Introduction
Last week, we discussed the pyrrhic victory recorded by the federal government over the stay of execution by the UK court. Also, we considered some of the legal arguments advanced by pro-government advisors. Today, we shall conclude our discourse on this very disheartening event and watch how the federal government will wriggle out of this mess. I have, in earlier editions, already copiously advanced and proffered my humble solutions to the way out of this apparent cul-de-sac.
U.S. Law: The Foreign Sovereign Immunities Act of 1976 (continues)
FSIA defines “foreign state” broadly, and extends immunity not just to the sovereign nation state, but also to its political subdivisions, agencies and instrumentalities. “Agencies and instrumentalities” include (i) any separate legal entity (ii) that is (or is majority-owned by) an organ of a foreign state or political subdivision, and (iii) that is created under the laws of that foreign state. The net effect of these broad definitions is that sovereign wealth funds may be entitled to immunity from suit under FSIA.
FSIA recognizes numerous exceptions to immunity from suit, however. Three of those exceptions are particularly relevant for funds and their investors – and only one need apply for the suit to proceed:
Commercial activity
An otherwise immune state entity can be sued in a U.S. court if the action is based upon a commercial activity with a sufficient nexus to the U.S. Investing in a private equity fund has been recognized as a “commercial activity” under FSIA, and a failure to make a payment in the U.S. may be sufficient to permit the suit.
Waiver
A state entity can waive its immunity under FSIA either explicitly (e.g., in a side letter) or by implication (e.g., by filing a responsive pleading in an action without raising a defense of sovereign immunity).
Arbitration
If a state entity has consented to arbitration, it may be subject to a U.S. court action brought to enforce an arbitration agreement or to confirm an arbitration award.
The scope of immunity from enforcement is somewhat different. Where FSIA treats foreign states and their instrumentalities roughly the same for purposes of immunity from suit, for enforcement, property owned directly by the state is treated differently from property owned by its agencies. A judgment can only be enforced against the property of the foreign state, if the property at issue is “used for commercial activity” – a definition which has not been fully developed as it applies to funds. Enforcement against the assets of agencies or instrumentalities, by contrast, looks to the actions of the entity, not the use of the targeted asset: the entity must be generally “engaged in commercial activity.” Even if these requirements are satisfied, enforcement may not proceed unless an exception applies. Again, these exceptions vary depending on whether the property subject to enforcement belongs to the foreign state or to an agency or instrumentality. Finally, the FSIA provides that the property of a foreign central bank or monetary authority “held for its own account” is immune from enforcement unless the entity, or its parent foreign state, has explicitly waived its immunity from enforcement. In other words, even if a fund secures a successful judgment or award against a foreign central bank or monetary authority, it will be virtually impossible to enforce that judgment unless the investor or its parent state has waived its right to immunity from enforcement.
English Law: State Immunity Act of 1978
English law is similar to FSIA, but contains some differences worth noting in the investment context. The relevant statute in the United Kingdom is the State Immunity Act of 1978 (“SIA”), which has been extended to numerous territories that follow English law, including the Cayman Islands and the British Virgin Islands.
SIA provides that foreign states, including their heads of state, government, and governmental departments, are immune from suit in the UK courts (or the courts of the jurisdiction that has adopted the SIA). Sovereign immunity under SIA also extends to “separate entities” (i.e., bodies distinct from the executive organs of the government of the state and capable of suing or being sued, such as certain sovereign wealth funds), if the proceedings against the entity relate to its exercise of sovereign authority and the circumstances are such that the State itself would have been immune. By tying immunity to the nature of the action, rather than the quasi-governmental nature of the actor, SIA allows for a more limited form of immunity than FSIA.
SIA also recognizes three exceptions to immunity that are particularly relevant to private equity funds, although with slight differences in scope from the exceptions under the FSIA. Specifically:
Commercial transactions
In proceedings related to a commercial transaction, the state entity is not immune and can be sued, unless the parties have agreed otherwise in writing. As drafted and interpreted, this exception potentially applies to investments in a private equity fund, but there is little caselaw on point.
Waiver/consent
As with FSIA, immunity under SIA is waivable. Roughly speaking, a state entity may waive immunity from suit by (i) prior written agreement (e.g., side letter), (ii) instituting proceedings without claiming immunity, (iii) submitting to jurisdiction as a defendant in a suit and (iv) intervening in or taking any steps in any suit (other than for the purpose of claiming immunity).
Arbitration
Under SIA, an agreement to submit a dispute to arbitration can constitute a waiver of immunity from suit for matters related to the arbitration.
The exceptions to immunity from enforcement under SIA are narrower than those relating to immunity from jurisdiction, and also somewhat narrower than the equivalent exceptions under FSIA. Under SIA, an action to enforce a judgment against the assets of an otherwise immune state entity requires (i) consent to enforcement (consent to suit is insufficient), or (ii) enforcement against property used or intended for use for commercial purpose. As under the FSIA, the particular use or intent of property is a fact-specific inquiry, and whether a fund capital commitment would constitute such property has not been fully resolved. The SIA explicitly provides that the property of a sovereign’s “central bank or other monetary authority” held for its own account is not in use for commercial purposes and cannot be enforced against absent consent. Sovereign wealth funds are not explicitly addressed in the statute.
Foreign states v. U.S. states
Sovereign immunity extends not just to foreign sovereigns, but to U.S. states and their agencies and actors, which are protected from suit by the Eleventh Amendment to the U.S. Constitution. Whether any particular state actor qualifies as an “arm” of the state and immune from suit is a complex and fact-specific question, but a number of states’ employee retirement plans have been found to meet the test and be presumptively entitled to sovereign immunity.
Unlike FSIA and SIA, the Eleventh Amendment does not distinguish between immunity from suit and from enforcement, and does not provide any direct exception from immunity for acts involving a “commercial activity.” A State may engage in commercial activity – including investing – without giving up its protection from suit. A state may waive immunity, however, either with a one-off agreement (e.g., in a side letter), through more generally applicable action (e.g., by passing legislation waiving immunity for a certain category of disputes) or by failure to assert it in the context of a particular litigation.
State and local governmental investors commonly request that any suit related to their investment in a fund be brought only in their home state courts, often because of state legislation permitting limited waiver of immunity for commercial disputes. For funds with such investors from multiple states, however, this approach presents significant challenges.
Final thoughts and practical considerations
While a full analysis of sovereign immunity requires careful attention to particular facts, two considerations are fundamental at the time of the investment. One is the court chosen by the parties to determine any disputes. Understanding – in more detail than can be presented here – the particular requirements and limitations of sovereign immunity under the law of the jurisdiction where the dispute is to be determined is essential to understanding the scope of legal recourse if a dispute arises. The second is the possibility of waiver. If immunity exists, it can be addressed in negotiations, and a carefully drafted waiver clause in the relevant transaction documents can make the parties’ agreement as to immunity clear and enforceable.
For funds, it’s also important to remember that the sovereign immunity doctrine discussed here governs the prosecution of legal actions and the judicial enforcement of judgments. In a private investment, other methods of recourse may be available, including “self-help” remedies built into the fund documentation, and may be drafted in such a way to avoid questions of immunity altogether.
(Concluded)
Thought for the week
“A good attitude is really important. And a sense of optimism, someone who has ideas and isn’t afraid to pitch them no matter what level she is. Someone who is proactive. Someone with efficiency and common sense. They don’t always go hand-in-hand, common sense and, well, everything else.” (Eva Chen)