EU Publishes New Best Practices Guidance, including Updated Ownership Test and Additional Control Guidance

Key Takeaways

• On 3 July 2024, the Council of the European Union (the “EU Council”) published its revised Update of the EU Best Practices for the effective implementation of restrictive measures (“Best Practices”).¹  This provides significant guidance and updates to the EU “Ownership” and “Control” tests, amongst other updates.
• The “Ownership” test threshold has been amended to possession of “50% or more” rather than “more than 50%” of the proprietary rights of an entity, as it previously was – now aligning the EU (European Union) with the United States (US) position and diverging from the UK.
• The “Control” test has been expanded to include new “indications” of potential red flags, such as majority shareholdings by designated persons, buyback options, transfers of shares close to the time of designation, the use of front persons, and the use of trusts and shell companies. Prong (e) of the EU “Control” test criteria, which addresses a person holding a dominant influence over an entity, has been expanded to explicitly cover “de facto” power as well.
• The notion of “acting on behalf or at the direction” of a person, entity or body subject to sanctions should now be considered equable (albeit separate) to the “Ownership” and “Control” tests.
• EU persons and entities remain required to inform national authorities of “any information at their disposal” which would facilitate the application of the EU’s financial restrictive measures.

Analysis

On 3 July 2024, the EU Council established new Best Practices guidance, which updated its prior version and introduced several changes, in particular (amongst others) to the EU “Ownership” and “Control” tests. This alert summarises the key changes made.

First, the EU “Ownership” test’s threshold for establishing ownership by an EU designated person (DP) has been reduced to “50% or more of the proprietary rights of an entity”. In addition, a non-exhaustive list of potential red flags for identifying whether a DP exercises “control” has been published, and prong (e) of the “Control” test criteria, which addresses a person holding a dominant influence over an entity, has been expanded to explicitly cover persons having the “de facto” power to exert dominant influence.

Secondly, the Best Practices guidance now confirms that consideration of whether an individual, entity or body is “acting on behalf of or at the direction” of an entity should be assessed by placing equal importance to the “ownership” and “control” tests, whilst remaining a separate concept.

In that regard, the clarification of the extent of disclosure obligations on EU persons and entities to their national authorities has been reiterated, requiring them to provide “any information at their disposal which would facilitate the application of the [EU’s] financial restrictive measures” (emphasis added)², the scope of which appears to extend beyond Article 8 of Council Regulation (EU) No. 269/2014, means EU persons must now carefully consider any information they have “at their disposal” as it regards ‘ownership’, ‘control’ and ‘acting on behalf of’.

New “Ownership” Test

Paragraph 63 of the Best Practices guidance provides that “The criterion to be taken into account when assessing whether a legal person or entity is owned by another person or entity is the possession of 50% or more of the proprietary rights of an entity or having a majority interest in it.”³

The EU Council has therefore departed from the previous EU position, which required a legal person, entity or body to be ‘more than 50%’ owned by an EU DP for the purposes of EU asset freezing measures.⁴

This means that the EU is now aligned with the “50 Percent Rule” applied by the U.S. Office of Foreign Assets Control (OFAC).⁵  Whilst this change to assessing ownership thresholds may provide legal certainty and greater co-ordination between the EU and US regimes, the EU is now in divergence from the position adopted by the UK’s Office of Financial Sanctions Implementation (OFSI) of “more than 50%”, creating further distinctions between the EU and UK sanctions regimes.

The Best Practices guidance has also clarified that the EU follows the US (again in contrast to the UK) in relation to aggregation of ownership, when calculating total ownership. Although this is not a new concept, this is the first time the EU has confirmed that its approach towards aggregation applies across its sanctions regimes, and not just in the Russia context.

Updates to the “Control Test” and New Red Flag Indicators

Where operators are unable to determine whether a legal person, entity or body is subject to EU restrictive measures by virtue of being “owned” by a DP, operators must also consider whether a DP exercises “control” over that person, body or entity. Paragraph 64 of the Best Practices guidance outlines several criteria which largely remain unchanged from the previous EU Best Practices guidance issued in 2022. However, limb (e) of the control criteria, which addresses a person holding a dominant influence over an entity, has been updated to clarify that persons should be considered to exercise “control” in situations where they:

“have the power to, de facto, exercise a dominant influence over a legal person or entity, without being the holder of that right.”⁶

The revision to this control criteria is to include reference to “de facto” power – this explicitly expands the scope to include arrangements that factually and practically facilitate the exertion of such power by DPs, beyond formal legal arrangements.

The EU Council has additionally provided further guidance on a non-exhaustive list of circumstances which may qualify as indications or “red flags” that a DP has “control” over a company.⁷  These “red flags” include:

Majority Shareholding

The Best Practices guidance clarifies that where a DP is the largest shareholder of a company (even if its shareholding is not 50% or greater), this could indicate “control” by the DP and warrant further analysis on whether any of the “control” criteria in Paragraph 64 apply.

