Ukrainian Crisis - Impact on the Supply Chain

As the situation in Ukraine intensifies following Russia's invasion of Ukraine on 24th February 2022 and the humanitarian crisis deepens, the US, UK and EU have adopted further sanctions against Russia and Belarus. Russia has already been the subject of sanctions for many years - a suite of measures, including asset freezes, trade restrictions and travel bans, were imposed following the annexation of Crimea in 2014.

Recent events in Ukraine have led to an expansion of previous restrictions. The newly imposed sanctions are aimed at strategic sectors of the Russian economy and are intended to block access to technologies and key markets. There has also been a blocking of access to certain Russian banks and a freeze of Russian assets in the EU. For more detail on the sanctions with Russia, click here. The position is rapidly unfolding and changing on a constant basis and any risk posed to the supply chain will depend on how the situation in Ukraine unfolds and how the sanctions will bite on international trade with Russia and also Belarus. As such we intend to update this article as events continue to unfold. This is the current position as at 2 March 2022.

Part 1 - Impact upon Supply Chain

As the conflict in Ukraine continues, it becomes clear that worldwide supply chains will be impacted and in this series of Q&A we consider the domino effect on supply chains as global companies close factories during the Russian invasion. We have prepared this Q&A for those seeking to navigate their contractual obligations where they may be delivering goods to, or receiving goods from, Russia at this time of turbulence and crisis. We consider the risks - both commercial and reputational - of continuing to do business with Russian entities.

Am I still required to deliver goods to Russia if I am contracted to do so? Can I suspend performance until mutual performance has either been provided or secured (purchaser's obligation to pay the supplier for the goods/services)?

Where there are no sanctions prohibiting supply to a named individual or entity, it is not currently illegal to continue to trade with a Russian counterparty. There are three key considerations here and we will deal with each one in turn. Firstly, am I required to deliver secondly, will I be in breach of contract if I fail to deliver and thirdly, will I be paid for my goods/services if I do deliver?

1. Am I required to deliver? When considering the question of whether you must perform the contract and deliver goods to a Russian entity or to a delivery location in Russia, the options are principally as set out in the contract itself. In light of the changing sanctions, it is possible that that the supply of the goods and /or services in question may be declared illegal. If the item is dual-use then check the terms of your export licence and the relevant Government website: there is currently a suspension of dual-use export licences to Russia with the prospect of new legislation to ban such exports at a future date There is a possibility that, for future supplies, and depending on how events transpire, you may be able to rely on the defence of illegality (for further detail click here), although at the current time, there is no precedent confirming this unless the performance of the contract would actually involve you in committing an illegal act (i.e. breaching a sanction that prohibits the supply).
2. Will I be in breach of contract if I fail to deliver? If you fail to deliver the goods or perform the services you are contracted to deliver, when there is no strict legal reason why you should not do so, could you be liable to the Russian counter-party in damages for breach of contract? The answer to this question in part depends in what the governing law that regulates the contract is. Under English law, you may have a defence to a claim for breach of contract. This is because the defence of illegality is based on the grounds of English public policy and English public policy will also make a contract unenforceable if the performance of the contract is damaging to good government in relation to foreign affairs, or would produce inconsistency and disharmony in the law, and so cause damage to the integrity of the legal system. If you would like further information around the defence of illegality or the public policy considerations on which it is based then please contact us and we would be happy to discuss your individual circumstances with you. Consider also force majeure (for further detail click here) and frustration (for further detail click here).
3. Will I receive payment? Depending on the financial sanctions imposed, a party's ability to electronically transfer money to/from Russia may be affected (such as the threatened sanction to remove Russian banks from the Swift payments system), which may then impact that party's ability to perform their obligations under the contract. This position should be closely monitored and revisited regularly. The UK has applied sanctions against a growing number of Russian companies and banks. There is currently in place an asset freeze on VTB, Russia's second largest Bank.

Consider whether you are under an express contractual obligation to supply, or do you have a discretion as to whether to accept a particular purchase order? Does your contract allow you to withhold or suspend performance, cancel orders that have been accepted or exit the relationship, in certain circumstances? Is your counterparty on the sanctions list? You should also consider your economic social and governance (ESG) responsibilities, and the reputational and economic risk you may run with other customers and suppliers if you are seen to be continuing to trade with Russia in the current environment. What impact may this have upon your business? If you are concerned you may not receive payment then speak to us before holding back the goods and we can work with you to evaluate your options and prepare the groundwork for a possible defence against a claim by your purchaser for breach of contract as a result of your failure to deliver the goods or perform the contracted for services.

