Key takeaways
Control must be current and demonstrable
Future influence or indirect links aren’t enough.
Trustees not liable without clear evidence
Court confirms no breach of sanctions rules.
Ongoing checks required before distributions
Trustees must monitor for changes in control.
In dealing with whether trustees in bankruptcy might potentially be breaching UK sanctions legislation by allowing Russian creditors to participate in UK liquidation proceedings, the Court has considered recent authorities on whether a designated person can be said to directly or indirectly own or control an entity and has offered its own perspective on how the relevant wording in the legislation should be construed.
The background facts
In this case, a Russian national living in London was declared bankrupt both in Russia and in the UK. The UK trustees in bankruptcy received proofs of debt in the bankruptcy totalling £741 million, with Russian creditors comprising a 52.88% majority. These were creditors whose claims arose out of the collapse of Russian banks, allegedly due to the financial mismanagement and fraud of the bankrupt, who had controlled those banks at the relevant time.
The trustees in bankruptcy were unsure whether UK sanctions regulations against Russia – the Russia (Sanctions) (EU Exit) Regulations 2019 – impacted the Russian bank creditors’ participation in the insolvency proceedings. They wished to avoid any potential criminal or civil liability for making the wrong decision if they permitted participation when this was prohibited or the converse.
The trustees sought the Court’s guidance as to the status of the Russian bank creditors under the 2019 Regulations.
The UK Office of Financial and Sanctions Implementation (OFSI), which implements and enforces sanctions legislation, was joined in to these proceedings. Among other things, the OFSI publishes guidance on how it uses its powers.
The 2019 Regulations
Broadly speaking, these provide for asset freezes over funds and economic resources of designated persons including, persons “owned or controlled” by designated persons.
They also make it an offence to make funds or economic resources available directly or indirectly to a designated person, or for the benefit of a designated person, where it is known or reasonably suspected that this is the case. The prohibition extends to making funds available to a person owned or controlled directly or indirectly by a designated person.
Regulation 7 states what is meant by persons being “owned or controlled” for these purposes. Essentially, this requires:
(i) holding directly or indirectly more than 50% of the shares or the voting rights in a company or having the direct or indirect right to appoint or remove a majority of the board of directors: Reg. 7(2); AND
(ii) it is reasonable to expect, having regard to all the circumstances, that the person in question would (if they chose to) be able in most cases and in significant respects to have the company’s affairs conducted in accordance with their wishes: Reg. 7(4).
Regulation 18A prohibits the provision of certain financial services (for the purpose of foreign exchange reserve and asset management) to certain specific persons (Central Bank of Russia and/or persons owned or controlled by the Central Bank and/or directed by it).
The High Court decision
A key issue was how to assess the circumstances in which a person should be regarded as being owned or controlled directly or indirectly by a designated person.
The trustees had satisfied themselves that the Russian bank creditors were not themselves designated persons and that they were not in the direct or indirect ownership of designated persons. However, they were unclear how to apply the test in Regulation 7(4), which requires value judgments as to what is reasonable to expect as regards the conduct of the company/entity in question in accordance with the putative controller’s wishes.
The authorities
In PJSC National Bank Trust & anther -v- Mints & others [2023] EWCA Civ 1132, the Court of Appeal did not need to decide whether the relevant claimant was in fact owned or controlled by a designated person. However, it expressed the (non-binding) view that if the 2019 Regulations extended to control via political office, the control test would be satisfied if either President Putin or the Governor of the Central Bank of Russia could exercise influence in significant respects over the Russian bank in question. It was assumed in that case that the Russian Central Bank was an “organ of the Russian state” over which President Putin exercised de facto control and which in practice “serves as an arm of the executive.” An appeal in this case is due to be heard by the Supreme Court.
In Litasco SA -v- Der Mond Oil & Gas Africa SA [2023] EWHC 286 (Comm), the Court distinguished the circumstances of Lukoil, the Swiss company in question, from the circumstances under consideration in Mints. However, the Court thought that the better interpretation of Regulation 7(4) was that it is concerned with an existing influence of a designated person over a relevant affair of the company, not a state of affairs which a designated person is in a position to bring about.
In the present case, the Court also thought that Regulation 7(4) should not be construed so far as to extend to companies of whose existence the putative controller was wholly ignorant and whose affairs were conducted on a routine basis without any thought of that controller.
