Sanctions and arbitrability

Roberto Oliva

The sanctions adopted against certain Russian entities and individuals after the invasion of Ukraine by the Russian Federation might raise an issue of arbitrability of disputes between sanctioned entities and third parties.

This is not a new subject for practitioners of international arbitration, as it has been addressed in the past when the international community adopted sanctions, for example, against Iraq or Iran. The current sanctions are somehow different (for example, they are not adopted by the United Nations) and are more similar to those adopted against the same Russian Federation following the annexation of Crimea.

The issue now requires further attention, either because of the scope of the new sanctions or because of the relevance in the international trade of several of the sanctioned entities.

At first glance, the analysis of the issue could start from the sole pieces of legislation expressly addressing the relationship between sanctions and arbitration proceedings: European Union Regulation No. 883 of 2014, as amended by European Union Regulation No. 1269 of 2022 and by European Union Regulation No. 1904 of 2022. This Regulation clearly excludes from the scope of sanctions: (i) the “transactions which are strictly necessary to ensure access to (…) arbitral proceedings, as well as for the recognition or enforcement of (…) an arbitration award rendered in a Member State”, and (ii)the provision of services which are strictly necessary to ensure access to (…) arbitral proceedings in a Member State, or for the recognition or enforcement of a judgment or an arbitration award rendered in a Member State”.

The apparent meaning of these provisions is that sanctions do not directly affect arbitration. It is not by chance that several European arbitration institutions welcomed the enactment of such provisions with great satisfaction.

Nonetheless, this first impression proves to be wrong.

The said provisions merely state, in a few words, that sanctions do not apply: (i) to payments from sanctioned entities to arbitral institutions, arbitrators and lawyers, and (ii) to services rendered in connection with arbitration proceedings pending in a Member State. Their scope of application is very similar to that of the general licence recently issued in the United Kingdom in favour of the London Court of International Arbitration. However, these provisions (as the British licence) do not address the issue at hand, that of the arbitrability of disputes.

In fact, there is no univocal answer.

For the sake of clarity, with regard to the issue at stake, we can distinguish two kinds of jurisdictions.

A first kind of jurisdictions – “Type A jurisdictions” – are quite more conservative. In these jurisdictions, a dispute may be referred to an arbitral tribunal only if the parties are allowed to dispose of the underlying rights.

On the other hand, the second kind of jurisdictions – “Type B jurisdictions” – are more liberal. In these jurisdictions, it does not matter if the parties may freely dispose of their rights. A dispute may be referred to arbitrators if it concerns an economic interest. Nothing more is required.

With this great distinction in mind, it is possible to make a preliminary assessment of the effects of the sanctions on the issue of arbitrability. Sanctions have or may have great – potentially disruptive – effects on arbitration in Type A jurisdictions. In Type B jurisdictions, in contrast, their effects are quite limited.

These effects may occur (i) before, or (ii) during the arbitral proceedings. The party that considers the dispute non-arbitrable due to the sanctions may (i) disregard the arbitration clause and initiate litigation in State Courts, or (ii) raise an objection in the arbitral proceedings, or (iii) bring an action in State Courts while the arbitration is pending. But the losing party may also use the argument of non-arbitrability to prevent the circulation of the award under Art. V, para. 2(a) of the New York Convention. In the near future, the risk is that of having a number of “lame” awards, which are valid and enforceable in the jurisdiction where they were issued but cannot be enforced in some other jurisdictions (an issue also under Art. 42 of the ICC Rules or similar provisions of other institutions).

Starting with Type A jurisdiction, the first example is Italy.

Italian Code of Civil Procedure provides that the parties may defer to arbitrators only disputes concerning rights of which they may dispose. If the parties cannot dispose of the right in dispute, jurisdiction only belongs to the State Courts.

Then, a question arises. Do sanctions have the effect of transforming a disposable right, such as the right to receive contractual consideration, into a non-disposable right? As Italian law currently stands, the answer seems positive, also considering the sanctions nature as rules of public policy.

Indeed, Italian Courts have already ruled on the point: the Court of Appeal of Genoa in May 1994 and, more recently, the Supreme Court in November 2015. The sanctions that then came into play were those adopted against Iraq. And in both cases the conclusion was that, as a consequence of sanctions, rights became non-disposable and therefore, there was no room for arbitration.