Could force majeure help?

An express force majeure clause in the contract protects a business in the event that it is unable to perform its contractual obligations as a result of an event outside of its control. Most (but not all) commercial contracts contain a force majeure provision, but the scope and operation of the protection afforded will be as set out in the contractual provision,  there is no overarching principle of force majeure in English law outside any protection afforded in the contract itself. When looking at the effect of force majeure on your contracts, consider the following key questions:

1. Is there an express force majeure clause? Under English law (unlike many European legal systems where force majeure is a concept enshrined in the civil or commercial code which govern contractual arrangements), force majeure is not an automatic right, it will only apply if you have an express force majeure clause or equivalent in your contract.
2. Does the current situation fall within the definition of force majeure? Often force majeure clauses contain express references to events like war, threat of, or preparation for war, armed conflict, imposition of sanctions etc. Also look out for wording talking about events beyond a party's reasonable control.
3. Is the current situation causing a breach of contract? If you, or your counterparty, breach a contract, you or they are only protected by the force majeure clause if that breach is caused by the force majeure event. If performance is just made more difficult or more expensive, the vast majority of force majeure clauses are unlikely to provide protection. Check your wording here and see if it covers part performance or hinderance.
4. Is the current situation the only cause of the breach of contract? Depending on the wording of your force majeure clause, a party looking to rely on force majeure to excuse them from contractual obligations may need to be able to show that current events are the only reason they have been unable to perform their obligations, and that if it had not been for those events they would have been willing and able to carry out the contract.
5. Was the current situation foreseeable, and does it matter? As for other elements of force majeure, this depends on the contract wording. Some force majeure clauses specifically exclude foreseeable events, and others do not mention this.  Given previous actions of aggression by Russia against its neighbours, and the fact that the crisis in Ukraine had been brewing for a considerable period, there is a risk of argument that, depending on the scope of the force majeure clause and when the contract was entered into, action of this nature may have been foreseeable.
6. What do you need to do in order to rely on the force majeure clause? There will often be a requirement to formally notify the other party, or carry out other steps, before the force majeure protection applies. Making sure you are aware of these requirements early on will put you in a better position if you need to exercise your rights in the future. If you do need to rely on the force majeure provisions then follow the requirements set out for doing so in the clause to the letter. If you are expecting there to be an impact on your business, consider pre-emptive notifications warning your customers that there may be disruption in the future.
7. What are the consequences of the force majeure clause? Typically a force majeure clause will say that a party is not in breach of the contract if they fail to perform their obligations as a result of the force majeure event. In effect they allow a period of time in which the parties are suspended from their obligations under the contract. However, the party that is not in breach may also have the ability to terminate the contract if the force majeure event continues for longer than a given period of time. Again, this period will be detailed in your contract.

What about frustration? Can I rely on that?

If your contract does not include an express force majeure clause, you cannot rely on force majeure for protection. However, your business may still be able to rely on the common law principle of “frustration”. This remedy is available without requiring an express clause in your contract, but it can be much harder to successfully argue that the contract has been “frustrated”.

Frustration occurs when a party is prevented from performing its contractual obligations for a reason that is both:­ (1) entirely unforeseeable; and (2) the fault of neither party. The event must make the performance of the contractual obligations impossible, illegal, or radically different from the obligations contemplated at the time that the contract was entered into. The frustrating event must also be so fundamental as to defeat the entire “commercial purpose” of the contract.

Whether you are able to rely on frustration will depend on the circumstances of each particular contract in dispute and it is generally something that can be difficult to prove in court. The threshold to prove frustration is extremely high as the courts do not lightly relieve parties of their contractual obligations.

Be aware that if you are successful in claiming frustration, then this will bring the contract completely to an end - you cannot pick and choose which elements you want to keep, nor can you assert your own control over the date that the contract comes to an end. Money that has been paid under a frustrated contract is usually recoverable and any money still due to be paid will cease to be payable (taking into account the value of any goods/services you have already received). Consider carefully whether this is the result you want.

What about a defence of illegality/morality?

If sanctions apply which make performance of the contact illegal, then you may wish to rely on the common law doctrine of illegality, which would mean that your impacted counterparty will not be able to enforce a breach of contract against you. Under this principle, English law will not enforce a claim which arises from illegal or immoral conduct. In other words, your defence for non-performance could be because your business refuses to commit an illegal or immoral act.

At present, outside the scope of the express sanctions regimes, it is not illegal to trade with Russian entities on the basis of their nationality or location alone, although this position may change.

