OVERVIEW OF THE LATEST COURT PRACTICE ON THE RUSSIAN SANCTIONS-RELATED AMENDMENTS—IS WINTER COMING?

This analysis was first published on Lexis®PSL on 29 October 2021 and can be found here (subscription required).

Ivan Teselkin, partner, Maria Dolotova, of counsel, Alexander Gridasov, senior associate, and Sergei Eremin, senior associate, of Herbert Smith Freehills provide an overview of Russian court decisions on the impact of recent amendments to Russian law relating to international sanctions against the Russian Federation.

The sanctions-related amendments

In June 2020, the Russian Arbitrazh Procedure Code was amended to provide the Russian courts inter alia with (a) exclusive jurisdiction over any disputes with individuals and entities subject to international sanctions against Russia (in case there is no dispute resolution clause to the contrary, or if this clause is unenforceable due to ‘obstacles to access to justice’ caused by sanctions); and (b) issue anti-suit injunctions with respect to such disputes (the ‘Sanctions-Related Amendments’). We discussed the details of these amendments in our Arbitration Notes post here.

The Sanctions-Related Amendments have caused much controversy among the business community in Russia and abroad. In particular, there was no consensus as to what ‘obstacles’ would be sufficient for the Russian courts to render the dispute resolution clause in the contract unenforceable and accept jurisdiction to consider the dispute. The business community therefore has been waiting for the first reaction of the Russian courts to the amendments.

However, the development of the court practice has not been rapid. To date the Sanctions-Related Amendments have been directly applied only in four cases. Nevertheless, even these few reveal that the courts are yet to find common ground in the application of the amendments.

At the moment, two divergent interpretations of the new law coexist in the court practice. According to the first interpretation, the introduction of international sanctions against a person is in itself sufficient to justify application of the Sanctions-Related Amendments in cases where there is a dispute resolution clause providing for the jurisdiction of foreign court or tribunal. In the meantime, the courts supporting the second approach require extensive evidence confirming that the sanctions have actually hindered the sanctioned person's access to justice, before the Sanctions-Related Amendments can be applied.

We discuss these interpretations of the Sanctions-Related Amendments, the cases supporting such interpretations and the possible direction of the court practice in more detail below.

Interpretation 1—sanctions as a ground to accept jurisdiction

The first interpretation has been widely accepted by the courts in Moscow. In two cases described below, where such approach has been used, these courts have agreed to apply the Sanctions-Related Amendments just on the basis of sanctions introduced against the applicant and hypothetical arguments on potential difficulties that may arise for the applicant should the proceedings abroad be commenced. The factual background and the courts' conclusions in these two cases are summarised below.

JSC Tsargrad Media v Google (Case No А40-155367/2020)

In this case, Russian media company, Tsargrad Media (‘Tsargrad’) filed a claim against Google Ireland Ltd (Ireland), Google LLC (the USA) and Google LLC (Russia) (‘Google’) with the Moscow City Arbitrazh Court. The claim was based on Google's decision to block Tsargrad's access to its accounts at various Google services, which Tsargrad sought to challenge in the Russian courts.

Google disagreed with the jurisdiction of the Russian courts with reference to Google's general Terms of Service providing for the jurisdiction of English courts over disputes involving Google Ireland Limited (Ireland), and the courts of California, USA over disputes involving Google LLC (the USA). In response, Tsargrad referred to the Sanctions-Related Amendments and argued that Russian courts have exclusive jurisdiction over the dispute, given that the EU and the US sanctions introduced against the beneficial owner of Tsargrad, Mr Konstantin Malofeev (which accordingly apply to Tsargrad) created ‘obstacles to access to justice’.

It appears that Tsargrad did not make any attempts to commence proceedings against Google in foreign jurisdictions. In that context, the position of Tsargrad was based only on the following two hypothetical arguments which, in the view of Tsargrad, evidenced that any proceedings in the UK or the US would be futile:

• it would not be possible for Tsargrad to engage legal counsel in both the UK and the US due to the sanctions. In support of that argument Tsargrad submitted a letter from an international law firm claiming that the firm required approvals from the Office of Foreign Assets Control (OFAC) in the US and the Office of Financial Sanctions Implementation (OFSI) in the UK before any legal services could be rendered to Tsargrad
• the EU and the US sanctions would not allow Mr Malofeev to travel abroad in order to participate in the court hearings in case the proceedings in the UK or the US courts commence
• It is worth noting that generally the obstacles referred to by Tsargrad are not impossible to overcome. For instance, the OFAC has previously issued licences to lawyers representing sanctioned entities, upon request. The speed of the OFAC's reaction may differ, however in our experience such licences may be issued within weeks. It appears that Tsargrad did not even attempt to obtain such licence.
• Finally, the travel ban introduced against Tsargrad's UBO does not prohibit Tsargrad's employees (including the CEO or Chief Legal Counsel, or their lawyers who no doubt could travel on general grounds), from travelling to the EU or the US to attend the court hearings. Accordingly, the presence of Tsargrad's management (including for the purposes of witness testimony) could have been secured, if necessary.

