One of the key features of the UK Government’s sanctions legislation for the post-Brexit era was a new ‘owned or controlled’ rule. Modelled loosely on the so-called ‘50% Rule’ used by the US Treasury’s Office of Financial Assets Control (OFAC), the UK legislation gives the Government new powers to control how broadly asset freezes are to be applied and to prevent circumvention.
In simple terms the rules provide that, where any person or company is sanctioned, not only are their assets frozen but also those of any entity that they own or control, directly or indirectly. In effect, therefore, the entity becomes subject to financial sanctions too even though its name may not appear on any sanctions list.
But how easy are the rules to interpret and apply in practice? It is crucial for UK businesses (and in particular compliance officers and sanctions teams) to determine with certainty whether they are able to deal with a particular entity, or its subsidiaries and group companies. Do the new rules help them do that?
It is still early days (the legislation only came into force on 1/1/21) but indications from industry are that there are already some difficult areas of interpretation, particularly with regard to sanctions against political figures.
To assess why and how it is necessary to look briefly at the legislation itself and the guidance issued by the Government’s Office of Financial Sanctions Implementation (OFSI).
OFSI’s sanctions are grouped by country or regime, with each having its own set of applicable regulations. The following example of an ‘owned or controlled’ rule comes from Section 7 of the Burma/Myanmar Regulations (ie The Burma (Sanctions) (EU Exit) Regulations 2019)):
“(1) A person who is not an individual (“C”) is “owned or controlled directly or indirectly” by another person (“P”) if either of the following two conditions is met (or both are met).
(2) The first condition is that P—
(a) holds directly or indirectly more than 50% of the shares in C,
(b) holds directly or indirectly more than 50% of the voting rights in C, or
(c) holds the right directly or indirectly to appoint or remove a majority of the board of directors of C.
(4) The second condition is that it is reasonable, having regard to all the circumstances, to expect that P would (if P chose to) be able, in most cases or in significant respects, by whatever means and, whether directly or indirectly, to achieve the result that affairs of C are conducted in accordance with P’s wishes.”
It can be seen from this that the rules are split into two sections: first, a scenario where the sanctioned person/entity (P) has clear legal ownership or control of another entity (C), whether by direct or indirect ownership of more than 50% of C’s shares or voting rights, or the ability to control the makeup of C’s Board. In most cases, it should be relatively straightforward for a third party contemplating dealing with C to determine whether it can do so by carrying out online business intelligence searches or by asking C for documents or answers to direct questions. However, this might not always be so – eg in a jurisdiction where there are minimal formalities for forming or maintaining companies. What then?
The second limb or ’condition’ is potentially much more difficult for the third party since it operates where there is no clear legal mechanism by which P owns or controls C, but nevertheless that is what happens – or would if C chose to – in practice. It is a very broad
provision and on the face of it much more difficult for the third party to determine whether P does in fact have (or could have) the ability to make C do what P wants.
There is some help to be found in OFSI’s guidance note ‘UK Financial Sanctions – General Guidance for Financial Sanctions under the SAMLA 2018’ – December 2020 edition (though that doesn’t begin promisingly; it is headed ‘Ownership and Control’ when the legislation
concerns ‘ownership or control’). This sets out a number of examples in which the second condition would be met (eg where P can appoint the management or supervisory body of C, not just its Board, or where P generally exercises a dominant influence over C).
However, the guidance (and the legislation itself) is silent as to how a third party is supposed to go about determining whether P has or could have de facto ownership or control over C. If the third party asks C a direct question and is told that P has no ownership or control over it is that sufficient? And is the test for ‘reasonable, having regard to all the circumstances’ a subjective or objective one?
These points remain unclear and so are likely to present practical problems for third parties in deciding whether they can do business with an entity which is in some way linked to a sanctioned person. The safest course might seem to be to simply cut all ties with both the
person and the entity. Though that may have ramifications – eg where the third party owes money to P or C.
The situation is also difficult where – as often happens – the sanctioned person is the holder of a political office within a particular country eg the head of the army, or a government minister. In these circumstances, it is unlikely to be the case that office holder ‘owns’ the
government assets him/herself, but because the legislation refers to ownership or control, a case could probably be made for the office holder ‘controlling’ all of the assets of that ministry. And what if the sanctioned person is the minister of finance – does that make all of that government’s assets subject to an asset freeze because they are under his/her control? In theory, yes, because the legislation is so broad. But sanctions are supposed to work in a more targeted fashion than this so is that what OFSI intends? To date, it has not said.
Early indications are that this issue is already causing problems for UK companies trying to decide whether they can trade with foreign entities.
Since the penalties for breaching UK sanctions are severe (fines and/or imprisonment, as well as reputational damage), the issue needs to be approached very carefully and it would be wise to seek legal advice.
Elborne Mitchell LLP / Feb 2021
(Contact Andy Stevenson – firstname.lastname@example.org