It is essential that any UK individual or entity doing business, managing funds/other economic resources, or providing financing or professional services, keeps abreast of the current UK Russian sanctions regime, which is chiefly set out in the Russia (Sanctions) (EU Exit) Regulations 2019 (the "Regulations"). The question of how the Regulations might apply to those with fiduciary duties – either as trustees or as directors – has been considered in two recent High Court cases. (Hellard & Ors v OJSC Rossiysky Kredit Bank & Ors [2024] EWHC 1783 (Ch) and Garofalo v Crisp & Ors [2024] EWHC 1737 (Ch)).
The Regulations
The UK Sanctions List includes a comprehensive list of all individuals or entities that are subject to sanctions under the Regulations. They are known as "Designated Persons". The UK Government has the power to designate individuals or entities that are involved in destabilising Ukraine or supporting the Government of Russia. Once designated, the Designated Person is subject to restrictions, such as asset freezes or travel bans, and non-sanctioned individuals or entities might commit an offence by continuing to deal with them.
Under the Regulations, it is an offence for a person to make 'funds' available (a term which essentially encompasses anything of value, including the writing off of a debt), directly or indirectly, to a Designated Person if they know or have reasonable cause to suspect, that they are making funds so available. Amongst other measures, under Regulation 7(4), Designated Persons are considered to own or control entities where "it is reasonable, having regard to all the circumstances, to expect that the [Designated Person] would (if [they] chose to) be able, in most cases or in significant respects, by whatever means and whether directly or indirectly, achieve the result that the affairs of [the entity] are conducted in accordance with their wishes."
There is a defence in civil proceedings available to persons who can demonstrate a reasonable belief that they were acting in compliance with the Regulations. However, no such defence applies in criminal proceedings.
Background to the Hellard case
Mr Anatoly Motylev was a Russian national living in the UK. He was declared bankrupt in Russia in 2018, and the bankruptcy was recognised in the UK in 2020. Just over half his total debt is owed to Russian banks which are themselves under a Russian insolvency process and therefore controlled by the Deposit Insurance Agency, a wholly owned subsidiary of a Russian state agency thought of as an "organ" of the Russian state.
Mr Motylev's trustees in bankruptcy were unable to satisfy themselves that the banks were not owned or controlled by President Putin or the Governor of the Russian Central Bank (Elvira Nabiullina), both of whom are Designated Persons. If so controlled, by dealing with the banks and distributing Mr Motylev's assets to them, the trustees were concerned that they could face civil and criminal penalties under the sanctions regime and therefore applied to the English court for directions and declarations on three issues:
- Are the banks caught by the sanctions imposed under the Regulations?
- If so, is it lawful for the trustees to allow the banks to take part and vote in the creditors committee?
- Are the trustees providing financial services, in further breach of the Regulations?
The Hellard decision
The meaning of ownership and control
In addressing these questions, Deputy High Court Judge Nicholas Thompsell provided a helpful commentary on the meaning of control in different circumstances:
| |
Type of control |
Meaning |
There is reasonable cause to suspect this is present if: |
| 1 |
De jure |
An absolute legal right to exercise control is embedded. |
There are constitutional documents and surrounding legal instruments affording rights exist. |
| 2 |
Actual present de facto |
The putative controller is manifestly “calling the shots”. |
There is reasonable cause to suspect that the putative controller has exercised decisive influence over what has happened. |
| 3 |
Potential future de jure |
Although the Designated Person enjoys no current legal right, they have the legal means to obtain ownership or control. |
There is reasonable cause to believe that agreements, such as options or other legal instruments affording the right to take control, exist. |
| 4 |
Potential future de facto |
There is good reason to believe that the putative controller could, if they wished, exercise control in some manner. |
Even though there is no evidence the putative controller is currently exercising de facto control, some particular feature indicating they could exercise control is present. However, the Judge struggled to conceive a manner in which this could be demonstrated. |
In this case, the Court found that: (i) control must be considered in the context of direct or indirect control of the property in question; and (ii) where there is no evidence of present control (see types 1 and 2 above), it is necessary to consider the particular circumstances required for the Designated Person to bring about any future control of the assets.
Were the banks caught by the sanctions regime?
The Judge was satisfied that the trustees could not be said to have reasonable cause to suspect that the right to enforce the debts owed to the banks (being the assets in question) were owned or controlled indirectly by President Putin and/or Governor Nabiullina:
- In respect of control types 1 and 2, neither of the Designated Persons actively participated in the management of the banks through the state agency; and
- In respect of control types 3 and 4, at the very least, either Designated Person would be required to breach existing constitutional arrangements and/or compel the cooperation of third parties and so, in the Judge's view, it was going too far to say that they could exercise the relevant control.
This is in line with OFSI's guidance on state control here.
However, the Judge could not make a definitive determination on whether the banks were in fact owned or controlled by the Designated Persons, due to the lack of information provided to the Court.
If they were treated as caught by the regime, was it lawful for the trustees to allow the banks to vote in the creditors' committee?
The Judge found that voting pursuant to a statutory insolvency procedure like a creditors committee would not constitute a breach of the Regulations. Save for where the vote concerns final distributions, such voting does not make funds so available to a Designated Person. Indeed, he commented that it would be an absurd outcome if every bankruptcy with a Russian element ground to a halt in light of the Regulations.