Nevertheless, the Moscow City Arbitrazh Court concluded that Tsargrad presented ‘overwhelming evidence’ confirming impossibility for Tsargrad to obtain access to justice and protect its rights in the jurisdictions which had introduced sanctions. Accordingly, the court accepted its jurisdiction over the claim of Tsargrad against Google and considered the dispute on the merits. The approach chosen by the court in this case follows the logic of the earlier case Instar Logistics LLC v Nabors Drilling International Ltd, which we covered on Arbitration Notes here.

JSC Sovfracht v Prosperity Estates LTD (case No А40-156736/2020)

Russian company JSC Sovfracht and UK-based company Prosperity Estates LTD entered into a contract in 2010 whereby Prosperity Estates undertook to conduct certain repair works with respect to the buildings in London. The contract provided for the jurisdiction of the courts at the location of the buildings (ie London).

It appears that in June 2020 Prosperity Estates sent a pre-action letter to Sovfracht claiming repayment of debt owed by Sovfracht to Prosperity Estates under the contract. Sovfracht however responded by requesting the Moscow City Arbitrazh Court (a) to issue anti-suit injunctions prohibiting Prosperity Estates to initiate court proceedings under the contract in London; and (b) to order that Prosperity Estates shall compensate £190,991 (likely, represents the amount claimed by Prosperity Estates) to Sovfracht in case Prosperity Estates breaches the anti-suit injunctions of the Russian court. The request of Sovfracht was based on the Sanctions-Related Amendments.

In its request, Sovfracht used the following line of argumentation:

• Sovfracht is subject to the US sanctions and is included in the SDN list
• the US sanctions seriously limit the ability of a sanctioned person (including Sovfracht) to protect its rights and economic interests. For instance, the sanctioned person cannot engage a counsel unless the OFAC grants its approval (the receipt of which, according to Sovfracht, is ‘a long and complicated process’ which may end up with unmotivated refusal)
• furthermore, Sovfracht referred to certain court practice (unrelated to this particular case and Sovfracht) which, in the view of Sovfracht, proved that the foreign courts have prejudice against inter alia Russian nationals
• on that basis, Sovfracht argued that it could only receive adequate protection of its rights and interests in the Russian courts and that initiation of court proceedings under the contract with Prosperity Estates in London shall therefore be restricted

It is not entirely clear from the judgment of the Moscow court in this case what connection the US sanctions have to the potential dispute between the Russian and the UK company in the London courts under the contract for repair works with respect to the buildings in London. The judgment does not discuss the governing law of the contract. However, if it is governed by English law (which is likely the case, given the jurisdiction of the provider and the location of the real estate), it is also difficult to see why the OFAC's approval would be required for Sovfracht to hire an English law-qualified counsel. Finally, Sovfracht is not subject to the UK sanctions, so there should not be any additional complexities coming from this front.

It appears that the position of Prosperity Estates was based on similar arguments. In response to Sovfracht's request, Prosperity Estates argued in the Russian court that there was no evidence of obstacles to Sovfracht's access to justice in the UK.

Nevertheless, on 8 October 2021 the Russian court decided to issue anti-suit injunctions (the request to order compensation in case the injunctions are breached was refused). In fact, the court agreed with Sovfracht that the US sanctions limit the possibility of Sovfracht to protect its rights and interests abroad which, in the words of the court, puts Prosperity Estates in the superior position (no detailed explanation was provided in the judgment with respect to this point).

With reference to the provisions of the Russian Constitution and the recent Resolution of the Constitutional Court (Resolution of the Russian Constitutional Court No. 34-П dated 9 July 2021), the court further noted that the most adequate reaction of the public authorities to the international sanctions should be the full support of the sanctioned entities and individuals who have ‘got into difficult situation due to unlawful circumstances’ (meaning that the sanctions were, from Russian law perspective, unlawfully imposed).

