Russia’s prolonged invasion of Ukraine has resulted in the imposition of an unprecedented range of sanctions on Russia by governments around the world. Businesses operating in the EU have been at maximum capacity, reviewing, receiving advice on and modifying their practices as each new package of sanctions is released by the EU. Similarly, U.S. businesses have spent significant time and efforts on tracking and complying with the sanctions imposed by the U.S. government.

EU prohibition in relation to public procurement

An updated FAQ on the EU’s public procurement directives was issued on 2 June 2022 to provide businesses with greater clarity on the EU restrictions on public procurement, the essence of which is to prevent European public funds going to Russian contractors.

Under article 5k(1) of Council Regulation No. 833/2014 (the Sanctions Regulations), it is prohibited to award or continue to execute any public or concession contract falling within the scope of the public procurement directives and other specified regulations to or with:

a) A Russian national, or a natural or legal person, entity or body established in Russia;

b) A legal person, entity or body whose proprietary rights are directly or indirectly owned for more than 50 per cent by an entity referred to in point (a) of this paragraph; or

c) A natural or legal person, entity or body acting on behalf or at the direction of an entity referred to in points (a) or (b) of this paragraph,

including, where they account for more than 10 per cent of the contract value, subcontractors, suppliers or entities whose capacities are being relied on within the meaning of the public procurement directives (the Prohibition).

It is clear from the above that the Prohibition is intended to be wide-reaching and it is now incumbent upon businesses that are engaged in EU public procurement activities to understand the impact of these sanctions and the additional duties and responsibilities the Prohibition places upon them and their public contracts.

Commencement of the Prohibition

The Prohibition applies to all ongoing and future public procurement procedures as well as awarded public contracts and concessions.

It took effect on 9 April 2022; i.e., from this day, new contracts falling under the Prohibition should not be signed where this also starts the period of termination for ongoing contracts falling under the Prohibition.

Interpretation of the Prohibition

Subcontractors and suppliers

While points (a)-(c) of article 5k(1) are relatively clear, we have received numerous questions about the interpretation of the subcontractor/supplier requirements under the Prohibition.

It is prohibited to contract with any person, regardless of their place of establishment or nationality, who implements or intends to implement a contract using Russian or Russian-owned subcontractors, suppliers or capacity providers where their participation is above 10 per cent of the contract value.

Total Russian ownership of the contractor must be above 50 per cent; i.e., regardless of whether ownership is split between multiple persons or entities, if the cumulative Russian ownership (across all owners) is over 50 per cent, the contractor, subcontractor or supplier is caught (a covered entity).

The Prohibition and application of the 10 per cent of contract value, applies individually to each subcontractor, supplier or capacity provider and not on a cumulative basis. Where more than one covered entity is involved, the value of their participation has to reach 10 per cent of the contract value in at least one case for the Prohibition to apply.

Application when the business is not a public buyer, but a subcontractor

As detailed above, the Prohibition not only prohibits the direct bidder or contractual partner, but also covers subcontractors, suppliers or entities whose capacities are being relied on – in each case provided they account for more than 10 per cent of the contract value.

Consequently, the obligation to comply with the Prohibition (and subsequent due diligence) is not limited to direct bidders or main contractors, but passes down through the entire supply chain and all parties have a duty to comply.

Additional duties of businesses

Where the Prohibition applies, businesses are obliged to reject the tender or terminate the contract (if already ongoing). Moreover, when a Russian contractor/subcontractor may be involved, businesses are now obliged to request the tenderer to replace the Russian subcontractor in its supply chain and offer them an opportunity to submit a revised tender.

Businesses must now check the shareholding of their suppliers/subcontractors whose individual contribution on a covered project is 10 per cent or more of the contract value to ensure that they are not Russian-owned.

The EU has advised that the terms ‘suppliers’ and ‘subcontractors’ include the whole supply chain and not only direct suppliers. Thus, contracts are covered even if the 10 per cent of Russian subcontracting is provided through intermediary entities, third parties or entities further down the supply chain.

