The fifth month of the new stage of the military confrontation in Ukraine is coming up. Its consequence was the declaration of martial law on February 24, 2022. A considerable list of laws and regulations has been already adopted to ensure defense capability and overcome the consequences of hostilities. At the same time, the world society and the governments of many countries supported Ukraine and strongly condemned the actions of the aggressor country, introducing a number of prohibitions and restrictions on the assets and activities of persons related to the resolution of the war. During this period, an unprecedented number of sanctions has been applied against the Russian Federation.
In these difficult conditions, saturated with constant risks and restrictions, it is necessary to continue working and keeping the business, providing the needs of society and the state with jobs, revenues to the budget and necessary goods and services. Currently, many factors have had a negative impact on most sectors of the economy and areas of business activity. From the physical destruction and theft of assets, the killing and hostage-taking of employees, to the forced emigration of personnel outside the country, the evacuation of equipment, the mobilization of conscripted employees and the seizure of vehicles for the needs of the Armed Forces. Of course, this is not a complete list of all the factors that the business community has faced recently, but today we will talk about an equally important risk of modern economic relations – sanction restrictions and the consequences of their application.
Although the question of compliance with sanctions has been heard in our country for more than a year, few business representatives (especially small and medium-sized ones) have seriously thought about it. Why is this important and why should it be given due attention right now? At this point, there are actually many risks, from property, financial and reputational to criminal prosecution of those involved. Because even a company that was the least affected by other manifestations of military actions can get quite big problems due to imprudence and carelessness in complying with certain rules. This can significantly affect its stability and, in general, the further possibility of carrying out certain economic activities.
Probably, many have noticed that the practice of imposing sanctions against legal entities and citizens of Ukraine has gained popularity in recent years. When the state and society were under the direct influence of an external threat, the main priority of many state structures was the task of preventing the influence of the aggressor country and its related persons on the economy, infrastructure, and defense capabilities of the state. Unfortunately, in such circumstances, due to shortened deadlines and limited opportunities, some are in a hurry to fulfill such an assignment and demonstrate the results of the struggle, including with the “internal enemy”. Accordingly, any individual or legal entity who, in the opinion of officials, meets certain criteria can be subject to the application of such procedures. The Law of Ukraine “On Sanctions” provides that sanctions may be applied by Ukraine to a foreign state, a foreign legal entity, a legal entity that is under the control of a foreign legal entity or a non-resident individual, foreigners, stateless persons, as well as subjects carrying out terrorist activities.
The grounds for applying sanctions under this Law are:
• actions of a foreign state, a foreign individual or legal entity, other entities that create real and/or potential threats to national interests, national security, sovereignty and territorial integrity of Ukraine, promote terrorist activity and/or violate the rights and freedoms of a person and a citizen, the interests of society and the state, lead to the occupation of the territory, expropriation or restriction of property rights, causing property losses, creating obstacles to sustainable economic development, full exercise of rights and freedoms by the citizens of Ukraine;
• resolutions of the General Assembly and the Security Council of the United Nations;
• decisions and regulations of the Council of the European Union;
• facts of violations of the Universal Declaration of Human Rights, the Charter of the United Nations.
Among the non-exhaustive list of more than 25 types of sanctions listed there are the following: blocking and confiscation of assets in state income, restrictions on trade operations, prevention of capital outflows outside of Ukraine, suspension of economic and financial obligations, cancellation or suspension of licenses and other permits, prohibition of participation in the privatization or lease of state property, restriction of the use of electronic communications, prohibition of public procurement, prohibition of securities transactions, prohibition of increasing the size of the authorized capital, termination of trade agreements, joint projects and industrial programs, prohibition of transfer of technologies, rights to objects of intellectual property rights, etc.
Proposals regarding the application, cancellation and amendment of sanctions are submitted to the National Security and Defense Council of Ukraine by the Verkhovna Rada, the President, the Cabinet of Ministers, the National Bank, and the Security Service of Ukraine. The decision on applying, canceling and amending sanctions is made by the National Security and Defense Council, put into effect by a presidential decree, and in certain cases approved by a resolution of the Verkhovna Rada.
In addition to this, the arsenal of controlling authorities is rapidly replenished with new laws and acts, such as the Law of Ukraine “On the Basic Principles of Forcible Expropriation of Objects of Property Rights of the Russian Federation and its Residents in Ukraine.” According to the current version of this Law, it is possible to forcibly seize the property of legal entities:
• the founder (participant, shareholder) or beneficiary of which is directly or indirectly the Russian Federation;
• and/or in which the Russian Federation is directly or indirectly or legal entities whose founder (participant, shareholder) or beneficiary is the Russian Federation;
• and/or in which the Russian Federation directly or indirectly has a share in the authorized (compounded) capital, shares or other membership (participation in any form) in a legal entity.
