Sanctions as Means of Security in Registering Information on Beneficial Owners in the Register of Enterprises

Lately, international community has been shaken by Russia's unexpected and overwhelming military aggression in Ukraine. Consequently, not only the future possibility of amicable international relations among states but also rule of international law has been deeply questioned. The breach of the very core principle of the non-use of force enshrined in the article 2(4) of the United Nations Charter which states that “all Members shall refrain in their international relations from the threat or use of force against the territorial integrity or political independence of any state, or in any other manner inconsistent with the Purposes of the United Nations” (United Nations, 1945) has endangered the very existence of international law. Unsurprisingly, serious steps on different levels have been taken since the beginning of the invasion, with an aim to restore international peace and lawful order.

On the international level, the United Nations General Assembly adopted a resolution No. A/ES-11/L.1 of 1 March 2022, in which it “demands that the Russian Federation immediately cease its use of force against Ukraine and refrain from any further unlawful threat or use of force against any Member State” (United Nations, 2022) and “also demands that the Russian Federation immediately, completely and unconditionally withdraws all of its military forces from the territory of Ukraine within its internationally recognised borders” (United Nations, 2022). Despite the very strong and condemning language resorted to in the aforementioned resolution, its nature is unfortunately merely declaratory. It means that in order to resort to stronger means in countering Russia's actions in Ukraine, it would be necessary to use force as well which would mean further breach of principles of international law, this time not only by Russia. Given the aforementioned, it is unfeasible to find an adequate and effective response on an international level. After all, even international norms remain rather vague and unexplicit as regards applying consequences to specific situations even nowadays.

The case is different when it comes to the level of regional supranational organisations with a truly international span of influence. Such organisation is the European Union (hereinafter – the EU) which has taken legislative actions to deal with Russia's aggression in Ukraine. Although the EU does not have the capacity to put an immediate end to invasion, it has other effective tools in its arsenal indirectly aimed at diminishing longevity of Russia's aggression. Thus, Article 2(1) of the Council Regulation (EU) No. 269/2014 of 17 March 2014 concerning restrictive measures in respect to actions undermining or threatening the territorial integrity, sovereignty and independence of Ukraine stipulates that “all funds and economic resources belonging to, owned, held or controlled by any natural or legal persons, entities or bodies, or natural or legal persons, entities or bodies associated with them, as listed in Annex I, shall be frozen” (Regulation (EU) 269/2014). Given that the Annex I is constantly being revised and supplemented, one might consider that funding Russia's activities in Ukraine is becoming more complicated once assets of the key involved persons are frozen.

Relevance and effectiveness of sanctions, however, depend on the ability of individual Member States to ensure their application. This means that national regulatory frameworks should be comprehensive enough to ensure that all state institutions involved in registration of assets of any kind are legally able to prevent the disposal of such assets if they belong to sanctioned persons. The aim of this research is to evaluate effectiveness of such legal framework in the Republic of Latvia as one of the Member States of the EU. In order to successfully conduct the research, overall doctrinal methodology has been used with the principal research method of analysis of relevant legal norms. Additionally, such method as case study has been used to illustrate the arguments stemming from the analysis of law.

Consequently, results of the research demonstrate insufficient clarity of legal norms regarding sanctions in the Republic of Latvia. Hence, certain proposals for amendments thereof are being put forward, so as to clearly define the place of sanctions as a means of security within the normative regulation in Latvia. The practicality of the aforementioned finding would be understanding as to when and in what cases sanctions should be regarded as a legal obstacle to registering information on beneficial owners. Originality of the research lies within the previously described topicality of the subject and the fact that the matter of application of sanctions regarding registration of beneficial owners is not widely studied in Latvia.

