Impact of EU Sanctions against Russia on the Enforceability of Arbitral Awards

In recent years, the world has experienced a period of unique geopolitical uncertainty and instability. One of the most evident indications of this shift in global order has been Russia's invasion into Ukraine. The conflict had been brewing for years before it escalated into the first nation state conflict in years.

Early - beginning in 2014 - the European Union reacted with an array of sanctions against numerous Russian individuals and entities. These sanctions gave rise to a considerable body of legal challenges, most notably within the domain of international arbitration and especially with regard to the question of the enforceability of arbitral awards in the context of Russian Party proceedings.

While arbitration proceedings would necessarily endeavor to preserve party autonomy, neutrality and enforceability of arbitral awards worldwide, EU sanctions entail mandatory public law restrictions on Member States that could limit access to justice or satisfaction of pecuniary obligations. This tension also raises fundamental questions about the boundaries to which arbitration proceedings and awards can be efficacious when a party is subject to sanctions and how Member States must reconcile their international obligations under the New York Convention with the binding effect of EU sanctions law.

The following article outline the general structure of EU sanctions under the law and address recent application thereof to the enforcement of arbitral awards and judgments in favor and against sanctioned parties.

General Legal Framework

EU sanctions (formally termed “restrictive measures”) are imposed through Council decisions and regulations that are directly binding in member states.

Since the start of Russia's full-scale invasion of Ukraine on 24 February 2022, the EU has imposed massive and unprecedented sanctions against Russia, extending the existing measures imposed on Russia since 2014 due to the annexation of Crimea and the failure to implement the Minsk agreements. The EU sanctions currently consist of 18 sanction packages with over 2,500 sanctioned individuals (including politicians, civil servants, oligarchs and entrepreneurs) and entities (including banks, state-owned and private companies, military and paramilitary organisations).

A cornerstone of the sanctions relating to the enforcement of arbitral awards is Article 2 of the Council Regulation (EU) No 269/2014, which provides the freezing of assets. On a technical level freezing targets “all funds and economic resources belonging to, owned, held or controlled by any natural persons or natural or legal persons, entities or bodies associated with” the the sanctioned parties. Freezing itself means that “no funds or economic resources shall be made available, directly or indirectly, to or for the benefit of [them]”. And this last part “or for the benefit” creates numerous problems in enforcing arbitral awards.

Notably, “funds” and “economic resources” are interpreted broadly and include not only cash or book money, but also, for example, money orders, securities and debt instruments, interest income and dividends. The freezing requirement applies to all types of “economic resources’”, i.e. assets of any kind, regardless of whether they are tangible or intangible, movable or immovable, or represent real or potential value. The aim is to prevent them from being used as parallel or substitute currencies and from being used to circumvent the freezing of funds. Freezing aims at making valuables unavailable to the sanctioned party during the effect, essentially depriving them of their worth.

However, prohibitions on disposal also apply not only to funds or economic resources owned by the sanctioned person, organisation or entity, but also to those controlled by them. The prohibition on making funds available therefore applies not only to the sanctioned party, but also to unlisted persons acting “on behalf of, under the control of or on the instructions of” a listed person. This means that even an EU company that is, for example, 51% owned by a sanctioned person can itself be treated as “frozen” unless it can prove its independence.

In practice, this means that a sanctioned individual or entity is economically inaccessible within the European Union. Their bank accounts, securities and other economic interests are frozen, while no person or organisation in the EU may lawfully transfer or release money or property to them. And importantly: Even to fullfil a contractual obligation or to satisfy an arbitration award, such a transfer may only be made with the prior authorisation of the competent national authority. However, it should be noted that such authorisations are exceptional and subject to strict rules.

Enforcing Arbitral Awards in Favour of Sanctioned Parties

But what exactly are the potential difficulties in enforcing an arbitral award in favour of the sanctioned party? Imagine that a sanctioned russian company has an arbitral award obliging a European trading partner to pay substantial compensation for breach of contract. Although the award is valid and enforceable under the New York Convention on the Recognition and Enforcement of Foreign Arbitral Awards (1958), its enforcement within the European Union is in direct conflict with the asset freezing regime introduced by Council Regulation (EU) No 269/2014.

