On April 22, 2024, the Verkhovna Rada registered the Draft Law “On Amendments to Certain Laws of Ukraine on the Mechanism for Protecting the Property Rights of Third Parties” No. 11195 (hereinafter referred to as “Draft Law 11195”).
The draft law proposes to amend the Laws of Ukraine “On Sanctions,” “On the Cabinet of Ministers of Ukraine,” “On Limited Liability and Additional Liability Companies,” and the Administrative Procedure Code” to improve the mechanism for applying sanctions in the form of asset forfeiture to state revenue.
It is worth recalling that this type of sanctions was introduced following the Law of Ukraine “On Amendments to Certain Legislative Acts of Ukraine on Improving the Effectiveness of Sanctions Related to Assets of Individuals” No. 2257-IX dated May 12, 2022. The Ministry of Justice of Ukraine (hereinafter referred to as the “Ministry of Justice”) was empowered to file a claim with the High Anti-Corruption Court (hereinafter referred to as the “HACC”) for the recovery (confiscation) of assets belonging to sanctioned persons, as well as assets in respect of which such persons may directly or indirectly take actions identical in content to the exercise of the right to dispose of them. Confiscation of assets can be applied only to persons who have already been sanctioned in the form of asset freeze and only during martial law.
Under this mechanism, the HACC has made about 35 decisions on confiscating Russian assets, demonstrating its effectiveness. However, it also contained a number of shortcomings, which were proposed to be corrected by amending the legislation. Experts from the Dnistrianskyi Center also proposed drafts of such changes.
Draft Law No. 11195 proposes changes that are intended to address these issues, namely:
- ● The Ministry of Justice is entitled to specify in the statement of claim the requirement to confiscate 100% of corporate rights (securities, shares) directly owned by a legal entity in the ownership structure of which the sanctioned person is a shareholder;
- ● In this case, the Ministry of Justice indicates in the statement of claim the amount of the share of both the sanctioned person and non-sanctioned persons;
- ● To restore the rights of non-sanctioned persons whose shares have been confiscated, the State Property Fund of Ukraine (SPFU) opens an escrow account and credits to such account corporate shares corresponding to the determined amount of non-sanctioned persons’ participation in the ownership structure of the asset to be confiscated;
- ● The Cabinet of Ministers of Ukraine (the “Cabinet of Ministers”) or the SPFU take measures to inform non-sanctioned persons of the need to act to formalize ownership of securities and/or shares credited to the specified escrow account;
- ● Non-sanctioned persons are entitled to apply to the institutions with which the specified escrow accounts were opened to transfer their rights to securities and/or shares;
- ● If the non-sanctioned persons fail to do so within 5 years, they will be deemed to have relinquished ownership of such corporate rights;
- ● Corporate rights credited to escrow accounts, until they are transferred to non-sanctioned persons, are not taken into account when determining the quorum, do not give the right to participate in the general meeting of shareholders (participants) of the company and when voting in the issuer’s/company’s bodies.
At the same time, it should be noted that this procedure applies only if the determined amount of the sanctioned person’s participation in the ownership structure of the asset to be collected as state revenue is at least 25%.
If this amount is less than 25%, the CMU will decide to confiscate 100% of corporate rights by the same procedure.
In general, it should be noted that the mechanism proposed by this law is necessary (section 1) and is already de facto functioning in practice. Therefore, the law’s adoption only streamlines the existing state of affairs (section 2). However, Draft Law 11195 itself is unclear, and its adoption is associated with serious risks. Along with completely necessary measures, absolutely arbitrary norms are introduced (section 3).
Proposals of Draft Law 11195
The application of the asset freeze sanction in Ukraine encountered an obstacle as the sanctioned oligarchs often did not directly own assets in Ukraine. Such most significant assets are owned by non-resident companies with a complex ownership structure, where, along with sanctioned Russian oligarchs, there may be a significant number of non-sanctioned persons. They may own a significant portion of the asset and are often internationally known people and companies.
In such cases, a “stalemate” situation arises. It is impossible to confiscate the share owned directly by the sanctioned person, as it is a share in a non-resident company registered under the laws of a foreign country outside the jurisdiction of Ukrainian justice. After 100% of the shares in the Ukrainian asset have been recovered, the court will also confiscate those shares indirectly owned by non-sanctioned persons. In this case, the rights of these individuals will inevitably be violated.
This problem is not new and has already been analyzed in our previous materials.
The authors of Draft Law 11195 propose a mechanism designed to eliminate this problem.
Thus, let us take the simplest possible case to demonstrate the existence of this problem.
