Trapped in a Sanctions labyrinth – What to do when a client’s structure contains frozen assets

Background

Many of these frozen assets require significant financial resources to maintain, particularly over the medium to long term.  While such firms are specialists at dealing with complex structures containing significant assets, the increased complexity introduced by liquidity depleted structures with resource hungry frozen assets can cause significant concern.         

Some frozen assets require significant expenditure to maintain their value.  In many cases the continued cost of maintenance of the asset exceeds any income it earns.  Where this is the case, it is important that there is sufficient liquidity in the structure to maintain cash hungry assets.  Where a structure has frozen assets and is unable to earn adequate income to support the continuing maintenance costs, does not contain sufficient liquid assets, or is unable to access adequate liquidity, this can be detrimental to the solvency and continued existence of the structure and potentially its wider group.

Sanctions obligations in the Channel Islands

Jersey and Guernsey both have legislation in place to implement UK sanctions regulations.  These regulations require that firms not deal with funds and economic resources that are owned, held or controlled by a person "designated" for sanctions.  Additionally, a firm must not make funds or economic resources available, directly or indirectly, to, or for the benefit of, any designated person, or engage in actions that, directly or indirectly, circumvent the financial sanctions prohibitions.  

In addition to financial sanctions, there are restrictions on professional services being provided to designated persons or persons "connected with" Russia, meaning those ordinarily resident or located in Russia.  Restrictions on the provision of accounting and bookkeeping services, amongst others, to designated persons or persons connected with Russia were introduced on 21 July 2022.  In December 2022, the list of activities which cannot be provided to designated persons or persons connected with Russia was expanded to include advertising, architectural, auditing, engineering and IT consultancy and design services.  

Also introduced in December 2022 was a prohibition on the provision of trust services to designated persons or those connected with Russia.  Trust services under the regulation are services such as creating trusts or similar arrangements, providing registered office, business address, correspondence address or administrative address for a trust or similar arrangement, or acting or arranging for another person to act as trustee of a trust or similar arrangement.

There are several exemptions in relation to the above restrictions.  Most notably, firms may continue to provide trust services to persons connected with Russia (but not designated persons) where those services were provided immediately prior to 16 December 2022.

Other Duties

Trustees and directors owe various duties due to their positions.  These duties include the duty to preserve frozen assets.  In normal circumstances, when clients can inject liquidity into their structures, or money can be moved around within a group as necessary, money hungry assets can be supported.  Where no money can be injected into a structure due to links with a designated person, it becomes significantly more difficult for trustees or directors to fulfil their duties and any potential contractual obligations relating to the frozen asset.  

Trustees and directors can be caught between breaching sanctions legislation and allowing the trust or company become insolvent (and in doing so, be accused of failing in their duties or causing the structure to become insolvent). The balance between breaching sanctions and keeping an entity solvent can therefore be a challenging one for trustees and directors.

The sanctions legislation does provide some protection from civil liability where a firm has performed an act in the reasonable belief that the act was required for compliance with Channel Islands sanctions.  That said, it does not absolve firms from responsibility where they simply sit on their hands and do nothing.  

Sanctions Reporting Obligations

In Guernsey, one of the obligations is for a Guernsey regulated firm to make notification to the Policy & Resources Committee and the Guernsey Financial Services Commission where the firm knows or has reasonable cause to believe that a breach of the sanctions provisions has been committed, an individual or entity is a sanctioned person (which is equivalent to a designated person), or an individual or entity is linked to a sanctioned person.

In Jersey, a Jersey regulated financial services firm and other relevant entities must make notification to the Jersey Minister for External Affairs where it holds an account of a person, has entered into dealings or an agreement with a person or has been approached by or on behalf of a person, or it knows, or has reasonable cause to suspect, that the person is a Designated Person, or has committed, is committing or intends to commit an offence under sanctions legislation.

Additionally, in both islands, there are notification obligations to the respective Financial Intelligence Units where there is a suspicion of money laundering or terrorist financing.

Official Parties are interested

The interest of the Channel Island regulators and government bodies doesn’t end with merely receiving a notification.  Given the risks related to this area as well as from international relation and public policy perspectives, it is natural for regulators and government bodies to have other concerns including whether:

• A license to allow frozen assets to be dealt with is required from the Jersey Minister or the Guernsey Policy & Resources Committee (as relevant).
• The regulated firm is complying with its regulatory obligations and legal obligations, including director and trustee duties (as applicable) and relevant minimum criteria applicable for licensing or registration.
• The regulated firm is dealing with designated people, frozen assets and related structures in an appropriate manner and in such a way as not to damage the reputation of the Bailiwick or Guernsey or Jersey as a financial centre.  Close communication with the regulator is necessary to ensure that their views are considered in relevant circumstances.

How issues relating to designated persons and frozen assets are communicated initially and on an ongoing basis is essential, not just to ensure that the regulated firm fulfils its legal requirements but so that its relationship with its regulator continues to be positive.  

Practical considerations 

We are seeing a significant increase in the number of complex private wealth structures containing frozen assets becoming financially distressed.  The ongoing costs of administration and maintaining the assets within the structures together with the inability to receive money into the structure from designated persons or their associated structures, often give rise to financial difficulties.  

Faced with this situation it can be difficult to see how you and your firm can fulfil your duties in relation to the client assets and structures of designated persons, deal appropriately with potential insolvency or distressed frozen assets or structures, and comply with sanctions legislation.

Where a firm controls a structure with distressed frozen assets, there are a number of issues which should be considered:

1. What are the continuing costs (such as maintenance) associated to those assets;
2. Whether there is liquidity in the structure available, and accessible, to cover the continuing costs for the short / medium / long term;
3. Whether there are any existing creditors in the structure, in which their debts are immediately due, and whether there is a lack of available asset to settle said creditors;
4. Whether the frozen assets will necessitate your firm taking steps in Russia or whether Russian counter sanctions are relevant.

Retaining value of the stranded frozen assets and covering their continuing costs is important to reduce the risk of a future insolvency event. However, if there are existing creditors and there is an immediate inability to settle said creditors now, this most likely will increase the risk of an insolvency event on a cash flow basis in the short term.

Ultimately the answer may be one or a combination of the following actions:

1. Engagement with authorities including obtaining a license to deal with frozen assets.  Prior to engaging with an authority, the firm will want to gather evidence to support the position that the frozen asset is wasting and identifying the continuing costs.
2. Seeking the blessing of the Court.  This is particularly useful where there is a potential dispute with the beneficiaries of a trust or beneficial owners of the structure.  This also has the benefit of confirming the independence of the director / trustee and discounting any claims of de facto asset ownership on the part of a settlor / shareholder.
3. In appropriate circumstances, retiring as trustee and transferring the role to a replacement more appropriately placed to navigate complex regulatory concerns, engage in litigation or otherwise challenge allegations of improper dealings with beneficiaries or involvement in a sham trust.

Where a firm is dealing with frozen assets and liquidity problems in related structures, they should seek guidance from an insolvency professional with experience in this area.

Grant Thornton has significant experience in providing assistance to clients in solving liquidity issues caused by stranded frozen assets as well as assisting regulated firms in respect of affected structures.  Often this involves providing forensic accounting services, whether to undertake an asset tracing exercise to support an application to Court for directions, or to more generally discuss the balance between breaching sanctions and keeping a structure solvent.