Tariffs, sanctions and embargoes in supply contracts (part II)

I. What impact do sanctions have on supply relationships?

1.) Legal consequences of sanctions

Sanctions and embargoes have a significant impact on the supply relationships of the parties concerned. They are measures directed either against individual states or territories (economic sanctions or embargoes) or against specific natural or legal persons (financial sanctions), hereinafter referred to as “sanctions”. Sanctions are issued by the European Union (EU) in the form of regulations. Once they come into force, they automatically apply to all natural and legal persons within the EU and thus also to all persons in Germany.

The core of economic sanctions usually consists of regulations that prohibit European entities from exporting certain goods, technologies, or software to a sanctioned country—in some cases also to specific individuals or organizations there. For example, it may be prohibited to sell so-called dual-use goods to natural or legal persons in a sanctioned country or to export them there for use of such persons. Alternatively, certain exports may be subject to the authorization of the competent authorities. Less common is the restriction of imports of goods from sanctioned countries into the EU.

(Individual) financial sanctions focus on the so-called freezing order and the prohibition on making funds and economic resources available to sanctioned persons. The freezing order prohibits sanctioned natural and legal persons from using their funds and economic resources located in the EU. The prohibition on making funds or economic resources available, on the other hand, prohibits the direct or indirect provision of funds or economic resources to sanctioned natural or legal persons and natural or legal persons associated with them.

In order to assess the impact of the relevant sanctions, it is first necessary to conduct a detailed and precise analysis of the individual elements of a supply contract. The existence of certain sanctions provisions does not automatically lead to a complete trade ban for the parties involved. For example, the prohibition of supplying dual-use goods to a country subject to economic sanctions does not necessarily lead to a prohibition on making payments to the business partner in that country. However, if the business partner is also individually subject to financial sanctions, payment to that partner would also no longer be permitted.

Similar to the context of punitive tariffs (see part I), the question arises as to what options are available to an affected party to withdraw from a supply contract affected by sanctions or at least demand its adjustment.

2.) Contractual provisions

Ideally, supply contracts contain specific provisions (known as sanctions clauses) that enable one party to withdraw from the contract to the extent that the contract cannot be fulfilled. If such clauses are not expressly provided for, general contractual clauses may be invoked, provided that these exist or have been agreed accordingly.

For example, force majeure clauses may apply here. Such clauses are often agreed upon to protect the contracting parties from liability if a contract can no longer be fulfilled due to force majeure. Some force majeure clauses, such as the standard clauses of the International Chamber of Commerce (ICC), expressly list sanctions as examples of force majeure. However, if this is not the case, sanctions cannot automatically be regarded as force majeure. In such a case, this must be determined by interpretation of the contract.

If a force majeure clause applies (directly or by interpretation) and a case of force majeure can be assumed, the contractual partner's obligation to perform is generally excluded. At this point, however, it is worth taking a closer look at two different scenarios: The contractual partner's obligation to perform is automatically excluded if the nature of the service owed is so time-sensitive that a later or subsequent performance can no longer be considered as a contractual performance. This applies, for example, to “just-in-time” contracts.

The case is more complex if there is only a general – i.e., not time-critical – obligation to perform. The ICC's standard clauses generally provide that the obligation to perform of an affected contracting party is revived as soon as the obstacle to performance ceases to exist in future. However, this provision is likely to be contrary to the purpose of the sanctions. The aim of the sanctions might be to permanently prevent the affected supply relations without giving the affected country or the sanctioned natural or legal person the opportunity to simply continue the prohibited supply relations after the sanctions have been lifted. However, a final assessment of the legal consequences must always be made on a case-by-case basis, taking into account all circumstances.

It is also possible to agree on hardship clauses. These maintain the parties' obligation to perform but grant a right to adjust the contract in the event of unforeseen circumstances that upset the contractual balance. In practice, however, hardship clauses are rarely effective in connection with sanctions, as sanctions usually also prohibit alternative forms of contract performance with a sanctioned contractual partner. Any possible contract adjustment must therefore always be examined critically and with regard to the possibility of sanctions circumvention.

3.) Statutory provisions

Unless contractual provisions apply, recourse to statutory provisions is also possible. In principle, it can be said that statutory provisions do not affect the validity of a supply contract that has already been concluded, as the imposition of sanctions does not automatically lead to the termination of the contract between the parties concerned.

The situation would be different if a supply contract were concluded after sanctions had been imposed. The legal situation in this context is extremely complex and must always be examined carefully on a case-by-case basis.

With regard to statutory provisions, reference should first be made to specific European provisions. Most sanctions regulations contain provisions that expressly exclude the performance of obligations affected by sanctions. Accordingly, no claims arising in connection with contracts or transactions whose performance or execution is directly or indirectly, wholly or partially affected by the respective sanction – including claims for damages and similar claims – may be fulfilled. Like force majeure clauses, this provision leads to an exclusion of the obligation to perform.

However, cases in which a contract is governed by the law of a country outside the European Union—or, even more complex, by the law of the country against which the sanctions were imposed—are problematic in this context. In such cases, at least the sanctioned party is unlikely to feel bound by European regulations. In practice, this often leads to extremely difficult cases that can only be resolved effectively through forward-looking contract drafting.

If German law has been agreed as the governing law in a supply contract, the statutory provisions on impossibility to perform pursuant to Section 275 (1) of the German Civil Code (BGB) may be apply in addition to the European regulations. It is important to note that the impossibility to perform pursuant to Section 275 (1) BGB occurs automatically without any further action or separate declaration on the part of the contracting parties. The performing party is thus released from its obligation to perform vis-à-vis its contractual partner at the moment the sanction is imposed.

Finally, the application of the provisions on frustration of contract under Section 313(1) of the German Civil Code (BGB) could also be considered. However, the scope of application is likely to be extremely limited in connection with sanctions, because it would rarely make sense to amend the content of a contract in this situation. This gives rise to the same uncertainties as before in connection with hardship clauses. The contracting parties must ensure that any possible amendment to the contract is not considered a circumvention of the sanctions provisions.

II. Recommendation and outlook

The above explanations illustrate that dealing with sanctions and embargoes in connection with supply contracts is particularly complex. Companies should therefore ensure that their contracts contain well-thought-out provisions to minimize risks and protect their business interests as best as possible. It is also crucial to understand the provisions on sanctions precisely and apply them correctly in order to avoid not only legal pitfalls but also administrative fines and penalties.

In this context, it may also be useful for companies to consider the impact of punitive tariffs on supply contracts. The consequences of punitive tariffs and how to deal with them in supply contracts are discussed in detail in part I of our commentary.