GDPR implications

When checking the shareholding of the supply chain, businesses are obliged to use advanced KYC checks to ensure that they have full information on the ultimate beneficial owners of each of the entities.

Any company involved in a public procurement procedure or contract, whether listed on a stock exchange or not, is obliged to provide detailed information on its owners, to the extent necessary to establish that it is not Russian-owned over the sanctioned limit. Information on ownership is necessary to implement the Sanctions Regulations, and public buyers are authorised to request this information under article 6 of the GDPR.

Nevertheless, all the rules on protection of personal data still apply. Thus, the information obtained must be protected, not shared beyond the purpose for which it was obtained, and destroyed when it is not needed.

Implementing compliance with the Prohibition

Checking the supply chain

As regards how far down the chain checks need to be done, businesses need to examine any supply chains they have control or visibility over. As a minimum, this would cover direct contractual counterparties, which businesses should insist comply with the Prohibition, likely with some form of declaration from the counterparty or its contractors/suppliers, so safeguarding the supply chain.

To this end, the recent FAQ has also included draft language for a universal declaration for businesses to ensure that there is no Russian involvement in the supply chain.

Notifying clients/suppliers of the business’s sanctions compliance

Businesses are not legally required to provide specific information to their clients/suppliers on sanctions-related issues unless they are under a contractual obligation to do so or if such disclosure is in relation to the clients’/suppliers’ own reporting obligations and KYC checks for sanctions compliance. The only direct reporting obligation is to national enforcement authorities and regulators, depending on the sector that the business is operating in.

However, there may be various commercial reasons why businesses may wish to engage with clients and suppliers on their measures to ensure sanctions compliance, such as bolstering confidence and maintaining good business relationships. To this end, businesses can certainly prepare a general statement that provides standard responses to the frequently asked questions on the measures being undertaken to ensure compliance.

Pending U.S. legislation

On 6 April 2022, the U.S. House Committee on Oversight and Reform passed H.R. 7185, more commonly referred to as the Federal Contracting for Peace and Security Act (the Act). If passed into law, it will prohibit the U.S. federal government from entering into any contracts with companies that are conducting business with Russia. This law has been proposed in direct response to the current war in Ukraine. Reed Smith previously discussed this pending legislation in depth.

The Act will mandate that the U.S. federal government not enter into contracts or otherwise conduct business with entities that are present and operating in Russia. The Act, as currently drafted, provides that this restriction will apply to businesses operating in Russia during the “covered period”, which is defined by the Act as beginning 60 days after enactment of the Act and ending upon a joint determination by the secretaries of State and Treasury that Russia has taken steps to “restore the safety, sovereignty, and condition of” Ukraine.

The Act will prevent the federal government from entering into, continuing, extending, or renewing any “covered contract” with any company that conducts business operations in Russia during the covered period. It should be noted that the legislation defines a “covered contract” as either a prime contract or a major subcontract. This means that businesses beyond those that contract directly with the federal government will be impacted. In addition, the Act is sweeping and so will impact affiliates of businesses holding a covered contract, meaning that it will apply to such businesses’ parent companies, subsidiaries, and beneficial owners.

Also, if the Act is passed, current federal contractors and major subcontractors conducting business in Russia will be likely to find their current contracts terminated. As currently drafted, the Act will require federal agencies to terminate covered contracts held by businesses operating in Russia. Termination must be initiated within 60 days of the Act’s passage, but appears to allow for a 30-day ‘good faith’ extension during which termination will not proceed if the government determines that the contractor is pursuing all reasonable steps to comply with the requirements of the Act. The Act also provides for exemptions from termination in certain limited circumstances.

As the Act is still making its way through the legislative process, changes to its parameters are likely. Businesses contracting with the U.S. government that continue to operate in Russia should be aware of the Act and begin to evaluate the extent to which its passage in its current form may ultimately impact current contracts and future contracting opportunities.