International: Crimea, Sanctions against Russia, and the Effect of these Sanctions on German Businesses

Background

Following the violation of Ukrainian sovereignty and territorial integrity by the Russian Federation, on 17 March 2014 the European Union (the "EU") and the United States of America (the "US") imposed sanctions against certain Russian individuals. The US, in addition, imposed sanctions against a Russian bank, the Bank Rossiya. Following an exacerbation of the situation in the Ukraine, additional sanctions were imposed on 28 April 2014.

In this article, we consider the respective EU and US sanctions and their scope, and ask the question, whether they are anything but symbolic. We take a look at why the West - including Germany - has, at least so far, been hesitant in imposing economic sanctions on Russia, and examine the impact of the current sanctions on German businesses.

The EU Sanctions

The EU sanctions of 17 March 2014 target 33 specifically-named individuals believed to be responsible for actions which undermine or threaten the territorial integrity, sovereignty and independence of Ukraine, by freezing their funds and economic resources. Pursuant to Council Regulation (EU) 269/214 of 17 March 2014:

the freezing of funds (i.e. financial assets and benefits of every kind) means "preventing any move, transfer, alteration, use of, access to, or dealing with funds in any way that would result in any change in their volume, amount, location, ownership, possession, character, destination or any other change that would enable the funds to be used..."; and

the freezing of economic resources (i.e. assets of every kind, which are not funds but may be used to obtain funds, goods or services) means "preventing the use of economic resources to obtain funds, goods or services in any way...".

These very broad definitions mean that it is in effect prohibited for any EU organised business or EU person to transact business with the targeted individuals. Furthermore, the prohibitions of the regulations also apply to non-EU companies and non-EU persons as regards any business which those non-EU companies conduct within the EU.

Exception may, however, be made with the prior approval of the competent authorities of the EU Member States, to release or make available certain frozen funds or economic resources under such conditions as the Member States may deem appropriate (e.g. for the limited purpose of enabling the sanctioned individuals and their dependents to obtain certain necessities and services).

On 28 April 2014, following the most recent developments in the Ukraine (including a group of OSCE observers being taken hostage), the EU imposed further sanctions in the form of travel bans and asset freezes on an additional 15 Russians.

The US Sanctions

The US imposed sanctions against 20 specifically-named individuals as well as the Russian Bank Rossiya on 17 March 2014. The persons targeted by the US sanctions differ from those targeted by the EU sanctions.

As a result of the US sanctions, any assets of the targeted persons that are within US jurisdiction have been frozen. Transactions by US persons or within the US involving the targeted individuals and bank have been generally prohibited. Importantly, even assets which are merely passing through the US are subject to being frozen (meaning that any transfer of funds which is routed through a US bank, or even the foreign branch of a US bank, could, for example, be frozen by that bank). The US sanctions forbid the targeted individuals from traveling to the US and prohibit the making of any donations to or for the benefit of any of the targeted individuals. They also prohibit any attempt to evade complying with the sanctions and any conspiracy to avoid the sanctions.

The US sanctions only apply to US persons and to property located within the US. A company incorporated in Germany, which is not owned or controlled by a US person and which has no US persons as employees, does thus not have any obligations with regard to the US sanctions. However, if the company is owned or controlled by a US person, or has a US person as an employee, it should carefully evaluate any plans to do business with the sanctioned individuals or bank. The penalties for US persons who participate in business with the targeted individuals are severe and may include imprisonment and substantial fines.

Under the US sanctions, US persons are subject to strict liability. This means that even if a US person does not know that business in which it is involved (also) involves one of the sanctioned individuals (or the bank), that US person can still suffer the penalties for violating the US sanctions. The situation is different for the EU sanctions, in terms of which persons who did not know and had no reason to suspect that they were engaging in prohibited business with the targeted individuals will not be subject to liability for their actions. As a result, it is essential that US persons and their employers take careful precautions to ensure that US persons are not involved in any business with sanctioned individuals or entities.

