Navigating sanctions and contracts - ThinkHouse

David Lowe: Hi everybody and welcome to our webinar on navigating contracts and sanctions. I am David Lowe, I am a partner in our commercial contracts team. I spend my time negotiating and drafting contracts, international supply chain and routes to market.

Emma Carr: And I am Emma Carr, I am a partner in our commercial litigation team here at Gowling, so I specialise in disputes, how to prevent them and then how to deal with them in the event the dispute becomes unavoidable.

David: And today's session is provoked really by the Russian invasion of Ukraine and the subsequent sanctions. Many of you will be working for businesses who are considering exiting Russia or who want to terminate contracts with Russian counterparties or with businesses elsewhere in the world which are subject to sanctions and so today we wanted to look at how sanctions impact contracts and how you should deal with them.

Now the starting point for this is obviously to work out if you are subject to sanctions or if your counterparty is subject to sanctions as that is the beginning of the story of what you are allowed to do and what you must do. Obviously if you are subject to sanctions or the other party is subject to sanctions that will stop you from doing certain things and you will have legal obligations to comply with that. Now we are not going to talk today about the whole complexity of those sanctions.

We have issued several alerts on the subject and are keeping those updated and I suggest that you have a look at those to work out what the impact is of sanctions. But they are complex, there are UK, EU, US sanctions and of course other countries have always had their sanctions. Some of those sanctions impact the banks, some of them impact payment arrangements, some of them impact the holding of assets, and different individuals and different companies are subject to different sanctions.

But let us imagine that you have worked your way through that and worked out what the position is on sanctions. You may have identified that you are clearly subject, or your counterpart is clearly subject to sanctions and that means that it will then be obviously, you know, that you can no longer deal with them depending on the nature of the sanctions. But all too often you will find it is not entirely clear or possibly you may discover that actually the party you are dealing with and the trade you are engaging is not subject to any sanctions or any restrictions and so therefore what we are now going to look at, is how to navigate through your contract.

I am going to start by talking about the force majeure clause because that will be the first place you will go to in your contract, looking at the force majeure clause and working that through so I am going to talk about that and then, Emma?

Emma: I am going to look at what happens and what you can do if there is not a force majeure clause or the force majeure clause does not bite. Are there any other options that you can pursue to exit the contract.

David: So, in my section I am going to look at is there a force majeure? What are the consequences of it. I am also going to talk about new contracts - contracts you might be entering into today now that you know there has been a Russian invasion of Ukraine with all the impacts that it is having.

But first, big headline is that this talk is from the perspective of English law and that is really important. Force majeure is very much a creature of the law of the contract. Under English law we have no real background or, except for what Emma is going to talk about, that deals with force majeure. Force majeure clauses will not get implied into your contract but other countries - China, Germany are just two examples do have local law of local codes that will be implied into your contract.

Do not go straight to the force majeure clause, go to the governing law clause and make sure you understand which law applies. Make sure it is English law and then look at the force majeure clause.

Obviously, read the clause! That is an obvious point but I emphasise it because every force majeure clause I have ever seen is different. Although they are often saying similar things, they almost always say it slightly differently. There is no such thing as an absolutely standard English law force majeure clause.

Here are some examples: the first example I have up here on the screen is from a contract that I have recently reviewed, that dealt with selling consumer products to Russia and it sets out what you typically see in a force majeure clause. It refers to an event or circumstance 'beyond the reasonable control of the party which causes or results in default or delay' and then usually has a long list of stuff that could well be a force majeure.

Now the important bits here are 'beyond reasonable control causing default and delay'. The long list is less relevant because almost always it is including without limitation, which means all this stuff might be a force majeure but other stuff might be as well.

And almost certainly, what is in that list will not cover the force majeure because force majeures by their nature are unpredictable and therefore you can expect that your particular occasion will not be listed. It may well not say sanctions because you had not imagined that when you drafted the contract, but that does not matter. The key question is, is it beyond the reasonable control of the party and does it result in default or delay?

