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Recent Developments in Key Legal Issues of International Reserves Investments
November 16, 2010
Posted November 19, 2010
Thomas C. Baxter Jr., General Counsel and Executive Vice President
Remarks at the Central Reserve Bank of Peru on the Foreign Sovereign Immunities Act and Central Bank Immunity in the United States
Let me begin by thanking Manuel Monteagudo, a dear friend and colleague, and the Central Reserve Bank of Peru for inviting me to speak and for hosting this important conference.
My task is to discuss the Foreign Sovereign Immunities Act (FSIA or Act), which provides specific immunity protections for central banks. I believe that central bank immunity generally, and the topic of this conference more specifically—legal aspects of central banks' reserve investments—is both timely and deserving of attention.
Our present situation has brought new challenges. In the emerging markets, some countries have experienced sovereign default and the attention of litigious and sophisticated investors looking to realize on the debt of the defaulted sovereign. In more mature markets like the United States, which is recovering from the worst financial crisis since the 1930s, the importance of foreign investment has been reaffirmed and our fiscal deficit relies on foreign investment. Emerging and mature markets share a common interest in trying to ensure that central banks invest their international reserves in a manner that is appropriate and safe. Concern about reserve management arises from the public nature of the reserves, and from the unique position of the central bank as an instrumentality of a sovereign state.
In some ways, central bank reserves are like a nation's savings account. On a personal level, most of us want to protect the security of our savings, because that savings enables us to achieve future goals, such as the purchase of a home or the education of our children and provides a safety net for the unforeseen, such as unemployment, illness and even death. For the same reasons, central bankers worry about the safety and liquidity of their national reserves.
In my view, central bank attorneys play a key role in ensuring that central bank reserves are kept safe and secure. A legal advisor who is counseling a client contemplating a transaction, including an investment, should provide advice about how to structure the transaction to minimize, to the extent appropriate, the risk of loss. An accurate understanding of legal risk is one factor in evaluating the overall risk of any given investment. For a central bank, especially a central bank from a jurisdiction that might be the object of unwelcome attention from creditors or other litigants, this legal risk might be critical. All of the work involved in the painstaking selection of an appropriate investment comes to nothing if that investment can be tied up in litigation, or worse, if the investment is seized to satisfy a judgment.
With respect to legal risk, and I do not mean to sound like an advertising executive here, the legal climate in the United States is welcoming to central bank investment. The stability of the U.S. dollar and its role as the principal reserve currency is one key aspect of this. Other economic considerations center on the highly developed nature of U.S. financial markets, providing a range of investment products that can generate a safe and appropriate yield for central bank dollar reserves.
U.S. Treasury securities, to use the classical example, are among the safest and most liquid investment vehicles in the world.1 I will not focus any further on the attributes of the United States as a place to invest reserves, or the diversity of available investment products, because these are subjects better left to economists and investment specialists. My topic is the U.S. legal infrastructure, and my message is that the legal environment in the United States is designed by Congress to incent central banks to place dollar reserves in the United States.
That said, the protections afforded by the statute should not give rise to complacency on the part of central bank attorneys. Notwithstanding the protections of the FSIA, central banks have occasionally been unpleasantly surprised when drawn into litigation in the United States. While the protections of the FSIA are considerable, they are not absolute and must be managed by informed legal advisors. For example, the FSIA does contemplate that many of its protections can be waived, either through explicit agreement or implicitly, through conduct.
Making one's way through the FSIA's provisions can be daunting. Judges in the United States have called the FSIA "remarkably obtuse," a "statutory labyrinth," with a "bizarre structure," and "deliberately vague provisions."4 In light of those remarks and the complexity of the Act, specific problems regarding application of the FSIA are best addressed in consultation with U.S. counsel. My first recommendation to you is to retain such counsel if it should happen that your central bank is served with a complaint in U.S. litigation, or alternatively, if you learn that your central bank's property in the United States has been restrained. But, you want to be an educated consumer of U.S. legal services. For that reason, I will now provide an overview of the Act, focusing on those aspects that have the greatest practical application for central banks.