Whilst such indications may enable operators to identify potential red flags for “control” by a DP in private companies, questions remain as to the position of DP shareholders in publicly listed companies, as well as companies with different classes of shares with different (preferential) voting rights.

Additionally, no threshold has been provided for “majority” shareholding (although the example provided by the EU Council is 40%) and therefore this could create additional compliance burdens where, for example, a DP only has a 10% shareholding, but all other shareholders own less than 10%.

Buyback Options

Where a designated previous owner has the option to buy back the company under favourable conditions e.g. following a management buyout, particularly where these conditions could easily be invoked, the Best Practice guidance recommends that operators conduct further analysis to identify whether the DP continues to exercise “control”. Therefore, legal rights, including those related to the situation after a divestment, will need to be scrutinized closely where there has been prior DP ownership.

Transfers of Shares At a Time Close to Designation

Where the “transfer of a relevant number of shares” in a non-designated entity to a new owner occurs shortly before or after a person has been designated, the Best Practices guidance suggests that this may indicate retained control by the DP. As such, further investigation should be conducted to determine whether the DP continues to have influence over the new owner. A ‘relevant’ number of shares is defined as “not only a large number thereof, but also smaller numbers which enable the [designated] seller, for instance, to fall below the ownership threshold” (emphasis added).⁸

However, the guidance does not provide any further clarification for determining whether a genuine transfer of ownership has occurred and how operators should approach situations involving deferred payments by DPs, reservations of title and the position of share purchasers who default under financing arrangements.

Use of Front Persons

Paragraph 67(d) of the Best Practices guidance notes that where a new owner of an entity is closely connected to the previous designated owner (e.g. a family member, former employee, business associate), or the sale was agreed at an undervalue, such situations may indicate that a DP continues to have “control” over the person or entity concerned. In addition, where there is a written agreement from which a non-shareholder or minority shareholder (e.g. the DP) is given the authority to make decisions on the business of entity, such situations may also indicate “control” by the DP.

The Best Practices guidance appears to re-affirm the position maintained by the European Commission within its ‘Frequently Asked Questions’ (FAQs), published on 8 April  2022, in respect of EU asset freeze restrictions.⁹  FAQ 5 notes that in situations involving third persons and potential family ties, operators should consider factors such as the closeness of those business and family ties with the DP, the content of any formal agreements between the parties, as well as the professional independence of third persons.¹⁰

Use of Trusts, Shell Companies and Limited Liability Companies

When considering the “Control” test, the Best Practices guidance warns operators to remain vigilant of entities that are part of a “needlessly complex corporate structure”, which potentially involve shell companies, limited liability companies and/or trusts linked to a DP.¹¹  According to the EU Council, some of these entities may have been incorporated or changed their identity prior to the adoption of an EU sanctions regime or the designation of a DP. The guidance also highlights that indications of “control” may exist where “the management of trusts involves professionals from the jurisdiction where the trust was/were formed.”¹²

However, whilst the EU Council has provided some indications of when a DP might be considered to “control” a legal person, body or entity, no additional clarification has been provided regarding what constitutes a “needlessly complex corporate structure”, particularly in light of the fact that many companies engage in complex corporate structuring for tax reasons.

Comparison with the UK Control Test

The new red flags included in the EU’s Best Practices guidance are largely consistent (albeit not identical) with those set out in the UK OFSI’s Financial Sanctions Enforcement and Monetary Penalties Guidance as well as its Joint Red Alert on Financial Sanctions Evasion Typologies, in the context of the UK “Control” Test.

However, although the UK “Control” test is largely premised on the same principles as the EU, it does not use identical criteria, making compliance with both the EU and UK regimes increasingly burdensome for clients. Unlike the EU, OFSI has not updated its criterion (set out in OFSI’s Financial Sanctions Guidance¹³) “having the right to exercise a dominant influence referred to… without being the holder of that right” with the language “de facto”.

In addition, as noted in our prior alert, the Mints and Der Mond Cases have created additional uncertainty to interpretation of the UK “Control” test.

Most recently, on 10 July 2024 Deputy Judge Thompsell provided additional guidance on the UK “Control” test in the High Court Hellard Case. In particular, he noted that “control” should be divided into four types:

• De Jure Control: does the controller have an absolute legal right to exercise control e.g. in the constitution of the company?
• Actual Present De Jure Control: is the controller “calling the shots” with no legal right to do so e.g. have they exercised a decisive influence to control what is happening?
• Potential Future De Jure Control: does the controller have the legal means to obtain ownership or control (but no current legal right) e.g. they have an option or a forward contract to acquire a majority shareholding?
• Potential Future De Facto Control (in rare cases only): is there good reason to believe that the controller could, if they wished, exercise control in the future (although they currently do not exercise de facto control) without exercise of a legal right or legal power, the cooperation of others, or facing penalties or undesirable consequences e.g. a billionaire may have resources to make a bid for control of a company, but he would not be able to acquire the company without other persons (e.g. shareholders) accepting his offer – therefore this would not be potential future de facto control.