Now, contrast that with this next slide. Here is another force majeure clause, again from a contract I have recently reviewed that dealt with a Russian business and you can see how different this force majeure definition is from the normal definition.

It consists exclusively of riots, acts of war, acts of terrorism, storms, fires or floods, which materially affect the production facility. So the Russian invasion of Ukraine is very unlikely to be a force majeure for this unless in invading the Ukraine, Russia drove its tanks through the middle of the production facility in an act of war.

So this force majeure clause is very much focussed on whether the production facility has been destroyed or not. Not about whether you can trade more generally and that is why it is really important to check your force majeure clause. In case you have one of these really narrow ones.

You then need to turn your mind to the force majeure clause. You have worked through the definition of force majeure and you have identified that you think you have a force majeure. So it could not reasonably be anticipated and it certainly could not be controlled by you, the imposition of sanctions for example preventing the export of certain stuff to Russia.

To get to that position though you need to work out what is being stopped by the force majeure. If there has been export restrictions introduced which means you cannot export your goods to Russia, then that is the force majeure that has caused the issue you need to deal with in your contract.

However, if you work through the sanctions and you work out that actually I can still export my goods to Russia there is no export controls on it, the counterparty I am dealing with can still pay me because there are still banking arrangements in the world that allow for the payments of, but for the product and if the counterparty is not subject to other sanctions and therefore I am allowed to deal with it, then there may not be any force majeure at all and so that is why you need to be really careful to work out what is going on. What has actually caused the force majeure and is it then a force majeure as defined by the contract.

Having done that, you then need to think about, well what can the supplier do instead? So let us imagine you are buying off a supplier and the supplier has a Russian factory. The supplier might be saying to you, I cannot supply to you. I have a Russian factory and I am not able to export my products from Russia because of the Russian sanctions, perhaps. That might well be true. But if your supplier is a multi-national company and also has a factory in South Africa or the UK or the US, actually they are obliged to be trying to overcome the force majeure and that includes finding alternative routes of supply.

You may be able to say to them, well I absolutely understand why your Russian factory may be closed or unable to supply but what about the other factories around the world, what are you doing to overcome this?

You then need to, as this slide says, read the clause carefully. You will need to notify probably, almost certainly, every force majeure clause usually says that the party that is suffering the force majeure has to give notice. But not always!  Not all force majeure clauses include that so that is why it is important you check. But it is good practice obviously to tell the other party that you are suffering a force majeure to prevent them assuming that you are simply in breach of contract.

There is an implication into any force majeure clause that the person suffering the force majeure has a duty to mitigate, to use reasonable endeavours to overcome that force majeure although there is recent case law that mitigation does not mean being compelled to provide a performance that is different to what the contract performs. There has been a recent sanctions case coming out of the Crimea sanctions, not the current sanctions, where under the contract the obligation was to pay in US dollars and the customer said I cannot pay in US dollars because the impact of the US sanctions but I could pay in Euros, come on what is the difference, Euros/US dollars you can easily convert that.

The court said, no the contract says US dollars so offering to pay in an alternative way is not allowed so that therefore there is a force majeure preventing payment.

Look at your force majeure clause to see what it does say about payment. We found did we not in Covid, that actually one of the problems in many force majeure clauses is they did not really deal with where there have been substantial payments in advance. Basically most force majeure clauses, the money just falls where it falls. So if you have got a contract where there is significant money passing in advance or in different ways, then you are going to need to think quite carefully about the impact that you may not want to call a force majeure as a result.

And of course, the issue that has been landed on your desk is, maybe your board of directors wants to end the contract. We need to end our contractual arrangements with Russia. So you are being asked to 'can we get out of this contract'. You will be looking at the force majeure clause to see how you can terminate.

