No industry feels the effects of the seemingly ever-changing regulatory landscape more than the energy sector. Multi-jurisdictional in nature and targeted by sanctions, players in the energy industry can confront the choice of either breaching sanctions, or breaching their contract, following a change in sanctions law. The interplay between sanctions and dispute resolution (usually by international arbitration), has become a difficult but important issue for energy sector businesses to navigate.
How has this happened?
The sanctions clause was once consigned to the status of boilerplate; rarely reviewed (let alone changed), it was “nice to have”, rather than a deal breaker. Nowadays, debate over single words in these clauses can delay multi-million dollar deals for months, as parties attempt to protect themselves against potentially significant exposure to reputations and balance sheets.
The reason for this change is not just the more frequent use of sanctions affecting an expanding number of countries. In our view, two factors are at play. First, the EU and the US (followed by many other countries, including Australia and Canada) have introduced a new variant of sanctions that targets industry sectors in specific ways, which differ from the general embargos against countries or persons that have traditionally been the core of most sanctions regimes. Secondly, the two widest reaching sanctions regimes, being those of the EU and US, have diverged in their application, both in dramatic and in more subtle ways.
Nowhere is this shift more evident or impactful than in relation to the energy industry. The sanction programmes that have arguably had the most effect on global trade in recent years are those with respect to Russia, Iran and Venezuela. Each of these programmes (both from EU and US perspectives) specifically targets the energy sector in those jurisdictions, albeit by different methods.
For example, the sanctions imposed with respect to Russia in 2014, and gradually expanded since that date, target key Russian energy sector companies and individuals, in limited or extensive ways, depending on the subject. Further, they target particular types of energy projects and the provision of goods, technology and equipment for those projects, and certain financing, insurance and services related to the energy sector. With respect to Iran, many of the sanctions reintroduced by the US following its withdrawal from the Iran nuclear deal specifically target Iran’s oil and gas and petrochemical sectors, together with the related finance and transport sectors. The sanctions recently imposed with respect to Venezuela have implications for any entities doing business with the state oil and gas company PDVSA. Highly specific prohibitions affect existing contractual commitments, trading positions, deliveries, pricing, hedging, scheduling, and forecasting, and any change in these prohibitions can have a significant impact for companies operating in this market.
Further, the manner in which the energy sector in various sanctioned jurisdictions is targeted by the EU and US sanctions programmes has diverged, and the difference is becoming more pronounced as various state actors pursue different goals. This is clearly evidenced by the strong divergence between the EU and US with respect to the Iran Nuclear deal, where energy companies face the impossibility of compliance with both EU and US sanctions with respect to Iran, and severely limited contractual options. Perhaps more subtle, but with a wider impact, are the differences of approach to the Russian energy sector taken by the EU and US, which require particularly deft consideration.
What does this mean for the energy sector?
Where there is uncertainty, disputes flourish. Any business operating in a sanctioned jurisdiction, or involving a sanctioned party, or where there are potential sanctions implications for the project or products involved, must apply well drafted and sufficiently sophisticated sanctions clauses in their trade, project and finance documents. “Market” sanctions clause wordings for various energy related contracts have drastically changed over the last four years. Sanctions clauses need greater flexibility to deal with divergent regimes and to adapt to frequently changing circumstances. Bespoke clauses that suited one transaction may be very different to what is acceptable to parties and their financiers in a different transaction.
As arbitration is the preferred dispute resolution mechanism in the international energy market, a robust arbitration clause is also vital in any energy sector related contract. Moreover, given the interplay between disputes and sanction risks, it is now more important than ever to ensure that contractual protections designed to mitigate exposure or to cause contractual outcomes (such as suspension, renegotiation, termination, waiver or alteration of rights) will all work effectively together.
Starting points include assessing potential present or future sanctions nexus and exposure, and recognizing that this may entail a deeper and more wide ranging enquiry into risk appetite than contractual parties may have previously found necessary. Contractual protections will be more successful the better the quality of the preceding analysis of underlying facts and circumstances. The ultimate aim should be so far as possible to ensure that dispute resolution mechanisms will work in tandem with the sanctions clause, regardless of how any sanctions issues actually play out.
By way of example, when new sanctions are introduced, it is very often not at all clear whether continuing to perform a contractual obligation will definitely be in breach of sanctions or not. Commercial positions would frequently cause parties to take opposite views. Depending on how sanctions are dealt with in the contract (if at all), a variety of different contractual consequences could follow, including allegations of failure to perform, attempts to claim or preserve termination rights, invocation of frustration, illegality or force majeure, each of which may engage the arbitration clause. There may be benefit to all parties in contractually preserving alternative pathways to resolving the sanctions issue, such as obtaining an independent legal opinion, applications for informal and anonymous guidance, or formal authorisation/licence, from a regulator. Finally, the parties must consider what happens within the arbitration process while one or more of these steps are being taken to avoid lengthy and expensive satellite disputes.
In light of the above, a holistic approach to disputes and sanctions risk mitigation is vital. Energy related trades that involve sanctions affected jurisdictions, parties or trade (or the risk of such), will continue, and will continue lawfully. The right preparation will not only protect energy businesses from investigative and enforcement action, but also help to avoid, minimise or resolve as efficiently as possible, any related disputes.
IBOR reform or LIBOR replacement represents one of the biggest changes to the financial services industry and impacts on all businesses that deal with it.