Frequently, assets outside of Russia held by the sanctioned persons find themselves in different legal structures and enterprises. A number of specialised non-governmental organisations have concluded that in order to ensure control of the Russian assets abroad, and for international sanctions to work, it is absolutely imperative to identify the sanctioned persons who are simultaneously beneficial owners in enterprises. Since there is a hazard that assets will be moved to new ownership, most likely even to another country, it is important that the competent institutions block such re-registration of assets. After all, Russian assets abroad are crucial for funding the war in Ukraine (Morris, 2022). Therefore, beneficial owners are to be regarded as subjects of sanctions which deserve special attention and legal treatment.

As stipulated by Section 1, Clause 5 of the Law on Prevention of Money Laundering and Terrorism and Proliferation Financing (hereinafter – AML Law), the beneficial owner is “a natural person who is the owner of the customer which is a legal person or legal arrangement or who controls the customer, or on whose behalf, for whose benefit or in whose interests business relationship is being established or an individual transaction is being executed” (Law on the Prevention of Money Laundering and Terrorism and Proliferation Financing, 2008). It goes on to specify that beneficial owner of a legal person is “a natural person who owns, in the form of direct or indirect shareholding, more than 25 per cent of the capital shares or voting stock of the legal person or who directly or indirectly controls it” (Law on the Prevention of Money Laundering and Terrorism and Proliferation Financing, 2008). This means that the assets essentially held by the beneficial owners are capital shares in capital companies. For the purpose of this research, it is relevant to specifically examine the definition of a beneficial owner in legal persons (capital companies) because the control exercised otherwise than that of an ownership of shares would not involve the risk of assets owned by the sanctioned person being transferred and potentially used for funding Russia's aggression.

The Law on International Sanctions and National Sanctions of the Republic of Latvia (hereinafter – the Law on sanctions) prescribes in Section 4, Clause 2 civil legal restrictions as one of the types of international or national sanctions that may be introduced or imposed in Latvia (Law on International Sanctions and National Sanctions of the Republic of Latvia, 2016). Regarding civil restrictions, it is further stated in Section 5, Paragraph two of the Law on Sanctions that “a subject of sanctions on which civil legal restrictions have been imposed, based on these restrictions, is prohibited from acquiring and alienating tangible and intangible objects to which ownership rights or other property rights must be registered, corroborated, or published in public registers” (Law on International Sanctions and National Sanctions of the Republic of Latvia, 2016). Consequently, it derives from this implied definition of civil legal restrictions that capital shares also fall within this type of sanctions. Logically, Paragraph three of Section 5 specifies that “the acquisition and alienation of the ownership rights or other property rights referred to in Paragraph two of this Section is forbidden to be registered or corroborated in public registers” (Law on International Sanctions and National Sanctions of the Republic of Latvia, 2016).

However, whilst the normative regulation stipulates what is to be regarded as civil legal restrictions and what the actions of the institution holding a public register of the relevant ownership rights are, the competence of these institutions in refusing to register certain amendments in the information is lately neglected. Although sanctions generally serve a noble aim, there are certain cases where legality of refusal of registration of ownership rights regarding sanctioned persons is dubious. When it comes to beneficial owners, the problem of insufficiently precise and effective legal framework is highlighted.

In examining interrelation of sanctions and registration of information on beneficial owners, it is necessary to assess the competence of the Register of Enterprises, i.e. the institution responsible for registering beneficial owners in the Republic of Latvia laid down in the normative acts. In other words, it is important to understand what place sanctions take in the normative regulation covering the operation of the Register of Enterprises and to what extent the Register of Enterprises is entitled to regard sanctions as an impediment for registration activities. Further, it is useful to view the practice of the Register of Enterprises in resolving the issue of sanctions by analysing the position of the institution and actual cases.

When viewing the Law On the Enterprise Register of the Republic of Latvia, it can be seen that only a single section is devoted to the topic of sanctions. More specifically, Section 4², Clause 1 stipulates that the state notary shall take a decision to postpone entering of the commercial company in the commercial register if civil legal restrictions have been applied to one of the members or founders, and refuse entering of the commercial company in the commercial register if civil legal restrictions have been applied to the sole founder (Law On the Enterprise Register of the Republic of Latvia, 1990). It seems logical that normative acts prescribe not to make an entry when a sanctioned person who is inevitably becoming a beneficial owner of the legal entity wants to found a commercial company. Thus, normative regulation prevents registration of new enterprises that would have sanctioned persons as their members or shareholders and ultimately the beneficial owners.

