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18 Aug 2022

Russian sanctions and the law of unintended consequences

On 4 May 2022, in a further measure to sharpen its sanctions regime, the Government prohibited Russian businesses from receiving certain UK professional services, including management consulting, accounting and PR services. UK legal services, by contrast, remain exempt from these prohibitions. Even so, the successive waves of Russia-related financial sanctions introduced in the past four months have presented increased risks for lawyers advising clients with links to Russia. This article considers three of these risks.

The primary objective of the Russia (Sanctions) (EU Exit) Regulations 2019 (as amended) (“the Russia Regulations”) is to apply pressure on the Putin regime to force it to cease its war in Ukraine. The Russia Regulations designate certain persons (“DPs”) if the Government considers that they threaten this objective and creates three main prohibitions in relation to them:

  • An asset freeze[1], which has the effect that all funds and economic resources owned or controlled by the DP are frozen, and prevents anyone from dealing with these funds or economic resources.
  • A benefit prohibition[2], which bans all funds and economic resources from being made available, directly or indirectly, to or for the benefit of the DP.
  • A circumvention prohibition[3], which requires a person not to intentionally participate in activities knowing that the object or effect of them is, whether directly or indirectly, to circumvent the asset freeze or benefit prohibition, or to enable or facilitate the contravention of the asset freeze or benefit prohibition.

Whilst the Office of Financial Sanctions Implementation (“OFSI”), the Law Society and the Solicitors Regulation Authority have each published guidance about these prohibitions, much of it simply repeats the statutory language. To some extent, this is unsurprising; there is little case law and much political advantage in ensuring that the prohibitions remain as ambiguous as possible. But legal uncertainty breeds commercial insecurity – and exposes otherwise legitimate businesses to the law of unintended consequences.

Where lawyers act for a DP

The first area of risk arises where lawyers act for a DP. The DP will typically want advice about: (i) how to comply with the sanctions; (ii) how to apply for licences from OFSI to authorise certain expenditure, e.g. basic means and unwinding companies that are no longer commercially viable; and (iii) how to apply for de-listing. All of this advice is expressly permitted under the Russia Regulations, subject to the lawyers receiving a licence for their fees.

In practice, however, obtaining licences from OFSI for legal fees – given the political scrutiny of lawyers perceived to be associated with Russian clients – is far from straightforward. OFSI’s general guidance is that they will respond to licence applications for legal fees in 4-6 weeks – a timeframe which, in this firm’s experience, OFSI generally adhered to for previous (non-Russian) sanctions regimes. Nowadays, by contrast, responses are taking around three times longer.

These delays are exacerbated by inconsistent messages as to whether OFSI will authorise fees incurred before the date on which the licence is granted. OFSI’s published guidance on reasonableness in licensing states that, in making the licence application, one of the factors the applicant should consider is “whether the work has already taken place or if it is anticipated work”, implying that lawyers can be paid for work that predates the granting of the licence[4]. OFSI’s General Guidance, however, seems to suggest that work that has already taken place cannot be retrospectively paid: “You are strongly encouraged to apply for a licence in advance of providing substantive legal services in order for you to have certainty as to the fees that will be recoverable whilst the designated person remains listed”[5]. OFSI should clarify this apparent conflict, so that lawyers (and their clients) have certainty as to what work they can lawfully perform pending a decision on an application for legal fees. OFSI’s position should be that lawyers can be paid for work that predates the grant of a licence. DPs rightly need urgent legal advice to ensure they do not breach the law – indeed OFSI itself encourages them to seek legal advice – and there is no good reason why they should have to wait many months to be entitled to receive it.

Where lawyers act for an entity associated with the DP

The second area of risk arises where lawyers do not act for the DP but an entity associated with the DP, typically a company in which the DP holds a minority interest, whether directly or indirectly. These entities typically seek legal advice as to whether they are “controlled” by a DP because, if they are, their assets are frozen – and any person dealing with frozen assets commits a criminal offence. In giving this advice, however, lawyers and their clients can rapidly find themselves trapped in a Catch-22.

Lawyers cannot accept funds upfront from these client because, at the beginning of the retainer, they will not know whether a DP controls the client. Indeed, the whole purpose of instructing lawyers is to obtain an opinion on this point. As such, the lawyers must either take the risk of working on credit for the client (see above) or find a source of third party funding that does not breach the asset freeze or benefit prohibition. If the lawyers conclude that the client is not controlled by a DP, the challenge then becomes trying to elicit a view from OFSI that it agrees. However, given the perceived risk of criminal prosecutions or civil fines for breaching sanctions, banks and other financial institutions have become (understandably) paralysed with fear: they are generally refusing to process payments on behalf of these entities without concrete reassurance from OFSI itself. And whilst OFSI is willing in principle to grant licences to permit certain payments that would otherwise breach sanctions, it is far less willing to provide comfort to non-sanctioned entities (and their banks) that payments they wish to make do not breach sanctions, even when provided with an independent legal opinion to this effect.