Are the trustees providing financial services?
The Judge found that none of the requirements as set out in Regulation 18A of the Regulations (prohibiting the provision of financial services to, among others, the Russian Central Bank) were met, not least because the Trustees are performing a statutory function to entities outside of those listed in Regulation 18A(2). Therefore, there was no breach of the Regulations in this respect.
Implications for trustees and insolvency practitioners
As of October 2023, £22.7 billion worth of assets frozen in relation to the Russia Sanctions regime have been reported to OFSI. Insolvency practitioners, debtors and creditors of Russian nationals subject to bankruptcy orders – both here and overseas – must be mindful of the wide-reaching effect of the UK Russia sanctions regime. As the Judge in this case noted, in instances where the Court's guidance is genuinely required, applications under insolvency law can and should be made. Trustees should be mindful that a failure to adequately consider the applicability of sanctions could lead to civil and criminal penalties.
The Judge's declaration on creditor voting rights will be welcomed by the insolvency community. However, it is notable that the Judge required the trustees to undertake enhanced monitoring of the situation with the banks, indicating that simply making an application will not entirely alleviate the burden on practitioners to undertake their own due diligence. Best practice will always include conducting a thorough investigation and continuing to remain up to date both on the factual matrix of your particular matter as well as the applicability of the Regulations to it.
Finally, whilst the Judge's clarificatory comments on ownership and control are helpful, we note that the Supreme Court's judgment is awaited in Boris Mints & Ors v PJSC National Bank Trust & Anor [2023] EWCA Civ 1132. This decision will further address the meaning of ownership and control in the context of the Regulations.
Directors' duties
The recent case of Garofalo v Crisp & Ors [2024] EWHC 1737 (Ch), in which an unusual "change of management" order was made prior to trial, highlighted the significance of the Regulations for fiduciary duties exercised by company directors.
Background to the Garofalo case
Mr Garofalo and Mr Crisp were the majority shareholders of a large perfume business operating in the UK, the Gulf, Europe and the US. Mr Crisp was also director of the various group companies.
Following the Russian invasion of Ukraine, Mr Garofalo and Mr Crisp agreed to cease operations in Russia. However, Mr Garofalo became concerned about how the business was being run and, following investigations, it emerged that the business was continuing to fulfil orders placed from Russia. Further investigations indicated that Mr Crisp was aware of that fact.
Fearing the reputational risks that come with flouting the Regulations and being cognisant of need to take swift action in this regard to ensure his company did not face significant financial penalties, Mr Garofalo reported Mr Crisp to OFSI and HMRC, commenced unfair prejudice proceedings and, prior to determination of the proceedings, applied to remove Mr Crisp as a director of the group companies.
The relevant Regulations
The Regulations prohibit the export of luxury goods to, or for use in, Russia. "Luxury goods" include perfumes where the sale price exceeds £250 per 6.25 litres. The Regulations also prohibit intentional circumvention of this prohibition or the enabling or facilitating of others to export luxury goods to Russia. There are severe penalties for breaching the Regulations: up to a 10-year custodial sentence, and fines up to 50% of the total breach, or £1 million – whichever is of greater value.
The Garofalo decision
Mr Crisp accepted that there had been a breach of the sanctions regime but submitted that this was a genuine and understandable error. He argued that he had misunderstood the Regulations – he thought the prohibition against trading luxury goods applied to perfumes that cost £250 per item (rather than to perfumes valued at £250 per 6.25 litres). He also claimed to never have concealed the continued trading in Russia.
However, Mr Justice Freedman considered that there was compelling evidence that Mr Crisp knew that he was in breach of the Regulations. In particular, Mr Crisp had told a private investigator that his trade with Russia should not be disclosed and was a secret, that he had ignored "government edicts" that he should not trade with Russia, and admitted that it was increasingly difficult to trade there. Further, reference to trade with Russia was relabelled as trade with the "Rest of the World" in the management accounts. Mr Crisp's failure to seek legal advice on the point was also described as "revealing" by the Judge.
The Judge therefore concluded that there was a high degree of assurance that there had been unfair conduct that was prejudicial to Mr Garofalo's interests as a shareholder. In that context, the Judge accepted that he had the power to make an order removing Mr Crisp as a director prior to final determination of the unfair prejudice proceedings, and that it was appropriate to do so in this case. While such an order was exceptional, the Judge noted the significant reputational consequences for the business if Mr Crisp was allowed to stay on as a director in the face of suggestions he had flouted the Regulations. Indeed, as the Judge observed, there is a certain gravity in not just being in breach of the criminal law but also the particular criticism that attaches to trading with Russia in the current climate.
Implications for businesses and directors
The Court's decision to vary the management of a company at an interim stage is reportedly the first of its kind. The Court is often reluctant to vary the status quo of a company before the conclusion of proceedings, but in recognition of the seriousness of the alleged sanctions breaches and the consequential reputational damage to the company, it was willing to do so in this case.
Directors owe a duty to act in the best interests of the company and can face shareholder action if they conduct the business in a manner that is unfair to those shareholders. That will clearly include a failure to comply with the sanctions regime, even where such failures are not deliberate. It is therefore essential for good corporate governance to consider sanctions as part of day-to-day business practices.