The invasion of Ukraine has fundamentally altered the world order. The tragic results already include both military and civilian casualties, property loss and destruction, and a mounting refugee crisis. It is unclear when and how a cessation of hostilities will be achieved. For those enterprises that have or had ongoing business arrangements and investments in Russia, now is the time to assess and fully understand risks entailed – whether electing to stay in Russia, to withdraw, or to curtail operations. A variety of disputes are likely to arise whatever business decision is made.
The invasion has led to a range of financial and other sanctions that have upended global commerce. An economy the size of Russia has never before been impaired by substantial economic sanctions and export controls. Current foreign direct investments in Russia are fundamentally changed, and future investment plans in Russia have largely halted. Hundreds of foreign investors with assets and activities in Russia have acted quickly to announce exits from Russia, or fundamental changes to their Russian businesses. This enormous upheaval is reminiscent of other recent seismic events, including 9/11, the Arab Spring, and the Argentinian Financial Crisis, and comes on the heels of a global pandemic that already strained global supply chains. Although the future of global commerce involving Russia is unpredictable, one thing is certain: these events will lead to legal disputes, many of which will be resolved in international arbitrations.
Foreign investors with assets in Russia need to move quickly to protect their rights and identify and prepare for possible disputes. So should parties with commercial agreements including joint ventures with businesses in Russia. Global sanctions and export controls on Russia and their corresponding economic pressure continue to increase, and the ripple effects and ramifications will only grow – as evidenced by the disruptions already being experienced in natural resources markets.
The Government of Russia, in response to these sanctions, has imposed counter-sanctions and credibly threatened to expropriate or nationalize Russian companies with significant foreign shareholding when the investors’ home governments are “unfriendly” towards Russia. Commercial arrangements and joint ventures with private Russian businesses and state-owned enterprises alike have already been impacted by sanctions, which may cause those businesses to be unable to function or to meet their commercial and financial obligations sooner rather than later.
Russia has credibly threatened retaliatory measures to harm foreign investors in Russia as a result of sanctions from a long list of countries. Specifically, Russia has proposed legislation that would allow Russia to seize companies with major shareholdings from host countries that have sanctioned Russia, and potentially to auction off the identified companies’ shares. Russia’s long list of “unfriendly” countries covers approximately 60% of global GDP, and encompasses the United States, the UK, most European countries, Canada, Australia, New Zealand, Switzerland, Japan, South Korea, Singapore, Taiwan, and others, and the list is growing. The precise nature of possible Russian action is still uncertain and differs on a company-by-company basis. Disputes arising out of Russian harm to foreign investors have not yet materialized publicly, but a general risk of Russian action against foreign investors exists.
Foreign investors in Russia should plan – now – to manage and mitigate against possible future disputes with the Government of Russia. One possible basis to recover for harm to a foreign investment is through an investment treaty. Investment treaties are often (but not always) between two countries, and are known as bilateral investments treaties or “BITs.” Investment treaties provide substantive protections to foreign investors and often include the right for the investor to bring arbitration claims directly against the host State – in this case Russia – for violations of the treaty. Investment treaties provide a powerful mechanism that has led to hundreds of awards against States, including several major awards against Russia to date.
The first step to assess investment treaty protections in Russia is to review the company’s and its beneficial owners’ chain of ownership in the investment structure, including whether there are treaty rights already in place. Russia has a large number of high-standard investment treaties in force, with countries from all parts of the world. One notable absence from this list, however, is that there is no investment treaty in force between the United States and Russia. An additional complicating factor is that several of Russia’s earlier treaties, particularly those completed near the time of the fall of the Soviet Union, have narrow arbitration clauses. For example, some treaties restrict arbitration to claims involving free transfer of convertible currency out of Russia and the amount in controversy for a nationalization or expropriation. See, for example, BITs with the United Kingdom, Germany, Netherlands, Luxembourg, Spain, Switzerland, and Korea.
Depending on an investor’s existing treaty rights, as well as tax and other commercial and legal considerations, investors may wish to restructure their investments in Russia prior to a dispute with Russia arising in order to ensure maximum treaty protections. Restructuring could allow for new or additional treaty-based protections, including substantive rights as a foreign investor in Russia and investor-state dispute settlement as a means to prosecute claims against Russia. There are likely also good business reasons to restructure, based on Russia’s existing threats toward investors located in home countries that are viewed by Russia as “unfriendly” due to sanctions policies. Because future Russian action is unpredictable and uncertain, investors should move quickly.
Foreign investors should also consider other options to enforce their rights beyond investment treaties. For instance, companies should evaluate existing political risk insurance policies.
For those foreign investors in Russia who seek to exit the Russian market or significantly curtail their business in Russia, it will be critical to evaluate contracts and joint venture agreements to evaluate their authority to take such action and to assess the commercial and financial consequences. Some commercial parties have already expressly contemplated sanctions impacting their agreements in Russia. Some contracts will have specific language to cover this type of situation, such as a joint venture party being designed as a Specially Designated National or an inability to perform under the agreement as a result of sanctions prohibitions. But others will need to rely on more general provisions – or will not definitively address the parties’ rights and obligations in these circumstances.
Even without a specific clause dealing with effects of sanctions, other provisions could provide relief. In particular, some force majeure clauses may be broad enough in some instances to allow a party to cease performance or even exit their commercial relationships in Russia or with affected entities or persons. There are a few key considerations when evaluating force majeure:
Applicable law. Many jurisdictions (such as New York) will apply force majeure clauses strictly and narrowly, whereas others might permit a broader interpretation.
