Following Russia’s actions in Ukraine, the United States, European Union and United Kingdom have all announced new sanctions largely targeting institutions from the financial and defence sectors, as well as high net worth individuals. The United States and European Union have implied further sanctions can be expected. In addition, German Chancellor Olaf Scholz has said his country has chosen to withhold key documentation required for the certification of the Nord Stream 2 pipeline.

There are likely to be a multitude of disputes arising from the current and potential sanctions that could cause an uptick in referrals for arbitration. Indeed, we have seen such arbitrations arising from issues relating to the previous round of sanctions imposed on Russia by Western governments during the events in Ukraine in 2014. The wide-ranging impact of these sanctions can be seen in part through the subsequent steep decline in foreign direct investment outflows from Russia – approximately 34% from 2013 to 2014, and a further 61% in 2015 according to data published by the World Bank.

Using the past as a guide, it is therefore worth considering quantum issues that may arise in these arbitrations and the related considerations for lawyers and quantum experts.

A common issue we often see resulting from sanctions are disputes in which a claimant seeks remedies associated with a respondent’s alleged breach of contract. The respondent often argues that its business ties to sanctioned entities or individuals meant it was no longer able to perform on a contract, causing it to be in breach of its obligations or causing it to terminate a contract early, often in reliance on force majeure clauses.

Parties and their advisers should consider whether a lost profits approach to damages is appropriate for their case. Relevant considerations, among others, includes the availability of historical financial data, the duration of any performance under the contract (if any) and whether the affected entity continues to remain a going concern.  Depending on the facts of the case, alternative methods of assessing damages could be more appropriate, and may include a more market-based or cost-based valuation approach.

In cases in which a discounted cash flow method may be most appropriate as a measure of damages, the common approaches used to assess risk, and in particular in computing a discount rate, may not be appropriate. Discount rates tend to be based on retrospective inputs that are assumed to be reasonable proxies for the future, such as the risk-free rate and industry beta (i.e. the measure of a specific asset’s risk in relation to its market).

Depending on the nature of the sanctions and their impact on the affected business, parties and their advisers should consider whether those inputs actually continue to be reasonable proxies for the future. For example, as sanctions may target a particular industry sector, the betas for that sector may change dramatically in the post-sanctions period as opposed to the pre-sanctions period. The timing of an arbitration, the facts of the matter and the chosen valuation date will impact whether there is sufficient data available to appropriately capture any such impact.

An obvious effect of sanctions is increased volatility in the value of a country’s currency, the causes of which can be multivariate but often fundamentally relate to the introduction of additional uncertainty. Consideration should be given to the nature of any foreign currency transactions to determine any impact on quantum. For example, we have seen heads of claim relating to loans denominated in a stable currency provided to a party whose operating currency is volatile, or devaluing, thereby calling into question the recoverability of those loans.

This brief list of examples of potential issues is by no means exhaustive. New sanctions are still being announced, and the full impact on foreign investment remains to be seen.