Financial sanctions and investment treaty arbitration

This article was originally published on Journal of International Banking & Financial Law, 2024 Volume 39, Issue 8.

KEY POINTS

• The last decade has seen an increase in the imposition of financial sanctions by states and other persons.
• Foreign investors may be able to challenge financial sanctions imposed by states through investment treaty arbitration.
• Whether an arbitral tribunal has jurisdiction to decide a dispute concerning sanctions imposed against a foreign investor, and whether a claim concerning sanctions is admissible, will depend on the applicable investment treaty and the applicable arbitration rules, as well as the timing, nature, effects and consequences of the specific sanctions measures imposed on the investor.
• Remedies resulting from investment treaty arbitration will most likely take the form of monetary damages, although non-pecuniary remedies are possible, and the respondent host state is bound by any arbitration award.

ABSTRACT

Financial institutions may be the subject of sanctions unilaterally imposed by individual states. while sanctions can be challenged through domestic means, foreign investors affected by sanctions have the right to bring proceedings against the sanction-imposing host state before international arbitral tribunals, provided investment treaty protection exists. Final awards, in particular monetary remedies against the host state, can be enforced globally.

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There is no universally agreed definition of the term “sanctions”. In broad terms, sanctions are economic, trade or other measures taken by a state, group of states or international organisation(s) for a variety of purposes.

In recent years, the financial sector has become a prime target of sanctions, particularly sanctions in connection with Russia. Financial institutions such as banks might be severely affected by sanctions in a variety of ways. For example:

• a bank itself might be sanctioned;
• stakeholders of a bank, such as shareholders and ultimate beneficial owners, might be sanctioned; and/or
• a bank’s counter parties (e.g. customers, lenders or debtors) might be sanctioned.

Banks can be severely affected by sanctions, even when they have complied with sanctions laws to mitigate any possible consequences. For instance, the designation of a bank’s parent company could cause severe operational difficulties for the bank because the bank’s counterparties (including corresponding banks) could find it difficult to continue transacting with the bank.

Indeed, even some of the bank’s non-financial counterparties, such as service providers, may terminate their services to the bank.

UN SANCTIONS AND UNILATERAL SANCTIONS

There remains disagreement on the nature of sanctions in international law, particularly over whether they can be lawfully imposed only by the United Nations (UN) or also by individual states or international organisations.

UN sanctions are imposed by the UN Security Council (UNSC). UN sanctions regimes have taken two broad forms:

(i) comprehensive regimes targeting states (eg the sanctions regime in respect of Southern Rhodesia in the 1960s and 1970s); and (ii) targeted regimes focusing on certain individuals, entities, groups, undertakings and/or activities. As of 21 May 2024, there were 682 individuals and 193 entities and other groups on the UNSC Consolidated List. Sanctions imposed by the UNSC can include full or partial trade, financial, commercial and arms embargoes.

States such as the US and the UK increasingly impose unilateral sanctions on other states, economic sectors, individuals and entities. These sanctions are not authorised by the UNSC. For example, as of7 June 2024, there were 1,701 individuals and 299 entities on the UK Office of Financial Sanctions Implementation (OFSI) Consolidated List of Financial Sanctions Targets under the Russia regime. Although the mechanics of how sanctions are imposed vary from state to state, a sanctioned person is typically the subject of an asset freeze, as well as broader limitations on investment and financial services, and even on personal expenditure. In fact, in the UK, there have been instances where designated persons have been prohibited from paying for private medical treatment and their children’s school fees.

A part from primary sanctions imposed directly on the targets, untargeted individuals and entities may also be subjected to secondary sanctions. These are imposed by a sanctioning state against individuals and entities anywhere in the world who co-operate with the primary targets in a manner prohibited by the sanction regimes of that state.

