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Nord Stream 2: Sanctions against Russia and the potential for arbitration

Russia’s illegal and catastrophic invasion of Ukraine has led to a new wave of sanctions and business withdrawals with far-reaching implications. One high-profile project, and one of the first targets of the sanctions against Russia, illustrates the situation and some potential avenues for navigating a resulting arbitration. 

Suspension of Nord Stream 2

Among widespread calls to stop buying Russian oil and gas (and by some to more generally reduce dependence on Russian energy), the Russian invasion also led Germany to suspend Nord Stream 2’s certification, without which the US$11 billion natural gas pipeline cannot be launched. The Swiss-based company behind Nord Stream 2 (a subsidiary of Russian state-owned company Gazprom) has fired all of its 106 local employees. 

Energy commentators have noted that halting Nord Stream 2 could lead to investor-state arbitration under the Energy Charter Treaty (ECT). Germany’s suspension of the project’s certification echoes the Vattenfall case, where following the 2011 Fukushima nuclear disaster, the German Parliament accelerated the phasing out of nuclear power, leading the Swedish state-owned energy company to file a €7 billion ECT arbitration in relation to its two nuclear power plants in Germany. That case ultimately settled for €1.4 billion

Incidentally, Vattenfall has now also suspended deliveries of nuclear fuel from Russia to its nuclear power plants. In another parallel, arising from concerns over limited supplies of energy and metals following the invasion, uranium spot prices recently jumped to their highest level since Fukushima.

Nord Stream 2 has already brought an ECT claim against the EU in response to the 2019 amendment to the EU Gas Directive that impacted new gas transmission lines. In that case, the Swiss company alleges that the project had been disadvantaged as a result of the new onerous rules, in breach of the ECT.

It is therefore worth recalling that recent developments within Europe, and worldwide, are relevant in considering potential arbitrations arising out of Russia’s invasion of Ukraine. 

First, EU-wide mandates that states withdraw from intra-EU BITs and the European Court of Justice’s decisions in Achmea, Komstroy and PL Holdings all seek to curtail arbitrations by EU-based investors against EU states. In Komstroy, the ECJ sought to go even further by finding it had legal authority to interpret the ECT and jurisdiction to opine on a dispute between Moldova and a Ukrainian investor – two non-EU parties. Under international law (and in accord with the Vienna Convention on the Law of Treaties), the Komstroy ruling does not change the ECT’s terms and investor-state tribunals have so far continued to find they have jurisdiction to hear existing claims. However, a newly launched ECT arbitration against an EU state might have the best chances of proceeding if it is brought by a non-EU investor (eg, Swiss or UK).

Continued announcement of Russia sanctions

Second, and also of relevance in the context of commercial arbitrations, is that a variety of Russia sanctions continue to be announced on a daily basis, including in relation to its Central Bank, the SWIFT payments system and specific Russian individuals, as well as thenNord Stream 2 (such as by the United States Office of Foreign Asset Control, or OFAC). 

In the energy sector more broadly, it has recently been announced that Italy’s Eni is withdrawing from the Blue Stream pipeline between Russia and Turkey, Shell and Exxon are pulling out of Sakhalin projects, BP is abandoning its stake in Rosneft, and Norway’s Equinor also plans to exit Russia. In contrast, Hungarian Prime Minister Viktor Orban has rejected calls to suspend a US$14 billion expansion of Hungary’s Paks nuclear plant conducted by Rosatom (the Russian state atomic energy company that is itself now being considered for additional US sanctions). 

In response to these withdrawals, Russia’s Ministry of Economic Development announced that legislation was being prepared to nationalise assets of foreign companies that leave the country in the wake of economic sanctions and to sell such assets at public auction, with the state acting as the buyer if there were no applicants. 

In addition to the potential for arbitrations initiated by Russia-related parties such as Nord Stream 2, there could be arbitrations against Russia under its investment treaties with over 60 states (including BITs with Sweden, the Netherlands, the UK, Italy and Ukraine), even though there would be difficulties in enforcing resulting awards. 

