The Shadow of Sanctions on Contracts

Anti Financial Crime

March 2, 2024

The author

Nasim Zargarinejad Senior Legal Officer

Contractual mechanisms for remaining compliant with sanctions

Introduction

A valid contract is binding upon the parties.

This statement serves as the cornerstone of contract law worldwide. However, it does not imply that there are no situations in which parties can legally terminate, suspend, or refuse to fulfill their contractual obligations for legal reasons. Typically, these reasons can be anticipated ex-ante in applicable law or in the contract itself. How about newly introduced sanctions? Can they provide a green light for parties to refrain from undertaking their contractual obligations?

On the one hand, given the severe consequences that violating sanctions can entail, ranging from fines imposed by state authorities to potential criminal liability and the looming risk of secondary sanctions, companies may choose not to perform their contractual obligations when sanctions are casting a shadow on their contract. Nevertheless, on the other hand, non-performance is not an easy way out, as refraining from fulfilling obligations can also result in legal consequences for the compliant party. Hence, it is common for the parties to the contract or the sanction-imposing authority to include a clause aimed at excluding the liability of parties who, for the purpose of being compliant with sanctions, choose to refrain from performing their contractual obligations.

Sanction Clause

Sanction clauses provide for the exemption of the parties from liability claims arising out of their compliance with sanctions. To mitigate or even avoid the adverse risk associated with the non-performance of a contract, the parties can include this clause in their contract.

Take, for instance, a situation where sanctions forbid offering financing or financial assistance to a sanctioned entity. In this scenario, an insurance company providing services like insuring aircraft, a domain falling under the umbrella of financing and financial assistance, is obligated to abstain from offering its services to the specified entity. Now, if this insurance company had integrated a sanction clause into its policy, it could depend on that clause to halt its services to sanctioned entities.

But do businesses really need to go to the trouble of adding this clause to their contracts? Of course, one might wonder why a standard force majeure clause may not be satisfactory for this situation and why a specific sanction clause could be essential. The reason lies in the challenge of categorizing and proving sanctions as force majeure events. Typically, contracts or applicable laws enumerate events qualifying as force majeure. If sanctions are explicitly mentioned in these events, it simplifies matters; otherwise, it might be challenging to prove that sanctions are an illustration of force majeure. Thus, a sanction clause is a more straightforward solution for this purpose.

An example of a sanction clause is a model clause LMA3100 that insurance companies can incorporate in their contract. [1]

“No (re)insurer shall be deemed to provide cover and no (re)insurer shall be liable to pay any claim or provide any benefit hereunder to the extent that the provision of such cover, payment of such claim or provision of such benefit would expose that (re)insurer to any sanction, prohibition or restriction under United Nations resolutions or the trade or economic sanctions, laws or regulations of the European Union, United Kingdom or United States of America.”

However, while employing model clauses can be beneficial, it is crucial to adjust these clauses to fit the unique circumstances of the parties involved and the specific characteristics of their contract. The wording within the sanction clause holds significance for its interpretation in later court proceedings. For example, careful consideration should be given to determining which sanction laws should be included in the clause, considering factors such as the jurisdiction of the parties and their ownership structure. An example that can attest to the importance of the wording of the sanction clause is when a European Union company and subsidiaries of a sanctioned entity have a contract. Whether or not relying on a sanction clause would be deemed justified would depend on the wording used in this clause.

Lastly, a sanction clause will not allow a party to refrain from performing its obligations in certain situations. For instance, some economic sanctions do not completely prohibit the trade of specific goods and services; instead, they introduce licensing or exemption requirements. [2] In such a situation application for a licence or exemption must be sent to the relevant competent authority and non-performance of the obligations is not justified.

No Claims Clause

When the EU imposes sanctions, there are usually clauses that provide that any person or entity complying with the obligations under sanction laws shall not be held liable vis-à-vis the other party for such compliance. A case in point is Article 11 of Council Regulation (EU) No 833/2014 dated 31 July 2014. [3]

“No claims in connection with any contract or transaction the performance of which has been affected, directly or indirectly, in whole or in part, by the measures imposed under this Regulation, including claims for indemnity or any other claim of this type, such as a claim for compensation or a claim under a guarantee, notably a claim for extension or payment of a bond, guarantee or indemnity, particularly a financial guarantee or financial indemnity, of whatever form, shall be satisfied, if they are made by:

1. entities referred to in points (b) or (c) of Article 5, or listed in Annex III; (b)
2. any other Russian person, entity or body; (c)
3. any person, entity or body acting through or on behalf of one of the persons, entities or bodies referred to in points (a) or (b) of this paragraph.”

No-Russia Clause

The 12th Package of EU Sanctions against Russia introduces a “No Russia Clause,” as outlined in Article 12g, establishing a novel stipulation for exporters dealing with specific listed goods and technology. [4] This provision mandates exporters to prohibit the re-export of such items to Russia and their use by Russia under a contract.

 In contrast to preceding clauses, this clause does not aim to absolve one party from the non-performance of a contract. Instead, they actively impose obligations on exporters seeking to engage in contracts with third countries. These specific obligations revolve around ensuring that, within their contracts, there exist “adequate remedies in the event of re-export of goods to Russia.” The second obligation underscores the importance of transparency and cooperation, as exporters are required to promptly inform and cooperate with relevant authorities once they become aware of any re-export of their product by third countries to Russia. So, what should exporters do? They should first review if their products fall under the list. If they do, they must include the No Russia Clause in their contracts which starts from March 20, 2024.

Conclusion

Sanctions have begun exerting an impact on contractual obligations, underscoring the need to anticipate their consequences on your business relationships and commitments to other parties. At Wiacon, we stand ready to help you maintain compliance with regulatory obligations well before entering into any contract. Our expertise lies in navigating complex sanctions regimes, assessing your risk profile, and conducting thorough due diligence on subsidiaries or counterparties. Trust Wiacon to guide you through the intricacies of compliance, ensuring your business is well-prepared and resilient in the face of evolving regulatory domain.