As explained in more detail above the “funds” and “economic resources” of the persons listed are frozen so that no payments, transfers or assets may be made available to them, either directly or indirectly. Accordingly, any attempt by an EU debtor to settle a claim in favour of a sanctioned creditor would constitute a prohibited act, whereby even a purely administrative transfer, such as depositing the amount with a bailiff, court or financial intermediary, would be treated as an illegal transaction. In practice, such payments are automatically blocked by banks and national enforcement authorities are legally obliged to refuse or suspend enforcement measures that would violate the freeze.

However, Article 5(1)(a) of Regulation 269/2014 allows the competent authorities of the Member States to authorise the release of certain frozen funds or economic resources if certain conditions are met. It is important to note, however, that a distinction is made between arbitral awards and court judgments. This is because, while court decisions can be enforced against frozen assets even if they were issued after the party was added to the sanctions list, arbitral awards are only enforceable if they were issued before that date. This distinction clearly disadvantages arbitration and exposes companies, arbitrators and arbitration institutions to considerable legal uncertainty.

Furthermore, the enforcement of arbitral awards may also be restricted by the New York Convention itself. Under Article V(2)(b) NYC, recognition and enforcement may be refused if it would be contrary to the ordre public reservation. Ordre public concepts vary from country to country. For this reason, it is impossible to give a universally valid answer as to whether sanctions are considered part of ordre public concepts. However, there is a clear trend in the European Union to treat compliance with sanctions as an integral part of European public policy. Consequently, it is likely that arbitral awards that contradict or circumvent EU restrictive measures will not be enforced by national courts on grounds of odre public.

In conclusion these provisions show that enforcement in favor of sanctioned parties within the EU is subject to significant restrictions. Nevertheless, even in circumstances where the sanctioned party is the debtor and not the creditor, the enforcement process remains challenging.

Enforcing Arbitral Awards Against of Sanctioned Parties

One might assume that on the other hand enforcing a against a sanctioned party would not cause the same troubles.

But nevertheless, freeze also halts any change to the assets, therefore making a transfer impossible. The Court of Justices has held in Bank Sepah that any change must be authorized by the government. This means that even that even if - and these are two big ifs - a claimant has an enforceable award and the respondent has seize-able assets, the success of enforcement ultimately depends on obtaining permission from the government. This permission underly strict conditions. These conditions are on the one hand anti-abuse measures (only satisfy the claim, do not benefit the sanctioned party) or formal (only awards before the sanctions took effect) and on the other hand open to the Member States own assessment (cannot contravene public policy).

This means even if you clear all hurdles the final decision lies with the competent regulatory authority. Any enforcement in the EU of awards is therefore not preferable. The obvious questions are then: what about outside the EU.

Awards under the New York Convention can be enforced in every signatory state (which might as well be synonymous with the world). While enforcement in Russia itself is impossible due to Russian sanctions, enforcement in third countries is possible.

Example: If a French company obtains an award against a Russian oil company, it cannot enforce it in the EU, for example transfer money from the Russian companies accounts in Germany to its own accounts. But can it enforce against the Russian companies assets in Brazil?

Theoretically, yes. A more practical problem will be to find sufficiently large assets, which are not connected to EU or US financial systems. In practice this route of enforcement will probably yield limited results if at all. A pre-requisite remains assets outside the EU; any Russian company will have moved them from there.

When discussing sanction and the EU sanctioning a country such as Russia, one rarely considers the effects on hard fought arbitral judgements. But when it comes to enforcing awards against Russian entities, sanctions should be top of mind these days. Russian assets remain frozen until Russia stops its illegal invasion of Ukraine. Until then all awards will not be enforceable in EU. Ultimately, for many award creditors and debtors, enforcement within the EU is legally and practically obstructed, leaving asset seizure and recognition proceedings in non-EU jurisdictions as the only viable path forward.