Sanctioned creditors allowed to participate in and vote at creditors’ committee meetings

In Hellard v Rossiysky Kredit Bank [2024] EWHC 1783 (Ch) the High Court confirmed that insolvency practitioners can accept votes of sanctioned creditors in relation to creditor decisions and allow them to take part in creditors’ committee meetings. Hellard also adds to the growing case law dealing with the meaning of control under the Russia (Sanctions) (EU Exit) Regulations 2019 (the “Russia Regulations”).

Background

Mr Motylev, a Russian national, moved to London in 2015 following the collapse of his Russian banking and pensions business. He was declared bankrupt in Russia in February 2018 followed by an English bankruptcy order in 2020.

Several of Mr Motylev’s former Russian banks are creditors in the bankruptcy (the “Russian Bank Creditors”), comprising slightly over 50% of the total proof of debts received and four of the five members of Mr Motylev’s creditors’ committee. The Russian Bank Creditors are themselves in Russian insolvency processes under the administration of the Deposit Insurance Agency (“DIA”). In the circumstances, the Russian Bank Creditors appear to be under the control of the DIA, which is in turn wholly owned by organs of the Russian state.

While neither the Russian Bank Creditors nor the DIA are sanctioned under UK law, both President Putin and Elvira Nabiullina, the Governor of the Central Bank of Russia, have been designated as sanctioned individuals under Regulation 5 of the Russia Regulations. Governor Nabiullina serves as ex officio chair of the DIA’s supervisory board. Her powers include recommending appointments of the DIA’s supervisory board, recommendations that require the approval of President Putin and the Russian Duma. Against that background, Mr Motylev’s joint trustees in bankruptcy had satisfied themselves (to the extent that it is possible to do so) that the Russian Bank Creditors are neither themselves designated persons nor in the direct or indirect ownership of designated persons. However, they sought guidance from the court as to:

1. Whether they should treat the Russian Bank Creditors as caught by sanctions under the Russia Regulations (on the basis that they are owned or controlled by designated persons); and
2. If yes, whether they could accept their votes in the insolvency process for the purpose of any creditors’ decision procedure and/or to allow those creditors to take part in and vote at meetings of the creditors’ committee.

Control

The question of ownership and “control” by designated persons is governed by Regulation 7(4) of the Russian Regulations, which sets out two conditions. If either of these is satisfied, the test of ownership or control is met:

1. Whether a designated person owns 50% or more of a company’s shares or voting rights or holds the rights to directly or indirectly appoint or remove the majority of the board of directors. This is a question of fact.
2. Whether “it is reasonable, having regard to all the circumstances to expect that” a 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 company are conducted in accordance with their wishes. That question can be more difficult to answer, requiring judgment as to what is reasonable and what is meant by in “most cases” and “significant respects”.

The court recognised that the circumstances relating to control of the Russian Bank Creditors were particularly difficult to construe.

Regulation 7(4) of the Russian Regulations and the question of control had previously been considered in:

1. Mints v PJSC National Bank Trust [2023] EWCA Civ 1132, where the Court of Appeal held that control via political office fell within the second condition and that if this led to the consequence of President Putin potentially being in control of every single company in Russia, then this was within the ambit of the legislature to correct. This decision is being appealed to the Supreme Court; and
2. Litasco SA v Der Mond Oil & Gas Africa SA [2023] EWHC 2866 (Comm) (in which the High Court found that a non-designated Swiss subsidiary of a non-designated Russian oil company was not “owned or controlled” by President Putin within the meaning of Regulation 7(4)  and that if matters were otherwise, it would follow that Putin was arguably in control of companies whose existence he was ignorant of.

In Hellard, the court sought to reconcile these two judgments. The court broke down the concept of control into four categories:

1. De jure control – where there is an absolute legal right to exercise control;
2. Actual present de facto control – where irrespective of legal rights, someone is manifestly “calling the shots”;
3. Potential future de jure control – where the designated person has the legal means to obtain ownership and control; and
4. Potential future de facto control – where there is no evidence of current de facto control, but “there is good reason to believe that the putative controller could, if he or she wished, exercise control in some manner”.

The court considered that the fourth category of potential future de facto control would be rare, as it required a situation where a party’s choice and action would be enough to make ownership or control come about, and that that choice needs to be one unfettered by the prospect of penalties or other adverse consequences. The court gave the examples of a billionaire who had the ability to take control of any company and an individual gunman taking over a store, concluding that it would be absurd to think that the billionaire could be said to control every company he could afford and for the gunman to control every organisation that he could hold up. In both instances the people involved would need to be willing to suffer consequences and require cooperation from the other parties.