Draft Law 11195 allows for the confiscation of 100% of the corporate rights of Non-Resident Company 3 in a resident company.
At the same time, indirectly, through Non-Resident Company 2, the share of the non-sanctioned person in Non-Resident Company 3, and thus in the resident company, was 80%. According to the Draft Law, the mentioned 80% will be automatically credited to an escrow account opened by the SPFU.
The non-sanctioned owner is notified. In this case, it will be Non-Resident Company 2, the first person in the upward corporate structure not subject to sanctions.
After that, Non-Resident Company 2 applies to the institution where the escrow account is opened, which contains 80% of the corporate rights in the Resident Company. Based on the results of its application, 80% of corporate rights in the Resident Company should be automatically transferred to its securities account.
Thus, the state, represented by the SPFU, acquires 20% of a Ukrainian company’s corporate rights, and a non-sanctioned non-resident company gets back its share in the Ukrainian asset. The ownership structure of a third party changes, but it is hardly a violation of its property rights.
Case-law and proposals of the HACC
The mechanism proposed by Draft Law 11195, although only submitted to the Parliament, has, from a certain point of view, been tested in practice. This refers to the decision of the HACC in the case of confiscation of assets of Russian oligarch Eduard Khudainatov (case No. 991/8725/23).
In this case, Alliance Holding LLC, which owned a network of gas stations in Ukraine, was 100% owned by the Dutch company Cicerone Holding B.V., in which the Russian oligarch had a 49% stake. However, the majority stake of 51% in Cicerone Holding B.V. was owned by Shell Overseas Investments B.V.
In its decision dated January 23, 2024, the HACC dismissed the claim of the Ministry of Justice regarding the confiscation of the corporate rights of Alliance Holding LLC, which was proportional to the oligarch’s 49% stake in Cicerone Holding B.V. According to the court, this would lead to the following:
1) the oligarch would continue to own a 49% stake in Cicerone Holding B.V., which would retain a 51% stake in Alliance Holding LLC;
2) the share of the non-sanctioned company Shell Overseas Investments B.V. would have decreased by 49%.
The Court rightly noted that “granting the claim in this part, without an available mechanism of compensation, will lead to Shell having to defend its rights in litigation against Ukraine, which the company is likely to win, which will lead to an additional burden on the budget and excessive burdening of a bona fide owner to protect its rights”.
At the same time, the HACC panel in the same decision proposed a mechanism to resolve the problem, noting that “satisfaction of the claim against Alliance Holding LLC would be possible if the law provided for the possibility to compensate for the loss of property rights of third non-sanctioned parties. In particular, one of such mechanisms would be a legislative possibility for a court to recover 100% ownership of a Ukrainian asset and, under certain conditions, to recognize the ownership of third parties in proportion to their share in a foreign jurisdiction.”
The court has de facto reproduced in general terms the mechanism proposed by Draft Law 11195. The HACC decision in the first instance in this case has already been analyzed by experts of the Dnistrianskyi Center.
Subsequently, the HACC decision in the part concerning the corporate rights of Alliance Holding LLC was cancelled by the HACC Appeals Chamber, which issued a new decision in this part, according to which it recovered 49% of the corporate rights in Alliance Holding LLC, which were indirectly owned by E.Yu. Khudainatov through Cicerone Holding B.V., to the state revenue.
The HACC Appeals Chamber also determined the method of enforcement of its decision, according to which the changes to the information on the size of shares in the authorized capital of Alliance Holding LLC were to be registered as follows:
- ● 49% of the corporate rights in Alliance Holding LLC were to be registered in the name of the state of Ukraine; and
- ● 51% – in the name of Shell Overseas Investments B.V. at the request of this company to the state registration authority.
In fact, the HACC Appeals Chamber implemented the mechanism provided for by the Draft Law in a slightly different way. How this decision is implemented in practice is currently unknown. The HACC decision in the Khudainatov case has already been analyzed in more detail as part of our project.
Obviously, in the future, the HACC and the HACC Appeals Chamber will follow the path already developed by the Appeals Chamber in case No. 991/8725/23.
However, this approach also raises a number of questions. Indeed, according to Article 372 of the Administrative Procedure Code of Ukraine, if necessary, the method, terms, and procedure of execution may be determined in the court decision itself. Similarly, the relevant public authorities may be assigned the responsibility to ensure the enforcement of the decision.