In the Court’s view, the decisions in Mints and Litasco could be reconciled.
In Mints, President Putin had existing de facto control over the Central Bank and the company in question, NBT, was almost a 100% subsidiary of the Central Bank of Russia. It was not surprising to find control in that context. There was a combination of existing de facto control at the level of the Central Bank and existing de jure control as between the Central Bank and NBT.
By contrast, in Litasco, there was no evidence that President Putin had existing de jure or de facto control over Lukoil. There was also no evidence to show any legal right that would establish potential future de jure control.
In the Court’s view, the wording of Regulation 7(4) i.e. whether the designated person chose to have the company/entity’s affairs conducted in accordance with their wishes, could not apply if they had no present means of controlling the entity in question without the cooperation of others and/or would face penalties or undesirable consequences in obtaining such control, particularly where the potential for benefit that the designated person would obtain if they were to take control was disproportionately small compared with the penalties or adverse consequences.
Application to this case
Firstly, control should be looked at in the context of control that would result in direct or indirect control of the property (amounting to funds or economic benefits) in question. The property in question here was the Russian judgment debts, the rights of the Russian bank creditors to prove in the bankruptcy, and/or their subsequent receipt of cash (or other assets) through distributions in the bankruptcy.
The question was whether President Putin or the Central Bank Governor would be able to exercise control over the Russian bank creditors via their liquidators so as to affect their dealings with these assets.
Secondly, there being no evidence of de jure control or of present actual de facto control or of any possible future de jure control, it was necessary to consider what circumstances would need to occur to bring about any possible future de facto control by President Putin or the Governor.
Findings
On the evidence, the trustees could not be said to know or to have reasonable cause to suspect that the funds or economic resources comprised in the claims that the Russian bank creditors have in the bankruptcy (or the judgment debts underlying such claims, or any proceeds that they may receive from the bankruptcy) are held or controlled by a person that is a designated person or is owned or controlled by a designated person.
There was also no evidence of present or future de jure control. Whilst the Governor and President Putin each had significant influence as to the supervision and senior management of the Russian insolvency authorities, they did not have any direct or indirect ability to control the individuals appointed as liquidators in the management of specific liquidations being conducted by those authorities.
There was also no evidence of any actual present de facto control in that there was no publicly available evidence that the Governor or President Putin had interfered with the conduct of any liquidation managed by the insolvency authorities.
As to potential future de facto control, the Governor or President Putin would have to breach constitutional arrangements and would require the cooperation of the Duma and others, if they wished to seek to directly influence the liquidators in carrying out their duties. This was highly unlikely.
The Court referred to joint guidance from the OFSI and the Foreign Commonwealth and Development Office, “Ownership and Control: Public Officials and Control Guidance,” published in response to Mints. While the guidance was not binding on the Court, it reflected the Court’s view that there needed to be sufficient evidence to conclude that an official exercises control. There was no such evidence here.
The Court also found that creditor voting rights in bankruptcy were not prohibited by the Regulations.
Additionally, the Court found the trustees were not in breach of Regulation 18A. The OFSI had raised the issue tentatively, but the Court stated that the trustees in bankruptcy were performing a statutory function, not a prohibited financial service. They were providing services for their role as trustees in bankruptcy, not for the purposes of foreign exchange reserves or asset management. In any event, their services were not provided to the prohibited persons but in relation to the bankrupt’s estate under the Court’s supervision.
In conclusion, in undertaking their duties as trustees in bankruptcy, they were not breaching the financial restrictions under the 2019 Regulations.
Comment
The Court declined to determine whether the Russian bank creditors were in fact owned or controlled by designated persons because this was a question of fact, and it did not have the evidential basis to make a ruling. However, its view was that the trustees’ efforts were such that they could not be said to know or have reasonable cause to suspect that this was the case.
Therefore, pending any change in circumstances, including any new facts of which the trustees might become aware, or any new or further guidance from OFSI, the trustees could and should deal with the Russian bank creditors on the basis that this was not prohibited by the 2019 Regulations.
The Court did, however, direct the trustees to undertake enhanced monitoring of the situation of the Russian bank creditors every time a distribution was to be made to check that there was nothing in the public records reflecting a significant change from the position presented to the Court.