One of the key features of the FSIA is that it defines two types of immunity: immunity from the jurisdiction of the U.S. courts, and immunity from the remedies of attachment or execution.5 "Jurisdictional immunity" means immunity from suit in U.S. courts. A foreign entity that enjoys jurisdictional immunity cannot be forced to defend itself in a lawsuit brought in a U.S. court (other than those minimal actions needed to establish its immunity). "Immunity from execution" means that assets cannot be used to satisfy a judgment. A foreign entity with immunity from execution can protect its U.S. assets from judgment creditors, even though it may have litigated and lost a suit in a U.S. court. The Act establishes different, but related rules governing each type of immunity.
To reinforce just how important this distinction is, consider two different conditions. In the first condition, your central bank has no property in the United States. Can your central bank nonetheless be subject to jurisdiction under the FSIA in litigation in a U.S. court? The answer is clearly "maybe." In the second condition, your central bank has property in the United States, let us assume in an account at the Federal Reserve Bank of New York. May your central bank's investment in the account be seized through legal process known as a writ of attachment or execution? The answer is probably "no," but there are actions that may foster a more definitive answer, either affirmative or negative.
While the courts do not always provide uniform interpretations of this definition, most central banks would be considered "instrumentalities" of their governments under the FSIA.8 Those central banks that have a separate legal identity from their governments are predominately or entirely government owned.9 Moreover, an entity which performs central banking functions would probably be considered an organ of the government, at least with respect to its performance of those functions.10
Indeed, when Congress enacted the FSIA, it expressly included the central bank as an example of an entity which would qualify under the definition of "instrumentality" of the state.11
Now, I have little hesitation in saying that a central bank will likely qualify as an instrumentality of a foreign state. However, a U.S. court will not presume such legal status and it is important for you to establish your status as an instrumentality if you are sued. Our courts have cautioned that, before immunity will attach, the defendant has the burden of showing that it is a foreign state, or an instrumentality of a foreign state.12 In one notable case, a default judgment was entered against a central bank that did nothing in response to legal process.13
The most significant exception to jurisdictional immunity for our purposes is the commercial activity exception contained in Section 1605(a)(2) of the Act. Under this exception, a foreign state is not entitled to jurisdictional immunity if the case arises from:
The FSIA provides that a court should look to the "nature" as opposed to the "purpose" of the conduct, in deciding whether the conduct is commercial.14 Thus, the fact that a particular transaction may eventually further a public goal is not relevant to deciding whether the transaction is a "commercial activity" under the Act.
Instead, a court will look at whether the conduct is essentially commercial, whatever its underlying motivation. Congress intended for U.S. courts to have considerable discretion in applying the "commercial activity" standard.15
The U.S. Supreme Court articulated its understanding of the commercial activity standard in a case called Republic of Argentina v. Weltover.16 The facts at issue in Weltover concerned bonds issued by the Republic of Argentina and payable in U. S. dollars, an offering done to cover a shortage of foreign exchange reserves.
When the bonds began to mature, Argentina found that it did not have sufficient dollar reserves to pay them. Acting under a Presidential Decree, Argentina unilaterally extended the time for payment and offered bondholders substitute instruments in a form of debt rescheduling.17 Two bondholders were dissatisfied with this arrangement, and sued Argentina and its central bank in the U.S. courts. The Supreme Court held that Argentina's issuance of the bonds fell within the commercial activity exception, because the bonds were essentially "garden variety debt instruments" and were payable in New York.18 Consequently, the Republic of Argentina enjoyed no jurisdictional immunity in this situation.
According to the Supreme Court in Weltover, "commercial activity" is any activity which could be performed by a private party engaged in "trade and traffic or commerce."19 The Court's rationale is instructive:
This reasoning is consistent with the underlying purpose of the FSIA, which is intended to extend immunity to foreign states for sovereign actions, but not when state actions are commercial or private.21
Weltover can have surprising applications. Central bankers, for example, think of measures taken to invest dollar reserves as classically sovereign activity, because these investments are done for public purposes. Yet, the nature of the investment will be commercial. The Supreme Court did not quarrel with the fact that Argentina was acting in furtherance of a public purpose in issuing the bonds, but that was not determinative of immunity. Instead, a State's entitlement to immunity will depend on the nature of the actions it takes to further its admittedly public purpose. For example, if Argentina had issued regulations imposing fees for the conversion of foreign reserves, that act would not have been commercial activity, because private actors do not regulate.22 Following Weltover, it seems clear that a foreign state issuing debt which is to be paid in the United States would be held to be engaging in commercial activity within the meaning of the FSIA.
