Leigh Crestohl and Daniel Powell examine how sanctions against Russia are impacting the aviation industry in Key.Aero

May 31 2023

Partner Leigh Crestohl and Chartered Legal Executive (FCILEX) Daniel Powell's article was published in Key.Aero, 30 May 2023, and can be found here

The impact on the aviation industry as a result of sanctions against Russia

The sanctions imposed on Russia since the start of the war in Ukraine last year have caused significant disruption to the global aviation industry. Prior to the conflict, Russia was a fertile market in which to enter into lease agreements and partnerships. However, sanctions have now largely brought to a halt these aviation dealings with entities connected to Russia.

UK companies and individuals are prohibited from entering into transactions with Russia to supply aviation equipment, and partnerships with Russian airlines have also been banned. Monies and aviation equipment allocated for transactions between UK and Russian businesses prior to the conflict must therefore now be directed elsewhere.

It is particularly problematic for UK companies holding existing lease agreements with those Russian entities impacted by sanctions. UK companies are prevented from supplying aircraft and parties cannot perform their contractual obligations to comply with the terms of an existing lease. This has led to significant tension and difficulties for companies to depart from an existing commercial agreement. For those lease agreements with arbitration clauses, this is further complicated by a Russian Supreme Court decision last year deciding that the Russian Arbitrazh courts would have exclusive jurisdiction over commercial disputes impacted by sanctions, regardless of the existence of a contractual provision of a different forum.

To further muddy the waters, a Russian law implemented and signed by President Putin in March 2022, which permits Russian airlines to register foreign-owned aircraft as Russian-owned, still stands. Moscow’s decision to allow such planes to be registered in Russia has sparked confusion among industry figures, who query a scenario where an aircraft is registered simultaneously in two jurisdictions.

This development has substantially added to the difficulty of leasing companies retrieving foreign aircraft from Russian parties, resulting in foreign aircraft continuing to be operated by Russian airlines in the meantime without the consent of the manufacturer or lessor. An estimated 400 aircraft, worth around USD$10 billion, are currently stranded in Russia as a result of the sanctions imbroglio.

What is more problematic, particularly for aircraft manufacturers, is that Russian-connected operators rely on foreign countries for aircraft resources and maintenance services. Now that sanctions limit the supply of these services, the situation will likely lead to aircraft being operated which are under-equipped or insufficiently-serviced. An incident involving one of these foreign aircraft, even if beyond the control of the aircraft manufacturer, may still have a devastating impact on the aircraft manufacturer and its reputation.

An unintended consequence of the sanctions regime has been the proliferation of alternative supply chains of aircraft parts, as Russian airline operators seek out arrangements that avoid prohibitions on the import of engines, brakes, and other vital equipment into the country to maintain their fleets. The recent arrest of a Russian national and his business partner on charges of violating US export controls and international money laundering suggests that regulators may become concerned by a growing trade in aircraft parts.

The pair had allegedly fielded requests for aviation equipment and technology from at least three Russian airlines since the introduction of sanctions on Russia and had facilitated the import of the parts in direct contravention of the sanctions regime. Some observers believe that their activity represented just a small proportion of a much larger trade in aircraft parts to Russia during 2022.   

Quite apart from any impact on the efficacy of sanctions regimes, the export of aviation equipment also adds to safety fears, since the parts are not subject to the usual strict safety checks and controls that govern the regulated trade in such products. The prospect of unsafe parts being used in their aircraft and the associated risk of accidents further compounds the problems facing lessors who have been unable to repatriate aircraft from Russia.

An additional grievance is that insurance arrangements for both aircraft manufacturers and leasing companies are further complicated by the prohibitions imposed by sanctions. In an ongoing UK High Court dispute, insurers are disputing that Russian seizure of aircraft is a loss under the insurance policy.

In what is seen as a pivotal test case for the aviation leasing industry, Dublin-based AerCap – the world’s biggest aircraft lessor – is suing insurers including AIG and Lloyd’s Insurance Company at the UK’s High Court, in an attempt to recover losses related to its aircraft and engines currently stranded in Russia. AerCap is seeking $3.5 billion in redress under its all-risks insurance policy; alternatively, it is claiming $1.2 billion under its war-risks policy.

In their defence, the group of defendant insurers claims that, despite the planes and parts having been seized by Russia, there has not yet been a crystallised physical loss. They also argue that the imposition of sanctions means that the original lease agreements are no longer valid, and that they are also no longer able to provide cover as per the rules set out under the sanctions regime.

Due to the wide breadth of sanctions, aircraft lessors unfortunately also have limited actions available to them to remedy or mitigate the losses arising from the disruption to lease agreements with parties connected to Russia. It remains to be seen in this tense global political climate if other nations will be drawn into the conflict, which would complicate the situation yet further and multiply the myriad issues already facing the aviation industry.

Industry participants will seek to draw lessons from this recent experience. In lease agreements with other non-UK companies that are not currently impacted by sanctions, a clause could be inserted accelerating the period for leased aircraft to be returned upon termination of the lease, in the event of military conflict. In addition, considering the ongoing UK High Court dispute, insurance policies should be reviewed to capture a range of possible risks associated with sanctions measures and government-imposed counter-measures.

Including at least some additional certainty in lease agreements and insurance contracts may help to avoid more confusion in the future should the existing conflict escalate further. In the meantime, test cases such as AerCap’s may at least provide some much-needed clarity as to how lessors, insurers and other key players in the aviation industry deal with the fall-out from the shockwaves that have rocked the sector to date. 

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