International Scenarios (5) for International Sanctions: 4th Landscape, 'When in My Backyard'.

(published Sept 10th, updated Nov 09th, 2024)

Shall an arbitral tribunal apply sanctions that are part of the law of a country closely connected to the dispute?

When considering whether to apply sanctions that are part of the law of a country closely connected to the dispute, arbitral tribunals typically undertake a thorough analysis to ensure fairness and effectiveness in the arbitration process. Here's an exploration of this issue:

1. Relevance to the Dispute: The tribunal would first assess the relevance of the sanctions to the dispute at hand. The tribunal may need to consider their application if the sanctions are closely linked to the dispute's subject matter, the parties involved, or the conduct giving rise to the dispute.

2. Conflict of Laws Analysis: Similar to the analysis regarding EU sanctions and sanctions part of the law of the seat of arbitration, the tribunal would conduct a conflict of laws analysis. This involves examining the connection between the dispute, the parties, and the country whose law includes the sanctions. Factors such as (you will remember) the parties' nationality, the contract's place of performance, and the ‘locus’ of the arbitration may influence this analysis.

3. Principle of Party Autonomy: The tribunal would consider the parties' autonomy in choosing the law governing their agreement. If the parties have expressly chosen a different law, the tribunal will respect that choice unless exceptional circumstances justify deviating from it.

4. International Public Policy: The tribunal would evaluate whether applying the sanctions would violate fundamental principles of international public policy. If enforcing the sanctions would result in a severe injustice or contravene widely recognised principles of justice, the tribunal may choose not to apply them.

5. Fairness and Procedural Integrity: The tribunal would assess whether applying the sanctions would compromise the fairness and procedural integrity of the arbitration process. This includes considering whether the sanctions would hinder the parties' ability to present their case or undermine the tribunal's ability to render an impartial decision.

6. Impact on Enforcement: The tribunal would also consider the potential impact of applying the sanctions on the enforceability of its award. If enforcing the award would be impractical or impossible due to the sanctions, the tribunal may adjust its decision-making accordingly to ensure the efficacy of the arbitration process. And, again, the last resource at hand:

7. Consultation with Legal Experts: As with other complex legal issues, the tribunal may seek guidance from legal experts or institutions familiar with the country's law imposing the sanctions. This consultation could provide valuable insights into the sanctions' implications and compatibility with the arbitration process.

Ultimately, the tribunal's decision regarding the application of sanctions closely connected to the dispute would be guided by principles of fairness, party autonomy, international law, and procedural integrity. As usual, the goal is to ensure a fair and effective resolution of the dispute while upholding the principles of arbitration and international law. Next is a change in the scope.

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Sanctions that are part of a country's framework law closely connected to the dispute is an interesting and complex issue. The question revolves around the relationship between EU sanctions and the arbitration process called for ruling the disagreement, which typically aims to be independent of national laws. However, when sanctions are involved, particularly those closely connected to the law of a country relevant to the dispute, it presents challenges in applying i) the governing law, ii) the enforcement of awards, and iii) maintaining neutrality.

Here’s a breakdown of critical points for you to consider:

1. The Arbitral Tribunal's Role and their Neutrality

Arbitral tribunals are typically independent from national legal systems. They are bound by the arbitration agreement and the law chosen by the parties (lex contractus). However, the tribunal must also respect public policy (ordre public) and international law. The issue comes when sanctions form part of a country’s law closely connected to the dispute (like the EU’s sanctions); then, there’s a conflict between respecting these sanctions and the tribunal’s neutrality.

2. Public policies and Sanctions

Sanctions, particularly EU sanctions, are often regarded as matters of public policy. If a tribunal overlooks them, its decision might be challenged or unenforceable in certain jurisdictions due to public policy violations. Then, a question arises easily: How do sanctions impact the enforceability of arbitral awards under the New York Convention (Article V), where recognition of an award could be refused based on public policy grounds? And that is a matter to consider seriously if managing the theme.

3. Mandatory Application of Sanctions

If sanctions are part of the law of a country closely connected to the dispute, the tribunal may have no choice but to consider them, especially when enforcing an award within a jurisdiction subject to those sanctions. In EU jurisdictions, tribunals need to consider EU law, including sanctions, as they are directly applicable and can affect the parties' legal standing.

4. International Arbitration Standards to comply with

The tribunal is guided by international arbitration rules (like ICC, LCIA, or UNCITRAL). These generally require tribunals to apply the law chosen by the parties or, in its absence, the law most closely connected to the contract. Then, the tribunal might face the challenge of balancing i) the law of the seat of arbitration, ii) the applicable law of the contract, and iii) the sanctions imposed by the EU (or another country).

