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Between a rock and a hard place – High Court admits that trustees in bankruptcy "Putin" a difficult position by the UK Russia Regulations
Hellard v OJSC Rossiysky Kredit Bank & Ors [2024] EWHC 1783 (Ch)
Introduction
Following our briefing back in November covering the FCDO's guidance on the meaning of ownership and control in the UK sanctions regime (in response to the Court of Appeal's judgment in Mints & Ors v PJSC National Bank Trustee & Anor [2023] EWCA Civ 1132), the High Court has further considered the scope of Regulation 7(4) of the Russia (Sanctions) (EU Exit) Regulations 2019 (the "Russia Regulations") in the context of determining whether President Putin and/or the Governor of the Central Bank (Governor Nabiullina) could be said to exercise ownership or control over certain of the creditors in English bankruptcy proceedings.
The case concerned the bankruptcy of Anatoly Motylev, who has been resident in London since 2015 having fled Russia shortly before the collapse of OJSC Rossysky Kredit Bank, CJSC Mosstroyeconombank, AMB Bank and JSC KB Retail Lending Company, who are creditors of Mr Motylev and the first to fourth respondents in the case (the "Russian Bank Creditors"). The Russian Bank Creditors are all in liquidation in Russia and Mr Motylev has been charged in absentia in Russia with various crimes involving alleged fraud and financial mismanagement.
The trustees in Mr Motylev's English bankruptcy proceedings (the "Trustees") applied to the court under section 303(2) Insolvency Act 1986 ("IA 1986") to request that the court provide directions as to whether the Russian Bank Creditors were subject to sanctions and could participate in the proceedings.
In his judgment Deputy Judge Thompsell considered the requirements to establish "ownership and control" under Regulation 7 of the Russia Regulations and sought to reconcile the recent authorities on this point in Mints and Litasco SA v Der Mond Oil and Gas Africa SA & Anor [2023] EWHC 2866 (which we covered in our previous update).
Case summary
Background
Mr Motylev was declared bankrupt in Russia in 2018 and in England in 2020. An agreement was reached in 2021 between Mr Motylev's English and Russian trustees in bankruptcy whereby the English proceedings would take primacy in most respects. Proofs of debt totalling £741 million were received in the bankruptcy proceedings, with the debts owing to the Russian Bank Creditors comprising a majority of 52.88% of this total.
A creditor committee was formed for the purposes of the bankruptcy proceedings but, having instructed significant background investigations into the Russian Bank Creditors, the Trustees were unsure whether President Putin and/or Central Bank Governor Nabiullina (who are both designated persons) should be considered as exercising control over these entities (by virtue of their control over the Russian Bank Creditors' liquidators) for the purposes of Regulation 7 of the Russia Regulations. The Trustees applied to the Court under section 303(2) IA 1986, which enables a trustee of a bankrupt's estate to apply to the court for directions in relation to any particular matter arising under the bankruptcy.
Issues
The questions which the Court were required to determine were:
- Should the Trustees treat the Russian Bank Creditors as subject to sanctions under the Russia Regulations?
- If the Russian Bank Creditors should be treated as caught by sanctions, whether it is lawful for the Trustees to accept votes from those creditors for the purposes of any creditors' decision procedure and/or to allow those creditors to take part in and vote at meetings of the creditors' committee?
- Whether the Trustees were themselves providing "financial services" in breach of Regulation 18A of the Russia Regulations?
Decision
Reconciling Mints and Litasco
In Mints, the Court of Appeal found (obiter) that, on the correct application of Regulation 7(4) of the Russia Regulations, one of the claimants, which was a 99% subsidiary of the Central Bank of Russia, was "owned and controlled" by President Putin and/or Governor Nabiullina and that the logical outcome of applying this test might well be that every company in Russia was controlled by President Putin and therefore subject to sanctions.
The Court of Appeal's decision in Mints was the subject of widespread discussion, given its potential implications. The FCDO subsequently issued guidance on this point that it would not automatically consider that a designated public official exercises 'control' over a public body (for the purposes of Regulation 7(4)) simply because that official holds a leadership function.
Mints was discussed in detail by Foxton J's judgment in Litasco (which was handed down shortly before the FCDO's guidance was published). Foxton J sought to distinguish Litasco from Mints on the basis that the Defendants in Litasco had not pointed to any similar evidence that Litasco was presently under the de facto control of President Putin.