A rise in issues similar to those as raised by the Covid-19 pandemic

Businesses may also find that the new commercial reality gives rise to a similar set of issues as that raised by the covid-19 pandemic, namely claims of force majeure, illegality, frustration and impossibility of performance, depending on the legal regime applicable.

Indeed, on 3 March, the Commercial Court confirmed (albeit in relation to OFAC’s 2018 sanctions against Oleg Deripaska, Rusal and others) one aspect of the relationship between sanctions and force majeure claims in MUR Shipping BV v RTI Ltd

In that case, an arbitral tribunal found that the sanctions on RTI’s parent company Rusal had an impact on its ability to pay MUR in US dollars, but that MUR’s case on force majeure failed as it could have accepted RTI’s proposal to accept payment in euros. The contract required that a force majeure event “cannot be overcome by reasonable endeavours from the Party affected”.

Upholding MUR’s appeal on a question of law, the court said that the reasonable endeavours provision did not require MUR to accept non-contractual performance and did not oblige it to accept payment in euros instead of US dollars; MUR was entitled to require the contract to be performed in accordance with its terms.

Conducting an arbitration between sanctioned entities

It is also worth considering, as a practical matter, how to proceed in conducting an arbitration involving sanctioned entities. Whilst some national/regional sanctions regimes contain carve outs for payment for legal services involving sanctioned entities, in some cases further authorisation is required or counsel/arbitrators can also risk falling afoul of sanctions.

For example, arbitrators with EU nationality or in a dispute with an EU seat must comply with EU sanctions (which require a licence for payment of an arbitrator’s fees when a paying party is subject to an EU asset freeze). Restrictions on activities in relation to US sanctions generally apply to “US persons” such as US nationals, residents or those working for a US law firm. Sanctions may also impose difficulties in recovering damages and/or enforcing an arbitral award, and for counsel receiving payment.

In a 2017 case in the Southern District of New York, United Media Holdings sought to vacate a AAA arbitration award issued in favour of Forbes Media, on the basis that the arbitration and the award were in violation of US sanctions. 

After initiating the arbitration, a beneficial owner of United Media was placed on an OFAC list of “specially designated nationals”. Forbes sought clarification from OFAC as to how to proceed and was informed that the arbitrator and United Media’s counsel would require an OFAC licence to participate in the arbitration or otherwise deal in property in which the sanctioned individual had an interest. Forbes would equally require a licence to enter into any settlement agreement or as part of any arbitral award. 

With various counsel teams appearing and subsequently withdrawing, OFAC ultimately licensed the arbitration proceedings, the arbitral award and its enforcement, and the New York court upheld the award.

However, this case illustrates some of the complications that can arise in conducting an arbitration involving a sanctioned entity (including maintaining the procedural calendar), as well as post-arbitration risks relating to enforcement of an arbitral award. 

Indeed, it is worth keeping in mind the difficulties arising from sanctions in the light of the recent spate of law firms refusing to continue acting for Russian clients, including most recently the announcement that the counsel team in the abovementioned ECT claim were no longer acting for Gazprom’s subsidiary in the Nord Stream 2 arbitration. In the same vein, the London Metal Exchange’s copper committee recently recommended banning new supplies of Russian metal, which would also drastically impact nickel and aluminium markets. 

In conclusion, the sanctions arising from Russia’s illegal invasion of Ukraine are likely to have a significant impact, and perhaps most immediately in the energy and metals sectors. Eventually, this may even create opportunities to increase energy independence (see, for example, the resumed construction of Baltic Pipe between Poland and Norwegian gas fields) and investment in renewables (see, eg the European Commission’s “REPowerEU” initiative).

In the short term, however, while more investor-state and commercial arbitration claims are likely to arise, parties will have some obstacles to navigate.