However, the case is not so obvious with respect to already existing companies. Clauses 4 and 5 of Section 42 maintain that the state notary shall “refuse to add a division of the register of shareholders to the registration file of a limited liability company, if an application for adding a division of the register of shareholders to the registration file has been submitted and a civil legal restriction has been imposed on the shareholder thereof, except for the case when the equity capital shares of the shareholder are inherited” (Law On the Enterprise Register of the Republic of Latvia, 1990), and, respectively, that in a similar case the registration shall be refused if “the number of equity capital shares of a person on whom a civil legal restriction has been imposed has decreased” (Law On the Enterprise Register of the Republic of Latvia, 1990). Essentially, this means that registration shall be refused when either a new sanctioned shareholder enters the company or the existing subsequently sanctioned shareholder disposes of their capital shares. Nevertheless, the Law On the Enterprise Register of the Republic of Latvia does not mention a word on what the activities of the Register of Enterprises should be in cases when an application for changes in information on the already registered subsequently sanctioned beneficial owners is received.

As it stems from the previously analysed norms of the Law On the Enterprise Register of the Republic of Latvia, express prohibition of registration when it comes to sanctions applies only to cases which involve changes in the composition of shareholders. However, it should be marked that the notion of a shareholder is not necessarily equivalent to that of a beneficial owner. Thus, the Supreme Court of the Republic of Latvia has concluded that the entry in the register of shareholders does not always mean that the person entered therein also possesses the property right to the capital shares. Those shares may belong to another person who on the basis of some private arrangement may hold them for the benefit of the actual shareholder entered in the register of shareholders.

That specific person is to be regarded the beneficial owner of the commercial company (Supreme Court of the Republic of Latvia, 2018). Moreover, Paragraphs five and six of Section 187¹ of the Commercial Law put forward an obligation to the board of directors of the commercial company to make a relevant entry in the register of shareholders whenever any change regarding the company's shareholders has taken place, and subsequently submit the new division of the register of shareholders to the Register of Enterprises (Commercial Law, 2000). Additionally, Section 18², Paragraph one of the AML Law imposes an obligation to provide information on beneficial owners simultaneously with application for changes in the division of the register of shareholders (Law on the Prevention of Money Laundering and Terrorism and Proliferation Financing, 2008). Hence, under the current normative regulation it is unclear what the competence of the Register of Enterprises is in registration of information on beneficial owners who happen to be sanctioned.

All the legal circumstances that need to be verified by the Register of Enterprises before any registration activity is made, are listed in Section 14, Paragraph one of the Law On the Enterprise Register of the Republic of Latvia. According to Clause 6 of the aforementioned norm, the state notary shall verify, whether “another legal impediment has not been registered in the Enterprise Register” (Law On the Enterprise Register of the Republic of Latvia, 1990). The notion of a legal impediment involves different means of security that may be applied decisions and orders of competent authorities or officials and that Register of Enterprises is obliged to register on the basis of Clause 3 of Section 4 of the aforementioned Law (Law On the Enterprise Register of the Republic of Latvia, 1990). However, the Law On the Enterprise Register of the Republic of Latvia neither separately categorises sanctions, nor expressly envisages whether sanctions are to be regarded as legal impediments or means of security.

The utmost issue at stake is the following: whether the Register of Enterprises has the right to interpret sanctions as being the means of security which prevent registration of information on beneficial owners who happen to be sanctioned. It should be noted that according to Section 10, Paragraph one of the State Administration Structure Law, “state administration shall be governed by law and rights. It shall act within the scope of the competence laid down in laws and regulations. State administration may use its powers only in conformity with the meaning and purpose of the authorisation” (State Administration Structure Law, 2002). Hence, the strict principle of separation of powers does not permit the Register of Enterprises to apply excessively free interpretation to certain legal notions. Nevertheless, to respond to the stated question above, it is necessary to study the practice of the Register of Enterprises in registering information on beneficial owners by examining actually received applications.