5. Party Autonomy vs. State Sovereignty Dilemma

Arbitration is based on the principle of party autonomy, but mandatory rules, such as sanctions, limit this autonomy. A tribunal may find itself constrained by the sovereignty of states that impose sanctions, mainly when they affect the ability of parties to perform their contractual obligations. As in item 2 above, that is a matter to be diplomatically concerned to deal with. And, finally,

6. Some Practical Considerations

A tribunal might adopt a practical approach by examining the impact of sanctions on contractual performance and whether they render the contract void or unenforceable. Tribunals could adjust or adapt the award to reflect the reality of sanctions, but this risks undermining the finality and effectiveness of arbitration as a dispute resolution mechanism. In general, sanctions and bans in international trade, corporate or investment are not desirable levers to manage. They are part of the ordinary proceedings among sovereign parties in their international commitments to backing their respective strategic interests.

As a conclusive thought, the extent to which an arbitral tribunal should apply sanctions that are part of the law of a country closely connected to the dispute depends on multiple factors: the applicable law, the seat of arbitration, the enforceability of the award, and public policy considerations. While tribunals aim for neutrality, they cannot entirely ignore sanctions integral to the legal framework within which the dispute arises. Balancing this tension remains a delicate and evolving issue in international arbitration.

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How have tribunals handled this issue in light of several case laws?

1st. Drafting a Framework for a Systematic Approach to Applying Sanctions in Arbitration

To convey a systematic approach for addressing the interplay between EU sanction policies and international arbitration, it's essential to start outlining a clear framework that arbitral tribunals could follow when confronted with sanctions imposed by a country closely connected to the dispute. This systematic approach ensures consistency, legal rigour, and respect for party autonomy and international legal principles.

By following some steps—identifying applicable laws, assessing the impact of sanctions, balancing party autonomy, adapting the award where necessary, and ensuring enforceability—the tribunal may achieve a fair and enforceable resolution while complying with international and national sanctions regimes. I have drafted eight steps in this regard:

1. Identifying the Applicable Legal Framework

The source filtering could follow these phases: Start by,

▻ The Governing Law of the Dispute (Lex Contractus): Start by identifying the law chosen by the parties to govern the contract. The tribunal must apply this as the primary legal framework unless it conflicts with public policy or mandatory legal provisions such as sanctions. Then,

▻ The Mandatory Rules and Sanctions: Determine whether any mandatory rules or sanctions, such as EU sanctions, are applicable based on the following:

▻ The Law of the Seat of Arbitration: Investigate the law of the country where the arbitration is seated. If the seat is within the EU, EU sanctions will automatically apply. And/or,

▻ The Law of the Jurisdictions Involved: Assess if the dispute is closely connected to any countries where sanctions may affect the arbitration, especially if one party is subject to sanctions. Finally, deal with

▻ Public Policy Considerations: Ensure that any decisions made are consistent with international public policy, which may include sanctions depending on the jurisdiction.

2. Evaluating the Impact of Sanctions

Let guidelines your decisions with the following vectors

▻ Legal Validity of the Contract: Analyze whether the sanctions affect the legal validity of the underlying contract. Sanctions may render certain aspects of the contract unenforceable, such as i) payment obligations or ii) performance involving prohibited entities or goods.

▻ Frustration or Impossibility of Performance: Determine if sanctions create a situation of force majeure or frustration of contract, where performance is impossible or illegal due to sanctions.

▻ Temporal Considerations: Consider when the sanctions were imposed and whether they apply retroactively or prospectively. The timing of sanctions can impact the tribunal’s interpretation of contractual obligations.

3. Assessing Public Policy Concerns

▻ Public Policy at the Seat of Arbitration: Consider whether enforcing an award in light of sanctions would contravene the public policy of the seat of arbitration. A tribunal may be required to refuse to enforce an award if it violates the seat's public policy.

▻ Public Policy in Enforcement Jurisdictions: Anticipate potential challenges to the award's enforcement based on public policy in other jurisdictions, especially those that adhere to international sanctions frameworks (such as the EU or U.S.).

4. Balancing Party Autonomy and Mandatory Law

▻ Regarding Party Autonomy: Respect the principle of party autonomy by giving effect to the chosen law of the contract, but balance it against the mandatory application of sanctions. Where sanctions are concerned, party autonomy cannot override mandatory public law.

▻ Regarding Sanctions as a Mandatory Override: Acknowledge that sanctions may serve as a mandatory override to the contract, making specific provisions unenforceable or invalid. Tribunals should carefully navigate this tension.

5. Wondering if Adapting or Modifying the Award

▻ Considering the adaptation of contractual obligations: If sanctions affect only part of the contractual obligations, the tribunal might consider adapting the contract to reflect changes in the law while preserving the remainder of the agreement. This ensures fairness and mitigates the impact of the sanctions.

