Russian sanctions: supervening illegality and impact on contracts with Russian interests

In the first case of its kind in Australia, the Federal Court held that Rio Tinto-backed Queensland Alumina Ltd (QAL) was correct in interpreting then applying the sanctions imposed by the Australian Government against certain Russian oligarchs. The Court further found that QAL was entitled to cease supplying goods to companies in which the designated oligarchs held indirect shareholding interests^[1]. This was particularly important for QAL given the Australian laws impose strict liability criminal penalties on conduct in breach of the autonomous sanctions laws.

This article will examine the key takeaways from the decision and practical steps to be taken to help minimise commercial risks.

Background

After the Russian invasion of Ukraine in February 2022, Australia has published ongoing sanctions against Russian entities associated with the Russian Government. Australia’s autonomous sanctions in the Autonomous Sanctions Act 2011 (Cth) (AS Act) and the Autonomous Sanctions Regulations 2011 (Cth) (AS Regulations) (collectively, AS Laws) cut through all commercial dealings and wherever any indirect interest in a project, a contract or any arrangement purports to benefit an individual or entity designated by Australia, it cannot proceed and Australian counter-parties are entitled to cease such contractual relationships.

Snapshot

• QAL and Alumina and Bauxite Company Ltd (ABC) were parties to various supply and shipping agreements that involved the refining and supply by QAL to ABC of alumina from its jointly owned alumina refinery in Gladstone, Queensland (Supply Agreements).
• ABC, together with the other applicants in the proceeding (Rusal Limited and JSC Rusal) are subsidiaries of United Company Rusal PJSC, a public joint stock company registered in the Russian Federation.
• Oleg Deripaska and Viktor Vekselberg (see below) are indirectly its largest shareholders^[2].
• In mid-March 2022, as a response to the ongoing Russian invasion of Ukraine, the Australian Government imposed sanctions that, among others (together, the Russia Sanctions):
  • prohibited the supply, sale or transfer of alumina (i.e. aluminium oxide) to a person where, as a direct or indirect result, the alumina is transferred to Russia, for use in Russia or for the benefit of Russia; and
  • more generally, directly or indirectly resulted in making an asset available to or for the benefit of a designated person, in this case, Oleg Deripaska and Viktor Vekselberg.
• On 24 March 2022, ABC responded to QAL’s concerns regarding the effect of the Russia Sanctions on the Supply Agreements by providing an undertaking that no contravention of the Russia Sanctions would occur.
• On 4 April 2022, by reason of the Russia Sanctions, QAL had:
  • ceased to refine and supply alumina; and
  • had exercised the step-in arrangements contained in the QAL/ABC Agreements to essentially  prevent ABC from obtaining any further economic benefits from its joint ownership of the Gladstone refinery.
• ABC consequently commenced proceedings against QAL alleging breach of contract (i.e. the Supply Agreements) and sought an injunction and damages for the losses it has suffered.
• In its defence, QAL relied primarily on the force majeure provisions in the Supply Agreements and the well-established common law principle of supervening illegality.

Decision

Each of the Supply Agreements contained a force majeure clause which was similar in wording.

Article 21.1 of the Monohydrate Bauxite Supply Agreement stipulates that RTA shall not be liable to ABC for any failure to deliver bauxite if such failure is due to any of the specified events of force majeure, which relevantly include “the imposition of Sanctions … which results in third parties refusing to provide services necessarily required by the parties to this agreement to perform their obligations contained herein”.^[3]

In determining whether the force majeure provisions in the Supply Agreements were enlivened and open for QAL to rely upon, the Court conducted an extensive review of the provisions of the AS Laws.

Relevantly, Regulation 12(1) of the AS Regulations provides that:

A person contravenes this regulation if:

 (a) the person makes a sanctioned supply; and

 (b) the sanctioned supply is not an authorised supply.

The dispute between the parties related to the definition of “sanctioned supply” in Regulation 4 and in particular, whether as a direct or indirect result of the delivery of alumina by QAL to ABC, the alumina would be transferred to Russia, for use in Russia or for the benefit of Russia.^[4]

Transferred for use in that country or for the benefit of that country

The Court rejected the main contention advanced by ABC that consideration should be given to the subjective intention of the person making the transfer.

Instead, the Court confirmed that the offence is one of strict liability, without any mental element.

“…in my view the word “for” in para 4(1)(c) means “object, effect or likely effect”, where the object of the transfer is determined objectively from the terms of the relevant transaction and any relevant surrounding circumstances.”^[5]

This means that the offence is committed as long as objectively, the sanctioned good is transferred for use or for the benefit of a sanctioned country, regardless of the intention of ABC. This is consistent with the notion of strict liability in an offence.

Benefit

Similarly, the Court rejected ABC’s contention that the intention of the person should be considered when determining whether the transfer is for the benefit of a sanctioned country.

