With the EU introducing its fifth round of sanctions against Russia in response to the crisis in Ukraine, Salomé Lemasson and Joshua Ray, assess the applicability of international sanctions against designated Russian entities and individuals, and how, in practice, these may target international businesses as well.
Sanctions’ effectiveness relies on designated persons being unable to circumvent them through affiliated third parties. As such, their scope is broad and capture companies that may, prima facie, appear completely unrelated to Russian designated persons.
This calls for extreme vigilance by all EU businesses with Russian shareholders, whether or not these are actually listed persons or entities. Depending on the outcome of such analysis, certain steps may be taken to reduce exposure and risk.
US sanctions—prevalence of the 50% rule
US sanctions are created in a two-step process:
•Congress passes a statute authorising the President to impose sanctions through executive orders; then
•the Treasury Department’s Office of Foreign Assets Control (OFAC) drafts the sanctions and publishes them in the Code of Federal Regulations
US sanctions cut off sanctioned individuals from accessing US dollars and the US financial system or otherwise doing business with ‘US person’, ie, US citizens and permanent residents (wherever located), businesses located in the US (including US subsidiaries of foreign companies), individuals physically located in the US, and all US-incorporated entities (including their foreign subsidiaries).
With respect to Russia, the US implements list-based sanctions (targeting specific people or entities with asset freezes) and sectoral sanctions (mainly prohibiting certain entities within the Russian finance energy, mining, and defence industries from accessing the US equity and debt markets).
With respect to Specially Designated Nationals (SDN), OFAC applies a ‘50% Rule’ according to which US sanctions extend to any property or asset in which a designated party (or multiple designated parties) own, individually or in the aggregate, directly or indirectly, a 50% or greater interest.
Unlike EU rules, OFAC’s 50% rule speaks only to ownership and not to control. This means that an entity that is controlled (but not owned 50% or more) by one or more SDN is not considered automatically blocked. However, OFAC advises that extreme caution should be observed when engaging in a transaction with an entity that is not designated but in which an SDN has significant ownership but below the 50% threshold. Close monitoring should be performed as such non-blocked entities may be subject to future designations or enforcement actions by OFAC.
The broader scope of EU sanctions—ownership and control
Within the EU, decisions on the adoption, renewal or lifting of sanctions regimes are taken by the Council of the European Union on the basis of proposals from the High Representative of the Union for Foreign Affairs and Security. The European Commission, together with the High Representative, give effect to these decisions into EU law through joint proposals for Council regulations, which are also adopted by the Council. Council decisions are directly binding on EU Member States, while Council regulations are binding on any person or entity under EU jurisdiction.
While EU sanctions have an effect in non-EU countries, the measures apply only within EU jurisdiction and the obligations imposed by EU regulations are only binding on so-called ‘EU Operators’, ie EU nationals or persons located in the EU or conducting part of their business in the EU.
Compliance with, or failure to respect, EU regulations and resulting sanctions are the responsibility of Member States’ national authorities.
With respect to Russia, EU sanctions include, inter alia, asset freezes and the prohibition to make funds available to designated persons, which significantly restrict business trade with EU entities ultimately owned or controlled by Russian entities that may, in turn, be owned or controlled by sanctioned persons or entities.
Indeed, the European Commission has previously taken the view that ‘making funds or economic resources available to a non-designated entity, which is owned or controlled by a designated person, entity or body, amounts to making them indirectly available to the latter’.
Determining whether a non-sanctioned entity is ultimately owned or controlled by a sanctioned person or entity requires establishing whether the latter ‘is able to and effectively asserts a decisive influence over the conduct of the other entity in question’.
This analysis is fact based, on a case-by-case approach, using European Commission criteria that relates to the power, whether in right or in effect, to appoint or remove a majority of board members, to access and use the entity’s assets, and more generally, to have a decisive or dominant influence over that entity’s business or corporate strategy. The European Commission considers that parent companies generally exercise control and direction over the activities of their subsidiaries, hence control is presumed to extend to the subsidiaries and the assets of the non-designated entity, which should therefore be frozen. If any of these criteria are satisfied, control is considered to be established, and sanctions should therefore apply to the controlled person. This is justified as a means of preventing that designated person circumventing the asset freeze imposed on them via a non-designated third party under their control.
This assumption of control may be rebutted if a case-by-case factual analysis establishes that the entity is not, in fact, controlled. In this case, the non-sanctioned entity may obtain the lifting of the freeze on some or all of its assets by demonstrating that these are not in fact controlled by the sanctioned person.
What EU corporates should consider
From a practical standpoint, this means that the presence of Russian individuals or entities in the shareholding or corporate structure of EU entities should be treated as a red flag requiring extensive analysis to determine whether they could qualify as being owned or controlled by a designated person. If this were to be the case, control would taint the entire corporate chain and significantly restrict the EU entity’s possibility to continue operate.
Several steps can be taken to anticipate and limit problems relating to this.
Corporates can consider diluting below the 50% threshold the stake held by Russian shareholders, whether because they are directly targeted by sanctions or because they are considered under designated persons’ control. Corporate rules should also be closely scrutinize to determine the extent to which such shareholders or board members may, in practice, exercise an influence over the EU entity’s business. Appropriate safeguards should also be put in place to prevent the sanctioned person from accessing the assets of the non-designated entity.
In addition, applying for a license with the relevant EU national authority may limit the impact of sanctions on non-designated entities that may have been unjustifiably targeted—and reassure third parties about the genuine lack of risk.
Finally, establishing a documented paper trail evidencing a bona fide approach to sanctions and the steps taken to reduce their impact (while preventing designated persons circumventing them) will prove extremely useful in case of control by the relevant competent authorities.
This article was originally published on 12 April 2022 on LexisNexis PSL, and is available at: International sanctions against Russia—assessing applicability and how to react (lexis.com)
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