Sanctions Relating To Trusts With A Russian Connection

All sanction “packages” can be broken down into two main types of actions. First, a list of designated individuals are subject to travel ban and asset freezing measures because of their role in the ongoing war or their support to the Russian government. There is no complete overlapping of these lists and as a result a person may be sanctioned in the US or Canada but not in the EU or vice-versa. This can of course create difficulties and confusion for practitioners who belong to groups or networks spanning across various continents and must thus comply with the sanction lists in force in the different jurisdictions where they operate.

The second type of sanctions do not address any specified individuals but impose restrictions on a number of commercial and financial activities with Russia in general. The EU trading sanctions in particular prohibit the export of a number of products to Russia, such as transportation equipment for the aviation and maritime industry, as well as the import of certain goods from Russia, such as crude oil and some petroleum products. At the same time, a package of financial sanctions cut out eleven Russian banks from the SWIFT international payment system and determined the freezing of the assets held by the Russian Central Bank. These sanctions were compounded by a prohibition to provide trust services as well as accounting, auditing, and legal services to entities with a Russian connection.

On 8 May 2022 the Office of Foreign Asset Control issued a Determination prohibiting US persons from providing accounting, trust and corporate formation or management consulting services to any person located in the Russian Federation.

A much more elaborate set of sanctions to this effect was enacted in the EU, where Regulation 2022/576 (the “Regulation”) was adopted on 8 April 2022 and went through several amendments, the last of which as at the time of writing was on 6 October 2022. Two articles in the Regulation concern these matters: Article 5m aims at trusts with a Russian connection and Article 5n (enacted on 3 June 2022) concerns accounting, auditing, advisory, legal, and other services.

Trusts with a Russian connection are those where at least one settlor or one beneficiary are Russian nationals or residents. Trustees operating in the EU have been prevented from offering their services to such trusts since 5 July 2022. The original deadline had been set on 10 May 2022 but a deferral was subsequently allowed as the European Commission was made aware of the practical difficulties that a trustee encounters to cease a trust relationship. Equivalent measures were enacted in Switzerland on 13 April 2022.

An important exception to this prohibition is the case where at least one settlor or one beneficiary of a trust is a national or the holder or a (permanent or temporary) residence permit in a member state of the EU, of the European Economic Area (EEA) or of Switzerland. A welcome clarification in this respect was provided by the European Commission in its Frequently Asked Questions (FAQ) on sanctions. The correct interpretation of the exception is that the prohibition does not apply if at least one settlor or one beneficiary of a trust is an EU national or resident, either permanent or temporary.

Even though the exception above may save a number of trusts created by Russian families and administered in the EU, there are certainly a number of cases where nobody is a national or a resident of the EU. In such cases the EU trustees must cease to provide their services. The main problem with this is that a trust relationship is not a contract that a party can terminate subject to a suitable notice period. A sole trustee continues to hold office until a successor takes over. Even though a trustee may wish to disentangle itself of a trust relationship - and may in fact be required to do so by law - it cannot do it unless a successor trustee is found. So long as a trustee continues to hold office, even though it may be unwilling to do so, it is bound by its fiduciary duties to the beneficiaries. In other words, so long as it holds office, a trustee must administer a trust in good faith and to the best of its skills for the benefit of its beneficiaries. The Society of Trust and Estate Practitioners (STEP) published a Position Paper to this effect as early as 21 April 2022, where it was pointed out that terminating a trust relationship is not an easy task and certainly not one which could be accomplished within the first deadline that had been originally established by the European Commission. A longer deadline was thus consented and an additional measure was introduced in order to allow the individual member states to extend their domestic deadline in order to accommodate the requirements of local trustees.

It is far from easy to identify non-EU trustees willing to take over trusts where the beneficiaries are all Russian nationals and residents. To the extent that the EU retiring trustee has the power to appoint a successor, it must be remembered that the new trustee must be at least as good as the retiring one for the purposes of the trust beneficiaries. EU trustees have therefore found themselves between a rock and a hard place. On the one hand, the newly enacted EU sanctions impose a ban on their services to all trusts with a Russian connection. On the other hand, in order to cease to provide trust services such trustees have to be replaced by new ones which should prove to be suitable to the beneficiaries. A failure in this respect could be a breach of trust by the retiring trustees which may involve their own personal liability to the beneficiaries.