As a matter of fact, sanctions is an issue of particular novelty and topicality to all the public registers related to registration of ownership rights in any sense, including the Register of Enterprises. The latter has expressed a position that the Law on sanctions imperatively obliges any responsible institution to verify whether the person regarding which any registration activity is to be made is subject to international or national sanctions. Interestingly, the Register of Enterprises goes on to explain that such verification procedure should also apply to registration of the transfer of capital shares and registration of newly founded companies by authorised persons. Importantly, the Register of Enterprises notes that imposition of sanctions does not affect the duty of all legal persons to register their beneficial owners, i.e., the changes in information on beneficial owners should be registered in any case (Register of Enterprises of the Republic of Latvia, 2022). While such approach is definitely in accordance with the purpose of the AML Law which is inter alia aimed at full transparency of legal persons, it can be questioned whether registration of changes in information on beneficial owners within the framework of normative regulation should and in practice always does take place. After all, refusal to the transfer of capital shares inevitably lead to the issue of registration of beneficial owners.

The previously described position deserves a thorough analysis. Although the practice on the matter of sanctions is currently rather scarce, from the emerged cases one might see a direction of how sanctions are being interpreted by the Register of Enterprises. Thus, on 25 April 2022 the Chief State Notary of the Register of Enterprises adopted the decision No. 1-5n/100 to uphold the administrative act by which it was decided to refuse registration of losing the status of the beneficial owner and registering a new beneficial owner. The case involved transfer of ownership rights of the sanctioned beneficial owner within the chain of legal persons behind the company which applied for registration of changes to a new owner who was indicated as the new beneficial owner. The Register of Enterprises substantiated its decision by stating that the state institution is bound by the sanctions, fulfilment of which from its part would mean non-registration of the transfer of ownership rights of the person to whom sanctions have been applied (Register of Enterprises of the Republic of Latvia, 2022). Another argument for refusal of registration lied within the provisions of Cabinet Regulation No. 327 adopted on 9 July 2019 “Procedures for the Proposition and Enforcement of International and National Sanctions” which expressly stipulates in Clause 2.2. that the Register of Enterprises is one of the public registers responsible for enforcement of civil legal restrictions (Cabinet Regulation 327, 2019). Thus, it can be concluded that the Register of Enterprises interprets sanctions as a means of security when beneficial owners change on the basis of the transfer of capital shares or ownership rights thereto.

As it can be seen from the case in question, SIA “Riga Fertilizer Terminal”, i.e., the company applying for registering the changes in beneficial owners still has the same beneficial owner as initially registered on 21 June 2018 (Register of Enterprises of the Republic of Latvia, 2022). The practice of the Register of Enterprises is further strengthened by the decision of the Chief State Notary No. 1-5n/101 adopted on 27 April 2022. This decision which also upheld the administrative act on refusal to register losing of status of the beneficial owner on the basis of the transfer of ownership rights to the capital shares essentially contains the same argumentation (Register of Enterprises of the Republic of Latvia, 2022). It is also visible from the public register that with respect to SIA “VENTAMONJAKS”, the company at stake in the specific case, information registered on its beneficial owner has not changed since 4 September 2018 (Register of Enterprises of the Republic of Latvia, 2022).