Whilst this is a helpful explanation for approaching the “Control” test in the UK, the UK Supreme Court has now granted permission to appeal the Mints Case, and therefore it remains to be seen whether the Court will confirm this approach elucidated by Deputy Judge Thompsell, or provide new guidance.

“Acting on Behalf or At the Direction Of”

The Best Practices guidance provides new criteria to assess whether a natural or legal person, entity or body is “acting on behalf of or at the direction of” an entity.¹⁴  Previously issued EU FAQ Guidance noted that while ownership or control of any entity is an element that increases the likelihood of such conduct, it does not on its own sufficiently determine whether an entity is acting on behalf or at the direction of another entity.¹⁵

The EU Council has now clarified that whilst the notion is distinct from ownership and control, its effects can be placed on an equal footing.¹⁶  In determining whether a person or entity is acting on behalf of or at the direction of a DP, operators are required to consider several criteria specified in Paragraph 71 of the 3 July ‘Best Practices’ note, which include:

1. the precise ownership / control structure, including links between natural and legal persons, entities or bodies;
2. the nature and purpose of the transaction, coupled with the stated business duties of the person, entity or body;
3. any previous instances where a person or entity has acted on behalf of or at the direction of the entity; and
4. disclosures made by third parties obtained from credible, reliable and independent sources and/or factual evidence which indicate that directions were given by the entity.

These criteria will therefore also be relevant to the EU “Control” test, as the EU Council has noted that the concepts are on equal footing.

Disclosure Obligation

Finally, in respect of the practical impact of the above changes, we note that the EU Council has provided an additional gloss to the obligation requiring EU persons and entities to inform their national authorities of any information “at their disposal” which would facilitate the application of the financial restrictive measures. The broad scope of the obligation, as interpreted by the EU Council, appears to extend beyond Article 8 of Council Regulation (EU) No. 269/2014, which requires EU persons, entities and bodies to supply “any information which would facilitate the implementation of this Regulation, such as … information held about funds and economic resources within the Union territory belonging to, owned, held or controlled by natural or legal persons, entities or bodies listed in Annex I and which have not been frozen…”.¹⁷

This reporting obligation raises several questions, such as what information is considered to ‘facilitate’ the application of EU financial restrictive measures, and when such information is deemed to be ‘at the disposal’ of an EU person. For example, it is unclear whether information obtained inadvertently, through a third party or by way of hearsay, would fall within the EU reporting requirement.

Concluding Remarks

The updated Best Practices guidance published by the EU Council marks a significant change to the established position with regards to assessing ownership, and provides some notable additional indicative red flags to consider when addressing questions of control by DPs. The confirmation that an assessment of whether a person is “acting on behalf or at the direction of” a DP should be considered on equal footing to the ownership and control tests also adds an additional layer of complexity to EU sanctions analyses. The change to the ownership rule and confirmation on the EU’s position on aggregation represent a notable divergence from prior alignment between the UK and EU regimes, to alignment between the EU and the US instead. 

Nevertheless, the guidance raises a number of unanswered questions, particularly in relation to the scope and interpretation of the new indicative control red flags under Paragraph 67. Additionally, there remains a lack of clarity regarding the reporting obligations which appear, at least in the EU Council’s interpretation, to expand beyond the requirements under Article 8. We hope to see the EU provide additional clarifications to the guidance or publish new FAQ guidance to address these uncertainties in the near future.

Please reach out if you have any questions regarding the updated Best Practices or any other queries.

^{1 Council of the European Union, ‘Update of the EU Best Practices for the effective implementation of restrictive measures’, 11623/24 (3 July 2024).} 

^{2 EU Best Practices Guidance, Paragraph 41.}

^{3 EU Best Practices Guidance, Paragraph 63.}

^{4 Council of the European Union, Update of the EU Best Practices for the effective implementation of restrictive measures, June 27, 2022, see Paragraph 62.}

^{5 U.S. Department of the Treasury, ‘Revised guidance on entities by persons whose property and interests in property are blocked’, August 13, 2024}

^{6 EU Best Practices Guidance, Paragraph 64(e).}

^{7 EU Best Practices Guidance, Paragraph 67.}

^{8 EU Best Practices Guidance, Paragraph 67(c).}

^{9 European Commission, Frequently Asked Questions: Asset freeze and prohibition to make funds and economic resources available, updated 24 July  2023.}

^{10 Ibid, see FAQ 5.}

^{11 EU Best Practices Guidance, Paragraph 67(e).}

^{12 Ibid.}

^{13 OFSI Financial Sanctions Guidance, Section 4.1.}

^{14 EU Best Practices Guidance, Paragraph 71.}

^{15 Commission Consolidated FAQs on the implementation of Council Regulation 833/2014 and Council Regulation 269/2014 (see FAQ 5 of the Trading FAQs)}

^{16 Judgment of 10 September 2019, HTTS Hanseatic Trade Trust & Shipping GmbH v Council, C-123/18 P, EU:C:2019:694, Paragraph 79.}

^{17 Article 8(1)(a) of Council Regulation (EU) No. 269/2014.}