For example, secondary sanctions are often used by the US through its extraterritorial jurisdiction, which it asserts against non-US persons and entities without a US nexus, but who are deemed to be directly or indirectly engaged in certain transactions with names on the Specially Designated Nationals (SDN) List. In particular, Executive Order 14114, issued by President Biden on 22 December 2023, targets “foreign financial institutions” and grants the Secretary of the Treasury the authority to impose sanctions on foreign financial institutions if they have conducted or facilitated transactions for a designated person (subjected to some exceptions).

CONSEQUENCES OF VIOLATIONS OF SANCTIONS

Breaches of sanctions may result in criminal and/or civil penalties. For example, in the UK, pursuant to regulations made under the Sanctions and Anti-Money Laundering Act 2018, primary financial sanctions offences and financial licensing offences are punishable upon conviction on indictment with a maximum sentence of seven years’ imprisonment, a fine, or both. As to civil penalties in the UK, inter alia, OFSI can publicly name persons who have been found to be in breach of financial sanctions, and it can impose monetary penalties for financial sanctions breaches. Any monetary penalty imposed may be substantial. In 2020, Standard Chartered Bank was the subject of two penalties totalling £20.47m because it made loans totalling £97.48m to a subsidiary of a designated person without a licence.

Financial institutions such as banks are therefore particularly cautious about complying with various sanctions regimes, not only because of the risk of criminal and/ or monetary penalties, but also due to the grave reputational impact sanctions breaches could have. UN Special Rapporteur, Professor Alena Douhan has noted that the excessive “de-risking” seen in various financial sectors has resulted in over compliance with unilateral sanction regimes, with examples including delaying – or refusing – the processing of authorised transactions and the freezing of assets not targeted by sanctions.

CHALLENGING SANCTIONS DESIGNATIONS

Evidently, a large number of individuals and entities, whether targeted under sanctions regimes or not, are affected by financial sanctions. The impact of such sanctions may extend beyond a mere restriction on business activity. Sanctions may be “both severe and open-ended” (Eugene Shvidler v Secretary of State for Foreign, Commonwealth and Development Affairs [2024] EWCA Civ 172 at [210]). Indeed, persons subject to asset freezes may be “effectively prisoners of the state” (Bank Mellat v Her Majesty’s Treasury (No 4) [2015] EWCA Civ 1052 at [22], referring to Ahmed and others v Her Majesty’s Treasury (JUSTICE intervening) (Nos 1 and 2) [2010] UKSC 5 at [4]).

Considering the direct infringement of fundamental rights, there are an increasing number of sanctions-related challenges in domestic courts to obtain relief from sanctions or to mitigate their effects under domestic law. In Bank Mellat v Her Majesty’s Treasury (No.2) [2013] UKSC 39, the UK Supreme Court (UKSC) adopted the following four-limb test in assessing the proportionality of measures taken by the Treasury to restrict access to the UK’s financial markets by a major Iranian commercial bank due to its alleged connection with Iran’s nuclear programme:

• whether the objective of the measure is sufficiently important to justify the limitation of a fundamental right;
• whether the measure is rationally connected to the objective;
• whether a less intrusive measure could have been used; and
• whether, having regard to these matters and to the severity of the consequences, a fair balance has been struck between the rights of the individual and the interests of the community.

Applying this test, the UKSC decided in favour of Bank Mellat and set aside the direction requiring all persons operating in the financial sector not to have any commercial dealings with Bank Mellat. In contrast, having regard to the Bank Mellat four-limb test, the Court of Appeal in Shvidler dismissed Mr Shvidler’s appeal concerning his designation.

To date, the courts in England and Wales have broadly rejected challenges to the domestic sanctions regime and its application in cases involving sanctions under the Russia regime. The courts have rejected arguments from sanctioned individuals challenging the lawfulness of the legislation or its implementation process.

The use of investment treaties to challenge the lawfulness of sanctions may offer greater opportunities for claimants to have all relevant issues considered comprehensively by arbitral tribunals, free from the influence of domestic legislation and its operation, which can often be influenced by highly charged political agendas and the court of public opinion. Furthermore, as stated above, the lawfulness of sanctions imposed unilaterally by states remains highly controversial in public international law. Academics and practitioners are divided on a number of fundamental issues, including whether sanctions constitute lawful counter measures and whether they are proportionate and necessary. These issues could be tested in investment treaty arbitration.

