Asset freeze measures enacted by the United Kingdom against designated persons (DPs) can, under certain circumstances, extend to entities “owned or controlled” by DPs. To date, there have been few—and at times partly contradictory—English court cases addressing the “ownership and control” criteria under the UK sanctions regime. The latest judgment in Hellard v OJSC Rossiysky Kredit Bank sought to reconcile the previous guidance provided by the courts in the Mints and Litasco cases.
The case also examined the nature of creditors’ voting rights in insolvency and whether these rights constitute “funds” or “economic resources” for the purposes of UK sanctions.
In Hellard,[1] the court considered whether UK trustees in bankruptcy might breach sanctions by allowing Russian creditors to participate in UK insolvency proceedings.
The case centered around Anatoly Motylev, a Russian national residing in London who faced bankruptcy in both Russia and the United Kingdom. The UK trustees in bankruptcy received debt claims totaling £741 million, including from four Russian creditors—OJSC Rossiysky Kredit Bank (in liquidation), CJSC Mosstroyeconombank (in liquidation), AMB Bank (in liquidation), and JSC KB Retail Lending Company (in liquidation) (collectively, the Russian Bank Creditors)—representing 52.88% of the claims.
The Russian Bank Creditors were banks previously controlled by Mr. Motylev, which collapsed due to alleged mismanagement and fraud shortly before his departure from Russia. The banks are now administered by the Russian Deposit Insurance Agency.
The central issue was whether the participation of the Russian Bank Creditors in the UK insolvency proceedings was affected by the Russia (Sanctions) (EU Exit) Regulations 2019 (the 2019 Regulations). Specifically, the trustees sought directions under Section 303(2) of the Insolvency Act 1986 (IA 1986) and/or declarations concerning the following questions:
These questions were crucial for the continuation of the insolvency proceedings. If the trustees incorrectly concluded that the Russian Bank Creditors were not subject to sanctions, while they actually were, they could face significant criminal and civil liabilities under the UK sanctions regime. Conversely, if the trustees mistakenly believed that the Russian Bank Creditors were subject to sanctions and, as a result, excluded them from participating in the insolvency proceedings, they could be held liable to the Russian Bank Creditors for civil damages.
Section 44 of the Sanctions and Anti-Money Laundering Act 2018 provides statutory protection, stating that if an act is performed under the “reasonable belief” that it complies with the 2019 Regulations, the person undertaking such act is shielded from civil liability. However, if the trustees cannot demonstrate that they had formed the necessary “reasonable belief,” Section 44 would not offer them protection.
Under Regulations 11–15 of the 2019 Regulations, all funds or economic resources owned, held, or controlled by a DP must be frozen, and it is prohibited to make funds or economic resources available to, or for the benefit of, a DP including through an entity “owned or controlled” by a DP. Regulation 7(4) of the 2019 Regulations stipulates that a person who is not an individual (“C”) is considered to be “owned or controlled” by another person (“P”) if, among other criteria, “it is reasonable . . . to expect that P would (if P chose to) be able . . . to achieve the result that the affairs of C are conducted in accordance with P’s wishes.”
Before Hellard, there were two key authorities on the definition of “control” under the 2019 Regulations.
In JSC National Bank Trust v Mints,[2] the Court of Appeal adopted a broad interpretation of Regulation 7(4). The court concluded, albeit obiter dicta, that P controls C if they “call the shots, or can call the shots” with respect to C. The court held that Regulation 7(4) did not impose limits on the means or mechanisms by which P can exercise control over C, and could include control exercised via a political office.
The Mints judgment raised concerns among practitioners because the court’s interpretation suggested that all companies in Russia could be deemed “owned or controlled” by DPs, based on the sanctions designation of the most senior Russian state officials. In response to such concerns, the Office of Financial Sanctions Implementation (OFSI) and the Foreign, Commonwealth and Development Office issued a joint statement reassuring the market that the UK government did not presume that all private entities incorporated in Russia were “owned or controlled” by the designated officials.
Shortly after Mints, in Litasco SA v Der Mond Oil & Gas Africa SA[3], Foxton J dealt with the “control” element of the Mints decision. Noting that the issue of control has, as its central focus, the ability of a DP to control the use of the funds made available to C, he adopted a much narrower interpretation of Regulation 7(4), coming to the conclusion that it is concerned with the existing influence of a DP over C, rather than a state of affairs which the DP could bring about.
In Hellard, Deputy Judge Nicholas Thompsell aimed to reconcile the narrow interpretation of “control” adopted by Foxton J in Litasco with the broader interpretation by the Court of Appeal in Mints. The Deputy Judge’s analysis focused on the phrase “(if P chose to)” in Regulation 7(4). He concluded that the concept of “control” can be categorised into four distinct types:
Importantly, potential de facto control is unlikely to exist if (1) P could only achieve control under the condition that others cooperate with P and/or (2) P would face significant penalties or undesirable consequences that make it improbable that P would opt to exercise such control.
Another issue considered by the Deputy Judge was whether a creditor’s right to vote in insolvency proceedings constitutes “funds” or “economic resources” under the 2019 Regulations, which would require freezing if belonging to a DP. This question arose because, under EU sanctions (which the 2019 Regulations were initially modeled after), voting rights have been treated as “economic resources” according to clarifications from the EU Commission.
The Deputy Judge drew a distinction between voting rights attached to shares and those related to insolvency proceedings. He concluded that the rights of creditors to participate in and vote at meetings of a creditors’ committee, as provided under Section 301 of IA 1986 and Part 17 of the Insolvency Rules 2016, do not constitute “funds” or “economic resources” for the purposes of the 2019 Regulations. As such, using such rights or accepting votes from creditors does not amount to dealing with “funds” or “economic resources” under the 2019 Regulations.
Financial institutions and other market participants often face the question of whether a customer is “owned or controlled” by a DP. Whether they can form a “reasonable belief” that their customers are “owned or controlled” by a DP determines whether they would be liable in potential civil proceedings, such as claims for the recovery of frozen funds.
The Deputy Judge’s guidance on the four types of control and what constitutes a “reasonable belief” regarding each type is welcome as it provides much-needed clarity for financial institutions and other market participants dealing with potentially sanctioned customers as well as for those customers seeking to refute assertions of being “owned or controlled” by a DP.
While the court did not definitively declare that the Russian Bank Creditors are not “owned or controlled” by DPs, it directed the trustees under Section 303 of IA 1986 to proceed as if the Russian Bank Creditors are not so “owned or controlled”, unless new evidence suggests otherwise. The court’s willingness to engage with these matters could be beneficial for many businesses that find themselves “between a rock and a hard place” (adopting the language from Hellard) trying to have a clear understanding of their own (or their counterparties’) sanctions status. Given OFSI’s reluctance to make definitive determinations on ownership and control, as demonstrated in this case, resorting to the courts could increasingly prove a viable option for many companies currently stuck in the limbo of sanctions compliance.
Finally, while the court’s determination that voting rights in insolvency are neither “funds” nor “economic resources” offers valuable guidance for insolvency practitioners, it does not address the nature of shareholders’ voting rights or the voting rights of lenders within a syndicate. The court’s distinction between voting rights arising under statute and those attached to shares may prompt further discussion on the nature of such rights for both lenders and shareholders, leaving the issue still open to interpretation.
Morgan Lewis lawyers are monitoring updates in this area following Hellard and stand ready to aid those interpreting these new judgments.
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