regard, the U.S. Court of Appeals adopted a liberal approach in the pivotal judgment of Parsons & Whittemore Overseas Co. v. RAKTA.[27] It held that a narrow interpretation should be given to the provision, and a valid foreign arbitral award should not be refused unless its enforcement violates the basic principles of morality and justice of the concerned State. It would be parochial to consider sanctions as devices that protect the nation’s political interests. Subsequent cases have also upheld and applied the ratio in Parsons & Whittemore, promoting uniformity.[28]

While most national courts have adopted this liberal approach, its application is limited in the face of unilateral sanctions imposed, for instance, by the U.S. and the E.U. against Russia and counter-sanctions enforced by Russia. Economic sanctions are considered mandatory provisions under E.U. law. Consequently, they will be deemed as a matter of public policy. Furthermore, Russian courts have rejected enforcement by holding sanctions as a part of public policy. In a case where a North Korean insurer applied for enforcement of the award, it was rejected based on sanctions imposed by the U.N. against North Korea since it contravened public policy.

Moreover, an award rendered in favor of a Ukrainian claimant by the ICC was rejected by a Russian court. It cited that the claimant’s director was mentioned in the list published along with the sanctions imposed by Russia against Ukraine.[29] Notably, it overlooked that only the director and not the company were on the list of sanctioned entities. Therefore, instead of applying a more liberal approach in the U.S. and the E.U., courts in Russia have followed the contrary.

V. CONCLUSION: THE WAY FORWARD

The potent impact of economic sanctions on international arbitration is evident at every stage of the resolution of the dispute. It threatens the core tenets of international arbitration by targeting party autonomy, efficiency, and timely disposal of cases. Nations tend to preserve their interests, especially when political tensions run high. This affects private parties entering into commercial relations. The issue of economic sanctions vis-à-vis international arbitration is still nascent due to little uniformity in its resolution. Certain recommendations that can be taken into consideration to ensure the successful completion of the arbitration process are:

1. Diligent approach by arbitrators: Economic sanctions affect the decision-making power of arbitrators. They must consider the binding provisions of sanctions, the regimes applicable in the parties’ states, and the seat of arbitration. Strict compliance with all measures would ensure that there is no breach in the rendering of the award.
2. Role of Arbitral Institutions: Arbitral institutions have the duty to also follow the same standard of compliance as arbitrators. Issues regarding advance costs, fees, and appointment of arbitrators can complicate matters involving sanctions. Only a few arbitral institutions, like the London Court of International Arbitration (“LCIA”), include sanctions in their rules. Hence, arbitral institutions must ensure that with the rise in geopolitical issues and imposition of sanctions, certain measures are reflected in their rules and guides, which satisfy the concerns of the parties involved.
3. Uniformity by national courts: Lastly, national courts from different jurisdictions apply different interpretations to recognize and enforce an arbitral award. A pro-arbitration stance must be maintained across jurisdictions by granting enforcement of arbitral awards.

* Charvi Krishna is a recent law graduate from Symbiosis Law School, Pune. She will be working as a Case Manager at the Mumbai Centre for International Arbitration. Her areas of interest include International Commercial Arbitration and Commercial Litigation.

[1] European Commission—Restrictive Measures, European Union External Action, available at: https://eeas.europa.eu/archives/docs/cfsp/sanctions/docs/index_en.pdf.

[2] N. Blackaby et al., Redfern & Hunter on International Arbitration, 110 (6^th ed., Oxford University Press 2015).

[3] Belship Navigation Inc v. Sealift Inc., 1996 AMC 209 (S.D.N.Y., July 28, 1995); G. SA v. V. SpA, 28 April 1992, DFT 118 II 193, c.5 c.a.a.

[4] Fincantieri Cantieri Navali Italiani SpA and OTO Melara Spa v. ATF, ICC Award No. 6719, 25 November 1991.

[5] La Compagnie Nationale Air France v. Libyan Arab Airlines, CanLII 35834 (2003), (Quebec Court of Appeal).

