Expropriation and other recent measures aimed at foreign investors in Russia
Russia’s invasion of Ukraine is still ongoing – and so are retaliatory measures by the Russian government that could potentially continue to impair foreign investments in Russia or contracts concluded with Russian entities.
Following up on our earlier post in March 2022 outlining the initial set of measures (see Market Insight of 14 March 2022 here), it is time for an update.
As of January 2023, the course of the conflict remains unclear, so this update is intended to be a snapshot of some of the legal developments to date.
Potential nationalisation of foreign businesses and their assets
As previously reported, last February saw the first signs of concern that the Russian government might take actions to nationalise or expropriate foreign businesses and their assets. Decrees providing for such measures were enacted in short order at the beginning of 2022. Although there have not been reports of widespread expropriations, some prominent examples forewarn all foreign investors to stay vigilant and monitor the situation carefully.
The Russian government has established new operating companies for the Sakhalin-1 and Sakhalin-2 oil and liquified natural gas projects in the far east of the country, thereby essentially stripping foreign investors of their interests in the projects. A Presidential Decree allows foreign companies to apply to the government to have their shares transferred to the new operating company. Against this backdrop, two major western energy companies have decided not to apply for a transfer of their shares, resulting in a loss of the shares in the projects and billions of US dollars worth of investments.
One investor’s previous attempt to sell its shares in the project was also blocked by Russia’s retaliatory measures. The Russian President issued a Decree on 5 August 2022 that aims at banning transactions with certain assets in certain investment projects, absent a specific permission by the Russian government. Decree 520 is applicable to interests owned or controlled by persons from “unfriendly” countries (a list of countries published by the Russian government that are considered to commit unfriendly actions against Russia, Russian companies and citizen). It is currently only applicable to shares and interests in specific companies and projects, as well as companies and projects specifically from the energy and banking sectors. This severely restricts an investor’s ability to restructure or even exit their investments without permission from the Russian government. It is reported that this prevented one of the foreign energy companies invested in the Sakhalin-1 project from divesting its shares by selling them to another investor, before they were forcibly transferred to the new operating company.
The aircraft leasing sector was also one of the first sectors that was directly impacted by Russia’s retaliatory measures. Several aircraft leasing companies incurred losses as they were unable to recover most, or all aircrafts leased to Russian airline companies. Disputes between leasing companies and their insurers on the potential insurance coverage of the “lost” aircrafts have since been reported. To date, it has been reported that foreign lessors have lost a total of 435 planes in Russia. In the meantime, it has also been reported that Russia plans to use over USD 22 billion until 2030 to replace the foreign made airplanes with domestic models.
Restriction related to the sale-purchase of interests in Russian limited liability companies
In March 2022, the Russian government imposed a special approval mechanism on purchase-sale of shares in Russian joint stock companies between residents and non-residents from “unfriendly” countries. This retaliatory measure adds further difficulties for foreign investors to divest from their business. This approval mechanism was extended on 8 September 2022 by Decree 618 to transactions relating to interests of Russian limited liability companies. The broad nature in which the Decree has been drafted, creates the possibility that the restrictions are not only limited to purchase-sale of stakes, but could extend to pledge or option agreements, management agreements or even shareholder agreements and articles of association, in case they would provide a targeted person or entity controlling or extensive rights. The Decree could also extend to indirect transactions occurring outside of Russia.
Potential restriction of patents and IP rights
The Russian government is continuing its discussions on potential restrictions of patent and IP rights. After already implementing a framework to essentially take over foreign patents without mandatory royalties, on 19 August 2022 a member of the Russian Duma introduced a bill that – if enacted – would enable courts to order compulsory licenses. The draft, essentially, addresses all rightsholders of copyrights, such as software, music, film etc., from “unfriendly” countries. The discussion on potential restrictions and IP rights in Russia is far from over and another space to continue to monitor closely.
Measures aimed at foreign currencies and the capital and financial markets
On 26 October 2022, Russia has taken measures with respect to financial services. This marks another escalation of the already far-reaching retaliatory measures by imposing an outright ban on dealings in or with shares or share capital of 45 banks and banking units, which are all either owned directly or through foreign capital by parties in countries that Russia considers “unfriendly”.
The pre-existing prohibition to transfer or move any foreign currencies amounting to an equivalent of USD 10,000 outside the country has been extended until March 2023. Non-Russian natural or juridical persons that are from the so-called “unfriendly states” are further prohibited to transfer monies abroad from Russian bank accounts until March 2023.
Furthermore, Russian banks that are sanctioned by “unfriendly” countries may unilaterally convert any foreign currency deposits into Russian Roubles.
There have been noteworthy developments with respect to investment protection in Russia. First, Russia has attempted to expand its territory by the purported annexation of four regions in eastern and south-eastern Ukraine: Luhansk, Donetsk, Kherson and Zaporizhzhia. Striking similarities with Russia’s purported annexation of Crimea in 2014 can be drawn.
