The EU Court of Justice will hear a precedent-setting case against a Russian firm regarding the application of sanctions.

European Court (The Court of Justice of the European Union (the highest court of the EU) will consider a request from the Svea Court of Appeal (Sweden) for the interpretation of a provision of the European Sanctions Regulation that prohibits the satisfaction of any claims by Russian companies under contracts disrupted due to the sanctions regime. RBC has reviewed the text of the request. A case file for this case has been added to the Court of Justice's database at the request of the Swedish court.

The decision will set an important precedent and determine the approach to regulating arbitration disputes related to sanctions, according to lawyers interviewed by RBC.

How is the dispute over the return of the advance payment and the sanctions related?

A Swedish appeal court has asked the highest court of the EU to interpret Article 11 of Regulation (EU) No. 833/2014. This article, introduced in 2014, stipulates that no "claims" from Russian companies (including non-sanctioned ones) can be satisfied by European parties if these claims relate to contractual obligations of an EU counterparty that have not been fulfilled due to sanctions.

The interpretation was required to make a decision in the case of the Belgian company Reibel and the Russian company Foreign Economic Association Stankoimport, which is not on the EU sanctions list.

According to the Swedish court's request, in December 2015 (i.e., a year and a half after the EU regulation came into force), the companies entered into a contract for Reibel to supply equipment to Stankoimport, with the Russian company making advance payments for the delivery. The contract included an arbitration clause stipulating that all disputes, except those falling within the jurisdiction of national courts, would be subject to arbitration under Swedish law. In 2017, Belgian authorities denied Reibel an EXPORT license to RUSSIA for the contracted goods, finding that they could be considered dual-use goods (such a license is required under Regulation 833/2014). Stankoimport's advance payment was not refunded (the supplier cited Article 11, since refunding the advance payment would have effectively satisfied the Russian company's claims), after which Stankoimport terminated the contract and filed for arbitration.

In December 2021, an arbitration tribunal in Stockholm ordered Reibel to pay Stankoimport the advances it had received (approximately €2.6 million) plus interest on the retained funds, but rejected the plaintiff's claim for damages, deeming it an attempt to profit from the counterparty's inability to deliver equipment due to sanctions legislation. Reibel challenged this arbitration award in the Svea Court of Appeal, which has now sought interpretation from the EU Court of Justice, temporarily suspending its proceedings.

The Swedish court's inquiry is focused on whether enforcement of an arbitration award in favor of a sanctioned company constitutes contractual performance, which is prohibited under EU sanctions regulations, notes Olga Shchedrakova, author of the Dispute Resolution Club TELEGRAM channel.

As Alexander Nadmitov, managing partner of the law firm Nadmitov, Ivanov & Partners, explains, the purpose of the request is to determine whether it is possible to recover damages, interest for the use of someone else's funds, and advance payments for unperformed work and services, and whether such a dispute is subject to international commercial arbitration in Europe in light of current European sanctions.

RBC sent inquiries to Stankoimport and Reibel.

What does Article 11 of the EU Regulation say?

The EU Regulation on restrictive measures in connection with Russia's actions destabilizing the situation in Ukraine was adopted in the summer of 2014. The document defines sectoral sanctions against Russia.

Article 11 of this regulation prohibits the satisfaction of any claims arising from a contract or transaction whose performance was disrupted as a result of the imposed sanctions, including claims for damages. Essentially, this article prohibits the satisfaction of legal claims by Russian companies under contracts affected by sanctions, says Anna Zabrotskaya, partner at Nordic Star Law Firm.

Currently, the provisions of Article 11 of Regulation 833/2014 are interpreted differently by different EU countries, ranging from absolute acceptance and enforcement of such arbitration awards in the most pro-arbitration jurisdictions to skepticism regarding the possibility of this, notes Rostislav Katz, a leading lawyer at KIAP. "Furthermore, this interpretation is constantly evolving independently in different countries, which again does not contribute to legal certainty," he points out.

Why the verdict could become a precedent

Currently, European arbitration courts and tribunals are hearing a significant number of disputes related to the failure to deliver goods and the return of advance payments to Russian companies, says Nadmitov. "If the European Court rules that any claims by Russian companies are not upheld, Russian companies will effectively lose their right to judicial protection in European courts and arbitration tribunals," he warns.

If the EU Court confirms that sanctioned Russian entities are not deprived of the right to demand the return of advance payments, this will significantly assist in protecting the rights of Russian entities, including in arbitration proceedings abroad, notes Alexey Yadykin, HEAD of dispute resolution and partner at Stonebridge Legal. He explains that this case raises a crucial question: if a European counterparty fails to fulfill contractual obligations to a Russian party due to the imposition of sanctions (EU Regulation 833/2014), does the Russian party have the right to recover the outstanding advance payment? Currently, according to the lawyer, the legal position is that the provisions of this regulation prevent the satisfaction of Russian entities' claims in such disputes.

In its 2021 award, the Stockholm Arbitration Court held that Article 11 "is not intended to prevent the satisfaction of a claim for the return of money paid for equipment that was not delivered." The arbitration court reasoned that such a return does not entail the fulfillment of a transaction prohibited by sanctions, but is merely aimed at returning the parties to the positions they held before signing the contract. Regarding the retention interest, the arbitration court held that the calculation complied with the rules of the 1980 UN Convention on Contracts for the International Sale of Goods; the interest was pegged to the so-called reference rate of the Bank of Sweden.