The decision of the Court of Appeal of Genoa also contains a very interesting clarification. When we are discussing of rights the parties cannot dispose of as a consequence of the sanctions, we are discussing of all the rights arising out of the contract between the sanctioned entity and the third party. The right to request the termination of the contract (for force majeure, frustration, and so on) is included. Indeed, as the Court stated, “otherwise, we could face the possibility (or rather, the risk) that the parties dispose of rights they cannot dispose of due to the sanctions”.

The same clarification is also contained in the Supreme Court’s decision. Indeed, the Supreme Court stated that the contractual relationship has to be assessed “in its entirety”, and that it is not possible to distinguish between rights of the sanctioned entity (of which the parties cannot dispose) and rights of the third party (of which it could dispose). All the rights and interests arising out of the contract are rights and interests of which the parties cannot dispose. Arbitration is not possible.

The recent reform of Italian arbitration law, which will come into force in June 2023, has not affected the definition of arbitrable disputes. Therefore there is no reason to believe that Italian Courts will change their conclusions. If they have jurisdiction, they will issue a decision on the merits, maintaining that an arbitration clause between a sanctioned entity and a third party is null and void or, in any case, unenforceable. And if they are requested to recognise a foreign award issued in favour of, or against a sanctioned entity, they may refuse recognition.

There are two other Type A jurisdictions of particular interest for their relations with the Russian Federation, in which arbitrability is defined in a manner overlapping with the Italian one: Sweden and Turkiye.

Swedish Arbitration Act provides that disputes “in respect of which the parties may reach a settlement” are arbitrable. This definition in some ways appears even more restrictive than the Italian one, and there is no doubt that sanctions preclude a settlement between sanctioned entity and third party.

The Svea Court of Appeal in November 2005 and the Swedish Supreme Court in November 2012 held that two disputes involving Russian parties that could not be settled under Russian law are nonetheless arbitrable under Swedish law. However, these are very different cases, and even then, the Courts made it clear that a case-by-case approach is necessary for such situations.

In this case-by-case approach, it could also be possible that Swedish Courts would distinguish on the basis of the specific rights that are the subject matter of the parties’ requests; that is to say, that they would draw the very same distinctions the Italian Courts willingly refused to do. Therefore, a Swedish arbitral tribunal could issue an award on the merits, for example, if the claimant is the non-sanctioned entity, and it claims the consideration for the services it rendered before the sanctions, or the termination of the contract due to the sanctions. On the other hand, the situation would be uncertain in case of a claim raised by the sanctioned entity. In addition, possible counterclaims or objections raised by the sanctioned entity would further complicate the matter, even leading to a possible bifurcation.

As a matter of fact, at least in one case an award was issued in Stockholm in arbitration proceedings involving a sanctioned entity: Pesa v. Ural Trans Mash. The sanctions then at stake were those enacted following the annexation of Crimea, and this case triggered the first application of Russian procedural counter-sanctions in December 2021. Nonetheless, the arbitral tribunal issued an award on the merits, and so it held that the dispute was arbitrable.

In addition, some rumours in the international arbitration community indicate that arbitration proceedings are currently pending in Stockholm between newly sanctioned entities and third parties.

In the end, it could be concluded that there is a risk that arbitration proceedings in which arbitrability is governed by Swedish law cannot be commenced, or cannot be continued, due to the sanctions. However, due to the lack of precedents from Swedish Courts on that very point, for the time being it is not possible to assess such risk.

Turkiye is the other Type A jurisdiction where arbitrability is defined in terms similar to Italy.

However, Turkiye has not, at least so far, adopted sanctions against the Russian Federation. The issue is thus more complicated: for Turkish law, no question affects the parties’ possibility to dispose of their rights; however, it could happen that these rights are not available to a party due to public policy provisions of its own jurisdiction (for example, if that party is an entity based in the European Union). There are no reported Turkish Courts decisions on the subject or related topics. Therefore, it could not be completely ruled out the risk that sanctions affect Turkish arbitrations. Nonetheless, for the time being such risk seems quite remote.

The same mechanism possibly applies to other Type A jurisdictions, such as a number of North African and Middle Eastern jurisdictions, which are in a position very similar to that of Turkiye.

The other significant set of jurisdictions – Type B jurisdictions – define arbitrability of disputes based on the fact that they concern an economic interest.