[6] BGH, June 15 1987, II ZR 124/86; OLG Munchen, 17 May 2006, 7 U 1781/06.

[7] H. Van Houtte, Trade Sanctions and Arbitration, (1997) 25 International Business Law 166, 168.

[8] Chitty on Contracts, 23-001 (29^th ed. Sweet & Maxwell Ltd., 2004).

[9] Melli Bank v. Holbud, [2013] EWHC 1506 (Comm).

[10] Windschuegl (Charles H) v. Alexander Pickering & Co., (1950) 84 Ll. L. Rep. 89.

[11] DVB Bank SE (DVB) & Ors. v. Shere Shipping Company Ltd. & Ors., [2013] EWHC 2321 (Comm.).

[12] Christoph Brunner, Force Majeure and Hardship under General Contract Principles: Exemption for Non-Performance in International Arbitration, (Kluwer Law International, 2008).

[13] Swiss Code of Obligations, Article 119, 1912.

[14] Russian Civil Code, Article 417, 1995.

[15] Russian Federal Law No. 171-FZ, 8 June 2020.

[16] Aurore Marchand, L’embargi en Droit du Commerce International, 247 (Larcier, 2012).

[17] Foster v. Driscoll & Ors., [1929] 1 KB 470; Regazzoni v. K.C. Sethia, [1958] AC 301; BGHZ 1961, 169, 21 December 1960.

[18] Mercedeh Azeredo da Silveira, Economic Sanctions and Contractual Disputes between Private Operators, in Research Handbook on UN Sanctions and International Law, 337 (Edward Elgar Publishing, 2017).

[19] Catherine Kessedjian, Mandatory Rules of Law in International Arbitration: What are Mandatory Rules?, 2007 American Review of International Arbitration 147, 148; Marc Blessing, Impact of the Extraterritorial Application of mandatory Rules of Law on International Contracts, in N. Vogt Swiss Commercial Law Series, Helbing & Lichtenhahn 5 (Vol. 9, 1999).

[20] A Barraclough & J Waincymer, Mandatory Rules of Law in International Commercial Arbitration, 6 Melbourne Journal of International Law 206, 217 (2005).

[21] Ukranian Coal Case I, Arbitration Court at the Bulgarian Chamber of Commerce and Industry, 24 April 1996-56/1995; Yugoslav Caviar Case, Arbitration Court at the Hungarian Chamber of Commerce and Industry, 10 December 1996-VB 96074.

[22] Macromex Srl v. Globex International Inc, American Arbitration Association, 23 October 2007-50181T 0036406 (Interim Award); National Oil Company v. Libyan Sun Oil Company, Case 4462, (1991) Yearbook of Commercial Arbitration 54, 61.

[23] Id. at 12, p. 324.

[24] Id. at 22; Belship Navigation Inc v. Sealift Inc., 1996 AMC 209 (S.D.N.Y., July 28, 1995); ICC Award No. 7575 (2010).

[25] Louis Kossuth, Transnational (or Truly International) Public Policy and International Arbitration, in Pieter Sanders (ed), Comparative Arbitration Practice and Public Policy in Arbitration, 272 (Kluwer Law International 1987).

[26] M. Paulsson, The 1958 New York Convention in Action, 225 (Kluwer Law International, 2016).

[27] Parsons & Whittemore Overseas Co. v. Societe General de l’Industrie du Papier (RAKTA), 508 F.2d 969, (2d Cir, 1974).

[28] Ministry of Defence of the Islamic Republic of Iran v. Gould Inc., 887 F.2d 1357; MGM Productions Group v. Aeroflot Russian Airlines, (2003) 573 F.Supp 2d 772 (SDNY); Iranian Co. Z v. Swiss Co. X, Case 4A_250/2013, 21 January 2014 (Swiss Federal Tribunal).

[29] Decree of Commercial Court of Moscow Circuit of 11.02.2019, Case No. N F05-24305/2018.