On account of the recent developments in the Ukraine, on 28 April 2014 further sanctions (in the form of asset freezes and U.S. visa bans) were imposed by the US against seven Russian government officials, as well as (in the form of asset freezes) against seventeen companies linked to President Putin's inner circle.

Sanctions without much Bite?

Although members of the Russian political elite have thus had their European and US assets frozen, and travel bans have been put in place to restrict their movements, the question asked by many is whether these sanctions actually have any bite, or whether they are merely symbolic.

Naturally, there are different views on the matter. While those imposing the sanctions may view them as a serious matter, Russia has said that the measures are "detached from reality". The facts of the matter are that sanctions against a small number of individuals are unlikely to have much economic impact against a whole country; at the same time, it is unclear to what extent the targeted individuals have assets in the EU or the US. It would thus appear that the sanctions are indeed largely symbolic. This will remain the case for as long as the EU and the US merely impose targeted sanctions; sanctions would only really have an effect if they became general measures directed against entire sectors of the Russian economy.

While the West has thus so far steered clear of imposing economic sanctions on Russia (and we will look at why this is the case, below), the current sanctions may, nevertheless - and particularly after the imposition of the most recent round of sanctions -, signal to Russia that the EU and the US are prepared to take progressively more serious steps to respond to the crisis. Importantly, this is a signal that may also already be feeding through to investors. Thus Russian deputy economy minister Andrei Klepach stated that investors were expected to take $65-70bn of capital out of the economy in the first quarter of the year, which compares with $63bn for the whole of last year. Taking into account that Russia's economy is already struggling (last year it saw GDP growth of just 1.3%), Russia may want to not completely disregard the warning signal sent out by the current sanctions.

The Hesitancy of the West to impose Economic Sanctions and Germany's Position

While both the EU and the US continue to threaten the possibility of additional broad-reaching economic sanctions if the current tensions between the Russian Federation and Western nations should continue, no such sanctions have been imposed to date. And there is a very good reason for this. Taking Germany as an example, the facts of the matter are that Berlin depends on economic ties with Russia, with bilateral trade volume equalling to some EUR 76 billion in 2013. Approximately 6,000 German firms and over 300,000 jobs are dependent on Russian partners with the overall investment volume of EUR 20 billion.

Germany is currently the EU's biggest exporter to Russia. German car manufacturing companies are likely to suffer first if sanctions against Russia become more substantial, as about half of German exports to Russia are vehicles and machinery. On the retail side, German Metro stores wanted to take its Russian subsidiary public this year, which plan is now imperilled. Earlier this year, Germany's KfW development bank cancelled a contract with Russia's VEB bank worth EUR 900 million in investment initiatives for mid-sized companies. Under the deal, German businesses were to have invested EUR 200 million in Russia. In addition, Germany is heavily dependent on Russian energy, with around 35% of its natural gas imports coming from Russia.

It is thus easy to see why the imposition of economic sanctions has been avoided so far, and why countries such as Germany have no real interest in imposing same. It is for this reason that German Chancellor Angela Merkel keeps stressing that she hopes for a political solution to the stalemate over the current crisis.

Conclusion

Given that the current sanctions are relatively limited in application, their economic impact can be expected to be correspondingly limited in scope. The sanctions may be more significant for the targeted individuals and those who have been conducting business with them. Thus German companies may find themselves economically affected by the current sanctions if they conduct business with the sanctioned individuals or bank, as the economic loss suffered by those individuals and bank may be passed on to their German business counterparties.

If the EU and the US were to impose additional sanctions targeted at broad-reaching sectors of the Russian Federation's economy, the economic impact for German businesses would be much more significant, both in terms of damaging their commercial interests, as well as in respect of their exposure to liability for dealing with sanctioned individuals or companies / businesses. The imposition of such sanctions may thus be expected to continue being very carefully weighed up.

Should you have any questions on how the sanctions may affect your business now or in the future, please do not hesitate to contact us.