Drafting contracts that address subsequent Russian sanctions


By John McIntyre and Cara Brack


April 22, 2022, 4:53 p.m. EDT

Law360 (April 22, 2022, 4:53 p.m. EDT) —

John McIntyre
Cara Brack
Cara Brack

Following the invasion of Ukraine in February, the United States and more than 30 other countries applied an escalating series of economic sanctions against Russia and Belarus, as well as prominent companies and individuals. associated with these governments.

US sanctions include both sweeping export restrictions and import bans on many Russian products, including diamonds, iron and steel.

The sanctions follow U.S. government restrictions limiting the importation of certain products from China under, among other things, the recently enacted Uyghur Forced Labor Prevention Act.

This adds stress to supply chains already reeling from state and federal restrictions imposed amid the COVID-19 pandemic.

This article will:

  • Explore issues that may influence the enforceability of trade agreements that are directly and indirectly affected by the new restrictions;
  • Briefly review the common law defenses of illegality, impossibility and impracticability, and harm to purpose, which have been invoked by contracting parties as a result of previous sanctions imposed on Iran and Yugoslavia;
  • Discuss the potential impact of the UN Convention on Contracts for the International Sale of Goods; and
  • Offer advice to parties negotiating agreements that may be affected by future government restrictions.

Illegality

The most direct impact of sanctions will be to void contracts with prohibited parties and those involving prohibited products. A contract becomes void for subsequent illegality if the enactment of a new law or a change in existing law prevents performance of the contract.

For example, the sanctions against the Russian Federation announced by President Joe Biden on April 6 relied in part on his authority under the International Emergency Economic Powers Act.[1]

In Kashani v. Tsann Kuen China Enterprise Co., the California Court of Appeals, Second Appellate District, upheld the trial court’s 2004 ruling that the parties’ contract was unenforceable because it involved trades and trade with Iran that were prohibited under the IEEPA.[2] According to the Kashani court, any

agreement in violation of trade restrictions enacted for reasons of national security and therefore for the purpose of protecting the public should be unenforceable.

Impossibility and impracticality

In addition to illegality, courts will also excuse non-performance of contractual obligations in certain circumstances where performance by one party is rendered impossible or impracticable – depending on the jurisdiction – by a subsequent change in foreign or national law. Section 264 of the (Second) Restatement of Contracts states the unachievable standard as follows:

If performance of an obligation is rendered impossible by the obligation to comply with any domestic or foreign government regulation or order, such regulation or order is an event the non-occurrence of which was a basic assumption upon which the contract has been concluded.

In order to establish the defence, companies will generally need to demonstrate that:

  • The change in law made performance impossible or possible only with extreme and unreasonable hardship, expense or loss;
  • The risks associated with the change in law have not been assigned to any of the parties; and
  • The promisor was not responsible for the difficulties of execution.

A recent New York decision dealing with the defense highlights how narrowly some courts interpret the requirement that the risks associated with changing the law must not have been allocated under the contract.

For example, the February 22 decision in Wang v. 44th Drive Owner LLC of the Supreme Court of New York, New York County, concerned a buyer’s claim for rescission of a real estate contract based on restrictions that were later enacted by the People’s Republic of China.[3]

Wang’s buyer argued that restrictions on electronic funds transfers involving the sale of real estate imposed by the Chinese government made his delivery impossible. Under the New York standard, however, non-performance is only excused when performance is objectively impossible due to an unforeseen event against which the contract could not have guarded.

Wang’s court found that the parties had agreed that the buyer would remain obligated whether or not it could obtain sufficient financing, even though the parties could not have foreseen the actions of the Chinese government.

Because it found that the buyer had assumed the risk of obtaining sufficient financing to make the required payment at contract closing, the court in Wang denied the buyer’s request for rescission on the grounds of impossibility.

Globally, more than 90 countries, including the United States, have adopted the United Nations CISG, which includes a provision relating to the impracticality of the sale of goods. The CISG governs contracts for the international sale of goods between parties whose places of business are in countries that are signatories to the treaty, in the absence of an express choice of law provision to the contrary.[4]

Echoing the requirements of contract restatement, Article 79 CISG provides that a

party is not liable for a breach of any of its obligations if it proves that this breach was due to an impediment beyond its control and that it could not reasonably be expected that it had taking into account the impediment at the time of the conclusion of the contract or having avoided or overcome it, or its consequences.