Covered events. Force majeure clauses often include a specific list of qualifying events; acts of governments and war are two common events that could apply.
Effect on non-performance. Force majeure clauses typically require that performance be prevented or delayed by the particular force majeure event; “prevent” often requires that performance be impossible, whereas “delay” and other terms can be more flexible.
Notice. There is typically a requirement to provide timely notice of the occurrence of a force majeure event as well as updates, and failure to follow the notice requirements may restrict a party’s ability to later invoke force majeure.
Effect of force majeure. A force majeure clause typically excuses performance until the force majeure event no longer prevents or delays performance; if a force majeure event affects performance for a long enough time, either party may have the right to terminate.
If the force majeure clause does not cover the situation, parties should consider other clauses that may be in their commercial agreements, including those addressing material adverse change or changes in law. Depending on the circumstances, a party could also look to the limitation of liability and consider whether an efficient breach is an option under the circumstances. In addition, a party should assess any sanctions compliance provisions in agreement and whether these provisions are sufficiently robust to permit suspension or termination of performance in light of sanctions risks. In short, these issues will arise in a large variety of contexts, and the risk imposed, and potential rights and obligations will be very case and contract specific and will vary from jurisdiction to jurisdiction. The sooner advice is obtained, the better prepared a contracting party will be to assess risks and consequences.
Compliance with sanctions when restructuring investments in Russia
Investors’ decision-making must consider the evolving global sanctions on Russia before taking steps to restructure or alter investments. The United States has already imposed restrictions on foreign companies’ potential investments and commercial arrangements in Russia, for example:
Full blocking or asset freezing restrictions through designation of certain Russian individuals and entities including several banks as Specially Designated Nationals (“SDNs”) or parties subject to EU or UK asset freeze. For instance, a SDN designation prohibits U.S. persons from engaging in all direct and indirect transactions with designated entities, and any entity 50% or more owned by the sanctioned party, unless a general license applies.
Additional payment processing restrictions and prohibitions on certain debt and equity transactions applicable to major Russian banks and certain Russian companies.
Prohibition of transactions with Russian state entities including the Central Bank of Russia, Russian Ministry of Finance, and the National Wealth Fund of the Russian Federation.
Prohibition of “new investment in the energy sector” in Russia, which includes transactions that constitute a commitment of funds or other assets for, or a loan or other extension of credit to, new energy sector activities located or occurring in Russia beginning on or after March 8 under EO 14066. Under the rule, the “energy sector” is broadly defined to include the procurement, exploration, extraction, drilling, mining, harvesting, production, refinement, liquefaction, gasification, regasification, conversion, enrichment, fabrication, or transport of petroleum, natural gas, liquified natural gas, natural gas liquids, or petroleum products or other products capable of producing energy, such as coal or wood or agricultural products used to manufacture biofuels, the development, production, generation, transmission or exchange of power, through any means, including nuclear, electrical, thermal, and renewable. However, certain transactions “related to energy” are authorized under General License 8A.
Prohibition of exports, reexports, sale, or supply, directly or indirectly, from the United States, or by a U.S. person, wherever located, of U.S. dollar-denominated banknotes to the Government of the Russian Federation or any person located in the Russian Federation.
Prohibition of transactions that involve any approval, financing, facilitation, or guarantee by a US person, wherever located, of a transaction by a foreign person where the transaction by that foreign person would be prohibited by U.S. law if performed by a U.S. person or within the United States.
These new sanctions on Russia impose limitations on types of transactions in Russia that foreign investors subject to U.S. sanctions requirements may enter into with certain parties. However, the sanctions to date do not broadly prohibit a foreign investor from restructuring the organization of its existing investment in Russia, unless an SDN is involved. For example, a U.S. investor that wishes to add additional ownership to its investment structure or transfer ownership from one subsidiary to another would not per se violate existing U.S. sanctions on Russia (unless certain SDNs are involved in the transaction). However, foreign investors in Russia should carefully evaluate sanctions at the time of restructuring and the possibility of new sanctions when making changes to businesses in Russia. Other jurisdictions, such as the European Union and the United Kingdom have imposed similar restrictions. Hogan Lovells has authored several client alerts on sanctions enacted on Russia including EU sanctions measures; UK sanctions measures, including new restrictions on registration of foreign entities; Singapore sanctions measures; Japan sanctions measures; and Australian sanctions measures.
Although specifics of future sanctions on Russia are uncertain, escalation of sanction measures are very likely. The United States Department of the Treasury Office of Foreign Assets Control (OFAC) is likely to designate additional sectors beyond the energy sector from which new investments are prohibited under its authority granted by President Biden in EO 14068, which was signed on March 11, 2022. Additional sanctions could potentially escalate to include, for example:
Additional sanctions designations that impact potentially large Russian companies including those owned 50% or more by oligarchs and companies owned by oligarchs.
Sanctions targeted toward the Russian stock markets including the Moscow Exchange.
Imposition of full blocking sanctions on the entirety of the Russian government including state-owned enterprises.
Enactment of a full trade embargo, which would ban all transactions, exports and imports with Russia. Such comprehensive sanctions would essentially make it impossible for a U.S. owned business to continue to do business in Russia.
Similar restrictions imposed by the EU, UK, Japan, Australia, Canada and other countries.
If you have questions concerning these matter involving foreign investors and investments in Russia, please contact the authors listed below. The Hogan Lovells team has broad global reach and is available to assist.
Authored by Jonathan Stoel, Michael Jacobson, Sam Zimmerman, and Cayla Ebert.