There may be a case to argue immorality in the defence of illegality. If legal sanctions are not imposed that will legally prevent you from supplying goods to Russia, what if you voluntarily take a decision not to supply goods on the grounds that it would be immoral or unconscionable to do so? Would you have a defence to a claim for breach of contract? There is no clear precedent for such an argument. In addition, English public policy (which is the concept on which the defence of illegality is based) will also make a contract unenforceable if the performance of the contract is damaging to good government in relation to foreign affairs or would produce inconsistency and disharmony in the law, and so cause damage to the integrity of the legal system. These arguments may therefore be worthy of more careful consideration depending upon the relevant facts. In summary, subject to the specific detail of your contract, which may have other provisions you can rely upon if the performance of the contract is not prohibited by the imposition of sanctions against Russia, there is no clear, analogous legal precedent to be able to voluntarily suspend performance of your Contract based on the current situation.

We have supplied goods for which payment is outstanding, what can we do?

Check whether your contract has any guarantees or payment bonds (ideally from entities outside Russia and the scope of current and anticipated sanctions regimes) and enforce as soon as possible where available. Does your contract provide for you to retain title to the goods in question pending payment? Although, note that where the goods have left the UK, even where you have a theoretical right to title, enforcement of that right is likely to be extremely difficult, if not impossible, particularly if the goods have reached Russia. Demand and seek to recover payment as soon as possible. If payment is not forthcoming, or you have concerns about eliciting payment, we would be happy to speak to you about the options available.

Can I avoid fulfilling a pending order?

Again, check your contract to understand the scope of your obligations and rights. If in any doubt as to whether you do have a right to cancel an accepted order, or the implications of not supplying, speak to us and we can work through this with you. 

What about new contracts which may be linked to Russia or Russian individuals?

Termination clauses and choice of law and jurisdiction clauses in any contracts linked to Russia should be reviewed and you should identify the contractual remedies available to you should those relationships be impacted by any sanctions imposed. Ideally your choice of law and jurisdiction clause will be outside Russia. Your force majeure clause should also be carefully considered and amended depending on whether you are selling or buying.

Given the uncertainty caused by the current crisis, you may want to consider/anticipate any future currency fluctuations that may occur as a result sudden changes in the relative value of world currencies and factor these into your future pricing strategy in new contracts.

We anticipate that food companies may be particularly impacted as Ukraine produces significant quantities of wheat, barley, rye and corn. This will have an impact on pricing and supply, so ensure that you can increase your prices to your customers in the event your base costs increase. Consideration should also be given to adding a specific sanctions clause, which enables the contract to be suspended should sanctions be escalated. 

Is it likely we will start to see insolvencies?

 It is reported that financiers are potentially looking at accelerating the making of loans to Ukrainian companies to assist in these crucial first weeks and there could be enforcement of security  of Ukrainian-based assets, which would lead to an increase in insolvencies along the supply chain. Speak to us if you have any concerns here.

What can we do to protect our business?

• Conduct a risk assessment to identify your exposure to the Russian economy, Russian businesses, individuals and potentially relevant assets. Be aware that the risk exists and ensure that you have a policy and procedures in place to deal with that risk.
• Identify the sanctions regimes that are applicable to your business. Be aware of secondary sanctions with extra-territorial effect, such as the US deeming certain of their sanctions to apply, even without a US nexus.
• Know your client or contractual counterparty. Remember that sanctions do not stop with those designated on the relevant lists - they will extend to entities owned or under the control of those listed. Ensure you have appropriate due diligence processes both for new business and for managing existing relationships, including establishing ownership and control structures to check for sanctioned entities (compliance software may assist with this). If your business is in a high-risk sector or has a profile with higher risk, ensure that your policies and procedures are adequate for that level of risk.
• Review your contracts and business relationships to ascertain whether these may be impacted by sanctions regimes. If they are impacted, or at risk of impact, consider potential mitigation actions now: Does your contract provide for the events that have unfolded, do you have a right to exit or withhold supply, do you need to be speaking to your counterparty now with a view to agreeing a variation or exit from the relationship?
• If a licence or authorisation is, or may be, required, think about preparing the application, or making initial enquiries with the relevant authority as soon as possible, particularly given the likelihood that they will be facing a deluge of enquiries.
• Remain vigilant: new entities are being added to sanctions lists and the situation is fluid. Ensure your risk assessment, sanctions checks and compliance procedures are robust, up to date and continue to review as the situation evolves.