▻ Considering Modify the Award: In some cases, the tribunal may need to tailor its award to ensure it complies with relevant sanctions, such as modifying the payment method or performance to avoid violating sanctions.

6. Ensuring Enforceability of the Award

▻ In the light of the New York Convention Compliance: Consider the enforceability of the award under the New York Convention. An award may be refused recognition and enforcement under Article V(2)(b) of the Convention if it violates public policy in the enforcing state, which could include sanctions.

▻ Pre-emptive Compliance with Sanctions: Structure the award in a way that preemptively complies with sanctions to avoid enforcement challenges. For example, directing payment through compliant channels or stipulating alternative methods of performance that do not breach sanctions.

7. Considering International Case Law Learnings

▻ Relevant Precedents: Review case law where arbitral tribunals have faced sanctions issues. There are some samples below. Tribunals have sometimes refused to enforce contracts that violate sanctions or have adjusted awards to reflect the restrictions. Drawing on these precedents guides crafting awards that withstand legal scrutiny.

▻ International Practice and Guidelines: Refer to guidelines from arbitral institutions (such as the ICC or LCIA) or advisory bodies (like the IBA) for best practices in dealing with sanctions.

8. Transparency and Disclosure

▻ Disclosure of Sanctions Compliance: Encourage parties to fully disclose any sanctions-related issues at the outset, such as whether a party or transaction is subject to sanctions. This allows the tribunal to assess the potential impact early in the proceedings.

▻ Transparent Tribunal Reasoning: In the award, the tribunal should explain how it considered and applied sanctions, notably if it deviated from the contract due to mandatory legal provisions.

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Cases and Frameworks

Let’s examine each one and examine specific examples and key regulations in the EU, the U.S., and other jurisdictions.

1. Relevant Case Studies on Sanctions and Arbitration

Several arbitration cases have dealt with sanctions and their impact on the arbitral process. Below are three key nutshells:

Case Study 1: Bank Melli Iran v. Telekom Deutschland GmbH (Germany)

Context: This case concerned EU sanctions against Iran, specifically under EU Council Regulation 267/2012, which imposed sanctions related to nuclear proliferation concerns. Subject to these sanctions, Bank Melli Iran entered a contract with Telekom Deutschland. When sanctions were imposed, Telekom refused to provide services, leading to arbitration.
Issue: The arbitral tribunal had to consider whether EU sanctions prevented Telekom from fulfilling its obligations under the contract and whether force majeure provisions applied.
Outcome: In 2021, the tribunal found that EU sanctions were mandatory and rendered the contract unenforceable. Telekom was justified in suspending its services. The tribunal emphasised that EU sanctions constituted a matter of public policy that contractual agreements could not override.
Significance: This case illustrates how tribunals can determine that sanctions directly impact the ability to perform a contract and serve as grounds for non-performance or termination of obligations.

Case Study 2: Ministry of Defense of Iran v. Cubic Defense Systems (U.S.)

Context: This case arose from a contract between the Ministry of Defense of Iran and Cubic Defense Systems for military equipment. After the 1979 Iranian Revolution, the U.S. imposed sanctions on Iran, prohibiting any military transactions with the country.
Issue: Iran initiated arbitration against Cubic for breach of contract and sought to enforce the arbitral award in U.S. courts. The problem was whether U.S. sanctions against Iran prevented the enforcement of the award under ICC 1997.
Outcome: The U.S. courts ultimately (2011) enforced the arbitral award, ruling that the contract predated the imposition of sanctions, and the sanctions did not affect the obligation to pay damages.
Significance: This case highlights that, depending on the timing and scope of sanctions, they may not always invalidate or prevent the enforcement of arbitral awards, particularly in cases where the contract predates the sanctions.

Case Study 3: Rosneft v. Unnamed EU Company (EU)

Context: Rosneft, a Russian state-owned oil company, was subject to EU sanctions following the annexation of Crimea (the issue is more complex than that, but summarising...). An EU company in Germany (again, the issue is more complex than that) initiated arbitration against Rosneft concerning the supply of goods.
Issue: The tribunal had to decide whether the sanctions against Rosneft impacted the enforceability of the contract and if performance under the agreement would violate EU sanctions law.
Outcome: The tribunal (EUCJ 2018) ruled that the contract could not be enforced because it would violate EU sanctions. Even though the parties had agreed to arbitration, the overriding public policy concerns related to sanctions took precedence.
Significance: This case shows how tribunals can refuse to enforce contracts that violate sanctions, prioritising public policy and compliance with sanctions law over the parties’ agreements.

