Are new EU Sanctions on government contracting a "Don't Buy Russian" rule?

The European Union continues to impose new sanctions and export control restrictions related to Russia, in response to the war in Ukraine (see our coverage here). The most recent “Fifth Round” of restrictive measures imposed by Council Regulation (EU) 2022/576 (the Sanctions Regulation) entered into force on 9 April 2022 and – for the first time – now also directly impacts government contracts.

Prohibitions on Russian contractors

Article 5k) of the Sanctions Regulation seeks to prevent European tax money going to Russian contractors. While other restrictive measures against Russia target specific persons, companies or industry sectors, Article 5k) has a wider scope: It not only covers Russian companies and individuals in general, but also any company that is majority-owned by, or acting on behalf or at the direction of, a Russian company or individual.

As of 9 April 2022, contracting authorities may therefore no longer:

• award a government contract to persons, entities or bodies having a connection with Russia within the meaning of Article 5k) of the Sanctions Regulation; or
• execute an already awarded government contract. However, there is a grace period until 10 October 2022.

National authorities may grant individual exemptions from this ban for a limited number of tenders described in Article 5k)(2), e.g. for the provision of strictly necessary goods or services or the purchase, import or transport of natural gas and oil.

Prohibitions on Russian subcontractors, suppliers, and other supply chain parties

Article 5k) goes even further. It not only prohibits the direct bidder or contractual partner from having a connection to Russia, but also covers subcontractors, suppliers, or entities whose capacities are being relied on – in each case provided they account for more than 10% of the contract value.

Government contractors therefore need to carefully examine their supply chain to determine whether any of their subcontractors, suppliers or entities whose capacities they rely on in public tenders may be Russian or Russian-controlled entities. And if the answer is yes, government contractors need to determine whether any of these companies contribute more than 10% of the relevant contract value.

A few questions remain:

• Does a government contractor only need to examine its direct suppliers and subcontractors or does the exclusion under Article 5k) also extend to suppliers and subcontractors further down the supply chain?
• And is the 10% threshold calculated individually per supplier and subcontractor or cumulatively across all parties involved?

With the European Commission adopting a proposal for a Directive on corporate sustainability due diligence on 23 February 2022 and the German Act on Corporate Due Diligence in Supply Chains taking effect on 1 January 2023, discussions on supply chain due diligence have been gaining more and more momentum. A diligent contractor might therefore have already begun assessing and monitoring its supply chain and can now benefit from prudent preparations.

Impact on ongoing tenders

In ongoing tenders bidders can expect contracting authorities to require a confirmation that the bidder and its supply chain comply with Article 5k) of the Sanctions Regulation. Failure to do so will likely be grounds for exclusion and, if there has been any misrepresentation, may also put a bidder’s ability to participate in future tenders at risk.

It will depend on the actual phase of the tender, the bidder’s overall situation and applicable procurement rules whether a bidder is able to replace one of its subcontractors, suppliers or entity whose capacity they make use of on short notice.

Impact on existing government contracts

Government contracts already awarded on or before 9 April 2022 may continue to be executed until 10 October 2022. And we would argue that in general either party may continue to demand performance until that time.

Contractors can expect their government customers to reach out to them with a request to confirm compliance with Article 5k) of the Sanctions Regulation. Absent a specific information request, the question arises whether a contractor is under an obligation to proactively disclose any ties to Russian companies and entities falling within the scope of Article 5k) of the Sanctions Regulation. This obligation is not expressly spelled out in the Sanctions Regulation and one could argue that it is only directed at contracting authorities, and not individual bidders.

If a government contract has to be terminated by 10 October 2022, a number of civil law questions around liability, damages and termination rights will arise that will have to be assessed on a case-by-case basis. In this context Article 11 of the Sanctions Regulation broadly excludes claims for damages from Russian persons, entities or bodies.

What to do next

• Companies relying on government contracts should carefully examine their supply chain and business partners to determine whether there is any risk of falling within the scope of Article 5k) of the Sanctions Regulation.
• In ongoing tenders bidders will need to assess whether it is feasible to replace the affected supplier or subcontractor within the often ambitious timeframes of a public tender and under applicable procurement rules. Otherwise bidders may have no choice but to withdraw from the tender, unless they qualify for an exemption under Article 5k)(2) of the Sanctions Regulation.
• For contracts already awarded, contractors will need to think about what the grace period until 10 October 2022 means for their performance. Will they be able to complete the contract before that deadline? If not, what are their contractual responsibilities towards suppliers and subcontractors? Do they share the risk of the government contract not being completed and can the agreements be terminated in time?