And usually most force majeure clauses require the force majeure clause to last for a period of time before you can terminate. Sometimes it is one month, sometimes it is as long as three months. Sometimes it is even longer. So it might not give you the immediate answer you want to give to your board. The board wants to terminate today but actually the clause may only allow you terminate on three months or a month's notice and you may therefore have to be considering alternatives.

Here is an interesting case on sanctions. A different case from the one I mentioned earlier. About how the contract is interpreted if - like this contract says - it refers to 'sums not paid in order to comply with any mandatory provision of law regulation or order of any court of competent jurisdiction'.

Now, interestingly, under English law it is assumed that the obligation on the parties is to comply with the law applicable to the contract. But there is no implication that it is also extended to cover foreign law. So if a party says, due to a foreign law I cannot comply. So due to US sanctions, maybe there are not any UK sanctions, just US sanctions and US law I cannot comply. Then there is a risk that that is not good enough for an English court. So the court had to look at this clause and weigh up whether to uphold the impact of the clause, which is that US sanctions would allow the relief of this person.

And the court seized upon the fact that it said, 'order of any court of competent jurisdiction' and therefore it said the intention of the parties is plain. This was not meant to be just restricted to English law, this is meant to capture other courts of competent jurisdiction which therefore will catch US sanctions and therefore the courts read this clause quite widely to effectively get to where the parties always intended to be.

So there is a tip there in drafting contracts, is to think about if you have got a sanctions clause or a illegality clause, is to think about whether you want it to be narrow - just relating to say English law or whether you want it to be broad - like this clause and to consciously do something about that in the drafting.

Now turning now to new contracts. Contracts that have been entered into after the Russian invasion. It is important to think about whether the Russian invasion has had in impact on your contract. When Russia invaded Ukraine that was almost certainly beyond the reasonable control or anticipation of most parties and will look probably like a force majeure, subject to everything I have already said.

But if there was new sanctions coming in now and you have got a contract with Russia, can you still hand on heart say that you had not reasonably anticipated that? Probably not. A court is going to say, look you entered into a contract today. You knew what the landscape looked like. You knew there were all these sanctions. You knew Russia had invaded Ukraine and you knew that it was very likely these sanctions were only going to get worse.

So therefore trying to claim force majeure on a contract that you entered into today, referring to the Russian invasion of sanctions, that might not work and therefore, it is important that you expressly deal with the impact of the Russian invasion and Russian sanctions.

So, for example if you are entering into a gas contract today with a supplier of Russian gas, well there is a good chance is there not, there is going to be some form of sanctions against Russian gas in the foreseeable future. So you may have to deal with it specifically in the contract because otherwise, it is not going to be clear what the situation is.

The other thought on new contracts is just looking ahead. At the moment we are all worried about the impact on Russia and the Russian invasion. But the ripple effect from around the world, what will this mean for example if you have got contracts with people in China. If China gets dragged into this through secondary sanctions. It is well worth you trying to anticipate what it means so that if the position tightens up on China, that at least you know what the broad landscape looks like.

So that is enough from me on the drafting of force majeure clauses. Now over to Emma when the contract has not provided you the answer you wanted.

Emma: Thanks David. Okay. So, I am dealing with what happens when force majeure is not an option, either because there is not an express force majeure clause or because the force majeure clause does not buy it for all the reasons David has just gone through.

Are there still potential options available to you to exit the contract? Well the answer is yes! I have listed some of them on that slide but I would like to go through each in detail. So if we turn firstly to frustration please.

Okay, so frustration. First question to ask. In the absence of force majeure. Can the contract said to be frustrated at common-law. If it can, then great because this may excuse you from performance of your obligations under the contract and act as a full discharge of those obligations. Does it apply? Where does it apply? Well, frustration will apply where something has occurred after the contract has been entered into, which happens through no fault of either party which was not foreseen or anticipated at the time the contract was entered into and which has caused the relevant contractual obligation to become physically or commercially impossible to perform or alternatively, transforms the obligations to perform into something radically different from that which was undertaken when the contract was entered into.

