RUSSIAN COURTS TO HAVE EXCLUSIVE JURISDICTION OVER SANCTIONED PERSONS

On 8 June 2020, the Russian President signed a new federal law (No.171-FZ), which will significantly change the dispute resolution landscape involving Russian sanctioned individuals and entities. It will come into force on 19 June 2020.

It is significant as it provides for exclusive jurisdiction of the Russian state arbitrazh (commercial) courts with respect to disputes involving Russian sanctioned individuals and entities as well as foreign entities controlled by them.

Even if the parties have agreed to the jurisdiction of a foreign court or an arbitral tribunal seated outside of Russia, sanctioned persons will be able to disregard the dispute resolution provisions if they cannot be enforced due to sanctions. A sanctioned person affected would need to assess the effect of sanctions on the contract, and, if there are grounds to believe that the applicable dispute resolution provisions cannot be enforced, it can refer the dispute for adjudication by the first-instance Russian arbitrazh courts at the place of its registration (for legal entities) or residence (for individuals). Such referral will be possible only if no similar dispute between the same parties is being considered by a foreign court or an arbitral tribunal seated outside Russia.

If the applicable dispute resolution provisions cannot be enforced, a sanctioned person will be entitled to apply to the Russian arbitrazh courts for an anti-suit injunction preventing the commencement or continuation of foreign court or international arbitration proceedings (where such proceedings are pending, this is the only way to seek protection from the Russian courts). The onus will be on a sanctioned person to demonstrate that either such proceedings have already begun or are imminently pending. At the same time, at the request of a sanctioned person, a foreign party failing to comply with the injunction imposed by a Russian court may be held liable to pay monetary compensation up to the amount claimed in the foreign court or arbitration proceedings. There is also a high risk that a decision rendered by a foreign court or arbitral tribunal as a result of such proceedings will not be enforceable in Russia.

Of course, it remains to be seen how the Russian courts will determine that the arbitration and other dispute resolution clauses involving sanctioned persons are unenforceable.

Even before the adoption of this new law, a disputable approach to enforceability of the dispute resolution clauses has already been tested by a Russian court. At least one controversial case exists (А40-149566/2019), where the Arbitrazh Court of Appeal held that an ICC arbitration clause is unenforceable due to the US sanctions and instead established the jurisdiction of the Russian courts. According to the court, the claimant, a Russian company subject to US sanctions, could not recover a debt from the defendant, a Russian branch of a US company, in reliance on the arbitration clause in the contract. The court concluded that the clause placed the defendant in a more favourable position, and an arbitral award in favour of the claimant would not be enforceable due to bank transfer restrictions as a result of sanctions. As the decision has been appealed, and the cassation court is due to hear the appeal at the end of June 2020, there will be many eagerly awaiting the judgment.

It is worth noting that the new law clarifies that a foreign court decision or an award of an arbitral tribunal seated outside Russia affecting a sanctioned person can still be recognised and enforced in Russia in accordance with general recognition and enforcement rules. Russia has been a party to the New York Convention since 1960 (replacing the former Soviet Union as a member state in 1991), and is a party to a number of international treaties that provide for enforcement of foreign court judgments and arbitral awards, and so the foreign party could rely on the relevant international instrument to ensure recognition and enforcement of the relevant decision or award in Russia.

However, according to the new law, enforcement will only be possible where either a sanctioned person filed a claim or did not make an objection to the jurisdiction of the foreign court or foreign-seated arbitral tribunal and did not make an application for an anti-suit injunction in the Russian courts.

So there are major changes in the offing.

It means that businesses dealing with Russian counterparties will need to carefully monitor whether the counterparty is a sanctioned person and whether the sanctions could affect the enforceability of the dispute resolution clauses in their contracts or provided by international treaties.

If this is the case, their disputes may be forcibly referred to the Russian arbitrazh courts, even though the parties have agreed to, or an international treaty provides for, an arbitration with a non-Russian seat; or opted for the jurisdiction of a foreign court.

In general, this law correlates with the trend determined by the draft amendments to the Russian Constitution providing for priority of Russian law and the Constitution over the international law. It will be interesting to see if these amendments are also adopted on a referendum scheduled for 1 July 2020.

Furthermore, as Russian law does not have extraterritorial effect, the relevant counterparty could nevertheless succeed in obtaining and enforcing abroad a foreign court decision or a foreign arbitral award in spite of the anti-suit injunction granted by the Russian court. However, it will still have to deal with and bear the consequences of any parallel proceedings in the Russian courts initiated in accordance with the new law and both assess whether a sanctioned person has any assets outside Russia and whether the Russian court judgment (including anti-suit injunction order) can be enforced against such party’s assets in Russia.

Enforceability of such Russian judgments abroad shall also be subject to supplemental analysis by foreign counterparties of sanctioned persons. So, in addition to monitoring sanctions legislation and its effects on the relevant contract with a sanctioned person, the foreign counterparty will need to consider whether any contractual mechanisms are available to protect its interests in the circumstances where the sanctioned person decides to rely on the new law.

It is also worth bearing in mind that the enforceability of the dispute resolution provisions could be misinterpreted by the Russian courts and confused with the possibility to enforce the decision of a foreign court or an arbitral award, as occurred in the example above. Hopefully, the cassation court will amend the approach taken by the Court of Appeal.

This law may complicate even further the already complex arbitration regime established as a result of the Russian arbitration reforms of 2016 and 2019, which were launched with the aim of eliminating the widespread practice of companies setting up their own "pocket" arbitration institutions to administer disputes. It could also lead to a deterioration of the investment climate in Russia.

This article was first published on Global Arbitration Review on 10 June 2020

For more information, please contact Alexei Panich, Partner, Olga Dementyeva, Associate, Polina Podoplelova, Associate, or your usual Herbert Smith Freehills contact.