However, the essence of the decision of the HACC Appeals Chamber is reduced to awarding 49% of the shares in the authorized capital of Alliance Holding LLC in favor of the state. The determination of the order and method of execution should ideally concern this 49%. In such circumstances, the right of Shell Overseas Investments B.V. to register 51% of corporate rights in its favor is not a method (procedure) of execution of the judgment, but a full-fledged part of the judgment, which the Appeals Chamber did not have the authority to issue, at least because the Ministry of Justice did not request it in its statement.
Thus, the court, to some extent, went beyond its powers. However, the analysis of the decision gives no reason to doubt its correctness and fairness: the share of Shell Overseas Investments B.V. was indeed 51% and this is the amount it will receive as a result of the Appeals Chamber’s decision. Therefore, there is no reason to talk about any violation of the company’s rights.
At the same time, in order to avoid any doubts about the legality of the decision and to harmonize future case-law (not all panels of the Appeals Chamber may agree with the position in case No. 991/8725/23), there is a need to regulate the functioning of this mechanism at the legislative level. It was with this goal in mind that Draft Law 11195 was submitted to the Verkhovna Rada.
Challenges of Draft Law 11195
The adoption of Draft Law 11195, despite the obvious need, may entail serious risks.
First of all, it should be noted that along with expanding the powers of the Ministry of Justice and the court to impose sanctions in the form of a penalty to the state, Draft Law 11195 gives broad powers in this area to the Cabinet of Ministers.
As noted above, the procedure provided for in Draft Law 11195 is applicable only if the sanctioned person’s share in the asset is at least 25%. If the share is less than 25%, the decision to foreclose on 100% of the corporate rights is made by the Cabinet of Ministers and in accordance with the procedure established by the same Cabinet of Ministers.
Thus, the executive body is given almost unlimited powers to interfere with property rights.
At the same time, it is not clear what the logic behind this legislative initiative is, since the law already provides for a mechanism to recover HACC assets to the state revenue in compliance with all guarantees of a fair trial. This mechanism has been successfully operating for over two years.
Thus, the question of why such broad powers should be vested in an executive body that does not provide even basic guarantees of a fair trial remains open.
In addition, the procedure for returning shares to a non-sanctioned owner that have been foreclosed involves the participation of many entities on which its proper implementation depends. The Ministry of Justice should correctly identify non-sanctioned persons in the application, the SPFU or Cabinet of Ministers should take measures to open escrow accounts and notify the owners, the owners should contact the relevant institution where the escrow accounts are opened, etc. At the same time, neither clear deadlines nor a clear stage of implementation have been defined by these executive authorities. Therefore, the field for abuse is too wide.
Such an approach may contradict the case-law of the ECHR, in particular the conclusions in the cases of Intersplav v. Ukraine and Polimerkonteyner, TOV v. Ukraine where the failure of the authorities to take a formal action, such as the one provided for in Draft Law 11195, led to serious violations of property rights (non-refund of VAT and assignment of an incorrect classification code to imported goods, which resulted in a higher duty rate, respectively).
These circumstances are complicated by the fact that until the non-sanctioned owners return their corporate rights in Ukrainian companies, they are 1) not taken into account when determining the quorum, 2) do not give them the right to participate in the general meeting and 3) when voting. Thus, for an indefinitely long period of time, the state gains full control over the asset, regardless of the size of the share it receives.
Conclusions and recommendations
Overall, the idea of Draft Law 11195 is correct and necessary. The sooner it is implemented in law, the better for the state and the legal security of confiscation decisions. However, its implementation within the framework of this particular initiative requires significant improvement of the shortcomings.
Among them is the fact that Draft Law 11195 grants too broad powers to the Cabinet of Ministers, which should not make decisions on deprivation of property rights at all. In our opinion, only the court should have such powers.
Furthermore, the procedure for returning property to non-sanctioned owners is very complicated and provides a wide field for abuse.
In this regard, the numerous warnings from the media about the corruption component of Draft Law 11195 and its adverse impact on the investment climate in Ukraine are not unfounded.
However, they should not be allowed to overshadow the very idea underlying Draft Law 11195, which has been developed in the HACC case-law: further improvement of Ukraine’s confiscation mechanism.
In addition, the mechanism for returning assets to non-sanctioned owners applied by the HACC Appeals Chamber, which consists of one step for the non-sanctioned owner, is much simpler and more transparent. Therefore, it seems that formalizing such a mechanism in law would be sufficient.
The material was prepared with the support of the International Renaissance Foundation as part of the project “#Compensation4UA/Compensation for war losses for Ukraine. Phase III: Advocacy of steps to guarantee a sustainable compensation strategy”.
Author: Markiyan Bem, Partner at Nazar Kulchytskyy & Partners.
Published: Dnistrianskyi Centre, May 2024.