So you can see quite easily I think how the Russian sanctions quite squarely fit within those premises. That said, the doctrine of frustration is quite narrow. It has got limited circumstances where it will apply and the threshold is very high. It is not sufficient for you to say, for example, that the event caused by the sanctions has just made the contract too difficult or too uneconomic to perform. It needs to be something much more than that. That said, and there is reference in the notes to the slides, to a number of cases which have shown that a change in law or circumstances which makes the performance illegal, such as could be said by the Russian sanctions, have been held to amount to a frustration previously.

So it is important to check the circumstances that you find yourself in, to see whether this presents itself as a possible exit route.

Continuing with the theme of illegality. It may be possible to apply the common-law doctrine of illegality. This doctrine will apply if by performing the contractual obligations under the contract, it would be illegal or damaging to the rule of law or public policy, to do so. The doctrine works more as a defence to performance? Rather than a cause of action within itself and unlike frustration which has the effect of excusing parties from all obligations under the contract, the defence of illegality will only excuse a party from the performance of the obligation in question.

Quite limited application but still potentially helpful if you are looking to exit with that particular obligations under a contract.

A further option is to review the contract to see if it contains any material adverse change or effect clauses. So these are clauses which are designed to allow for termination in the event of a specified change or event. They are designed to capture unpredictable and unforeseen events or circumstances and as I have put on the slide there, as the name suggests however, that impact change or effect will need to be material and also have a permanent, not temporary impact on a party's ability to perform.

So again the threshold is high, but it might also help exit if the clause bites although very much will depend on how those materially adverse change effects or change clauses are drafted.

However, what do you do if there is no force majeure, no frustration, no material adverse effect or change clauses? Is there anything else you can do? Well yes!  Quite often, you will either have a contractual and/or a common-law right to terminate. So dealing first with the contractual right to terminate.

Most contracts, and certainly most contracts that I have seen that are in writing, will contain a contractual right to terminate. But where they often differ is on the basis on which termination will be permitted. So sometimes, what you can see is a contract which contains a clause which will allow a party to terminate at will. So what a termination at will clause, allows you to do, as the name suggests is it gives the party relying on it, the ability to terminate the contract at will or on its own convenience without any rationale or reason.

It is, in my view, one of the most valuable contractual rights a party can have because it basically gives them the flexibility to adapt at very short notice to changing circumstances. Such as the imposition of sanctions, for example.

However, perhaps because it is so valuable, it is also not the most common form of termination to see. More often than not, and more commonly we see that there is a contractual right or rights to terminate based on a breach or a fault by one party? And again, what is considered a fault under a contract will differ from contract to contract and a contract may also contain the ability to terminate from more than one fault.

So some common faults that you may have seen in contracts include the ability to terminate the material breach? Although this in itself then raises questions as to what constitutes material. The ability to terminate for repeated breaches. So this is lots of less serious breaches but all taken together might give you the option to terminate and exit the contract.

You may have also seen the ability to terminate the contract for any breach which in itself can sound quite valuable and almost akin to the ability to terminate at will because essentially you can find whatever breach you like and base termination on that. However, just bear in mind and a word in caution on those that the courts have been quite reluctant to allow for a literal interpretation of that and for termination to be based on the most trivial of breaches. They are often looking at something quite more than just any breach.

Furthermore, you might have the right and the ability to terminate for an insolvency event or an event of financial difficulty which again might be something which is relevant with the knock-on cause and effect of the sanctions.

And finally, you might also see a right and one which is becoming increasingly common as part of the focus on ESG responsibilities at the moment, which was previously almost the exclusive domain of licencing and sponsorship contracts. But this is the ability to terminate or suspend a contract in the event either party brings the other into disrepute. So for example you may have seen in the press recently, the relationship between Chelsea Football Club and Three? Where Three sought to suspend its performance of the contract because of the relationship between Chelsea and Roman Abramovich. And you may also have seen in the press, the sponsorship deal between Manchester United and Russian Airline Aeroflot being terminated on the same basis.