The second important exception under the FSIA is waiver.23 The FSIA provides that jurisdictional immunity may be waived by an agency or instrumentality of a foreign state, either expressly or implicitly. Generally, situations where an entity is held to have implicitly waived its immunity from suit in U.S. courts include those where:
Courts in the United States have construed the waiver exception narrowly, and have generally limited the exceptions to the situations described above.24 Let me caution you that, to avoid an unintentional waiver of central bank immunity, you obtain adequate legal review of any agreement that relates to the United States.
As central bank attorneys, you may be thinking that the exceptions within the FSIA, principally the commercial activity exception, swallow the general rule of immunity. Many functions of a central bank (excluding regulation and supervision) are commercial in nature. Further, you might be concerned, and understandably so, that central bank investment activities in the United States would be viewed as commercial by a U.S. court. But the FSIA has provisions that create special protections for central banks beyond the protections afforded to foreign states, and these are important to your mission in protecting your national savings.
Remember, up until this point, we have been discussing only jurisdictional immunity, which refers to the ability of a foreign state to prevent a litigant from forcing it to defend a suit in U.S. courts.
The FSIA's provisions governing immunity from attachment and execution are parallel to those we have just discussed governing jurisdictional immunity. Section 1609 states a general rule of immunity, which is followed by exceptions set out in Section 1610. Section 1610 authorizes attachment or execution against the property of a foreign state that is used for commercial activity in the United States where the foreign state has waived immunity from attachment or execution.25 It is noteworthy that even where a foreign state has waived its immunity, its property will not automatically be subject to attachment or execution under Section 1610. Before permitting attachment or execution of a foreign state's property, U.S. courts require a showing that the property in question is located in the United States, and was used for commercial activity in the United States at the time the writ of attachment or execution was issued.26
The Act also has a provision specifically protecting the property of central banks. This is Section 1611(b)(1), which provides that, notwithstanding the exceptions to sovereign immunity from attachment and execution in Section 1610:
If you remember anything I say today, remember that Section 1611(b)(1) provides highly potent protections for central bank property in the United States.
First, Section 1611(b)(1) contains no exception for commercial activity. If such an exception existed, and it does not, the exception would overwhelm the rule because a central bank's investment or asset account will always look commercial in character. It would be impossible to distinguish a central bank's conduct as investor from that of any private investor. The power of Section 1611(b)(1) is that it does not depend on the distinction between commercial, on the one hand, and governmental, on the other.
The second significant feature of Section 1611(b)(1) is that it does not enable a central bank to waive its immunity from prejudgment attachment of assets. To appreciate this nuance in the statutory language, Section 1611(b)(1) must be read in conjunction with Section 1610(d), which does permit foreign states to waive immunity from prejudgment attachment.27 U.S. courts that have considered the question of prejudgment attachment under the FSIA have concluded that the Act does not permit a waiver of immunity from prejudgment attachment for central bank assets.28
Congress recognized the potentially disruptive effect of prejudgment attachment for central banks when it chose not to provide for a waiver of prejudgment attachment. Immunity from prejudgment attachment is a highly significant advantage for central banks that wish to invest funds in the United States. Prejudgment attachment allows a plaintiff to encumber funds before the legal theories and proof are tested in a courtroom. We can all imagine what an attractive target central bank reserves must present for a plaintiff seeking to realize on what he hopes will be a substantial judgment. Given this, without the beneficial protection conferred by Section 1611(b)(1), central banks could find their assets tied up in litigation. From a policy perspective, a license to hunt down central bank assets would be unacceptable due to the significant U.S. interest in encouraging U.S. investment by central banks, and to the foreign interest in protecting national savings.
A third feature of Section 1611(b)(1) is its requirement that any waiver permitting execution against central bank property be explicit. The significance of this provision is that it allows central banks to maintain strict control over the situations in which they choose to waive immunity. My advice to central bank attorneys who are drafting or reviewing agreements for their banks is to have any waiver language reviewed by U. S. counsel familiar with recent decisional law on this issue.
