EU Clarifies Russia Due Diligence Expectations for Parent Companies

The FAQs, released by the European Commission Nov. 22, offer guidance on a new requirement included in the EU’s 14th sanctions package from June, which calls on EU parent companies to take “best efforts” to make sure their third-country subsidiaries aren’t participating in activities that enable sanctions evasion (see 2406240024).

Although the EU’s due diligence expectations for European businesses can depend on the types of products the company sells and its size, the FAQs say EU-based parent companies, at a minimum, may need to meet certain compliance thresholds to ensure their subsidiaries comply with sanctions against Russia and Belarus.

“[E]ven if an operator is relatively small in size,” the EU said, “that it operates in a highly regulated sector with abundant compliance resources means that substantial actions are to be expected.”

Europe-based lawyers said they have been receiving questions from clients who are concerned the “best efforts” requirement is vague and are unsure about the specific steps they need to take to comply (see 2411210009). The FAQs say those steps depend on the market the company operates in, its “risk profile,” its profit turnover, its number of staff, the “compliance resources available” to it, and more.

The FAQs say parent companies should “ensure their awareness of the activities conducted” by their non-EU subsidiaries and how those activities could undermine EU sanctions. This may require the parent company to set up sanctions compliance program controls within their subsidiaries, send them “newsletters and sanctions advisories,” set up “mandatory reporting” or require sanctions training for staff, and put in place procedures to “rapidly react to sanctions violations,” including by reporting them to the EU parent company. The subsidiary can also publicly announce its “intent not to engage in any” sanctions evasion activities, the FAQs said.

When assessing whether the EU parent company took “best efforts,” the commission said it also will take into account how much control the parent company had over its non-EU subsidiary. It acknowledged that the laws of a third country may block some parent companies from exercising control over their subsidiaries.

“Where control is entirely absent,” the FAQs said, “the EU operator cannot be expected to have any power to prevent that the non-EU entity that it owns participates in activities that undermine the sanctions.”

But the EU stressed that this “mitigation of liability” doesn’t apply to situations in which “control over the non-EU entity is lost for reasons that the EU operator caused itself.” It added that Russia is a country where the “rule of law is virtually not applied anymore,” pointing to Russian laws that allow the government to take over assets “associated” with companies from “unfriendly” foreign states.

“In such circumstances, inadequate risk assessment and management, coupled with risk-prone decisions of the EU operator, can be considered as a factor that contributed to the loss of control,” the EU said.

The FAQs also say an EU parent company “cannot be considered” to have carried out “best efforts” to prevent sanctions evasion by its non-EU subsidiary if the parent company is aware and “accepts” that its subsidiary is undermining EU sanctions. It also said EU parent companies may not be able to use a lack of knowledge about their subsidiary’s activities as a defense, especially in cases where the parent company “failed to carry out appropriate due diligence.”

That due diligence “includes ensuring their awareness about the activities of non-EU entities that they own or control,” it said.

The guidance also addresses whether an EU parent company would be violating the “best efforts” requirement if its subsidiary in Russia or another third country produces or exports goods that end up in Russia. The EU said that may be a violation only if the goods were subject to trade controls and first produced or transferred from the EU parent company.

If the parent company “does not act to prevent such supply,” then it “cannot be considered to have performed all actions necessary and feasible to prevent the undermining of EU sanctions,” the FAQs said.

The EU also said the “timing of the transfer” of those goods “is not relevant” to whether a violation occurred. Even if the goods were transferred before sanctions or export controls over those goods took effect, “the undermining of sanctions by a non-EU entity on the basis of that prior transfer would render the EU operator owning or controlling the entity in violation,” the EU said.

The EU said it's working to provide more guidance to companies.

“The Commission will engage with Member States towards preparing a clear set of expectations for EU operators, thus enabling the latter to comply with their obligations and ensuring a level playing field across the EU.”