As it is the judgment of the first instance court, it is yet to be become final and binding. However, it appears that the conclusions in this judgment summarise the position of the Moscow courts regarding the Sanctions-Related Amendments quite accurately (and may potentially correspond to the position of the Russian Supreme Court, as discussed below).

Based on both Tsargrad and Sovfracht cases, it appears that the Moscow courts indeed tend to treat the sanctioned applicants more favourably and are ready to apply the Sanctions-Related Amendments effectively in each case where the sanctions were introduced against the applicants, including where the evidence of ‘obstacles to access to justice’ is limited. In these circumstances, it is expected that the foreign entities might have difficulties in opposing the jurisdiction of the Russian courts and ensuring that the dispute resolution provisions in the contracts are respected.

Interpretation 2—no jurisdiction without evidence of obstacles to access to justice

The courts outside Moscow tend to approach the Sanctions-Related Amendments quite differently. In the cases described below, the courts have effectively refused to accept that the sanctions alone justify application of the Sanctions-Related Amendments and required applicants to substantiate their requests with the evidence of hurdles that the applicants have actually suffered due to sanctions.

JSC Power Machines v DTEK (case No А56-57238/2020)

Russian company JSC Power Machines undertook to conduct works and to supply equipment under two contracts with the Ukrainian entity DTEK. The contracts contained an Arbitration Institute of the Stockholm Chamber of Commerce (SCC) arbitration clause with the seat in Stockholm.

Power Machines performed its obligations under the contracts and claimed payment from DTEK. The latter however refused to pay. According to DTEK, the transfer of funds under the contracts was not possible due to the sanctions introduced by the US and the Ukrainian Governments against Power Machines (the company is included in the US SDN list and, reportedly, in the equivalent Ukrainian list).

Further to DTEK's refusal, Power Machines tried to commence proceedings in the SCC under the arbitration clause in the contracts. For these purposes the company made three attempts to transfer the registration fee to the SCC. However, as evidenced by Power Machines, all of these transfers were refused by foreign and Russian banks (it is not clear from the publicly available information whether the refusal was due to the sanctions). As the SCC did not receive the registration fee in time, the case was dismissed.

As a result, Power Machines had to apply to the Russian Arbitrazh Court of Saint-Petersburg and Leningrad Region with the request to accept jurisdiction over the dispute with DTEK pursuant to the Sanctions-Related Amendments. Having considered the application of Power Machines and the available evidence, the Russian court concluded as follows:

• Power Machines’ inability to commence arbitration proceedings in the SCC deprived the company of its right to judicial protection
• even if the arbitration in the SCC did proceed, the award issued in these proceedings could not have been enforced against DTEK in Ukraine in any event due to the international sanctions
• in that context, existing SCC arbitration clause provided Power Machines with only a limited possibility to protect its rights and economic interests and effectively put DTEK in the superior position

The above obstacles to access to justice (ie and not the sanctions alone) allowed the court to declare the SCC arbitration clause unenforceable and to accept jurisdiction to consider the claim of Power Machines against DTEK on the merits. The judgment of the court in this case is being appealed.

JSC Uraltransmash v PESA (cases No А60-62910/2018 and А60-36897/2020)

Another case where extensive evidence was examined before the court could decide on the application of the Sanctions-Related Amendments concerned the tramway cars supply agreement entered into between a Russian purchaser JSC Uraltransmash (‘UTM’) and a Polish supplier Pojazdy Szynowe PESA Bydgoszcz Spylka Akcyjna (‘PESA’).

The supply agreement contained a SCC arbitration clause on the basis of which PESA commenced arbitration proceedings against UTM in the SCC. The return move of UTM and its parent company JSC Uralvagonzavod (‘UVZ’) was to claim in the Arbitrazh Court of Sverdlovsk Region that due to ‘obstacles to access to justice’ caused by the EU and US sanctions applicable to both UTM and UVZ:

• the SCC arbitration clause was unenforceable and therefore Russian state courts had exclusive jurisdiction to consider the dispute, and
• the anti-suit injunctions preventing continuation of arbitration in the SCC shall be issued against PESA

In support of their claims UTM and UVZ argued that the sanctions prevent UTM inter alia from:

• transferring funds to cover the arbitration fees
• engaging legal counsel
• filing counter-claims in arbitration
• having an independent and impartial tribunal, and
• attending arbitration hearings

This case is different from those discussed above in that the foreign proceedings were actually commenced against the applicant. The Russian court therefore had opportunity to check whether the sanctions indeed created obstacles to the applicant's access to justice in practice, rather than on the basis of hypothetical arguments.

