Obligation to include a "No Russia clause" in supply agreements

For some export transactions, re-exportation to Russia must be contractually prohibited. Model clauses present conflicts with German law on general terms and conditions.

Companies must keep abreast of the sanctions against Russia, especially when it comes to export transactions, and as far as possible prevent any attempts by their customers to circumvent these sanctions. Companies have been aware of this for a long time. What is new, however, is that since 20 March 2024, companies are legally required to explicitly prohibit re-exportation to Russia or re-exportation for use in Russia in their agreements when selling, exporting and transferring certain goods (see Article 12g Regulation (EU) No 833/2014 – Russia Embargo Regulation).

The aim of the regulation is to prevent the supply of certain listed goods to Russia that circumvent sanctions. Accordingly, exporters should also no longer sell the goods concerned to non-EU persons who are not willing to accept the envisaged contractual re-exportation prohibition.

What supply relationships will be affected? 

The obligation applies to agreements between exporters from the EU and contractual partners in third countries, with the exception of the partner countries listed in Annex VIII of the Russia Embargo Regulation: USA, Japan, UK, South Korea, Australia, Canada, New Zealand, Norway, Switzerland (as of May 2024).

There is also an exception for performance by 20 December 2024 or by the expiry date, whichever is earlier, of agreements concluded before 19 December 2023. A subsequent agreement of a "No Russia clause" may therefore also be required for agreements with a performance date after 20 December 2024.

What services/goods are affected?

The obligation to include the "No re-export to Russia clause" or "No Russia clause" applies to the sale, supply, transfer or export of goods or technologies listed below:

• In Regulation (EU) No 833/2014 in
  • Annex XI – Aircraft parts, aeronautical components, propellers and jets
  • Annex XX – Aviation fuel and additives
  • Annex XXXV – Firearms and other arms
  • Annex XL – Military electronics, components and other goods recovered from the battlefield and goods for their production, for which there is a high risk of re-exportation to Russia
• Firearms and ammunition as listed in Annex I to Regulation (EU) No 258/2012.

Since (i) certain third countries with a large share of EU foreign trade are excluded and (ii) only certain listed goods are affected, the application of Article 12g Russia Embargo Regulation can probably be ruled out at an early stage in many cases, even if a wider application of such clauses can be observed in the market.

What are the specific obligations?

If the agreement is covered, exporters must, in accordance with Article 12g (1), (3) and (4) Russia Embargo Regulation:

1. contractually prohibit re-exportation to Russia and re-exportation for use in Russia of the goods concerned,
2. provide for adequate remedies in the agreement in the event of a breach of the contractual re-exportation prohibition and
3. inform the competent authority of their Member State (place of establishment/residence) of breaches of the contractual re-exportation prohibition by the contractual partner as soon as they become aware of such breaches.

In its FAQ (April 2024), the EU made a model clause to this effect available, which can be used with appropriate adjustments:

(1) The [Importer/Buyer] shall not sell, export or re-export, directly or indirectly, to the Russian Federation or for use in the Russian Federation any goods supplied under or in connection with this Agreement that fall under the scope of Article 12g of Council Regulation (EU) No 833/2014.

(2) The [Importer/Buyer] shall undertake its best efforts to ensure that the purpose of paragraph (1) is not frustrated by any third parties further down the commercial chain, including by possible resellers.

(3) The [Importer/Buyer] shall set up and maintain an adequate monitoring mechanism to detect conduct by any third parties further down the commercial chain, including by possible resellers, that would frustrate the purpose of paragraph (1).

(4) Any violation of paragraphs (1), (2) or (3) shall constitute a material breach of an essential element of this Agreement, and the [Exporter/Seller] shall be entitled to seek appropriate remedies, including, but not limited to:

(i) termination of this Agreement; and
(ii) a penalty of [XX]% of the total value of this Agreement or price of the goods exported, whichever is higher.

(5) The [Importer/Buyer] shall immediately inform the [Exporter/Seller] about any problems in applying paragraphs (1), (2) or (3), including any relevant activities by third parties that could frustrate the purpose of paragraph (1). The [Importer/Buyer] shall make available to the [Exporter/Seller] information concerning compliance with the obligations under paragraph (1), (2) and (3) within two weeks of the simple request of such information.

Strict German law concerning general terms and conditions makes adjustments necessary

The clause proposed by the EU Commission is standardised for exporters from all EU states and therefore inevitably cannot take all the specifics of an individual legal system into account. 