In Hellard Deputy Judge Thompsell sought to reconcile these two judgments by focussing on the type of control that the public official (i.e., President Putin and/or Governor Nabiullina) was said to exercise over the relevant company in each case. The judge agreed with Foxton J's scepticism in Litasco as to whether the interpretation of Regulation 7(4) should extend to companies of whose existence the alleged controller was wholly ignorant and whose affairs were routinely conducted without any thought of the controller but noted that the reasoning in Litasco needs to be considered in light of two key points which arose in Mints:
- If there is any "absurdity" which arises from the Court of Appeal's decision in Mints, it arises from the designation of President Putin (as someone who is at the apex of Russia's command economy) rather than inherent absurdity in applying the wording of Regulation 7.
- The second was the Court of Appeal's warning against putting an "imperceptible gloss" on the plain wording of the Russia Regulations. Regulation 7(4) is not aimed at catching only existing exercises of influence by a designated person but also where a designated person may obtain that influence in the future if he or she were to choose to do so.
Control
In reconciling the two judgments, the judge broke down the concept of "control" into four categories:
De jure control: which exists where there is an absolute legal right to exercise control e.g., in the constitutional documents of a company.
Actual present de facto control: which exists where the alleged controller is "calling the shots" (as referred to in Mints) where they have no legal right to do so.
Potential future de jure control: which exists where the alleged controller enjoys no current legal right of ownership or control but has the legal means to obtain ownership or control e.g., if the designated person has an option or forward contract to acquire a majority shareholding in the company.
Potential future de facto control: which exists where, although there is no evidence that the alleged controller is currently exercising actual present de facto control, there is some good reason to believe that the alleged controller could, if he or she wished, exercise control in some manner. The judge felt that this category's existence would be very rare in practice.
Question 1: Should the Trustees treat the Russian Bank Creditors as subject to sanctions under the Russia Regulations?
Having outlined the different categories of control, the judge went on to consider whether President Putin or Governor Nabiullina could be said to exercise "control" over the Russian Bank Creditors via their liquidators.
In order to determine this point, the Court looked at two sub-issues:
- Do President Putin and/or Governor Nabiullina exercise control over the Russian bank creditors via their liquidators so as to affect their dealings with these assets?
- If President Putin and/or Governor Nabiullina could not be said to exercise control so as to affect the liquidators' dealings with the assets (i.e., they do not exercise de jure, actual present de facto or potential future de jure control), what circumstances would be needed to bring about any potential future de facto control?
Do President Putin or Governor Nabiullina exercise control over the Russian Bank Creditors via their liquidators so as to affect the Trustees' dealings with these assets?
Under Regulation 7 of the Russia Regulations, a company is "owned or controlled" by another person if either or both of the conditions in Regulation 7(2) and 7(4) are met. The Trustees' concern was specifically in relation to Regulation 7(4), that it is reasonable to believe that President Putin and/or Governor Nabiullina could, via their influence over the liquidators, achieve the result that the affairs of the Russian Bank Creditors were conducted in accordance with their wishes.
The Trustees' concern was that whilst the publicly available constitutional arrangements demonstrated "significant but limited influence of Governor Nabiullina, and the influence of President Putin, over the management of the [Deposit Insurance Agency] DIA"1, this evidence, combined with: (i) the DIA's public ownership by the Russian state; (ii) Governor Nabiullina's position as chairperson of both the Central Bank and the DIA; and (iii) the fact that Governor Nabiullina's decisions have to be approved by President Putin, may be sufficient to give rise to reasonable grounds to suspect that the DIA is controlled by Governor Nabiullina and/or President Putin within the meaning of the Russia Regulations.
The Office of Financial Sanctions Implementation ("OFSI") declined to give its opinion on whether or not the DIA and the Russian Bank Creditors were under the control of Governor Nabiullina and/or President Putin within the meaning of the Russia Regulations. The judge felt that he could not give a definitive ruling on this point without more evidence as to Russian law and of governmental practice in Russia.
However, the judge held that none of the evidence which had been provided to date meant that the Trustees could be said to know or have reasonable cause to suspect that the Russian Bank Creditors' claims in Mr Motylev's bankruptcy proceedings were owned or controlled by a designated person within the meaning of the first three categories of control he had outlined.
Whilst Governor Nabiullina and President Putin each had significant influence regarding the supervision and senior management of the DIA, they do not have any direct or indirect ability to control the individuals appointed as liquidators in the management of the specific liquidations which the DIA conducts (meaning they could not be said to exercise de jure or potential future de jure control) nor was there any publicly available evidence that Governor Nabiullina/President Putin have interfered with the conduct of any liquidation managed by the DIA i.e., had exercised actual present de facto control.
