Allowing Russian sanctioned entities to participate in UK bankruptcy proceedings?

Overview

In this case, the High Court considered whether Russian sanctioned entities are entitled to exercise their voting rights in UK bankruptcy proceedings. While the Court found that the entities in this case were not “designated persons” or controlled by designated persons, the Court ultimately concluded that sanctioned creditors can nevertheless participate in a bankruptcy vote. Exercising voting rights does not permit designated persons to access the underlying asset or its value — that remains within the bankruptcy until the trustee makes a distribution. In addition, prohibiting creditors who are designated persons from voting would give rise to highly inconvenient, if not absurd, consequences. The statutory machinery of a bankruptcy is supposed to operate for the collective benefit of all creditors and in the public interest. Where (as here) sanctioned creditors make up a majority of the creditor pool, there would be a serious risk of the bankruptcy developing contrary to the views of the majority creditor if sanctioned creditors were not permitted to vote.

Background

Mr Motylev is a Russian national who has been resident in London since July 2015. Shortly before Mr Motylev arrived in the UK, certain banks which he controlled (the “Russian Bank Creditors”) in Russia collapsed.

Mr Motylev has since been charged in Russia with crimes involving the alleged fraud and financial mismanagement of the Russian Bank Creditors. He was initially declared bankrupt in Russia in February 2018. In September 2020, his Russian Financial Manager (which is broadly analogous to a UK trustee in bankruptcy) obtained recognition of the bankruptcy in the UK.

Ultimately, Mr Motylev was declared bankrupt in England in late 2020 and Kevin Hellard, Robert Starkins and Nicholas Nicholson of Grant Thornton were appointed the trustees in bankruptcy (the “Trustees”). Proofs of debt totalling £741 million have been received in the bankruptcy but have yet to be adjudicated. The Russian Bank Creditors comprise a 52.88% majority of the total, and the Trustees have expressed initial concerns regarding almost all the other creditors.

The Trustees, finding themselves “between a rock and a hard place” and subject to potential criminal or civil liability if they got it wrong, applied for directions as to how the Russia (Sanctions) (EU Exit) Regulations 2019 (the "2019 Regulations") impacted the Russian Bank Creditors’ rights to participate in the bankruptcy. Specifically, were the Russian Bank Creditors subject to sanctions, and, if so, could the Trustees accept their votes for the purposes of any creditors' decision procedure and/or at meetings of the creditors' committee?

The Court’s Decision

The Issue of Control

Under the 2019 Regulations, it is an offence to deal with or directly or indirectly make available to a designated person funds or economic benefits owned, held or controlled by that person.

Regulation 7 provides that “own” or “control” means:

(i) holding directly or indirectly more than 50% of the shares or the voting rights in a company, or having the direct or indirect right to appoint or remove a majority of the board of directors (Reg. 7(2)); and

(ii) it is reasonable to expect that the person in question would be able in most cases to have the company’s affairs conducted in accordance with their wishes (Reg. 7(4)).

The Court considered the relevant authorities and guidance from the Office for Financial Sanctions Implementation ("OFSI") and determined that the concept of “control” can be broken down into four types (i) de jure control; (ii) actual present de facto control; (iii) potential future de jure control; and (iv) potential future de facto control.

The circumstances relating to the control of the Russian Bank Creditors was “particularly difficult to construe”. The Trustees had satisfied themselves that the Russian Bank Creditors were not themselves designated persons or in the direct or indirect ownership of designated persons. The question became whether other designated persons (i.e., President Putin and/or Governor Nabiullina) had — or had the potential to obtain — direct or indirect control of the Russian Bank Creditors by virtue of the liquidation arrangements.

Based on the evidence, the Court concluded that there was no present or future de jure control, that there was no present de facto control, and future de facto control of the Russian Bank Creditors by these individuals was “highly unlikely”.

Can sanctioned creditors participate in votes?

On the issue of whether voting is caught by sanctions, the Court agreed with the Trustees' argument that it was difficult to see why the legislature should have wished to prohibit the exercise of creditor voting rights within the bankruptcy process by designated persons. The Court stated: “Unlike in the case of shareholder voting rights, such creditor voting cannot permit the designated person to access the underlying asset or its value: they remain locked within the bankruptcy until the Trustee decides to make a dividend or distribution. Moreover (and, again, unlike in the case of shareholder rights) such voting rights are to be exercised within the context of a statutory scheme under the supervision of an officer of the Court and – ultimately – the court itself.”

In addition, the Court agreed with the Trustees’ argument that prohibiting creditors who are designated persons from voting would give rise to highly inconvenient, if not absurd, consequences. The statutory machinery of a bankruptcy is supposed to operate for the collective benefit of all creditors and in the public interest. Where (as here) sanctioned creditors make up a majority of the creditor pool, there would be a serious risk of the bankruptcy developing contrary to the views of the majority creditor if sanctioned creditors were not permitted to vote.

Judge: Mr Nicholas Thompsell sitting as a Deputy Judge of the High Court

Counsel: Thomas Munby KC of Maitland Chambers (instructed by CMS Cameron McKenna) for the Trustees