Overall, current practice of the Register of Enterprises is insufficient to make comprehensive conclusions as to how sanctions are interpreted in every case. One thing, however, is clear – when it comes to losing of the status of the beneficial owner on the basis of transfer of capital shares or ownership rights thereto – sanctions are unequivocally regarded by the Register of Enterprises as a means of security. Thus, a statement that changes in information on beneficial owners shall always be registered is not absolute. Nevertheless, it can be concluded that by refusing to register information on sanctioned beneficial owners, the Register of Enterprises applies teleological interpretation method to legal norms covering the matter of sanctions. Given that grammatical, systemic and historical interpretation methods in this case are not enough, the Register of Enterprises is following the principle of reasonable application of legal provisions enshrined in Section 11 of the Administrative Procedure Law (Administrative Procedure Law, 2001) and teleologically interprets sanctions in conformity with the purpose of the Law on sanctions. Thus, the Register of Enterprises fills the notion of the legal impediment mentioned in the Law On the Enterprise Register of the Republic of Latvia by including sanctions therein.

As the war in Ukraine is ongoing, it is clear that the issue of sanctions will not lose its topicality in the months to come. The public registers responsible for registering ownership rights will face numerous legal issues when deciding how to fulfil sanctions. The Register of Enterprises on its part will be concerned with freezing of the status quo in enterprises where sanctioned persons are involved. In this regard, beneficial owners will remain one of the complicities, albeit not the only one. As the Ministry of Justice of the Republic of Latvia has noted, status of the beneficial owner on the basis of an ownership right is crucial because it reflects control not only over the capital shares but also over the whole property owned by the capital company. Consequently, publicly registered restrictions are necessary to prevent the use of economic resources as an analogue to monetary resources (Ministry of Justice of the Republic of Latvia, 2022). Nevertheless, it would be wrong to assume that complicity of fulfilment of sanctions regarding registration of beneficial owners is limited to the question of ownership rights.

Although the practice of the Register of Enterprises has made it relatively clear that registration of the changes in beneficial owners is to be refused if such changes involve losing of status of the beneficial owner due to transfer of ownership rights to capital shares, with a high likeliness, a whole range of other legal issues will emerge in no time. More specifically, the status of the beneficial owner does not only derive from a direct or indirect ownership right to capital shares. The list of possible types of control is by no means exhaustive and is nowhere to be found in the normative acts but, as seen in practice, control in a legal person may frequently be exercised on the basis of an authorisation agreement, through a legal arrangement, on the basis of business relationship, or via status in a legal person, for instance, as a member of executive institution (Register of Enterprises of the Republic of Latvia, 2022). Therefore, it is important to understand whether sanctions would apply as a means of security if beneficial owners exercising control in the legal person in any way other than that of an ownership right applied for registration of losing of their status.

It can be concluded from this research that provisions of the normative regulation and practice of the relevant state institution put together are still not enough for decisive determination of whether sanctions are to be considered a means of security or legal impediment doe registration within the meaning of the Law On the Enterprise Register of the Republic of Latvia. It is visible from the practice of the Register of Enterprises that sanctions are indeed interpreted as a means of security when it comes to registration of sanctioned beneficial owners and their ownership rights to shares. However, the fact that the Register of Enterprises refuses to register loss of status of the beneficial owner in cases of ownership rights does not necessarily mean that such practice will apply to losing of status of the beneficial owner with respect to all other types of control.

Consequently, the aim of the research has been reached. It has been substantiated that the legal framework with respect to the competence of the Register of Enterprises in fulfilling the civil legal restrictions imposed on natural persons who happen to be beneficial owners of legal entities is insufficiently elaborated. It does not specify what the place of sanctions in the verification process of documents is and, as a consequence, leaves excessive room for interpretation for the Register of Enterprises. This, on its part, makes the function of the Register of Enterprises gradually move from that of an executive institution to that of a partly judicial institution.

To counter legal challenges posed by latest global developments, it would be necessary to make amendments to the normative regulation. In particular, it would be useful to define sanctions as a means of security within the framework of the Law on the Enterprise Register of the Republic of Latvia and supplement Section 42 of the aforementioned Law with a provision which would envisage in which cases the Register of Enterprises shall refuse to register information on beneficial owners. That way, the competence of the Register of Enterprises on the matter of beneficial owners and their relation to sanctions would be clear and the overall purpose of the normative regulation on sanctions aimed at preventing relevant persons from escaping from sanctions would be fulfilled much more effectively.