What circumstances would need to exist for President Putin or Governor Nabiullina to bring about potential future de facto control?
As the first three categories of control were not made out, the judge considered whether it could be said that Governor Nabiullina/President Putin could exercise potential future de facto control.
On the facts the judge felt that neither Governor Nabiullina nor President Putin could be said to exercise potential future de facto control. There was no clear easy way for either to exercise their influence without either breaching current Russian constitutional arrangements (by directly giving orders to the liquidators) or appointing individuals to the relevant positions in the DIA to give orders on their behalf, which would require the cooperation of those persons/the Duma (and could be expected to require the expenditure of political and/or reputational capital). The judge felt that it would be going "too far" to say that either Governor Nabiullina or President Putin could exert this influence if they wished, as this would ignore the fact that they would need other people to cooperate and/or face political and reputational difficulties to bring it about.
The judge felt that this conclusion was consistent with the FCDO's 17 November 2023 guidance that there would need to be "sufficient evidence to demonstrate that the designated public official exercises control over the public body" in order for the test to be met.
Question 2: Is voting in the bankruptcy proceedings caught by sanctions?
The judge concluded that, even if the Russian Bank Creditors should in fact be regarded as being owned or controlled by a designated person, affording the Russian Bank Creditors the voting rights of a creditor in a bankruptcy, or representation and voting on a creditors' committee, would not breach the Russia Regulations on the basis that:
(a) Whilst creditor claims in the bankruptcy and foreign judgment debts which are the basis of those claims were "funds" within the meaning of the Sanctions and Anti-Money Laundering Act 2018 ("SAMLA");
(b) Using voting rights under the bankruptcy regime does not amount to "using" such funds as what is being used is the right to vote afforded by the IA 1986, not any right attaching to the debts themselves (which remain unaffected by the use of voting rights); and
(c) The voting rights in this case could not be regarded as "economic resources" within the meaning of s.60(2) SAMLA as they could not be used to obtain funds, goods or services.
Question 3: Are the Trustees in breach of Regulation 18A of the Russia Regulations?
Regulation 18A prohibits the provision of certain "financial services" to certain specific persons including the Central Bank of Russia or any person controlled by/acting on the Central Bank's behalf.
The judge held that the Trustees were not in breach of Regulation 18A as the Trustees were undertaking the statutory function of a trustee in bankruptcy and these statutory purposes do not include anything that falls within the definition of "financial services". In addition, the Trustees were not providing services to the Central Bank as the Trustees' services are provided in relation to the estate of the bankrupt under the supervision of the court.
Practical significance
In making his findings, the judge considered the concept of ownership and control under Regulation 7 of the Russia Regulations. In order to reconcile the previous authorities on this point in Mints and Litasco the judge sought to break the concept of "control" down into four different categories, including "potential future de jure control" (which the judge felt is what the inclusion of the wording "(if P chose)" in Regulation 7(4) of the Russia Regulations refers to) and "potential future de facto control" (which the judge felt would only exist in rare circumstances). The Court will consider on a case-by-case basis whether it would be reasonable to expect that the affairs of a public body could in fact be conducted in accordance with the designated person's wishes.
The case is of particular practical significance as the judge concluded and issued a declaration to the extent that the voting rights of creditors in a creditors' decision procedure under the bankruptcy provisions of the IA 1986 and the Insolvency (England and Wales) Rules 2016, and the rights of creditors to participate in and vote at a creditors' committee, do not constitute "funds" or "economic benefits" for the purposes of the Russia Regulations and using such rights or accepting creditors' votes do not amount to dealing with "funds" or "economic benefits" for the purposes of the Russia Regulations.
The judge did, however, order that the Trustees should undertake enhanced monitoring to make sure that there was no change in the position of the Russian Bank Creditors (at least) whenever the Trustees were about to make a distribution.
The case is also noteworthy due to OFSI's reluctance to participate in the proceedings (in which it was joined as a respondent by the Trustees). In his judgment, Deputy Judge Thompsell noted that OFSI had declined to express any opinion on the questions raised by the Trustees, citing "constraints on resources and [OFSI's] need to prevent unnecessary costs to public funds". OFSI had previously sought to remove itself as a respondent to the proceedings, but the judge agreed with the Trustees that removing OFSI would undermine the protective nature of the Trustees' application.
1 The DIA is the administrator of the Russian Bank Creditors' liquidation proceedings in Russia.