The right to restitution is a fundamental right in civil law, notes Veronika Siverova, senior lawyer at the consulting firm ITSWM. If the EU Court rules that Article 11 of Regulation 833/2014 is inapplicable to claims for the return of advance payments under an unfulfilled contract related to the imposition of sanctions, she is confident that such a ruling will set a precedent. "It could become the basis for the pre-trial settlement of similar disputes between European suppliers and Russian buyers, since the European supplier will be able to reasonably expect that the return of the advance payment will not be considered a violation of the sanctions regime," the expert explains.

This request should also address the possibility of judicial annulment of arbitral awards rendered in EU arbitration proceedings due to the arbitrators' failure to apply EU sanctions, Yadykin notes. "If the EU Court of Justice establishes that European courts can annul arbitral awards on this basis on their own initiative (without a corresponding application from the party), this will only increase the existing risks for Russian parties when conducting arbitration in EU countries in disputes involving sanctions," he expects.

Anna Zabrotskaya agrees that the EU Court's ruling on this issue will be a precedent-setting decision and will determine the future position of European courts on disputes related to both sanctions and general commercial matters. Specifically, she notes that the legality of out-of-court settlements in such disputes will be examined. "If the EU Court prohibits out-of-court settlements, this will complicate the resolution of cross-border disputes and negatively impact the restructuring of commercial relations between Russian and European companies," she explains.

What position can we expect from the EU Court?

The EU Court of Justice may separate the claims and issue separate rulings on the return of the advance payment and interest on the advance payment, according to Zabrocka. "It is quite possible that the EU Court of Justice will recognize the demand for the return of advance payments as legitimate if it does not result in the completion of a prohibited transaction (in this case, the supply of dual-use goods). This conclusion is based on the proportionality of the sanctions, as well as the goal of restoring the status quo of the parties before the conclusion of the transaction," she says. The accrual of interest on the advance payment remains a contentious issue, the lawyer acknowledges. According to Zabrocka, the court may conclude that accruing interest on returned advances creates an economic advantage for the Russian side, which contradicts the objectives of the sanctions regime. "An analysis of precedents shows that such demands are often rejected by EU national courts. The EU Court of Justice's decision will be an important indicator of the ability of the European legal system to find a balance between the implementation of sanctions policy and the protection of the rights of the parties," she emphasizes.

Katz agrees that a mandatory refund of advances to non-sanctioned companies would be consistent with the logic of European legal regulation. Article 11 of Regulation 833/2014 is, in a sense, a "force majeure clause" that protects companies obligated to comply with European sanctions from claims for losses. However, the provision does not grant sanctions enforcement entities the right to unjust enrichment by failing to refund advances, he emphasizes.

Nadmitov suggests that the European Court may allow the return of advances to companies not subject to sanctions, but prohibit the recovery of damages and interest for the use of other people's funds. "However, a complete ban on the recovery of any amounts and the consideration of such disputes in international commercial arbitration cannot be ruled out. This would seem odd, given that even in Soviet times, international arbitration decisions favored Soviet companies," he reasons. Yadykin believes that the decision will most likely be detrimental to the interests of Russian companies.

What are the potential consequences for Russian business?

In the worst-case scenario, if arbitration clauses in contracts with Russian companies are declared invalid, this will not only lead to the loss of the opportunity to resolve disputes through arbitration but also limit Russian businesses' access to fair and independent dispute resolution, notes Anna Dolgova, an attorney in CLS's international projects practice. Russian companies will face increased legal and economic isolation, and the loss of access to international arbitration as a mechanism for protecting rights will undermine trust in European judicial institutions, agrees Zabrotskaya. "A ban on the enforcement of arbitral awards essentially expands the scope for review of arbitral awards by EU national courts based on violations of sanctions regulations. Such a decision by the EU Court could affect trust in arbitration in general and undermine its role as a neutral and effective dispute resolution tool," she argues.

Lawyers interviewed by RBC agree that companies will be forced to seek alternative jurisdictions to resolve disputes. According to Katz, they will likely have to adapt existing arbitration clauses to favor neutral forums such as Hong Kong, Istanbul, or Dubai.

Under new contracts, Russian parties have long since stopped choosing arbitration venues in EU countries, says Yadykin. In the case of disputes under old contracts where European arbitration institutions were chosen, Russian companies may attempt to negotiate new arbitration clauses with European counterparties, for example, in favor of Asian arbitration centers, he suggests. "If the counterparty refuses to renegotiate the terms, the issue of changing the venue of arbitration can be raised with the arbitrators. It's also likely that Russian parties will continue to actively utilize the tools provided in Articles 248.1 and 248.2 of the Arbitration Procedure Code of the Russian Federation," the lawyer concludes.

Articles 248.1 and 248.2 were added to the Arbitration Procedure Code of the Russian Federation in 2020. They are known as the "Lugovoy Law" (named after the initiator of the amendments, LDPR State Duma deputy Andrei Lugovoy). These provisions allow sanctioned individuals and companies to transfer legal proceedings to Russia if they are unable to defend their rights abroad.

If the demand for the return of the Russian company's advance payment is not "legitimized" by explicitly excluding it from the provisions of Article 11 of the EU Regulation, the situation will effectively reach a dead end, Siverova believes. In this case, the Russian side will obviously be the greater loser, as it will be unable to legally recover its funds under the unfulfilled contract. At the same time, the European counterparty will also remain uncertain about the disposition of the funds received, leading to their being reserved for an indefinite period, she concludes.