This applies in particular to German law, because as a pre-formulated contractual condition, the clause must comply with strict German law concerning general terms and conditions (Section 307 (1) German Civil Code (BGB)). In particular, the proposed no-fault contractual penalty is likely to fail this strict standard. This is because contractual penalty clauses without a fault requirement are generally invalid under German law concerning general terms and conditions, even in B2B transactions (see German Federal Court of Justice (BGH), NJW-RR 1991, 1013). It therefore makes sense where German law applies to include such a fault requirement in the clause.

Determining the appropriate penalty amount is extremely complex

Comparable difficulties arise when determining the permissible amount of the contractual penalty, which was not specified in the EU Commission's model clause. This is because, according to established case law of the German Federal Court of Justice (BGH), a contractual penalty is always invalid if it is disproportionate to the severity and number of breaches of duty and the corresponding consequences for the parties (German Federal Court of Justice (BGH) NJW 2016, 1230, margin no. 34). The main reason for the contractual penalty is to exert pressure on the other party. For this reason, the average expected damage may also be exceeded as a general rule. At the same time, however, the amount of the contractual penalty must still be reasonable even for the smallest conceivable breach of duty. Furthermore, a contractual penalty must never assume a predominantly punitive character, as this is alien to German civil law.

The point of the contractual penalty is to exert pressure, not to penalise

"Squaring the circle" in this way rarely succeeds and the requirements of German law concerning general terms and conditions clearly conflict with the primary objective of Article 12g Russia Embargo Regulation, which is reflected in the model clause and can be summarised as follows: To combat deliveries via third countries which could circumvent export bans. This is because this objective is less in the original interest of the exporter than it is in the public interest. On this basis, it is clear that the focus is on the punitive character of the contractual penalty: The exporter is expected to act as an extension of the state to (indirectly) enforce the right to impose sanctions and – in accordance with the proposal in the model clause – penalise the buyer accordingly in the event of breaches.  However, even though this may be possible in many other legal systems, German civil law does not provide for such a mechanism, which is why it is difficult to realise the EU's objectives in this way.

(Imperfect) solution: Contractual penalties according to the "Hamburg custom" 

So what can be done? The amount of the contractual penalty could be based on 5 % of the net order amount, as is now customary in other commercial transactions. The German Federal Court of Justice (BGH) recently clarified once again that this is the highest permissible sum for performing construction work (German Federal Court of Justice (BGH), judgment of 15 February 2024 – VII ZR 42/22). However, delaying a service in a construction agreement is barely comparable to a sanction for breaching a ban on onward deliveries to Russia. For this reason, resorting to the 5 % case law here seems largely arbitrary and its content cannot really be justified. There is therefore usually no other option than to adjust the amount of the contractual penalty – insofar as possible – on a case-by-case basis to suit the industry.

Another option to consider is adopting the so-called "Hamburg custom" (Hamburger Brauch). In this type of clause, the amount of the contractual penalty is not specified in the clause itself. Instead, it is set by the other party (i.e. the "non-offending" party) only after the breach at a "reasonable" amount with regard to the severity of the breach of duty. If the offending party does not consider the amount to be reasonable, it may have the amount reviewed by the competent court (or arbitral tribunal). This type of clause gets around the high hurdles imposed by German case law as to the validity of a contractual penalty. Internationally, however, this type of clause (the high complexity of which is entirely the result of the strict and somewhat unrealistic nature of case law from the German Federal Court of Justice (BGH)) is frequently unheard of and often impossible to communicate.

Note: Simply adjusting the general terms and conditions is not enough

It is rather rare for the EU Commission to impose specific contractual clauses on cross-border trade. The EU Commission's model clause expressly stipulates that the provision is identified as an "essential element" of the concluded agreement. It is necessary for the clause to become part of the agreement in the first place. This is rarely the case if the clause is merely included in the company's own terms and conditions of sale, since, as is common knowledge, their general terms and conditions do not become part of the agreement in the event of a conflict between terms and conditions of sale and of purchase (battle of forms) – which is regularly the case. Simply adjusting one's own general terms and conditions is therefore often insufficient for the clause to actually become part of the agreement.

Therefore, in the case of agreements that have not yet been concluded, it is necessary to include the clause in the actual text of the agreement itself. The identification of the clause as an "essential element" even implies that the clause should be highlighted visually – for example with bold print. However, if an agreement is concluded by way of orders and order confirmations, a side letter should be concluded on this aspect. The same applies if the agreement has already been concluded and Article 12g Russia Embargo Regulation now requires that it be adjusted subsequently.