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March 24, 2022updated 08 Jun 2022 4:16pm

Gazprom: UK customers face challenges to break ties

Contract law puts businesses and councils trying to do the right thing in a sticky spot: they must face high fees, the cost of a new contract and a potential breach of procurement law – or be seen as financing war.

By Elizabeth Meager

Gas pipeline like those used by Gazprom
Frozen assets? Local governments and UK-based companies are finding ways to exit existing gas contracts with Gazprom. (Photo by sarkophoto via iStock)
  • The reliance of thousands of UK businesses and councils on Russian gas is evidence of the gaps inherent in sanctions regimes in the age of globalisation.
  • UK commercial customers are heavily reliant on Gazprom and face hefty exit fees to leave these contracts, which the government has encouraged them to do.
  • They say they need more government support, including potential full-scale sanctions on Gazprom – which ministers appear reluctant to do.

Sanctions regimes are often referred to as Swiss cheese – they are so full of inconsistencies and loopholes that their effectiveness is far from guaranteed. The vast number of sanctions placed on Russia has also highlighted how complex it is for those tasked with applying them to actually do so.

Take the UK as an example. Russian gas supplier Gazprom’s local arm, Gazprom Marketing & Trading Retail, is the largest non-domestic supplier of gas to businesses and public bodies. With thousands of contracts across the country, its customers include McDonald’s, Siemens, Domino’s Pizza, as well as dozens of local authorities, schools and universities. Its market share was 22% and it supplied gas to 178,000 sites, with contracts worth approximately £4bn, based on Capital Monitor estimates.

To date, UK government ministers have blocked Gazprom Marketing & Trading Retail from raising capital on UK markets, sanctioned its chief executive, and have encouraged its clients to end existing contracts as soon as possible.

But exiting contracts is where it gets tricky. Many clients are struggling to do so through a combination of expensive break clauses, government regulations, and the extraordinarily high cost of taking on a new contracts amid a global gas crisis.

This all puts local authorities and businesses wanting to do the right thing in a tight spot.

Do they keep their current contract with a company whose main shareholder is committing atrocities? Or do they honour the spirit of sanctions and wash their hands of the contracts at the cost of a large penalty fee on top of negotiating a new contract with another supplier? Either way, they will have to defend their decision to taxpayers or shareholders.

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The situation is further complicated by rumours Gazprom’s UK subsidiary is on the brink of administration – the UK government is reportedly considering nationalisation – as customers turn their backs.

Gazprom customer responses

Capital Monitor asked a cross-section of UK-based companies and local governments with contracts to Gazprom Marketing & Trading Retail how they intend to handle this situation.

While some plan to exercise conveniently timed break clauses, others face hefty bills if they do so outside of such a window. Portsmouth City Council has said it will pay £57,000 ($75,000) in penalty fees to exit its £5.5m contract in September, which it added is the earliest possible date it could change supplier.

“Not only could we be pursued for not paying, but they could also stop us getting our gas supply,” council leader Gerald Vernon-Jackson said on 21 March.

Merton Council says it is exercising a March break clause that has allowed it to exit without a fee, but it still faces higher costs with its new supplier. Stockport Council says it will start a retendering process “as soon as possible” but that clarity from the government was needed as to what steps it can take to do so legally.

Suffolk County Council says it would exercise a break clause in October to exit its £10m contract. The University of Manchester says it is “actively reviewing” its contract.

“The Russian energy sector has propped up Putin’s regime for far too long,” says Mark Allison, leader of Merton Council. “We have been unhappy with that until now, but with all that’s happening with Ukraine it’s now totally unacceptable.”

On the corporate side, Domino’s Pizza spokesman Will Hill says that while the business was reviewing its options, “very few suppliers have been able to meet our needs, and we need to maintain a guarantee of supply”.

Not all contracts have an early exit clause, and if one party ends the contract without one, this could be considered a wrongful termination – which would give Gazprom the right to pursue a court claim against customers, explains Kieran McGaughey, national procurement law lead at Lawyers in Local Government.

“Customers could pay a settlement payment in the context of a wrongful termination to avoid court action, but there is certainly the prospect of litigation in this scenario,” he adds. “Presumably, those that did terminate might point to the moral, political and reputational issues that could arise from continuing to use an entity linked to the Russian state.”

To mitigate litigation risk, councils have proposed a number of solutions: that the government outlaws trading with Gazprom. This would allow all UK businesses to exercise the force majeure clause in their contracts.

Most commercial contracts contain a force majeure clause, which either party has the right to trigger in the case of an event that is out of their control – typically extreme weather events, wars and riots. A full-scale sanction of Gazprom would trigger this clause, as would a direct war between the UK and Russia, says David Capper, a law professor at Queen's University Belfast. But the current situation is unlikely to qualify, leaving many legally stuck without further government action.

Another ask is an amendment to the 1988 Local Government Act, a law that prohibits councils from taking account of noncommercial considerations.

“In running a procurement, a council could not exclude providers from certain countries or with certain political affiliations, nor could it score them down on this basis,” McGaughey says. Councils can and do consider social value elements when procuring, such as whether the service will improve the local area, though those considerations are unlikely to be relevant here.

Some local governments, including Merton, are also asking for financial support to cover the cost of their new contracts.

The government response

Capper says a safer way to escape the contracts would be for the UK Parliament to pass legislation making it illegal for UK companies or public bodies to trade with, including take gas supplies from, Gazprom.

Still, it is not fail-safe. Capper believes this could potentially breach a provision of the European Convention of Human Rights addressing confiscation of property rights.

“However, legislation or government action that is in the public interest and in accordance with the general principles of international law would not infringe this provision,” he adds. “I doubt if a court would second-guess if making performance of these contracts illegal was in the public interest – the invasion of Ukraine is clearly contrary to the principles of international law.”

If the company is put into administration its customers would likely still be on the hook, but it would make enforcement of Gazprom’s own obligations to its customers effectively unenforceable, adds Capper, especially if it was then liquidated. In that event, each contract would likely be addressed case by case, says McGaughey.

There will be major questions for the government going forward: namely, how a Russian state-owned enterprise, which has been the subject of some form of sanction since 2014, became the country’s biggest non-domestic supplier for something as sensitive and strategically important as energy.

“It is of the utmost importance we explore every possible avenue to ensure British taxpayers’ money isn’t funding Putin’s war machine and we’re exploring all options on how we can further cut ties with companies that prop up the Russian and Belarusian regime,” said government spokesman Frederick Stevens.

A spokeswoman for the UK’s energy regulator Ofgem acknowledged the issue but declined to comment on specific suppliers’ finances or positions. A spokesperson for Gazprom Energy said any customer wishing to terminate their supply agreement can do so in accordance with its terms and conditions.

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