So it is important though whichever form of default you are relying on to terminate to make sure and this applies actually as well for termination at common-law. That you check any notice provisions in the contract to make sure you comply with those in full. So there might be a method of service in order to terminate, there might be a certain person you have to notify to terminate. There might be some pre-conditions such as the need to follow a dispute resolution procedure before you terminate. Whatever those provisions may be, it is important to follow them to the letter because otherwise you could find yourself in a position of having wrongfully terminated.

As I said, that warning if you like also applies to termination at common-law. So the common-law right to terminate can exist alongside or in conjunction with a contractual power to terminate. And the common-law right to terminate will exist provided it is not being excluded in the contract, although it can only be excluded in the contract if it is excluded by very very clear wording to that effect.

What will a common-law right to terminate allow you to do? It will allow you to instantly terminate a contract on the grounds of the most serious repudiatory breaches. What is a repudiatory breach? Well, you may remember from days at law school that a repudiatory breach can be a breach of a condition, a breach of intermediate term where it goes to the root of the contract and is sufficiently serious. Renunciation of the contract by a party i.e. where one party outright refuses to continue to perform the contract or repudiation based on impossibility, where one party makes it impossible to perform the contract.

It is important to consider whether the crisis in the Ukraine has in some way caused there to be a repudiatory breach of the contract allowing you to terminate at common-law. As I said earlier, you can have both co-existing so you can have the common-law right to terminate and a contractual right to terminate. And you can elect one over the other or allow for both if circumstances permit. The key difference between the two, being that termination at common-law will generally allow a party to claim damages for future non-performance as well as past losses, whereas a contractual right to terminate will generally just cover past losses. So it can make a difference on your circumstances depending what your losses are so it is important to consider.

Okay, if none of those provisions are helpful for whatever reason. Other things to have a little think about and check the contract for, include cancellation rights. So are there/is there a framework under the agreement you have for cancellation. Are there any cancellation charges. What do those cancellation charges look like when weighed against the relative costs to your business and its reputation of continuing to perform under the contract. Important things to check

Other clauses are useful to check are exclusivity provisions. If the contract is not exclusive, if you do not exclusively have to buy or sell to that counterpart, then is there a way you can, you know, practically circumvent supplying or buying from that entity by simply winding down orders or purchasing and supplying elsewhere. So effectively terminating, but by another name.

And then finally, breach - which might be stating the obvious. But we are all fire-fighting at the moment and it might just be that rather than look at what the contract allows for in terms of termination or force majeure or frustration that you just actually take the view that you are just going to breach the contract? And then deal with the consequences later. Before doing so, it would be worthwhile just to look at what the consequences of the breach are so that you can weigh those consequences up against the potential commercial/reputational/ethical costs of continuing to perform.

So for example, look at the limitation provisions. Is your liability limited to such a level that commercially that is an acceptable level to deal with and a price worth paying in order to exit the contract, or the further damage that might be caused to your ESG agenda or are there any other clauses which might help mitigate the risk of breach. I would suggest looking at those before deciding ultimately to bring that guillotine down and breach the contract. But that is still an option available to you.

David I do not know whether you had any further thoughts?

David: Yes. I think when you reflect on force majeures I have got a number of things that come to mind. Firstly, force majeures happen. I think we sometimes kid ourselves when we put the force majeure clause in the contract. Probably barely read it sometimes. Is that they do not happen very often. Well, look we have just had the Ukraine. That is a big force majeure moment. We have had Covid that has been a massive force majeure moment. We had that ship that got stuck in the Suez Canal that is another force majeure moment.

We have got people claiming force majeure because they cannot source semi-conductors and that is all now! And if you look back, I look back over my career over the last 20 years, I would say that force majeures happen all the time. Whether it is Arab Spring or Tsunamis in Japan or summer solstice in the UK causing traffic jams in Cornwall. They do happen and it is worth thinking about what the contingency is.