As it follows from the files of this case, most of the arguments raised by the applicant appeared to be factually incorrect. That allowed the court to conclude that the evidence provided by UTM and UVZ was not sufficient to prove ‘obstacles to access to justice’ which could justify application of the Sanctions-Related Amendments. To the contrary, the evidence presented by PESA clearly indicated that the SCC arbitration clause was enforceable.

In particular, the court noted the following:

• generally, the introduction of the EU or the US sanctions alone is not sufficient to justify application of the Sanctions-Related Amendments in case there is a dispute resolution clause providing for the jurisdiction of foreign court or tribunal. The applicant therefore has to prove that the sanctions have actually caused unenforceability of the dispute resolution clause of the contract due to ‘obstacles to access to justice’
• the EU sanctions against UTM and UVZ did not restrict (a) commencement or continuation of the SCC arbitration proceedings under the supply agreement; (b) provision of legal services to UTM; or (c) transfer of payments by UTM in connection with the supply agreement. The application of the US sanctions to the arbitration proceedings in Stockholm was not supported by evidence
• furthermore, it was proved that the EU or the US sanctions did not create any ‘obstacles to access to justice’ to UTM in practice, as the evidence confirmed that UTM:
  • had been actively involved in the SCC arbitration proceedings for more than two years (including by nominating one of the arbitrators, engaging legal counsel and European experts, and filing a counter-claim and other legal submissions in the arbitration proceedings)
  • had transferred funds to PESA through the EU banks and therefore was not restricted from transferring arbitration fees to SCC (which was expressly confirmed by the SCC itself), and
  • had insisted on in-person arbitration hearing, notwithstanding coronavirus (COVID-19) lockdown and availability of virtual hearings (in the meantime, the sanctions did not put travel restrictions on the employees of UTM)
• no evidence of the tribunal's partiality or lack of independence due to sanctions was presented by UTM or UVZ

Based on the above, the court refused the applications of UTM and UVZ to declare the SCC arbitration clause unenforceable and to issue anti-suit injunctions.

The end of confusion?

The above divergent interpretations of the Sanctions-Related Amendments by the courts could not have missed the attention of the Russian Supreme Court. On 21 September 2021, the Deputy Chairman of the Supreme Court referred the appeals of UTM and UVZ to consideration of the Judicial Panel of the Russian Supreme Court. The Deputy Chairman noted the following in her ruling:

• the sanctions introduced against a person cannot but create doubts that this person would be subject to a fair trial in the jurisdiction where the sanctions were introduced
• therefore, the mere fact of introduction of the sanctions shall be presumed to be sufficient to conclude that the sanctioned person is restricted from access to justice
• in light of that, the sanctioned person is not required to prove the existence of such restrictions and has the right to apply for anti-suit injunctions to the Russian court regardless

The position of the Deputy Chairman in the ruling is, however, capable of several interpretations.

One could be that the Deputy Chairman has just reiterated the default position under the law that the Russian courts have exclusive jurisdiction over disputes with the sanctioned persons and, if there is no dispute resolution clause providing for the jurisdiction of foreign court or tribunal, there is no need for the applicant to prove that there are ‘obstacles to access to justice’ before the Sanctioned-Related Amendments can be applied.

However, there may be another interpretation of the Deputy Chairman's ruling (which follows the logic of the Moscow courts). It may mean that, according to the Deputy Chairman, the Sanctions-Related Amendments can be applied effectively in each case where the sanctions were introduced against the applicants (including where an enforceable dispute resolution clause was agreed by the parties). In that case, the risks that notwithstanding the pre-agreed dispute resolution provisions, any dispute with the sanctioned person would be moved to Russia or that the Russian courts would agree to issue anti-suit injunctions increase dramatically.

On 2 December 2021, the Judicial Panel of the Supreme Court will consider the appeals of UTM and UVZ and the conclusions of the Deputy Chairman. It is likely that the decision of the Supreme Court in this case would not only address the abovementioned interpretations of the Deputy Chairman's ruling, but would also determine the whole landscape of disputes against the sanctioned persons, thus putting an end to the contradiction between the courts' approaches to the application of the amendments.

The only question is—would the foreign counterparties of the sanctioned persons have any chance to stand against the exclusive jurisdiction of the Russian courts after the Supreme Court's decision?

We are keeping a close eye on this case and provide further analysis when the full judgment of the Supreme Court is available.

For more information, please contact Ivan Teselkin, Partner, Maria Dolotova, Of Counsel, Alexander Gridasov, Senior Associate, Sergei Eremin, Senior Associate, or your usual Herbert Smith Freehills contact.