INVESTMENT TREATY ARBITRATION

In broad terms, investment treaty arbitration is a procedure for dispute settlement by which a foreign investor can directly sue before an international arbitral tribunal a state which admits its investment (namely the host state). The right of a foreign investor to proceed in this manner is conferred by a bilateral/multilateral investment treaty entered into between the foreign investor’s home state and the host state.

SANCTIONS DISPUTES: JURISDICTION AND ADMISSIBILITY

Whether an arbitral tribunal has jurisdiction to decide a dispute concerning sanctions imposed against a foreign investor, and whether a claim concerning sanctions is admissible, will depend on the applicable investment treaty and the applicable arbitration rules, as well as the timing, nature, effects and consequences of the specific sanctions measures imposed on the investor. In general, crucial considerations include but are not limited to:

• Whether the investor is considered a qualified “investor” under the applicable treaty. Common considerations include: whether the investor holds the nationality of the home state and/or is a dual national (where the investor is a natural person); and whether the investor is legally registered in the territory of the home state, whether the investor is physically headquartered in the territory of the home state and/or whether the investor engages in actual business activities (where the investor is a legal person).
• Whether an investment is considered a protected “investment” under the applicable treaty. While most treaties stipulate that qualifying investments include every kind of asset of the investor, there may be conditions such as the investment must be directly owned or controlled by the investor, the investment must be maintained for a certain period of time or the investment must be lawful under the laws of the host state.
• Whether the dispute arose before or after the treaty’s entry into force.
• Whether the claim is time-barred.
• Whether the treaty provides for international arbitration as a forum to settle disputes between the investor and the host state, and, if so, what kind of disputes are arbitrable and whether all prerequisites have been met before the filing of an arbitration request.

Sanctions have featured in investment treaty arbitration. For example, in Bank Melli Iran and Bank Saderat Iran v Bahrain (PCA Case No. 2017-25), Bahrain challenged the jurisdiction of the tribunal and the admissibility of the claimants’ claims on the basis that, inter alia, the bank established by the claimants (Future Bank) engaged in activities contrary to sanctions that the UN, the US and the EU imposed against Iran and multiple Iranian entities. The tribunal dismissed Bahrain’s challenge. Notably, it did so after distinguishing between, on the one hand, sanctions imposed by the UNSC, and, on the other hand, sanctions imposed by the US and the EU. The former “qualify as norms of what is generally called transnational or truly international public policy” (at [382]). The latter do not constitute fundamental rules of international law, but “seek to advance non-universal political or economic interests of specific States” (at [381]).

REMEDIES, RECOGNITION, ENFORCEMENT AND IMMUNITY

When a tribunal finds that a respondent state has breached its obligations under an investment treaty, the tribunal may order the state to make reparation for the injury caused by its breaches. In public international law, forms of reparation available to an investor include restitution, compensation and satisfaction (see the customary international law reflected in Art 34 of the Draft Articles on the Responsibility of States for International Wrongful Acts 2001 adopted by the International Law Commission (ILC)). The Bank Melli arbitration provides an instructive example of the different forms of reparation that might be claimed. In their written pleadings, the claimants’ primary request was for restitution (including reinstating all of the claimants’ rights as shareholders of Future Bank, and reinstating all of Future Bank’s rights and licences prior to the expropriation) and compensation (at [317]-[318]). However, during the hearing, the claimants amended their request for relief, withdrawing their request for restitution and claiming monetary damages only (at [319]). Having found that Bahrain unlawfully indirectly expropriated the claimants’ shareholding interests in Future Bank (at [690] and [696]), the tribunal ordered Bahrain to pay to the claimants compensation in the amount of €243m plus interest.

