Strong support for arbitration in sanction-related disputes despite new risks

The increased risk of sanction-relation disputes was reflected in findings from a major energy arbitration survey (50-page / 20MB PDF) undertaken by Queen Mary University of London (QMUL) in partnership with Pinsent Masons. Respondents were asked to consider the impact of sanctions on the arbitral process and arbitration’s suitability for resolving sanction-related disputes. This included, for example, what risks and challenges may arise in the arbitral process as a result of sanctions.

The QMUL survey findings on sanctions-related disputes

The most common response (72%) indicated that “enforcement of awards, including public policy issues” was the main challenge to the arbitral process as a result of sanctions. A common feature of sanctions regimes is that no claims in connection with contracts or transactions impacted by sanctions restrictions can be enforced, or damages awarded, in the countries or territories which have imposed the sanctions.

Another problematic issue with sanctions and the arbitral process centres around the financial friction they create on cross-border payments. More than half (54%) of respondents perceived there being problems in making payments, such as advancing costs for arbitral proceedings and making payment to satisfy awards. In October 2022, for example, the UK’s Office of Financial Sanctions Implementation (OFSI) granted the London Court of International Arbitration (LCIA) a licence to allow sanctioned parties and their representatives to pay funds to the LCIA to cover arbitration costs.

Despite these hurdles, 80% of respondents who answered questions about the impact of sanctions on the arbitral process indicated that arbitration was a suitable method for resolving sanctions-related disputes. This demonstrates respondents’ confidence in the mechanism despite the myriad complications involved in sanctions-related disputes.

The large number of comments received in relation to this question further confirmed the continued vitality of arbitration as a method of sanctions-related dispute resolution, even though many qualified their answers by noting that public policy, enforcement, and regulatory concerns would likely impact the efficacy of arbitration for some sanctions-related disputes.

Disputes in the energy industry

The survey results come amid ongoing debate around energy supply and volatility caused by the Russian invasion of Ukraine, which has prompted widespread use of sanctions by the EU and individual states including the US and the UK. Countries have also reacted with a range of regulatory measures designed to control energy prices and secure energy supply.

Sanctions resulting from the invasion of Ukraine was listed by 33% of respondents as one of the major causes of disputes relating to security of energy supply. “Volatile oil and gas prices” and “changes in supply-demand balance for oil and gas” scored highly as causes of security of supply disputes, with 42% and 37% of respondents choosing these categories respectively. These three interconnected categories reflect the cause-and-effect chain that the sector is currently experiencing.

Respondents to the QMUL study considered that Russian sanctions will cause the acceleration of renewable and nuclear energy projects, increased global liquified natural gas (LNG) production, and result in a shift towards an increase in production in Africa, the Middle East and Asia.

Sanctions are also having a significant impact on contractual performance, with 67% of respondents telling the survey that they thought the impact of international sanctions on the ability to perform pre-existing contracts would cause a rise in force majeure and hardship claims. An equally high number noted that suspensions and terminations have been rising, and will continue to rise due to sanctions.

Asked how sanctions will impact major projects and transactions in the energy sector, the majority of respondents indicated that an acceleration of projects to develop renewable energy sources, and an increase in nuclear energy production will be a consequence of Russian-targeted sanctions.

Many respondents also noted that global supply chain issues have been exacerbated by international sanctions, and follow-up interviews revealed that one of the most pressing issues caused by sanctions was the inability to get parts and raw materials at a commercially sensible price.

The future of sanctions-related disputes

Sanctions have worsened already existing supply chain disruptions and created a tipping point causing more disputes being resolved in a contentious way, such as by arbitration or litigation, rather than solved amicably. Parties are no longer willing to bear additional costs and are looking for ways to push these costs to their contractual counterparts.

Overall, European businesses have been more strongly affected by Russian sanctions and more likely to be involved in sanctions-related disputes. Disputes relating to terminated contracts or projects with links to Russia that are now “on hold” – such as those that cannot proceed because arbitration itself is affected by sanctions – are likely to re-emerge once the war in Ukraine reaches a resolution. It remains unclear to what extent there has been a shift away from European arbitral seats.

Special provisions allowing Russian entities affected by sanction to litigate their disputes in Russian commercial courts in breach of arbitration and choice of court agreements might lead to judgments that these entities will try to enforce in “friendly” jurisdictions. There is a significant risk for businesses and their assets to be faced with such proceedings in countries that did not, or are expected not, to impose sanctions against Russia.

The relatively low number of disputes relating to bond calls, at least between foreign contractors and the banks, can be explained by the caution applied by the banks faced with such demands from Russian entities. It seems that – if in doubt – they are unwilling to process payments. This might, however, only be a temporary effect and bond calls could re-emerge years later once the sanctions on Russia are eventually lifted.