Given that arbitral tribunals as well as State courts have consistently found that Ukrainian investors could initiate investor-state arbitrations against Russia for damages caused to their investments by Russia in Crimea, the newly purported annexed regions could likely provide the same possibilities for investors that are damaged by Russia. Non-Russian investors in Luhansk, Donetsk, Kherson and Zaporizhzhia should review their investment structure and carefully keep track of all harm caused to their investment by Russia. Given that Russia has already hinted at taking control over private energy infrastructure, expropriations might follow suit. By purportedly annexing the Ukrainian regions, Russia has opened itself up to liability under its existing investment protection agreements.
Secondly, as previously reported, there is considerable dispute over the Energy Charter Treaty’s (ECT) application in Russia for pre-2009 investments in Russia’s energy sector, because the state never ratified the ECT. A recent court decision from August 2022 in Switzerland joins a 2021 decision from the Dutch Supreme Court to affirm the ECT’s application. Russia, in its recent attempts, has failed to set-aside arbitral awards that are based on the ECT. It might be too early to identify an emerging pattern by arbitral tribunals and state courts that affirm the ECT’s application with respect to investments made in Russia’s energy sector before 2009. However, the current decisions are rather encouraging for investors and the potential protection of their investments under the ECT, conditional on whether (i) their investments are made in the energy sector and (ii) have been made pre-2009.
It has been reported that Ukraine and the EU are working towards establishing a War Claims Commission as a procedure to process reparation claims against Russia. International Claims Commissions have been successfully used in the past and can be designed for a specific situation. However, certain limitations exist that could make the claims commissions a difficult endeavour. First, Russia has not – and very likely will not – agree to the War Claims Commission. Establishing a commission with a treaty – without Russia’s consent – is argued by some as a violation of the third-party rule of treaty law, namely that no state is bound by an agreement reached by others.
Second, Ukraine’s plan to use frozen Russian assets in Western states for payment of the reparations is also considered legally difficult. Some argue that this would set a dangerous precedent and a violation of sovereign immunity, which is considered to also cover assets that states hold abroad. To this regard, several roadblocks still exist on the way to establishing a claims commission. The commission would be of unprecedented and unknown size, due to the fact that the war is still ongoing. If Ukraine succeeds and a Russia-Ukraine claims commission is to be established in the future, private claims for reparation from Russia for damages incurred because of the war will likely also be possible. Despite the overall concerns of using frozen assets for reparations, the Canadian government has started a first process to seize and pursue the forfeiture of a sanctioned Russian oligarch’s assets to use the proceeds for the reconstruction of Ukraine and compensation of victims.
We also refer to our previous Insight of 14 March 2022 regarding the possibilities of such a claims commission and the more general enforcement difficulties (see Market Insight here).
Arbitrating Disputes with Russian Parties
Companies conducting business or with existing business in Russia or with Russian business partners might have arbitration agreements as robust dispute resolution clauses in their contractual agreements. Given the number of changes in the business environment and non-commercial considerations that have resulted from Russia’s invasion of Ukraine, disputes could easily arise even for most prudent and diligent companies. In the current situation, even arbitral proceedings are not “business as usual”.
Critically, in 2020, Russia passed legislation that provided for Russian courts’ exclusive jurisdiction over disputes involving sanctioned Russian parties. The Supreme Court in a 9 December 2021 ruling upheld the law and decided that a sanctioned party could request an anti-arbitration injunction based on the legislation, regardless of whether the other party to the arbitration or the dispute has any connection to the country where the Russian party is sanctioned. Given the rising number of sanctioned companies and entities – as well as the nature of the sanctions – the risk that a dispute is connected to a sanctioned counterpart is more likely than ever. This could give Russian counterparties an excuse to not participate in an arbitration from the start.
Sanctions against Russian companies and state-owned entities are also feared to disrupt arbitral processes even if both parties are willing to proceed to arbitration. In summary, sanctions must be complied with by all natural and juridical persons within the territory of the state and all nationals of the state that enacted the sanctions, regardless of whether they are in- or outside of the state’s territory. Different sanction regimes might have to be considered in a single arbitration depending on the nationality or residence of a party, arbitrator, counsel, witness or arbitral institution, the location of the seat of the arbitration or wthe place(s) the dispute is connected to. For example, an arbitrator or arbitral institution might be prohibited from receiving payment from a party, then Counsel may be prohibited from rendering legal services for a sanctioned party or an important but sanctioned witness might not be able to travel to an in-person-hearing.