Indeed, it is the ordinary meaning of “benefit” which is relevant to the question; this being, whether “anything (i.e. both financial and non-financial) that is for the good of”, in this case, Russia.^[6]

However, the Court emphasised that while there must be a “nexus” between the transfer of the sanctioned good and the benefit to the sanctioned country, the benefit must be apparent. It found that it would be a “step too far” to claim that the transfer of alumina would result in a “benefit” to Russia given it would mean an increase in taxation revenues payable by the Rusal group in Russia.

Instead, notwithstanding the undertakings given by ABC, the Court found in favour of QAL on the basis that:

• the alumina from the Gladstone plant was predominantly supplied into Russia for “use” in UC Rusal’s Russian aluminium smelters, and hence met the definition of sanctioned supply; and
• as Deripaska and Vekselberg are designated persons, their indirect connections to ABC.

This analysis was also relevant to the alternate defence of supervening illegality, such that the introduction of the Russia Sanctions had made it unlawful for QAL to perform its obligations under the Supply Agreements which had been entered into prior to the imposition of the sanctions.

Making an asset available to or for the benefit of a designated person

The Court considered the application of Regulation 14 of the AS Regulations, which relevant reads as follows:

          14 Prohibition of dealing with designated persons or entities

(1) A person contravenes this regulation if:

(a) the persons directly or indirectly makes an asset available to, or for the benefit of, a designated person or entity; and

(b) the making available of the asset is not authorised by a permit granted under regulation 18.

The Court considered the proper statutory interpretation to apply to the key concepts of “directly or indirectly” and “makes an asset available”^[7]. The Court held that “make an asset available” means to cause or bring about the availability of the asset; that is, rendering it suitable or ready for use or able to be used^[8]. The meaning of “directly or indirectly” was a term harder to pin down. The Court, in looking at the degrees of remoteness that might arise, said the following^[9]:

In my view reg 14(1) should be given the full meaning that is open from the words “indirectly makes an asset available for the benefit of a designated person”, where “indirectly” includes doing so through interposed corporate entities, and where the benefit is either the object, effect or likely effect of making the asset available. That construction does not provide a definitive answer to the application of the regulation in every case. Ultimately, the specific facts must be examined to assess whether the regulation applies.

While the Court noted that there may be a de minimis threshold below which a minority shareholding interest in a downstream company may be insufficient to satisfy the regulatory language, that does not on its face appear in the AS Laws and there is not, unlike in the US, the UK and the EU sanctions laws, a permitted level of interest held by a designated person that is tolerated before sanctions’ jurisdiction is triggered.

The Court recognised the merit of this argument by the Rusal parties, accepting if a zero tolerance approach to an indirect interest, in a public company, may greatly broaden the purposive scope of the AS Laws^[10]. While the Court found it did not have to decide the point, its observations on the scope of what might be “indirect” bear careful consideration:

The adverb “indirectly” qualifies the phrase “makes an asset available”. In that context, indirectly can take the meaning that the relevant conduct occurs through an intermediary such as an agent; ie, the asset is made available indirectly to or for the benefit of the designated person by being made available to or for the benefit of another person who acts as agent of the designated person. Indirectly can also take the meaning that the relevant conduct occurs through the interposition of corporate entities that are owned or controlled by the designated person, or in which the designated person has a financial interest; ie, the asset is made available indirectly to or for the benefit of the designated person by being made available to or for the benefit of a body corporate that is owned or controlled by the designated person or in which the designated person has a financial interest.

Practical steps

Australia’s AS Laws, while enacted in 2011 have only really arisen into the business consciousness since Russia’s invasion of Ukraine. The ASL Laws impose strict liability on companies and seek to prevent dealings with designated persons and entities as a matter of foreign policy. The language of the AS Laws, as highlighted in the QAL judgment, demonstrates its impact on existing commercial agreements and the extent to which the existence of designated oligarchs, with interests in opaque corporate structures, can mean any direct or indirect dealings with them are prohibited.

It is important to constantly review contracts and the parties with whom such contracts are maintained with against the countries, persons and entities subject to the AS Laws. Designations are regularly updated and while some cases have been brought by oligarchs challenging their designations, that have, to date, failed^[11]. Penalties are significant^[12], not to mention the reputational brand damage of a criminal conviction for “sanctions busting”. Knowing your supply chain and its risk points as against how sanctions apply, remains important – particularly as there is a “due diligence” defence for bodies corporate.

For bodies corporate, engaging in conduct that contravenes a sanction law carries a penalty of the greater of three times the value of the transaction or 10,000 penalty units, being $3,130,000 (as at 1 July 2023).^[13]

Important Disclaimer: The material contained in this article is comment of a general nature only and is not and nor is it intended to be advice on any specific professional matter. In that the effectiveness or accuracy of any professional advice depends upon the particular circumstances of each case, neither the firm nor any individual author accepts any responsibility whatsoever for any acts or omissions resulting from reliance upon the content of any articles. Before acting on the basis of any material contained in this publication, we recommend that you consult your professional adviser. Liability limited by a scheme approved under Professional Standards Legislation (Australia-wide except in Tasmania).