The decision of a tribunal will be contained in an award. Awards are binding on the parties to the proceeding. But what happens if a party fails to comply with an award? The answer depends largely on the type of arbitration.

Where the award is rendered in an arbitration under the 1966 Convention on the Settlement of Investment Disputes between States and Nationals of Other States (ICSID Convention), the other party can have the pecuniary obligations in the award recognised and enforced in the courts of any ICSID member state as though it were a final judgment of that state’s courts (Art 54(1) of the ICSID Convention).

Where an award is rendered in a non-ICSID Convention arbitration, the recognition and enforcement of the award is governed principally by the 1958 UN Convention on the Recognition and Enforcement of Foreign Arbitral Awards (New York Convention). Unlike an ICSID award, the enforcement of a non-ICSID award is not limited to pecuniary obligations imposed by the award. However, the New York Convention affords domestic courts more leeway to refuse the enforcement of an award. In the context of sanctioned foreign investors who prevail in arbitration, it is conceivable that respondent states will attempt to resist enforcement on the basis that enforcement would be contrary to public policy (New York Convention, Art V(2)(b)).

Irrespective of the arbitration rules which govern the arbitration, issues of state immunity may arise. For example, a respondent state might argue that: (i) the process of executing an award against its property is a process separate from recognition and enforcement; and (ii) it is immune from execution. The distinction between recognition/enforcement and execution was recently drawn by the High Court of England and Wales in Border Timbers Ltd v Zimbabwe [2024] EWHC 58 (Comm). Ultimately, questions of execution will turn on the enforcing court’s law of state immunity.

In some circumstances, in addition to ordering non-pecuniary remedies, an international tribunal may have the power under relevant rules (such as Art 47 of the ICSID Convention) to recommend or order provisional measures to, for instance, temporary lift certain restrictions on transactions, although the enforcement of such an interim measure will be more unpredictable.

CONCLUSION

All financial institutions have been significantly affected with the impact of sanctions on their business in recent years. For financial institutions that are designated or fear they may be designated by unilateral sanctions regimes, international investment treaty arbitration may serve as another available channel to challenge the lawfulness of sanctions apart from domestic routes, although the admissibility of disputes are subject to facts and applicable treaties and arbitration rules. An international arbitral tribunal may order monetary damages and/or non- monetary remedies by form of an arbitral award. Remedies resulting from investment treaty arbitration will most likely take the form of monetary damages. Awards are binding on the parties to the proceeding and can be enforced under applicable international treaties.

The authors would like to thank Stephen Bailey of Three Raymond Buildings for reviewing this article and his invaluable comments.

Features

Roger Gherson is the founding partner of Gherson LLP. With over 40 years in practice, he is recognised as the “go-to lawyer” for individuals with multifaceted legal issues and is considered one of the best in the industry for those requiring expert advice on international protection, as well as asylum, extradition, deprivation of leave and travel bans, international investment treaty matters, sanctions, unexplained wealth orders and other forms of asset seizure. Email: roger@gherson.co.uk

Valeriya Grebenkova is an arbitration lawyer at Gherson LLP. She is a Russian-qualified lawyer who specialises in investor-state dispute settlement and has represented both investors and sovereign states in investment arbitration proceedings administered by the PCA (Permanent Court of Arbitration) as well as under the auspices of ICSID. She is actively involved as counsel in commercial arbitrations under major institutional rules including LCIA, ICC, SCC and ICAC (Moscow). Email: vgrebenkova@gherson.co.uk

Dr Cong Gao is a solicitor at Gherson LLP. She is a dual-qualified lawyer in England and Wales and the People’s Republic of China. With experience at pre-eminent international law firms in both jurisdictions and a PhD in investment treaty arbitration, she has a deep understanding of international dispute resolution and a proven track record of working on complex cross-border disputes before national courts and international arbitration tribunals. Email: cgao@gherson.co.uk

Publication source: https://www.jibfl.co.uk/articles/financial-sanctions-and-investment-treaty-arbitration