The first example of Type B jurisdiction is Switzerland.

Under Swiss Private International Law, any claim involving an economic interest may be the subject matter of an arbitration. And it is worth noting that Swiss Supreme Court has already examined the matter with respect to trade sanctions. It heard the very same case that was heard in Italy by the Court of Appeal of Genoa in 1994. And it came to an opposite conclusion: in the view of the Swiss Court, that dispute between the Italian company and the sanctioned Iraqi entity could have been decided by the arbitral tribunal. In a few words, the sanctions did not affect arbitrability, but only the content of the law to be applied to the merits.

France is also a Type B jurisdiction, but a peculiar one. Indeed, Art. 2050 of French Civil Code sets forth that “It is not possible to enter an arbitral agreement concerning (…)” among other things, also “public policy”.

Nonetheless, that Article only applies with respect to French domestic arbitration. Concerning international arbitration, French Courts have a very liberal approach. In fact, also a French Court – the Court of Appeal of Paris – heard the case heard by the Court of Appeal of Genoa. And it came to the conclusions already reached by the Swiss Supreme Court: sanctions do not exclude arbitrability.

The decision of the Court of Appeal of Paris is also interesting under another point of view. Besides informing us that France is a Type B jurisdiction, it also informs us that French Courts would be reluctant to recognise a decision issued in a Type A jurisdiction by a State Court maintaining that an arbitration clause entered into by a sanctioned entity is not enforceable.

The same conclusions would be reached in two other Type B jurisdictions, Germany and Austria: indeed, although there are no reported precedents in these jurisdictions, they adopt a definition of arbitrability overlapping with that of Switzerland. A dispute is capable of arbitration if it concerns an economic interest. And a dispute between a sanctioned entity and a third party would involve an economic interest.

Consider, for instance, the cases between Russian principals and their European contractors, which resulted in the recent issuance in Moscow of anti-suit injunctions preventing the European contractors from commencing or continuing ICC and VIAC arbitration proceedings. The disputes would be arbitrable under French law and Austrian law, i.e. the law of the seats of the arbitrations. But the awards would not be enforceable in Russia due to the said anti-suit injunctions. Nor would it be enforceable in Type A jurisdictions adopting sanctions (such as Italy) where arbitrability depends on the parties’ possibility to dispose of their rights.

Similarly, moving from civil law to common law jurisdictions, it could be reasonably assumed that the sanctions against the Russian Federation do not prevent a dispute from being referred to arbitration. The English Arbitration Act, for example, is utterly silent on the issue of arbitrability, and the English Courts are very reluctant to uphold objections asserting the non-arbitrability of a dispute. A situation that is very similar to that in France concerning international arbitration. It is very difficult for an English Court to follow the doctrine whereby a dispute may be referred to arbitrators only if it concerns rights of which the parties may freely dispose. Nonetheless, caution is required, as at least an English authority in 2009 held that an arbitration clause is null and void if it is purported to require the submission to arbitration of questions pertaining to mandatory provisions (in that case, of European Union law).

The same situation occurs in the United States. Indeed, as in England and Wales, the Federal Arbitration Act does not address the issue of arbitrability. Nonetheless, the evolution of US case law in the past four decades has been viewed as a striking example of the decline of the nonarbitrability doctrine in this field. In short, a claim would be deemed as non-arbitrable under the statutory regime of the Federal Arbitration Act only where federal legislation expressly requires this result.

In the end, particular caution is required, and a case-by-case approach has to be followed: arbitrability is a very sensitive issue for domestic Courts, even more sensitive because of sanctions.

A one-size-fits-all answer that applies to every international commercial arbitration is not possible. On the contrary, it is necessary to weigh the specific features of the jurisdiction whose laws govern the issue of arbitrability.

In addition, it should be taken into account the risk (or rather, the likelihood) that a dispute concerning a contractual relationship between a sanctioned entity and a third party could be decided by (i) a State Court in Russia (as a consequence of Russian counter-sanctions), (ii) a State Court in some Type A jurisdiction (as the sanctions could prevent arbitration in these jurisdictions), and (iii) an arbitral tribunal in a Type B jurisdiction (as the sanctions do not affect arbitration in these jurisdictions). And that would also possibly imply conflicting decisions, and serious issues in their circulation and enforcement.

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