What is the business continuity plan? Should I be sole-sourcing from this supplier who has got one factory in one very particular part of the country? Because that makes me exposed if he cannot or she cannot supply.

So that is thought one.

Thought two is, I think we have also learned through Covid and indeed through the Ukraine is that force majeures tend to protect suppliers and do not tend to protect buyers and that is worth thinking through, especially if you are the buyer. Because after all, your obligation as buyers is usually to place orders and to pay for them. So they are very limited obligations. Much easier for the supplier to get off because he or she has to make the products or provide the service so much more that can go wrong.

And certainly we saw that in Covid where often what was happening is that the suppliers were able to supply, they were able to provide a cleaning service in your building it is just that the buyer did not want to buy any more because the office was closed. So therefore do think about where you are the buyer, how could I get out of this contract or reduce my exposure in this contract if I did not want to buy and that takes me to one of Emma's comments about termination at will being really valuable.

I really encourage people to think about having some ability to terminate on three or six or even twelve months' notice with no fault. They can just do it with no explanation because that will be valuable for dealing with the unknown and the unforeseeable. It is worth it even if you have to pay a fixed sum to get out of the contract. Because then at least you have choice. You can say to the board of directors, well look we could get out of this contract on three months' notice but it is going to cost us X hundred thousand pounds, but we have no arguments. We could just do it. Is that going to be better/cheaper/more quick/more effective than scrambling through the contract and arguing about the contract and whether or not it is a force majeure.

Emma: I think, sorry David just to add to that, I think as well, whilst termination at will - I think we are both agreed is an extremely valuable right to have, is increasing commonality of having some ability to terminate where a party has brought the other into disrepute in some way, is also becoming increasingly valuable with the ESG landscape at the moment. Obviously it then raises the question of what does disrepute mean and what is your level and your bar for saying you have drawn us into disrepute. But just allowing that ability, in so far as the party's reputation has been affected I think is becoming increasingly valuable in contracts outside of licencing and sponsorship.

David: Yes and I think that is a really good point because, you know, historically supply contracts were focussed on a certain specification of goods which needs to be delivered by a certain time and a certain price and just what else might be going on was irrelevant as long as you have got your goods, who cared and of course we are now in an environment where people do care.

You do care if the supplier is sourcing their goods from a mine in Africa where there is child labour. Or whether the palm oil is coming from somewhere that had been rainforest and has been illegally logged. And therefore there are lots of other things that can happen where you may, as a buyer have concerns about the supplier and which you may not have managed to cover in your contract because who is to know what the issue is going to be and therefore an ability to terminate for disrepute can be really valuable if you are finding yourselves in the headlines for all the wrong reasons.

Having said that, I would not like to pretend that is common. I think it is obviously common in sponsorship agreements and other agreements where reputation is at the very front of the contract. It is not common in routine supply chain contracts but I wonder perhaps whether it should be, given that ESG agenda. Of course, what that then leads to, as Emma said is well what do we mean by disrepute. Are we just simply shifting the arguments to an argument about disrepute. Well, yes but at least often it is quite obvious? If you suddenly find yourself in the headlines for the wrong reasons, then it is quite obvious that you are being brought into disrepute. So it does give you an angle and it quite difficult for a supplier to resist because why should they, as a supplier, why would they be wanting to bring you into disrepute?

Emma: Yes. I think together with the termination at will we might see an increase in that type of clause going forward.

David: Absolutely. So yes, I think that is definitely the direction of travel as the ESG requirements become ever more important.

I hope you have enjoyed this webinar today, talking about the impact of sanctions on your contract as you work through the impact of the Russian invasion of Ukraine. We have explained how force majeure clause should typically work and then of course Emma has explained what happens if the force majeure clause does not give you the answer you want, with some ideas as to using other parts of the contract or perhaps simply, to just as Emma said, is to accept that you are going to be in breach and wrongfully terminate, but at least being able to weigh up what the costs of doing that.