The global pandemic presented many new challenges across all industry sectors and economies around the world. Post pandemic strains such as super inflation and global conflict have further compounded economic volatility. The conflict in Ukraine and sanctions imposed on Russia have introduced yet further problems. Do these effect this industry sector in the UK, and if so, how?
What are the sanctions and the Legislation that supports them?
In simplified terms an economic sanction is a legal asset freeze or restriction of assets which is designed to pressure economies, military capabilities, media and politically affiliated individuals. Historically, sanctions against states on the ‘naughty step’ are not new, nor uncommon, with restrictions already existing under the Sanctions and Anti-Money Laundering Act 2018. However, post the invasion of Ukraine, the sanctions imposed by the UK and EU are progressively broader, robust and stringent and are now borne from the Russia (Sanctions) (EU Exit) (Amendment) Regulations 2022, and are monitored and enforced by the Office of Financial Sanctions Implementation (OFSI). OFSI maintain two sanctions lists; one containing entities affected by asset freezes and one containing those affected by specific financial and investment restrictions (the Lists).
Sanctions can be focussed on individuals and entities encompassing broader economic sanctions which affect trade, such as restrictions on imports and exports or, alternatively, prohibitions on investments or transactions with certain banks. In relation to the construction industry, it is the economic sanctions, particularly those involving raw materials, which are beginning to bite.
In summary, the effect of the sanctions currently in force prevent UK entities from:
1. Dealing with funds or economic resources belonging to, owned, held or controlled by someone on the Lists (i.e. handling or receiving their money);
2. making funds or economic resources available directly or indirectly to anyone on the Lists; or
3. engaging in activities that directly or indirectly circumvent either of those two things.
It is worth noting that, with regards to international arbitrational disputes, the London Court of International Arbitration (LCIA) is one of the few international bodies to include provisions which allow it to refuse to act on matters (or make payments) that may see it fall foul of sanctions.
What sort of issues may affect projects?
Increased costs of fuel and raw materials.
The cost of completing projects has increased. With some manufacturers reporting price increases of somewhere between 5-11%, with energy intensive products up to 20%. To ensure projects are not blighted with insolvencies compounding project cost escalation further, parties will need to collaborate. Their contract may not give an equitable outcome. Astute parties may have negotiated provisions that deal with volatility with inflation and cost escalations, and which create a more equitable sharing of risk.
Supply Chain Disruption
A more pressing issue is the effect on oil and gas from Russia. It is prohibited to purchase, import or transfer crude oil or petroleum products. For Europe as a whole this is catastrophic; Russia supplied over 40% of Europe’s natural gas in 2021 and 30% of its oil. This has led to inflated petrochemical prices which, in relation to the construction industry, has caused heightened shipping costs for building materials and the materials themselves. As projects move through winter, the cost of onsite overheads such as heating, lighting and plant will increase substantially.
Where project finance originates from will invariably be subject to closer scrutiny. The UK real estate market attracts hefty global investment, meaning funds that may have previously attracted legitimate investments from individuals and companies must ensure that they are not falling foul of any new sanctions. Where there is a risk that project monies are from a sanctioned entity, then specialist advice needs to be taken immediately.
Practical Sanctions Issues
The sanctions regime raises some practical questions for construction, engineering and energy projects. We have already highlighted the fact that there is a risk associated with investment and/ or consortiums who finance projects (in terms of checking where the funds come from). However, there is a larger and more practical challenge to this – does this indirectly impose obligations on a construction company or contractors to carry out appropriate checks on the people or organisations that they are dealing with or performing work for? This may not sound like anything new – but many of those organisations are unlikely to be in the ‘regulated’ or ‘financial services’ sectors (and Money Laundering Regulations), and so may not be under an obligation to hire a money laundering reporting officer (who would be well placed to help manage risk). This is an additional cost that many businesses may need to incur. In addition, there is a wider question about the extent to which an organization indirectly affected by sanctions could apply for a license or to be de-listed in relation to specific projects.
Contractual issues and specific clauses
Cost plus contracts:
Amidst such volatile times, contractors may seek to mitigate costs risks by attempting to seek cost plus contracts. Employers on the other hand will be seeking lump sum/guaranteed maximum price arrangements. In this trade off, it is often employers that will have the upper hand as they hold the power in issuing the tender. Are collaborative contracts going to be back in fashion?
