The UK Office of Financial Sanctions Implementation (OFSI) and the Foreign, Commonwealth and Development Office (FCDO) recently released expanded guidance on “ownership and control” in UK sanctions. This guidance was meant to address the Russia Regulations after the Mints v PJSC National Bank Trust & PJSC Bank Otkritie decision in October 2023. What exactly does the guidance clarify and how can businesses determine ownership and control in practice?
Determining control
You are a European food production company with five hundred employees and a plant in Russia. You want to divest this asset. The bidder with the most attractive proposal and cash on hand is a company established last month. This company is managed and owned (on paper) by a low-profile individual whose past corporate interests include 20 now-liquidated consultancies.
You like the bidder’s proposal. They plan to retain all employees. They have offered to add a clause that will allow you to buy the asset back within ten years. The registered owner and the bidding company are not referenced on any sanctions lists. All of this appears promising. But how do you determine who owns and, crucially, who controls the company?
Both the EU and the UK have set out broadly similar guidance on what may constitute control. Power of appointment, influence over budget and asset management decisions, the nature of the entity’s financial relationship with an individual, particularly its dependence on them – any of these could constitute control according to the current guidance.
The recent guidance from UK authorities offers a bit more clarity on this issue of control. It states that sanctioned Russian officials, including President Vladimir Putin, do not necessarily exercise control over entities within jurisdictions where they have power (or within all of Russia, in the case of Putin). While helpful, this still leaves ample room for broad and, in some cases, harsh interpretations of control.
The Court of Appeal’s decision in Mints
UK courts have taken contradictory stances on “control”. The issue came to the fore in two recent cases. In its 6 October 2023 ruling on Mints v PJSC National Bank Trust & PJSC Bank Otkritie, the UK Court of Appeal took a broad interpretation of control, stating that Russian president Vladimir Putin, subject to blocking UK sanctions, “could be deemed to control everything in Russia”, and Elvira Nabiulina, the UK-sanctioned head of the Russian Central Bank, could be deemed to control either of the defendant banks in which the Central Bank held majority stakes.1 However, in its binding 15 November 2023 ruling on Litasco SA v Der Mond Oil and Gas Africa SA & Locafrique Holdings SA, the UK High Court held that the control test required “an existing influence” rather than a hypothetical one.2
On 17 November 2023, OFSI and FCDO issued a joint statement that seemed to affirm the Litasco ruling: “There is no presumption on the part of the UK government that a private entity is subject to the control of a designated public official simply because that entity is based or incorporated in a jurisdiction in which that official has a leading role in economic policy or decision-making”.3 Nevertheless, the statement also noted an example of control in which “it is reasonable to expect that the person would be able to ensure the affairs of the entity are conducted in accordance with the person’s wishes”. This language could be subject to broad interpretation, and the statement makes it clear that enforcement will be decided on a “case-by-case basis.
Challenges in conducting control tests on counterparts, be they Russian or (increasingly often) foreign ones acting as proxies for designated Russians, are rarely as blunt and headline-grabbing as those that led to these clarifications. They are more subtle, more elaborate and require careful thought to investigate. We explain some of these methods later in the article.
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A murky context
Determining control is not a theoretical exercise. Prior to February 2022, numerous companies operating in the former Soviet Union and publicly listed in G7 countries relied on financing from Russian banks. Many foreign corporates had relationships (some of which continue) with Russian partners. After their shareholders were sanctioned in the months following February 2022, these Russian partners either changed their ownership structures or claimed that they had been changed.
Foreign companies, even those in the process of disengaging from Russia, now often find themselves unable to determine whether they can sell their asset to a seemingly non-sanctioned Russian buyer or even accept payment for services previously rendered to long-standing partners. These companies cannot establish whether their partners are truly controlled by non-sanctioned individuals or whether they have simply transferred shares to nominal third parties.
Public availability of reliable documents in Russia is currently so limited that foreign counterparties are effectively unable to conduct traditional public record-based sanctions due diligence into Russian companies. Documents that could provide official confirmation to control questions are typically unobtainable through diligence if they exist at all. Russian entities operating in industries exposed to high sanctions risks or owned by individuals exposed to such risks can, and in our experience do, remove shareholding and leadership information from their corporate records. Moreover, Russian banks are no longer obliged to publish shareholding or board information at all and will resist requests to provide documentation.
The control test in practice
We recently supported an international energy company that was re-evaluating its relationship with an energy industry joint venture (JV). The JV was co-owned in equal shares by a recently sanctioned, politically exposed Russian entrepreneur and a state-owned enterprise (SOE).
The company's internal dynamics, the level of the sanctioned shareholder’s influence, and the financial relationships between the parties were unclear, requiring an in-depth control-test investigation. We were tasked with identifying who influenced the JV and whether the sanctioned entrepreneur was ultimately in control of it.
Finding answers to questions regarding control for companies operating in Russia means making carefully managed enquiries with individuals familiar with the decision-making processes at the company and in the sector within which the company operates. To identify the extent of each shareholder’s control over the company, we examined publicly available databases and spoke to knowledgeable sources in the Russian energy industry (including former employees of both the JV and the SOE). We also looked at companies that had provided services to the shareholders and spoke to sources close to Russian authorities with oversight of the energy industry.
Our enquiries uncovered a complex control pattern at the JV. Not only did the SOE maintain a majority on the board of the JV, but it had also lobbied for the appointment of its CEO, a former SOE executive. Sources familiar with both strategic and day-to-day decision-making at the JV indicated that despite the entrepreneur holding no formal position at the JV, these decisions by the SOE were taken by the sanctioned entrepreneur or by those they had appointed. Speaking to sources with insight into Russia’s elite, we linked this dynamic to the entrepreneur’s political standing, which had allowed the entrepreneur’s influence in the JV to eclipse that of the SOE even though the SOE held formal veto rights. Individuals familiar with the JV’s financials reported to us that the two shareholders co-financed the enterprise on equal terms, with neither contributing disproportionately.
The control test may be easier for other enterprises and in other scenarios. However, organisations seeking to comply with EU and UK sanctions should consider applying the control test for every transaction and relationship that may have a Russia nexus – be it an Eastern European electronics store increasing its purchase volumes threefold in the past year, a recently registered oil trader offering energy products from Central Asia, or the low-profile bidder interested in the Russian plant from the beginning of this article. Let’s return to that example now.
After conducting a thorough control-test investigation, you might discover that the top bidder for your Russian plant, while experienced in the industry and capable of running the enterprise, intends to acquire the asset using financing from a sanctioned entrepreneur. Your control-test investigation clearly shows that this entrepreneur would, in turn, retain unofficial control and veto power over any major decisions regarding the plant. Without applying a robust control test, you might have made the sale and inadvertently violated EU and UK sanctions. In a context of opaque control and ownership, with less than straightforward guidance, careful consideration of control and ownership can make all the difference.
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1 https://www.judiciary.uk/wp-content/uploads/2023/10/Mints-v-PJSC-judgment-061023.pdf
2 https://www.bailii.org/cgi-bin/format.cgi?doc=/ew/cases/EWHC/Comm/2023/2866.html&query=(litasco)
3 https://www.gov.uk/government/publications/ownership-and-control-public-officials-and-control-guidance/ownership-and-control-public-officials-and-control-guidance