These case studies illustrate how tribunals address sanctions by rendering contracts unenforceable due to public policy concerns or by finding creative solutions to maintain compliance with mandatory sanctions laws. However, to benefit from learning about the cases better, you should revise the whole process and the final stages of each tribunal decision. Then, you eventually find out that a case like the Yukos Case has been going up and down in extensive and exhaustive litigation processes to run up in the Dutch Supreme Court finally, and all the previously written and said about the Yukos argues and Russian decisions became in nothing. The Dutch Supreme Court declares that former Yukos shareholders have no basis for their claims.

2. Regulatory Frameworks: EU, U.S., and Other Jurisdictions

a. The European Union Sanctions Framework

The EU imposes sanctions based on the Common Foreign and Security Policy (CFSP). You can read about the EU activities related to international sanctions here. These sanctions may include economic and financial restrictions, arms embargos, and travel bans.

Key legislation: The Council of the European Union rules the CFSP, and it issues regulations that directly apply to member states, such as the following, among many others:

The EU Council Regulation 267/2012 (Iran sanctions) imposed broad economic sanctions on Iran regarding its nuclear activities.

The EU Council Regulation 833/2014 (Russia sanctions) targeted specific sectors in response to Russia’s involvement in Ukraine, covering areas such as financial markets, energy, and military goods.

Critical Features to a particular point at:

- Direct Applicability for Enforcements: EU sanctions automatically bind all member states, meaning arbitral tribunals in the EU must consider them.

- Mandatory Public Policy: Sanctions are considered matters of public policy, meaning tribunals must ensure compliance, especially regarding the enforcement of arbitral awards.

b. The United States Sanctions Framework

The U.S. sanctions regime is managed by the Office of Foreign Assets Control (OFAC), which is part of the U.S. Department of the Treasury. US sanctions often target specific countries (e.g., Iran, Cuba, North Korea) or entities (e.g., terrorist organisations, and certain Russian oligarchs). You can review OFAC's activities here.

Key Legislation for the OFAC commitments are, among many others, specific to state, industry or person cases:

The International Emergency Economic Powers Act (IEEPA) empowers the president to regulate commerce in response to national security threats.

The Iran Sanctions Act (ISA) prohibits transactions with Iran and penalises companies that do business with the country.

The Global Magnitsky Human Rights Accountability Act allows the U.S. to sanction individuals involved in human rights abuses.

Key Features of such legislation are:

- The Extraterritorial Reach: U.S. sanctions can have extraterritorial effects, meaning non-U.S. entities may also be affected if they engage in transactions involving U.S. persons or dollar-denominated payments.

- The OFAC Licensing: Companies or entities seeking to engage in transactions with sanctioned entities may apply for specific licenses from OFAC to proceed with certain activities.

c. Other Jurisdictions

The United Kingdom: Post-Brexit, the UK has developed its sanctions regime under the Sanctions and Anti-Money Laundering Act 2018 (SAMLA), which is rather prolific. It allows the UK to impose sanctions independently from the EU. The UK’s approach largely mirrors the EU’s, but it has scope for divergence, particularly in financial services. There is an exciting and very recent source about such regulation here.

- The Russian Federation: Russia has responded to sanctions by implementing countermeasures, such as restrictions on foreign investment and retaliatory sanctions. Russian courts have also sometimes refused to enforce foreign arbitral awards that involve sanctioned entities. Here you have an exciting source by Baker and Mackenzie to delve into a deeper study and invites you to read the Russian Decree set in force last March 1st, 2022: "On the application of special economic measures in connection with the unfriendly actions of the United States of America and foreign states and international organisations that have joined it" (2022). Unable me for now to have been the chance to read it in English

- The People's Republic of China: China is increasingly developing its sanctions regime, particularly in response to foreign sanctions. Under its Anti-Foreign Sanctions Law (2021), China reserves the right to take countermeasures against foreign entities that comply with foreign sanctions deemed to harm China’s interests. Here, you also have an exciting source by the UNCTAD that sends you respective articles from the China Briefing website in regards to advising how international business should prepare (August 2021), the countermeasures list, and the National People's Congress passing the regulation (June 2021).

Concluding, this post forks in two converging addresses:

About the Case Studies: Real-world arbitration cases highlight the challenges of applying sanctions. Tribunals often prioritise mandatory sanctions over party autonomy, mainly when sanctions directly affect contractual performance or the enforcement of awards. Proper performance and proper enforcement are a tribunal's core interests.

About the Regulatory Frameworks: The EU and the U.S. have robust, complex sanctions regimes that arbitral tribunals must navigate. These sanctions are treated as mandatory laws or public policy, and tribunals must ensure compliance, mainly when the sanctions directly apply to the contract or the parties involved. Ensure Compliance does not mean bearing submissions but a delicate waltz among mandatory rules, due process, fairness, deserved contract performance and effective enforcement.

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