Thus, as with restatement, the CISG requires any party invoking the defense based on a change in law to demonstrate that the change was not reasonably foreseeable at the time the contract was signed.

Goal frustration

Even where performance is possible, a party’s non-performance may be excused under the frustration of purpose doctrine where an unforeseen change in circumstances has frustrated the primary purpose of the contract. Generally, a party seeking to excuse performance for breach of purpose must demonstrate:

  • Total or almost total destruction of the main object of the agreement;
  • That both parties have understood that the transaction would have little meaning without the object;
  • Frustration cannot fairly be considered a risk that the party has assumed under the contract; and
  • The non-occurrence of the frustrating event must have been a basic assumption upon which the contract was made.

Section 265 of the Restatement (Second) of Contracts expresses the standard as follows:

Where, after entering into a contract, a party’s primary purpose is materially frustrated through no fault of its own by the occurrence of an event the non-occurrence of which was a basic assumption on which the contract was entered into, its obligations remainders of execution are released, unless the language or the circumstances indicate otherwise.

In Sage Realty Corp. v. Jugobanka 1998, the U.S. District Court for the Southern District of New York rejected a Yugoslav bank’s assertion of a frustration of purpose defense in a commercial lease dispute, even after the revocation of its banking license as a result of economic sanctions imposed against Yugoslavia by the United States[5]

The rental agreement at issue in the Sage case was signed in June 1991. In April 1993, pursuant to a decree prohibiting all Yugoslav entities from using or accessing any of their assets located at United States, the Office of Foreign Assets Control revoked the license of the tenant bank, Jugobanka, to carry out activities in the United States

After Jugobanka subsequently stopped paying the rent, the landlord sued to recover all amounts owed under the lease and Jugobanka asserted a frustration of purpose defense.

Although the Sage court agreed that the executive order frustrated the parties’ purpose in entering into the lease, it declined to excuse the tenant’s breach based on its finding that the events in question were reasonably foreseeable.

The court said that if a contingency is reasonably foreseeable and the agreement does not provide protection if it does occur, the defense of purpose annihilation is not available.

Based on press reports and depositions, the court found that Jugobanka representatives were aware of the strained relations between the United States and Yugoslavia during the lease negotiations and the possibility that future sanctions could affect the agreement of the parties. As such, the court dismissed the tenant’s defense of purpose destruction.

Summary

These decisions illustrate some of the challenges associated with establishing the defenses of illegality, impossibility and impracticability, and frustration termination at common law.

Given these challenges, it is prudent for contracting parties whose prospective agreements could foreseeably be impacted by future economic sanctions — including supply chain contracts involving products containing raw materials or sub- imported components — to negotiate force majeure provisions that directly affect the parties’ respective rights and obligations in the event of subsequent sanctions.

Among other things, any such agreement should specify the types of restrictions that will trigger the application of the force majeure provision, the manner in which notice must be provided and the manner in which the risks will be allocated if the performance is delayed or entirely prevented due to subsequent government action.


John M. McIntyre is Partner and Cara L. Brack is Partner at Porter Wright Morris & Arthur LLP.

The opinions expressed are those of the authors and do not necessarily reflect the opinions of the company, its customers or Portfolio Media Inc., or any of its respective affiliates. This article is for general informational purposes and is not intended to be and should not be considered legal advice.

[1] 50 USC § 1705.

[2] 13 Cal. Rptr. 3d 174, 118 cal. App. 4th 531, 547 (2004).

[3] 2022 NYJL LEXIS 128 (NY Sup. Ct. Feb. 23, 2022).

[4] Minh Dung Aluminum Co. c. Aluminum Alloys Mfg. LLC , 2021 US Dist. LEXIS 143459, at *6 n. 3 (MD Pa. Aug. 2, 2021).

[5] 1998 US Dist. LEXIS 15756, 1998 WL 702272 (SDNY 8 October 1998).

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