The fallout from Russia’s illegal invasion of Ukraine has reverberated across the globe, leaving in its wake a landscape of economic sanctions, political tension and unprecedented challenges. In such tumultuous times, arbitration remains a crucial mechanism for resolving disputes. Here we consider the ongoing interrelationship between sanctions and arbitration, addressing high-profile cases, the extent to which arbitration can function in parallel to sanctions and the roadmap forward.

One of the most prominent projects impacted by the sanctions is Nord Stream 2, an $11bn natural gas pipeline that became one of the first targets. As the world called for a halt to Russian energy imports, Germany suspended Nord Stream 2’s certification. The consequences were swift, with the Swiss-based company behind the pipeline declaring bankruptcy in Switzerland and terminating all local employees.

Energy experts highlighted that the suspension of Nord Stream 2’s certification could trigger investor-state arbitration under the Energy Charter Treaty (ECT). Interestingly, ECT claims have already arisen concerning Nord Stream 2, stemming from the EU Gas Directive amendment of 2019, which affected new gas transmission lines. The Swiss investor even filed a claim against the EU itself in 2019, alleging that the project had been disadvantaged due to new onerous rules, thus breaching the ECT. This claim suffered a halt and the proceedings were suspended in 2022 for over a year, as the bank accounts of the Nord Stream 2 were blocked. The proceedings have now resumed, as the Swiss investor managed to obtain an alternate source of funding.

Arbitration under sanctions

The current wave of sanctions imposed by various countries brings to light the intricate interplay between arbitration proceedings and restrictive measures. The question arises: can arbitration continue as normal in the face of sanctions?

Sanctioned entities and legal challenges

In many instances, sanctioned entities and individuals find themselves unable to access arbitration fora, and even when they do, the process can be fraught with complications. For example, some sanctions regimes have carve-outs allowing for payments related to legal services. However, these exceptions might require additional authorisation, adding layers of complexity. Arbitrators with EU nationality or disputes with an EU seat must comply with EU sanctions, necessitating a licence for payment of an arbitrator’s fees when a paying party is subject to an EU asset freeze. Arbitrators with non-EU nationality are also required to carry out basic due diligence of any potential impact of the sanctions on the dispute or the legal regimes involved in the proceedings. In the Nord Stream 2 case, the tribunal requested the parties provide a supplementary deposit, to ensure availability of sufficient funds for the seamless continuance of the proceedings. Such compliance can be challenging and might lead to delays.

Legal challenges also loom large. The case of United Media Holdings NV seeking to vacate an arbitration award issued in favour of Forbes Media LLC in 2017 exemplifies this. The case involved a beneficial owner of United Media finding themselves on a list of “specially designated nationals” maintained by the United States Office of Foreign Asset Control (OFAC). This placed significant hurdles in the path of arbitrators and legal counsel, requiring OFAC licenses for their participation.

Although the arbitration eventually proceeded and the award was upheld, the case underscored the complications of conducting arbitration involving sanctioned entities.

Sanctions and the future of arbitration

As the sanctions regime continues to hold, what is the future for arbitration proceedings?

Arbitration is known for its flexibility and impartiality and its adaptability allows parties to address unique issues such as sanctions. However, while it is designed to function independently of political or economic considerations, in practice sanctions can disrupt the arbitration process.

One critical challenge is the fluctuating legal environment. Sanctions are ever-evolving, with governments continuously updating measures and restrictions. In the context of ongoing arbitration, the shifting sanctions landscape can pose significant hurdles, affecting the feasibility of awards, enforcement and damages. This is also leading international traders to amend their contracts into a neutral currency to avoid any negative repercussions of sanctions.

Another challenge is the potential reluctance of law firms to represent sanctioned entities. The recent trend of firms refusing to continue representing Russian clients demonstrates the growing complications in this arena. The withdrawal of legal representation can impede the progress of arbitration and raises questions about access to justice and due process. Also, refusal by arbitral institutions (or their banks) to administer cases and arbitrators rejecting appointment in cases involving sanctions further complicates access to arbitration.

The roadmap forward

As more states join the sanctions regime, parties embroiled in disputes may find themselves navigating a complex web of challenges and opportunities. To chart a course forward, several considerations come into play:

1. International law and treaties: parties involved in arbitration can seek guidance from international law and treaties. The ECT, as seen in the Nord Stream 2 case, offers a framework for addressing disputes related to energy investments. Bilateral investment treaties can also provide a basis for arbitration.

2. Evolving legal practices: in response to the changing landscape of sanctions, legal professionals, arbitrators and arbitration institutions will need to stay attuned to evolving legal practices and carve-outs that facilitate compliance while ensuring justice is served. The choice of legal regimes and arbitral institutions is increasingly reflecting attempts by parties to avoid the implications of sanctions on arbitral proceedings, which is leading to increased popularity of arbitration institutions such as SIAC and HKIAC.

3. Diplomacy and negotiation: while arbitration can be a valuable tool for resolving disputes, diplomatic efforts and negotiations should not be underestimated. Sanctions are ultimately a response to geopolitical issues, and addressing those issues may lead to de-escalation and the removal of sanctions. Equally, international organisations, such as the United Nations, may play a more prominent role in mediating disputes in the face of sanctions, providing a neutral platform for addressing international conflicts.

The interplay between sanctions and arbitration is complex and evolving. While sanctions undoubtedly introduce challenges, arbitration remains a viable and valuable means of resolving disputes. Parties, arbitrators, arbitration institutions and legal professionals will need to adapt to the changing landscape, leaning on international law whilst being adept with the realities of the sanctions and evolving practices to navigate the path ahead. As the sanctions regime gains momentum, the world of arbitration finds itself at a crucial juncture, where adaptability and creativity are paramount.

Tomas Vail is a specialist investor-state arbitration lawyer and the founder of London-based law firm Vail Dispute Resolution