Conflict and sanctions – key considerations for contracts 

April, 2022 - Shoosmiths LLP

Here we look at some of the possible avenues to explore in relation to contracts governed by English law if you are affected by events unfolding in Ukraine.


Reviewing your contracts might seem like a minor inconvenience compared to what has been happening in Ukraine over the last month or so.


There are, however, numerous reasons that organisations will need to do this given the significant disruption to the supply chain and the fact that sanctions have been, and are continuing to be, imposed in relation to Russia. Here we look at some of the possible avenues to explore in relation to contracts governed by English law considering the current landscape.


I have heard a lot about sanctions. What are they?

Russia is no stranger to sanctions; however, February 2022 saw a wave of new tougher sanctions being imposed with others following shortly afterwards, including in relation to Belarus. There may also still be more sanctions to come.


Sanctions can be tricky and complex to navigate. Please see Russian sanctions update - March 2022 (shoosmiths.co.uk).


If you are faced with the reality of dealing (directly or indirectly) with a party that is either named on a sanctions list, or which is controlled by a person or organisation on a sanctions list, or where there are trading restrictions relating to contract goods, then urgent action to look at your contracts is required.


While historically there are relatively few reported cases of sanctions breaches in the UK, the consequences of breaching the requirements can be extremely serious – in some situations a breach can result in fines, a possible custodial sentence, reputational damage, the investigation and related proceedings costs and the impact on other contracts that might be vulnerable to termination if you trade contrary to sanctions requirements.


Sanctions should not be taken lightly, and immediate action must be taken if you realise your contract is going to be affected by them.


Start with the contract terms

There is a possibility that the consequences of the parties being affected by sanctions or conflict have been expressly catered for in a contract, such as an express sanctions clause or a clause which relieves a party(s) of their obligations where they would otherwise be in breach of an applicable law.


If so, you should consider any relevant clauses carefully in terms of when they apply, who they apply to and what the consequences of exercising the rights under those terms are. Of course, you may also want to include an express sanctions clause or termination right in your contracts now given the uncertainty organisations are currently facing.


You might also be able to walk away from a contract if that is what you want or need to do and there are easy-to-exercise ‘no fault’ termination rights (e.g. termination at will on notice) or if there is no obligation to purchase or supply (or related minimum purchase requirements). Again, careful consideration of the terms is required so as to understand any potential knock-on implications.


Can I plead force majeure?

Force majeure clauses are a potential route you can use to terminate or suspend your dealings if you are either prohibited from performing your obligations under the contract (for example, due to sanctions) or as a result of a conflict and its impact on the contract.


A force majeure clause cannot be implied into a contract – in other words you must have an express force majeure clause in a contract in order to rely on it – but it can provide a helpful mechanism if the clause allows a party to be relieved of its performance obligations, or indeed to terminate.


How the clause is worded, the definition given to ‘force majeure’ and the context giving rise to the event is key. For example, while war is often a common event found in the definition of a force majeure, if the war itself has not actually affected a party’s performance of the contract, then the force majeure clause won’t necessarily apply. You should also remember that a force majeure clause may not be triggered just because performance has become harder or the contract less profitable.


Even if the force majeure clause applies, you will also need to consider whether there are any obligations in the contract to mitigate against the effect of the force majeure.  For example, if sanctions are causing the performance issue, it may be possible to obtain a licence to allow the contract performance to continue notwithstanding the sanctions, in which case you would not then be allowed to rely on the force majeure clause to excuse your performance.


A careful look at the situation you are presented with and the wording of the force majeure clause itself will be key to understanding if and how the force majeure clause can be applied. If force majeure is an available means of excusing a party of its performance obligations and you need to rely on it, you will need to look at whether the clause provides for a notification process and comply with this – failing to do so might mean you lose the benefit of the clause.


Further practical considerations relating to force majeure are discussed on our podcast as part of our “Journey Through a Contract” series.


“It was not this that I promised to do”1

If force majeure is not an available method of excusing a party of its performance obligations, then the next port of call is usually to consider whether frustration is an option.


It can, however, be difficult to prove frustration and it might not be something you want to invoke because the contract will come to an end.


A contract may be held by the courts to be “frustrated” where, owing to no fault of the parties, performance of that contract has become impossible or radically different to what was originally intended due to unforeseeable events, therefore defeating the commercial purpose of that contract.


Proving frustration requires consideration of several factors, including the terms of the contract, the parties’ knowledge and expectations at the time the contract was entered into, alongside how and when the contract can potentially be performed again.


Parties would be expected to first explore and exhaust workarounds, so again, if licences allowing performance, notwithstanding sanctions, are a possibility, then frustration may not be a viable avenue and pleading it without looking into the relevant considerations could open the door to a claim that the party seeking to rely on frustration has breached the contract without good reason.


