Introduction of “No Russia” Clause

On 18 December 2023, the EU introduced its 12^th package of Russian sanctions by amending its Russian sectoral sanctions regime as governed by Regulation (EU) 833/2014[1] (as amended from time to time the Regulation). The amendments were made by way of Regulation (EU) 2023/2878[2] and took effect on 19 December 2023 and were subsequently further amended on 24 June 2024 pursuant to Regulation (EU) 2024/1745.[3]

The initial amendments introduced a new requirement to include a “No Russia” clause, which has significantly impacted the aviation industry. Specifically, article 12g of the Regulation (Article 12g) requires EU companies to contractually prohibit the re-exportation to Russia and re-exportation for use in Russia of sensitive goods and technology (including aircraft, aircraft engines and their parts) when selling, supplying, transferring or exporting those items to a third country, with the exception of certain “partner countries.”

Article 12g applies to all contracts entered into by a company based in the EU with a counterparty in a jurisdiction that is not an EU Member State or located in a “partner country” which countries are set out in Annex VIII of the Regulation and currently comprise Australia, Canada, Iceland, Japan, Liechtenstein, New Zealand, Norway, South Korea, Switzerland, the UK and the USA.

Scope

The requirement to include a “No Russia” clause applies to all new contracts concluded from 20 March 2024 and also applies retrospectively to all existing contracts concluded prior to 19 December 2023. It applies to all contracts that govern “selling, supplying, transferring or exporting.” In an aviation financing and leasing context this has been interpreted to include many of the principal documents for aviation transactions including operating leases, financing leases, sale agreements and maintenance agreements.

The retrospective requirement is subject to a transition period (being the earlier of 1 January 2025 or the expiry date of the contract).  Accordingly, aircraft leasing companies based in the EU have not only been considering including a “No Russia” clause in their new contracts but have also been investigating what other actions should be taken to ensure compliance with the Regulation in relation to existing contracts.

On 24 June 2024, the EU created an exemption for Article 12g in relation to public contracts concluded with a third country public authority or with an international organisation.  Where exporters are seeking to rely on this exemption, they must inform the competent authorities of the Member State in which they are based of the entry into such contracts.

Compliance

In order to assist companies in complying with the “No Russia” clause requirements, the EU published guidance on 22 February 2024[4] (the Guidance) (as updated on 15 July 2024). The Guidance provides a suggested “No Russia” clause (the Sample Clause), which the EU would deem to satisfy all the relevant requirements of Article 12g. However, the Guidance specifies that parties remain free to draft their own clause.

In practice, leasing companies generally elect to draft their own “No Russia” clause rather than use the Sample Clause because it is broadly seen as overreaching the legal requirements of Article 12g; particularly the Sample Clause seeks to impose (i) a “best efforts” obligation to prevent export or re-export to Russia, which is very difficult to comply with in the context of a highly moveable asset and given the nature of operating leases and (ii) a potential penalty of the value of the Aircraft for breach of the Sample Clause, which may contradict any legal prohibition on penalties (as provided under English law, for example) and certainly beyond the actual Article 12g requirement for “adequate remedies” only.

Introduction of “No Belarus” Clause

On 29 June 2024, the EU adopted additional sanctions on Belarus which mirror the measures that have been imposed on Russia. The new measures notably introduce similar anti-circumvention provisions and a “No Belarus” clause requirement pursuant to article 8g of  Regulation (EU)  2024/1865 (Article 8g).[5]  Notably, the Article 8g requirements  apply only to contracts entered into from 1 July 2024, with no retroactive application.

Penalties for Sanctions Breach

Failure to comply with EU sanctions regulations can have serious consequences: if an aircraft, its engines or parts are exported or re-exported to Russia or Belarus in breach of sanctions, contracts may be subject to scrutiny by Member States to check for compliance with Article 12g or Article 8g, as applicable, and, additionally, whether there was any failure to take adequate due diligence in relation to the relevant counterparty in the first instance.

On 19 May 2024, Directive (EU) 2024/1226[6] came into force, setting out the minimum penalties which Member States must incorporate into their national legislation for sanctions breaches:

• For individuals: a maximum term of imprisonment of up to five years, depending on the nature of the breach, in addition to possible fines, disqualification and publication of decision related to prescribed criminal offences; and
• For companies: the penalty that is given depends on the offence, and companies may be subject to fines of up to 5% of their turnover or €40 million.

Given its focus on anti-circumvention, the EU will likely take a strict view of any structuring which could be used to avoid compliance. It is significant that Article 12g and Article 8g were introduced by the EU as additional requirements to the general aviation sanctions restrictions in Article 3c of the Regulation – this can be seen as a further indication that the EU would expect additional steps to be taken to mitigate any compliance risk.

Actions for Leasing Companies

It is clear that many aircraft leasing companies have been taking a prudent approach in determining which contracts will be affected by this requirement, and have been reviewing existing contracts to ensure compliance with current sanctions requirements.

However, the market has diverged on its approach towards implementation of a specific form of clause – it is generally considered that despite the robust sanctions provisions baked into most aviation contracts, an additional affirmative action is required to ensure compliance with Article 12g and Article 8g.  At the strictest end, parties have amended their contracts to include an appropriate “No Russia” or “No Belarus” clause, whilst others have opted to notify counterparties of the change in law and basis upon which they consider the requirements of Article 12g to be satisfied by existing contractual provisions.

US State Court Split in Russia Insurance Cases

In two separate Russia insurance cases in the United States, differences in choice of law yielded opposite results to the question of whether aircraft seized by Russia following the invasion of Ukraine constituted physical loss or damage under the aircraft lessor’s hull insurance policy. In Florida, a state court applying Florida law found that “Florida law holds ‘physical loss’ requires some physical change to the insured property.”[7] Because the aircraft continue to operate in Russia, there was no physical change to the property.  In contrast, a California state court applying California law has found that “‘physical loss or damage’ as used in the [p]olicy reasonably may be read to refer to a government seizure of an aircraft” despite lack of physical damage.[8]