Force Majeure, Termination and Extensions of Time:
Parties looking to terminate their construction contracts or gain extensions of time must look carefully at the wording within their contract. Often, routes to termination through clauses relate to specific force majeure events however, this entirely depends on the wording of the clause itself. In relation to extensions of time for example, clauses in JCT, NEC and FIDIC contracts provide for an entitlement to extensions of time but by different definition. The FIDIC contract for example, does actually list events by which the parties are able to seek extensions of time under the contract.
Enforceability of Contracts.
Parties may unwittingly find themselves in a situation where they are contracting with an entity on the sanctions list. In that instance, is the contract void for illegality? Can a contractor seek to enforce claims for outstanding monies or time? A contractor in that scenario may enter into sub contracts, and may not have a valid escape from those performance and payment obligations. In such situations, a license may be needed to allow funds to be transferred or services provided. This in itself can be significant work and requires careful and specialist legal advice (including considering the reputational impact of providing those services).
Responsibility for Sanctions Compliance
Can an employer shift some or all of the sanctions compliance onto the contractors (or include clauses that require warranties and representations to be given about sanctions compliance). Whether or not this is sufficient protection, or even practically enforceable, remains to be seen.
John McKendrick KC, is a barrister who practices in the fields of commercial and public law and often deals with sanctions within construction and energy spaces. He comments on some topical issues:
“For many lawyers who have worked with Russian or Russian-related clients 2022 has presented challenges. Morally, many have considered it right to cut ties with Russian businesses. Others have significant apprehension about the risks, presented both by criminal law sanctions and professional conduct issues, of continuing to represent or advise Russian clients and/or those subject to EU, US or UK listing. In the UK alone OFSI have designated over 1200 entities as a result of the aggression in Ukraine since February 2022. The metaphorical minefield is widely cast. As a result some lawyers have chosen to down tools. Others have tried and failed: in the BVI, Justice Jack of the Eastern Caribbean Supreme Court refused an application by a leading law firm to ‘come off the record’ in respect of representing a major Russian Bank. The court noted that: “Their contractual terms entitle them to terminate the retainer. On the other hand, their duties as officers of the Court require them to maintain the rule of law by ensuring access to the Courts for the proper and fair determination of parties’ rights and obligations.” The court proceeded by concluding the balance lay in the lawyers remaining and refused their application.
Since then in the UK, OFSI has granted a ‘Legal Fees General Licence’ which permits lawyers in the UK to be lawfully paid for advice and representation provided to a designated entity. The reality is that OFSI were beleaguered and unable to process all lawyers licence applications in a timely manner. They were failing to fend off applications for interim relief in the Administrative Court.
Notwithstanding this simplification of the process of lawyers acting for those designated, the field remains a very complicated one. The provisions of the Sanctions and Anti-Money Laundering Act 2018 and the 2022 Regulations are deliberately broad and vague to discourage business with Russia in order to inflict maximum economic damage. Statutory provisions such as ‘making funds or economic resources available directly or indirectly to a designated person’ cast the sanctions (and criminal law) net widely. The CJEU noted that explicitly when interpreting EU legislation in Afrasiabi.
The statutory scheme also provides a for a wide definition of ‘ownership and control’ and advisers must carefully consider the fact sanctions apply to designated persons but also entities they own or control. Naturally as the web of assets and legal vehicles becomes complicated, and often spills over into the world of off-shore jurisdictions, knowing whether an entity is sanctioned or not can be difficult.
Similarly, SAMLA also operates an extraterritorial jurisdiction which is set out in section 21, capturing the activities of UK persons and corporates overseas. OFSI’s guidance appears to adopt an expansive interpretation of these provisions, claiming a jurisdiction in respect of actions overseas where it can be established a ‘sufficient UK nexus’ exists. What does this mean? The combined effect of these rather vague statutory provisions is political: to cause sufficient fear to prevent economic relations with anything vaguely Russian.
Lawyers must proceed with considerable caution. This is particularly the case for those advising and representing in arbitration where litigators are not ‘officers of the court’ and the rule of law issues which have provided a legitimate context for lawyers to continue to act before national courts or litigation, is much less apparent. The reality is that the need to proceed with caution will remain for some time to come.
Given the serious consequences that will arise from contraventions, if in doubt take specialist advice. The reality is that the sanctions imposed on Russia are unlikely to be relaxed any time soon and awareness of how they affect the industry is relevant.
Republished by permission.