In fact, not every trust instrument allows a trustee to retire and appoint its successor. In many cases the appointment of new or additional trustees is a power vesting in another officer, the protector, or the settlor. If these power holders are unable or unwilling to appoint a new trustee, the original one continues to hold office irrespective of the sanctions in the EU Regulation.

The only available alternative for an EU (or EEA or Swiss) trustee if no successor can be found may be to terminate the trust and distribute the entire trust fund to the beneficiaries. Most trust instruments confer a discretionary power to distribute the trust income and corpus on the trustee, sometimes with the protector’s consent. Even in this case, though, the power must be exercised in the best interests of the beneficiaries and not only in that of the retiring trustees. Litigation appears to be under way in some cases where the beneficiaries of a trust have challenged the trustee’s attempt to distribute the entire trust fund to them and thus bring the trust to an end.

The dynamics between a trustee’s obligation to comply with the law of its country of residence, including the sanctions against Russia, and its fiduciary obligations to the beneficiaries can pose some intractable problems to any trustees who find themselves in such a situation.

It is perhaps for this reason that the Liechtenstein Financial Intelligence Unit (FIU) published in its FAQ to the Russian sanctions a statement that Liechtenstein foundations are not trusts and as such are not caught by the sanctions even though there may be a Russian connection and no exception can be relied upon based on the nationality and residence of the beneficiaries.

After World War One the US President Woodrow Wilson is credited to have stated that sanctions are a terrible remedy that does not cost a life outside of the nation boycotted but it brings such a pressure that no modern nation could resist it. The facts of the Second World War proved that such statement was perhaps overly optimistic. On this basis one could also question the effectiveness of the EU sanctions against trusts with a Russian connection. To be sure, this comment does not concern sanctions in general and their ability to stop the war but only the specific sanctions against trusts with a Russian connection. These sanctions are hardly viable in practice because a trustee can only retire and cease to hold office when a successor takes over. Even though this transfer of trusteeship were possible, an important question should be answered: is it really desirable from a policy perspective to have these trusts transferred to other jurisdictions outside of the EU (and of most Western nations) where no comparable sanctions have been enacted nor can be expected to be enforced in the foreseeable future? The alternative to terminate the trust and make the resources directly available to the Russian national and resident beneficiaries poses a similar question from a policy perspective.

It is perhaps for this reason that the UK, which has a higher familiarity with trusts than the EU, despite announcing similar measures has not implemented them so far.

Perhaps it would have been easier and more appropriate to impose a ban on any trust distributions to Russian nationals and resident beneficiaries who are not EU nationals or residents. A licensing system could have been enacted in a similar way to the designated individuals in the sanctions lists. That would have ensured that the trust assets remained under the control of EU trustees where they could have been more easily located and even frozen if necessary.

On this basis, one can only hope that this war will end soon and the sanctions will no longer be necessary as a result.

Paolo Panico
Paolo Panico is a solicitor in Scotland and a director of Private Trustees SA, an independent trust company in Luxembourg, and of Teton Trust Company LLC, a regulated trust company in Wyoming (USA). Paolo is chairman of the STEP Europe Region and a member of the Council and Board of STEP Worldwide as well as deputy chairman of the International Tax Planning Association (ITPA). Paolo teaches at the Master in Wealth Management of the University of Luxembourg and at the LLM of the University of Liechtenstein. His publications include: Private Foundations. Law and Practice (Oxford University Press, 2014), International Trust Laws, 2d ed (Oxford University Press, 2017), and as editor Beneficial Ownertship Registers: The STEP Handbook for Advisers (Globe Law and Business, 2021) and Trust Laws in Cyprus: An International Perspective (Globe Law and Business, 2022).