On 15 March 2022, the EU had imposed sanctions that aimed at prohibiting transactions with Russian state-owned entities. The Arbitration Institute of the Stockholm Chamber of Commerce (SCC), Vienna International Arbitration Center (VIAC), Arbitration Institute of Finland Chamber of Commerce (FAI), Milan Chamber of Arbitration (CAM), German Arbitration Institute (DIS) and the Swiss Arbitration Centre reached out to the EU to address concerns by parties, counsel and arbitrators at their institutions regarding potential negative effects on access to and conduct of arbitral proceedings that involve Russian state-owned entities. This would not have only impacted arbitrations with state-owned entities as direct parties, but even the question as to whether an arbitral institution’s bank could accept the transfer of funds from a party’s bank that is a Russian state-owned entity. The EU reacted and on 21 July 2022 clarified that “transactions which are strictly necessary to ensure access to judicial, administrative or arbitral proceedings in a Member State, as well as for the recognition or enforcement of a judgment or an arbitration award rendered in a Member State” are not prohibited (Council Regulation (EU) 2022/1269 of 21 July 2022 amending Regulation (EU) No 833/2014 concerning restrictive measures in view of Russia’s actions destabilising the situation in Ukraine).
On 17 October 2022, the London Court of International Arbitration (LCIA) has likewise been granted a license from the UK’s Office of Financial Sanctions Implementation for arbitrations administered and conducted under its own arbitration rules. The license allows the LCIA to process payments from parties for their costs of arbitration, even if they themselves or controlling entities are subject to UK’s sanctions against Russia and Belarus in connection with Russia’s invasion of Ukraine. The license also allows banks to process these payments.
While the EU and UK have clarified that sanctions should not hinder arbitral proceedings, some problems and issues remain. Secondary sanctions in force in other jurisdictions still cannot be ruled out entirely. Even with exceptions in place, banks for example might still be hesitant to process payments made to arbitral institutions by sanctioned entities. Or some sanctioned entities’ banks might be disconnected from the SWIFT payment system and thereby not able to make payment. Additionally, it might be difficult for any Russian party or bank to make payment in the appropriate currency.
Overall, arbitrating disputes with respect to Russia and in particular sanctioned entities have become more complex. It requires careful considerations to ensure the effectiveness of an arbitral proceeding. Existing arbitration agreements are still used to settle dispute with Russian parties, as evidenced by the two German energy companies Uniper and RWE that reportedly brought two separate claims in December 2022 against Russia’s Gazprom over missing gas deliveries. Given the war’s impact on the gas and energy market, it is likely that this is only the tip of the iceberg of war-related arbitrations in the energy sector.
Enforcing arbitral awards
Sanctions may also impact enforcement of an award, because enforcement of an award under the New York Convention could be refused if a national court considers that the enforcement would be against public policy. While it is unlikely that sanctions are generally considered public policy, the existence of sanctions will give a resisting party an additional avenue of defence that could – and according to some in extreme cases – even be successful. It will also be practically difficult to enforce an award against a Russian party that had its assets outside of Russia frozen. Enforcement in Russia under the current circumstances might be considerably more difficult if not impossible at this time.
Enforcing arbitral awards against unwilling states, but particularly Russia, has a long and difficult history. Attempted enforcements have seen colourful examples of creative ways to enforce against unwilling states. The most recent example is an attempt to enforce an arbitral award by way of auctioning off seized trademarks of Russian vodka brands in the Netherlands. Russia ultimately lost its appeal against the attachment of the trademarks in November 2022, because the court found the vodka trademarks of commercial and not public purpose. In an unforeseen plot-twist the trademarks were not sold in an auction on 6 December 2022, because the received offers were considered to be too low. Given that we can expect more awards against Russia in the future, it will be crucial to build on past enforcement experiences and find creative ways to successfully enforce arbitral awards.
Furthermore, the Commercial Court of St. Peterburg and Leningrad in Russia decided on 30 December 2022 to freeze assets in the amount of nearly USD 500 million from a German company to prevent the company from disposing of its Russian assets. The petitioning Russian company successfully argued that it was intending to bring a HKIAC arbitration against the German company in excess of EUR 1 billion and because the imposed sanctions outside Russia would make subsequent recovery outside Russia impossible, the freeze was considered necessary to ensure the enforcement of the potential future award. This decision and its consequences highlight the complex situation all (potential) parties to a dispute face in the current situation with the plethora of sanctions and countersanctions that are in place.
If you have any questions on investment protection or arbitrating with Russian parties, please get in touch with Georg Scherpf (Clyde & Co, Hamburg).
For a detailed analysis of investment protection in the CIS region, please see the article published by Georg Scherpf (Clyde & Co) and Nikita Kondrashov (External) in the German Arbitration Journal (Investment Protection and Arbitration in the CIS Region (SchiedsVZ 2020, 8 – beck-online). Georg Scherpf also co-authors the Article-by-Article Commentary of the ICSID Rules and Regulations 2022 (Editors Happ/Wilske, Beck, Hart, Nomos).
For an overview of Clyde & Co’s international arbitration team in Germany, please see here: https://www.clydeco.com/en/insights/2021/06/arbitration-germany.