Fundraising: Sanctions – Export Controls and Trade and Investment Sanctions

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Author: Alexandra Woodcock Partner | Mourant Ozannes (Cayman) LLP, Sara Galletly Partner | Mourant Ozannes (Cayman) LLP, Alex Last Partner | Mourant Ozannes (Cayman) LLP and Finn Howie Counsel | Mourant Ozannes (Caimans) LLP

Following the Finance Fund Friday articles from March 11 and May 13, which examined the sudden escalation of sanctions measures in the wake of Russia’s invasion of Ukraine and associated issues being considered by lenders in the fund financing space, this article focuses on the current situation in the Cayman Islands and some of the issues that Cayman Islands funds face in practice.

The Cayman Islands Sanctions Framework

While sanctions may be imposed domestically in the Cayman Islands, in practice the financial sanctions in force in the Cayman Islands are essentially those in force in the United Kingdom. UK policy is to ensure that British Overseas Territories such as the Cayman Islands are legally and practically permitted to implement UN and UK sanctions to ensure compliance international. This is mainly achieved through the extension of UK sanctions measures to the Cayman Islands, with some modifications.

While other non-UK sanctions regimes, such as those of the United States and the European Union, do not apply to the Cayman Islands in law, these regimes can have far-reaching extraterritorial impact and can still be applicable. Consequently, many Cayman Islands funds choose to monitor and comply with non-UK sanctions in practice, particularly the US regime administered by the Office of Foreign Assets Control (“OFAC”). This may be necessary in situations where there is jurisdictional overlap between different regimes due to the structuring of a fund and the underlying transactions. These waters can be difficult to navigate and, in particular, there are areas where the UK/Cayman Islands regime differs from the US/EU sanctions regimes.

Aggregation of holdings of separate sanctioned investors

One such area is aggregation, which is when a fund has more than one sanctioned investor/sponsor, none of whom individually “owns or controls” the fund for the purposes of the relevant legislation.1 The Cayman Islands follows the UK’s position here, with the Office of Financial Sanctions Implementation (“OFSI”) recently updating its guidance to clarify that in an assessment of ownership and control, the OFSI would not automatically consolidate the assets of sanctioned persons into a fund; there must be evidence of a joint agreement between those parties, or evidence that a sanctioned person controls the fund for the purposes of applicable sanctions law.2 Notably, this differs from the US and EU sanctions regimes, both of which aggregate the holdings of multiple sanctioned individuals into a fund to determine whether the ownership threshold has been met.

Actions required

The Cayman Islands Anti-Money Laundering and Anti-Terrorist Financing regime requires applicable sanctions lists to be checked frequently to determine whether a fund maintains accounts or holds funds or economic resources for designated persons or entities. , either directly or indirectly. The fund must address the ultimate beneficial owners of their clients/direct investors. In practice, this “cleaning” of sanctions lists is often done through a third party service provider or as part of the compliance function within larger or more sophisticated fund managers.

In the event of sanctions, the fund is required to:

  • Freeze: freeze all accounts, other funds or economic resources (the terms of which are extremely broadly defined) that are held or controlled by designated persons or entities;

  • No transaction: refrain from dealing (also extremely broadly defined) with the funds or assets, or making such funds or assets available (directly or indirectly) to, or for the benefit of, the designated person or entities, unless that an appropriate license is held;

  • Report: report any findings to the Cayman Islands Financial Reporting Authority (the “FRA”) as soon as possible by completing and submitting a Compliance Statement Form in the prescribed form;3 and

  • SAR: consider whether a Suspicious Activity Report (“SAR”) should also be sent to the FRA.4

What is an asset freeze?

In the context of a fund, an asset freeze means that the fund cannot make any redemptions, withdrawals or transfers, nor make any distributions in respect of the frozen interest; nor can the fund accept additional subscriptions or make capital calls to the investor concerned. In addition, the fund must not otherwise modify, move or allow the designated person to access or receive the benefit of the investment. Additional complexities may arise in practice, depending on the precise terms of an investment fund, in determining how far an “asset freeze” may extend and what actions, such as payment of fees, may be permitted at fund level. However, where a designated person holds a minority stake in a fund, the impact on day-to-day operations can be expected to be minimal.

Impact on underwriting credit facilities

Most credit agreements will also include express representations and covenants that require the borrower to actively monitor the risk of sanctions at the investor level, where it is possible that persons controlling persons or officers or employees be sanctioned. Although the language of sanctions is often negotiated with input from expert counsel, the term “sanctions” is generally defined broadly to include all economic or financial sanctions imposed, administered or enforced by any governmental authority. having jurisdiction over the borrower or its affiliates, including OFAC in the case of US sanctions and OFSI in the case of UK and Cayman Islands sanctions.

The exact wording of these penalty provisions should be considered on a case-by-case basis. Sanctions provisions may not necessarily be breached solely because an individual non-controlling/minority investor in a fund is subject to sanctions. However, when an investor in the fund is sanctioned, the borrower will have to take active steps to ensure that they remain in compliance with these contractual provisions, which can lead to difficulties in practice. In particular, a typical sanctions clause will strictly prohibit any proceeds from a sanctioned transaction from being used to repay advances under the facility, and will prohibit any proceeds from the facility from being made available (directly or indirectly) to anyone sanctioned.

In any event, both lender and borrower should bear in mind that under a typical credit arrangement, a sanctioned investor (including those with a minority stake) will likely incur, at a minimum, the exclusion of this investor from the borrowing base (by becoming an “excluded investor” or according to a similar definition). In turn, this can trigger a prepayment requirement if the borrowing base is exceeded.

General license to lighten the position

That being said, there are reasons why a Cayman Islands fund would want to bring a named person out of the structure, including due to the nature of the other investors in the vehicle and reputational or perception issues, or due the impact on existing conditions. installation requirements. Currently, a compulsory transfer cannot be carried out without a specific license for this vehicle and the authorization process is, at this stage, uncertain and time-consuming.

However, discussions are ongoing between the FRA and the UK authorities regarding the granting of a general license which would allow Cayman Islands funds to carry out redemptions or squeeze-outs from frozen investors and place the proceeds on a blocked account. If issued, such a license will provide operators and managers of funds with frozen investors (including funds with majority frozen investors, which are themselves subject to sanctions) a path to improve the position of the fund (and its remaining investors) and remedy any technical breaches of the terms of the credit facilities.

It is expected that any such license would be for an indefinite period, which would require the funds concerned to act within a certain period of time. Therefore, it is essential that fund promoters and their advisors keep abreast of these developments.

Footnotes

1. Under the Russia (Sanctions) (Leaving EU) Regulations 2019, an entity is “owned or controlled, directly or indirectly” by another person if:

  • the person owns (directly or indirectly) more than 50% of the shares or voting rights of an entity;

  • the person has the right (directly or indirectly) to appoint or remove the majority of the members of the entity’s board of directors; Where

  • it is reasonable to expect that the person (if he/she so chooses) would be able, in material respects, by any means whatsoever and whether directly or indirectly, to obtain the result that the entity’s affairs are conducted in accordance with its wishes.

2. Paragraph 4.1.4, OFSI General Guidance – UK Financial Sanctions.

3. Available on the FRA website here.

4. It should be noted that suspicious activities are reported to FRA in a different format than sanctions-related reports; the SAR form prescribed by the FRA is available on the FRA website here.

The content of this article is intended to provide a general guide on the subject. Specialist advice should be sought regarding your particular situation.

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