Compulsory seizure in Ukraine of property rights of the Russian Federation and its residents is carried out without any compensation (reimbursement) of their value. The decision on the forced seizure in Ukraine of property rights objects of the Russian Federation and its residents is adopted by the Council of National Security and Defense of Ukraine and is put into effect by a decree of the President of Ukraine.
On March 3, 2022, the Resolution of the Cabinet of Ministers of Ukraine No. 187 was adopted in order to ensure the protection of national interests in future lawsuits by the state of Ukraine in connection with the military aggression of the Russian Federation, established a ban on the execution of agreements (including by force) with persons, associated with this state. Such persons, in addition to the residents of the Russian Federation, also include legal entities created and registered in accordance with the legislation of Ukraine, with the ultimate beneficial owner, member or participant (shareholder) having a share in the authorized capital of 10 percent or more of which the Russian Federation is, a citizen of the Russian Federation, in addition to residing on the territory of Ukraine on legal grounds, or a legal entity created and registered in accordance with the legislation of the Russian Federation. It has been established that deeds (including powers of attorney) concluded in violation of the moratorium specified in paragraph 1 of this resolution, including if they provide for appropriate alienation in the future, are null and void.
In addition, the National Bank of Ukraine, by Resolution No. 18 of February 24, 2022, effectively made currency transactions with residents of the Russian Federation and the Republic of Belarus impossible, blocking their accounts and prohibiting transactions using rubles. Transactions initiated using electronic means of payment issued by participants of international payment systems operating on the territory of these states are also prohibited.
In addition, on March and April of this year, the Criminal Code of Ukraine was supplemented with new articles 111(1) and 111(2), which provide responsibility for collaborative activity and assistance to the aggressor state, respectively. According to the content of which, in the absence of law enforcement practice, scientific and practical interpretation and insufficiently clear definition of specific actions almost any business relationship and economic activity with counterparties from the Russian Federation and temporarily occupied territories may fall under the signs of a criminal offense. For offenses provided by Art. 111(1) of the Criminal Code of Ukraine such measures as confiscation of property and liquidation may be applied to a legal entity.
In addition, we should not forget about the international sanctions that have been introduced and continue to be increased by a number of institutions and states. It should be mentioned that not only persons who directly violate international law and pose a threat to the national security of a certain country could fall under the influence of such restrictions. These so-called “secondary sanctions” are measures that could be taken against companies that violate the sanctions regime by carrying out significant transactions with companies on sanctions lists. For example, the US federal law that entered into force in 2018 established the secondary sanctions mechanism (CAATSA). This law extended the obligation to comply with the sanctions regime to non-residents who cooperate with Russian legal entities and individuals subject to US sanctions. The introduction of secondary sanctions against business entails significant adverse consequences. Individuals due to the secondary sanctions may be subject to measures of influence, ranging from varying degrees of restriction of access to US markets to inclusion on a list of special category persons (the “SDN List”), which results in the blocking of all accounts of such persons in the US and a ban on cooperation with them for US persons. For companies conducting foreign economic activities not related to the USA, the main risk is the refusal of banks and other credit organizations to provide services, the impossibility of carrying out dollar transactions, as well as the refusal of cooperation from foreign counterparties.
The professional community has been discussing for many days the conformity of the Constitution of Ukraine with the international rules of the provisions of domestic sanctions legislation and the decisions adopted on its basis. Many lawyers believe that the application of sanction restrictions without establishing guilt and bringing to justice violates constitutional rights – the presumption of innocence. We are sure that currently a more detailed legal analysis of the relevant legislation is not as interesting to managers and business owners as clear practical advice on avoiding possible negative consequences of their application.
After all, although there is a mechanism for appealing sanctions, this process is quite difficult and can last a considerable period, during which the business will continue to experience losses. Therefore, it is better to take all the necessary measures in advance and carry out appropriate measures to avoid them, than to deal with the consequences of their use later.
What should be done to avoid or minimize the possibility of being sanctioned or charged?