Non-sanctioned companies are thus caught between a rock and a hard place: their banks insist on a green light from OFSI, but OFSI refuses to give them a green light in all but the largest cases. Businesses with no links to Russia – let alone sectors of the Russian economy of strategic importance to Putin – find themselves in a financially corrosive purgatory, unable to pay their employees, pensions or insurance. Some have no option but to go into administration.

These unintended consequences have led some businesses to pretend that they are controlled by a DP. This concession, whilst incorrect as a matter of law, at least provides a framework in which to apply for a licence for certain basic expenses, rather than embarking on the more difficult and time-consuming battle of persuading OFSI, and getting them to agree in writing, that they are not designated. For legitimate businesses to engage in these fictional contortions is wholly unsatisfactory – and leaves their lawyers stranded, professionally unable to apply for a licence (because no licence is necessary) and unable to be paid (because their client’s bank is unable to process payments without a licence).

Where lawyers suspect that a person is a DP

The third area of risk arises from the obligation imposed on law firms to file reports to OFSI if they know or have reasonable cause to suspect that a person is a DP, if the information on which this knowledge or suspicion is based came to the law firm in the course of carrying on its business[6]. This obliges law firms to report the information or other matter on which its bases its knowledge or suspicion and any information it holds about the DP by which the DP can be identified. Failure to do so is a criminal offence.

This is different from the equivalent money laundering reporting obligations in the Proceeds of Crime Act 2002, because it does not require knowledge or suspicion that someone may have committed a criminal offence. It is sufficient to trigger the reporting obligation that the lawyer knows or has reasonable cause to suspect that a person is a DP; suspicion that the DP (or anyone dealing with the DP’s assets) may have committed a criminal offence is unnecessary. Whilst this type of information –coming as it must in the course of the firm’s business — will usually be protected by legal professional privilege, and is therefore exempt from reporting, the circumstances in which the obligation is triggered – and the precise nature of the non-privileged information that must be reported – remain vague. Indeed, the Law Society has recently suggested that solicitors should report relevant information arising from tentative or abortive instructions, i.e. where solicitors receive information in a preliminary meeting but do not enter into a retainer[7]. OFSI and the SRA should give more detailed guidance explaining what solicitors must do to comply with this obligation, with practical examples.

Indeed, OFSI has the ability to address all three areas of risk outlined above. With no history of prosecutions and only a few civil fines under its belt, the questions as to whether and how OFSI might enforce alleged sanctions breaches have recently assumed an existential significance for certain businesses and their banks. The latest published figures for OFSI state that it has 37.8 full time staff[8]. The staffing challenges facing OFSI were emphasised in a House of Commons Committee report from 23 March 2022, which observed that: “[…] the Government needs to consider increasing the Office of Financial Sanctions Implementation’s resources without delay and to provide the surge capacity in the form of staff with appropriate expertise”[9]. This report rightly highlighted that increasing capacity alone was not sufficient; OFSI must also be staffed with appropriately qualified staff, who can handle enquiries more quickly and effectively, who can enable OFSI to publish more detailed guidance and who can establish greater cooperation with regulators including the SRA. In particular, OFSI needs to follow the example of the European Commission, which is more adept at providing comfort letters to businesses which are not caught by EU sanctions and which need to persuade their banks of this fact. This firm’s experience is that OFSI staff are working hard and trying to be helpful in exceptionally difficult circumstances, but until OFSI increases in size and expertise, the laws it is responsible for overseeing risk unintended and sometimes disastrous consequences for legitimate businesses – and the law firms advising them.

 

Sources:

[1] Regulation 11 of the Russia Regulations

[2] Regulations 12 to 15 of the Russia Regulations

[3] Regulation 19 of the Russia Regulations

[4] See https://ofsi.blog.gov.uk/2021/06/30/reasonableness-in-licensing/

[5] See para 6.6.1 of https://assets.publishing.service.gov.uk/government/uploads/system/uploads/attachment_data/file/1062452/General_Guidance_-_UK_Financial_Sanctions.pdf

[6] Section 70, The Russia (Sanctions) (EU Exit) Regulations 2019 https://www.legislation.gov.uk/uksi/2019/855/regulation/70/made

[7] https://www.lawsociety.org.uk/Topics/Anti-money-laundering/Features/Sanctions-and-Russia-answering-your-questions

[8] https://www.gov.uk/government/publications/hm-treasury-outcome-delivery-plan/hm-treasury-outcome-delivery-plan-2021-to-2022

[9] ‘Defeating Putin: the development, implementation and impact of economic sanctions on Russia’, Treasury Committee, 23 March 2022 https://publications.parliament.uk/pa/cm5802/cmselect/cmtreasy/1186/report.html#footnote-043