Illegality defence

If performing a contract results in illegal activity (e.g. breach of sanctions legislation), then this would be a potential defence to a claim from a counterparty for breach of contract, assuming the party is subject to the UK sanctions requirements and the contract is subject to English law.


The situation may not always be clear cut, for example, where an organisation says that it cannot comply with a contract because it would breach the sanctions laws of another jurisdiction or where a party can find a way of avoiding the illegality such as applying for a licence to allow the relevant activity to continue.


Again, thorough consideration of all the circumstances is required and this is where the terms of the contract may help. For example, in Lamesa v Cynergy Bank2, there was a clause which provided that payments were not required to be made where “such sums were not paid in order to comply with any mandatory provision of law”. In this case, Cynergy was relieved of making the payments as it would have likely resulted in secondary sanctions being imposed on Cynergy, and the court considered that the reason for its default was “to ‘comply’ with a foreign statute that would otherwise be triggered”.


Other watch points

U.S. organisations have traditionally been more forthcoming in terms of contractual provisions concerning sanctions. For example, they might require their counterparties to comply with U.S. sanctions requirements, no matter where the counterparty is located.


So, you should be vigilant as to whether you have contractually agreed to comply with any sanctions measures imposed by other parties to your contracts that would not ordinarily have applied to you and look at how you will navigate this.


We have also recently seen reports in the news of household names pulling out of business in Russia because of Russia’s actions in Ukraine. In this scenario, the organisation will have to weigh up the risks and cost of a breach of contract claim if (i) there are no applicable sanctions which compel it to cease to trade in Russia or with Russian counterparties, (ii) the contract does not provide an applicable exit/termination right and (iii) the organisation wishing to walkaway is under a positive obligation to accept orders and provide the relevant goods/services.


It’s not just sanctions...

Even if you are not facing an issue with sanctions requirements, undertaking risk assessments on your counterparties and being familiar with your contract terms is a good idea given that the situation between Russia and Ukraine is likely to have widespread impacts on the global supply chain.


Organisations should be preparing for potential availability issues, price fluctuations and disruptions to logistics both in relation to existing contracts and as part of negotiations for new ones.


Practical considerations

There are several practical steps organisations should consider taking in light of the current situation:


  • Organisations should:

    • undertake a risk assessment identifying potential exposure of their business and the steps that can be taken to mitigate the risks identified and update their risk registers accordingly; and
    • review their approach and policies regarding “know your customer”/counterparty and other due diligence checks for both existing and new counterparties.  This is with a view to being able to identify whether they are dealing with counterparties subject to sanctions (or which are owned or controlled them).

    In particular, when carrying out checks, organisations should screen against the UK Sanctions List and the OFSI’s list of asset freeze targets and be familiar with any goods in respect of which there are trading restrictions.


    Please bear in mind that there are different types of sanctions in place and understanding what each one is will help you understand whether there is a blanket restriction against dealing with a counterparty or whether you are legally allowed to continue to trade with them subject to other restrictions and conditions.


  • Organisations are encouraged to be vigilant concerning the risk of cyber crime and attacks (see Cyber – Should I be worried about Ukraine? (shoosmiths.co.uk)) as there are indications that there is currently a heightened risk of cyber-attacks. This could include a review of the risks, refresher training/reminders to colleagues of what to look out for and an assessment of security measures taken by the organisation.
  • In light of travel restrictions and the Foreign, Commonwealth and Development Office advice against all travel to Russia, any business travel requirements should be reviewed.
  • There is bound to be disruption to supply chains on a large scale for an unpredictable amount of time. Reviewing contracts now to ensure continuity of supply and to mitigate against key risks is advisable.
  • We would also encourage early engagement with your supply chain to understand the extent to which suppliers foresee any disruption or changes to supply and determine how best to manage this with them. You may be able to manage risk allocation relating to supply chain issues if you are entering into new contracts with suppliers (and thorough due diligence on them is advised to ensure that they can meet any agreed obligations).
  • In light of the rapidly changing situation, organisations are also advised to check the Government website here for further details on the sanctions in place at any given time.

Summary

Navigating your way through contractual issues where there is a requirement to stop your dealings with a counterparty for sanctions-related or other reasons can be daunting.


While few contracts will have express provisions dealing with exactly this scenario, there are other potential methods to protect your organisation from a breach of contract claim where the reason for your non-performance is related to a requirement to comply with sanctions laws or disruptions caused by conflict. Most will depend on the specific circumstances, the contract and its terms, whether there are alternative methods of delivering the required performance.


 


1 Davis Contractors Ltd v Fareham UDC [1956] AC 696
2 Lamesa Investments Ltd v Cynergy Bank Ltd [2020] EWCA Civ 281


 



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