First, you should conduct an internal corporate audit to identify the risks related to the citizenship of the ultimate beneficiaries, the structure of corporate governance and ownership, the origin of the main assets, existing counterparties and their connections. To do this, it is necessary to carry out a thorough review of the company’s activities in terms of current contracts and obligations, create or bring into order an effective accounting and settlement policy, conduct a thorough survey of participants and shareholders regarding their connections with states and persons from sanctioned lists, check existing partners and counterparties thanks to available registers and sources. During the temporary unavailability of some registers, search analytical systems that collect and aggregate information in the required format, allowing to update it and promptly monitor changes, will be able to help with this. It will also help to learn about historical changes in cases where many individuals are present, in order to avoid sanctions and make appropriate formal changes in the structure of their asset ownership. Now it is not difficult to get access to the relevant lists of other countries, most of them are publicly available: USA (SSI, SDN), Great Britain, Canada, Switzerland, as well as international bases: UN, European Union. The following sanctions packages are widely covered in the media and are available on Reuters, Statista, globalsanctionsdatabase, RuAssets, and others. It is necessary to pay attention not only to the direct connections with sanctioned persons but also to such factors as: a complex and confusing scheme of ownership that leads to “offshore” jurisdictions where there are no open registers, recent changes in this structure, insufficient information about management, lack of public data about the person and his activities, connections with companies that actively conduct activities in states that have become the object of sanctions. Verification of your customers (KYC) may be based on international AML (anti-money laundering) standards.
In cases where your company has lost control of assets and personnel because of their seizure, these events and facts must be recorded in any possible way. It is necessary to report this to the competent authorities at the first opportunity, in order to avoid suspicions of collaborative activity, assistance and cooperation with the aggressor in the future.
Secondly, it is worth implementing the so-called sanctions compliance. This is necessary to secure current operations and assets, strengthen business reputation and avoid risks in the future. It is recommended to start with identifying the responsible employee or even the head of this unit or solving the issue of involving third-party specialists. Based on the specifics and geography of the activity, the nature of the construction of the corporate structure and the decision-making process, identify the main risks that can negatively affect the company, both in the short and long term. Develop and implement appropriate rules for compliance, analysis and assessment of possible risks. From the very beginning, it is desirable to think about how to maximally automate all possible stages in this process in order to speed up the processing and analysis of a large array of data, distribution among interested parties, and avoidance of technical errors and systematization of the obtained results. If a future business transaction is being investigated, experts suggest answering three simple questions: What is forbidden to do? Who is forbidden to do? On what territory is it prohibited? It is worth distributing and separately analyzing the presence of both personal (regarding specific persons) and sectoral sanctions (regarding a specific industry and an undefined circle of persons) using various information and analytical systems.
Finally, after testing and improving the compliance analysis system, the next steps should be integrating its results into the necessary business processes, creating the necessary databases (blacklist, whitelist), involving all the necessary employees and setting up constant monitoring and prompt notification of important changes.
Particular attention should be drawn to the procedure for making appropriate decisions based on the results of the compliance analysis: can any risks be acceptable, and which ones immediately indicate the impossibility of establishing any relations? To find the answer, you can define a kind of scale or matrix with indicators that will allow you clearly and accurately weigh all factors and decide on further actions. This will help you to understand whether getting on sanctions lists, blocking of assets, transactions, criminal and civil liability, financial penalties, etc. correspond to the benefits that the future agreement with a dubious counterparty promises.
We would like to emphasize that it is necessary to implement the necessary checks as soon as we receive the first information about the potential person with whom we plan to establish business relations, and not after the agreements have already been signed and executed or after any suspicions have arisen about him.
A pleasant bonus from this process in the future may also be the implementation of rules and the compliance of economic activity with the requirements of financial monitoring, protection of personal data, anti-corruption rules and other legal requirements, based on the specifics of the activity of each entity.
So, today we can firmly state that the existence of certain legal prohibitions and restrictions (sanctions) both at the national and international level is already a permanent and integral factor of conducting business in many areas, which should not be neglected. You should not hope that your senses or experience will not fail you and that responsible persons will make the right decisions without following certain algorithms and all kinds of procedures. A professional approach to sanctions compliance will help to react to risks in a timely and qualitative manner and avoid their undesirable consequences, investments in which, although not immediately but will definitely pay off.
We hope that the given information was useful for you. If you need help in carrying out relevant research, legal analysis and practical application of legal rules, contact the members of the Smartsolutions team, who will provide qualified advice and professional legal assistance.
We would like to inform you that Smartsolutions and the “Smart Angel” Charitable Foundation are collecting funds for the needs of the Armed Forces of Ukraine and providing the most necessities to the children who suffered from the armed aggression of the Russian Federation against Ukraine. You can support our project by following the link.