Against that background, the court considered:

1. Whether President Putin or Governor Nabiullina would be able to exercise control over the Russian Bank Creditors to affect their dealings with the debts in question; and
2. What circumstances would need to occur to bring about any possible future de facto control by President Putin or Governor Nabiullina.

The court found that:

1. On the basis of the evidence provided, the trustees were not in a position where they could be said to know or to have reasonable cause to suspect that the funds or economic resources comprised in the claims of the Russian Bank Creditors are held or controlled by a person that is a designated person or is controlled or owned by a designated person;
2. There was no evidence of present or future de jure control. Whilst Governor Nabiullina and President Putin each have influence over the senior management of the DIA, they do not have a direct or indirect ability to control the individuals appointed as liquidators in specific liquidations;
3. There was no publicly available evidence of any actual present de facto control; and
4. With regard to potential future de facto control, there would be no easy way for either Governor Nabiullina or President Putin to seek to directly influence the liquidators in carrying out their duties. Until either of them take steps to control the liquidators in carrying out their duties, it is going too far to say that either of them could do so if they wished.

Finally, the court noted this conclusion was consistent with guidance published jointly by OFSI and the Foreign Commonwealth and Development Office entitled “Ownership and Control: Public Officials and Control Guidance” (dated 17 November 2023).  

Sanctioned Creditor Voting

Notwithstanding the finding that there was a lack of evidence that the Russian Bank Creditors should be treated as if they were subject to the ownership or control of designated persons, the court went on to consider whether, on that footing, the Russian Bank Creditors could lawfully exercise and the trustees lawfully count the Russian Bank Creditors’ votes as creditors and members of the creditors’ committee or if those rights fall under section 60(1) of the Sanctions and Anti Money Laundering Act 2018 (SAMLA).

Section 60 SAMLA sets out a definition in relation to both “funds” and “economic resources”. Regulation 11 of the Russia Regulations introduces an asset freeze in relation to designated persons and makes it illegal to “deal with funds or economic resources owned, held or controlled by a designated person” or if people have reasonable cause to suspect they are dealing with such funds and economic resources. Regulation 11(4) of the Russian Regulations specifies that “deals with” includes using, changing in volume, amount, location, ownership, possession, character, or destination, or changing in any other way.   

The court concluded that it was possible to accept the vote of a sanctioned creditor in an insolvency procedure. While the claim of the Russian Bank Creditors is a fund, voting rights in insolvency procedures do not constitute “using” funds as envisaged by Regulation 11(4)(a) of the Russia Regulations. Such voting rights arise in accordance with the Insolvency Act 1986 (“IA 1986”) as part of a statutory process to resolve the bankrupt’s affairs and do not attach to the debt itself. In addition, the debt itself remains unaffected by the use of voting rights, pending payment of any distribution and the eventual discharge of the bankruptcy. In the circumstances, using a vote did not equate to dealing with debts as funds within the meaning of Regulation 11(4).

The court also found that voting rights under the bankruptcy machinery could not themselves be regarded as benefits so to fall within the definition of “funds”, as such voting rights have no value, cannot be separated from the statutory machinery of the bankruptcy process, and cannot be used to obtain funds, goods or services within the meaning of section 60(2) SAMLA.

The court could not see why the legislature would wish to prohibit the exercise of creditor voting within insolvency processes by designated persons. This could lead to “absurd” situations where one sanctioned creditor could prevent the operation of statutory machinery enacted for the collective benefit of all creditors and the public interest.

Accordingly, the court made a declaration that voting rights of creditors under 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 under section 301 IA 1986 and Part 17 of the Insolvency Rules 2016 do not constitute “funds” or “economic benefits” for the purpose of the Russia Regulations, and using such rights or accepting any such votes do not amount to dealing with “funds” or with “economic benefits” for the purposes of the Russia Regulations.

Conclusion

Hellard is the first authority to address the impact of the Russia Regulations on the voting rights of sanctioned creditors in an insolvency process and, specifically, whether voting rights arising out of a debt claim should be considered as funds falling within the overarching definition of “financial assets and benefits of every kind” in section 60(1) of SAMLA. Whilst Hellard concerned the acceptance of votes by creditors in a bankruptcy, the analysis will likely apply across insolvency procedures. The decision provides Insolvency Practitioners with much needed clarity and certainty as to how to move forward.

On the question of “control”, the court has made an extensive effort to reconcile the judgments in Mints and Litasco. By breaking down the various categories of control in the way it has, the court has helped focus the arguments. It will be interesting to see how the Supreme Court approaches the Mints appeal.