How do central bank lawyers become comfortable that their bank's assets enjoy the protection of Section 1611(b)(1)? Section 1611(b)(1) provides immunity from attachment or execution to all property "of a foreign central bank or monetary authority held for its own account." There are two parts to this requirement. First, the entity seeking protection for its assets must be a "central bank" or "monetary authority." While we may think that the meaning of these terms is obvious, there is considerable diversity from country to country, and there are some unusual cases. The FSIA itself contains no definition of the two terms, and U. S. courts have rejected some entities claiming to be central banks.29
The second part of what is required to qualify for protection under Section 1611(b)(1) is that the funds for which protection is sought must be "held for [the entity's] own account." The FSIA, however, does not define the phrase "held for its own account." Some courts in the United States have applied what is known as the "central banking functions test" to analyze the phrase "held for its own account."30 This test requires an inquiry into whether the property in such account was held or used in connection with "central banking activities."
There is a case currently pending in New York with respect to the applicability of Section 1611(b)(1) that merits discussion. That case is E.M. Ltd. v. The Republic of Argentina. In this case, the holders of defaulted bonds issued by the Republic of Argentina obtained judgments against the Republic in a United States district court, but could not collect on those judgments because the Republic did not have attachable assets in the United States. In an attempt to collect on those judgments, the bondholders have twice brought legal proceedings seeking to attach the reserves of the Central Bank of Argentina on deposit at the Federal Reserve Bank of New York.
The bondholders' initial effort to attach central bank reserves in New York was unsuccessful. The bondholders claimed that an Argentine Presidential Decree directing the use of central bank reserves to repay the Republic's debt to the International Monetary Fund (IMF) converted all central bank reserves into attachable assets of the Republic.31 The district court denied the bondholders' motion, and the court of appeals affirmed, finding that the reserves were immune from attachment under the FSIA. Because the bondholders did not challenge the separate juridical status of the central bank, the reserves were found to be property of the central bank "held for its own account" under Section 1611(b)(1) of the FSIA.32 In addition, the payment to the IMF was held to be a sovereign, rather than a commercial, activity under Section 1610 of the FSIA.33
When their initial attempt to attach central bank reserves was denied, the bondholders filed another motion—this time alleging that the central bank is the alter ego of the Republic, and that its reserves on deposit at the Federal Reserve Bank of New York are property of the Republic that should be attached to satisfy judgments against the Republic.34 This motion is currently the subject of ongoing litigation in New York.
The district court granted the bondholders' second attachment motion. The court found that the central bank is the alter ego of the Republic, based in part on press articles suggesting that the central bank is under the control of the Republic, and in part on the finding that the Republic had used central bank resources to pay off certain debts like the debt owed to the IMF, but had not paid the bondholders' judgments and thus did not act "honestly and in good faith."35 Based on its alter ego determination, the district court concluded that the protections for central bank assets set forth in Section 1611(b)(1) did not apply.36 The district court found that the reserves in question were property of the Republic used for "commercial activity" under Section 1610 because they were invested in interest bearing accounts, and that the Republic had expressly waived immunity.37 The court thus ruled that the reserves were subject to attachment and execution to satisfy judgments against the Republic.38
The Republic and the central bank have appealed this decision, and the appeal is currently pending. The Federal Reserve Bank of New York believes that the district court incorrectly applied the provisions of the FSIA, in particular Section 1611(b)(1), and has filed an amicus curiae, or "friend of the court," brief to communicate our views to the court. We believe that with respect to Section 1611(b)(1), it is irrelevant how independent the central bank is from its sovereign. Section 1611(b)(1) protects the immunity of a foreign central bank's property "notwithstanding" the provisions of Section 1610 and without regard to the relative independence of the central bank. It is our view that the account is the property of the central bank held for its own account. The record in this case shows that the reserves were used for typical central banking functions such as managing reserves and making payments to the IMF. While central banking functions may at times appear commercial in nature, they are not "commercial activity" that loses immunity under the FSIA.39
Earlier this month, the U.S. Department of Justice also filed an amicus curiae brief in this appeal on behalf of the United States of America. The United States, like the Federal Reserve Bank of New York, took the view that a central bank's relative degree of independence from its parent government is irrelevant for purposes of Section 1611(b)(1) analysis. Under the "central banking functions" test, the United States believes that the central bank reserves on deposit at the Federal Reserve Bank of New York were used for traditional central banking activities and should thus be immune from attachment or execution.
In closing, I hope that my discussion today has been helpful in broadening your understanding of sovereign immunity, and my view that the United States provides a safe legal environment for central bank investment.
____________________________________________________1 Treasury securities are obligations of the U.S. government backed by the full faith and credit of that government. See 31 U.S.C. §§ 3123, 3104 (West 1983). They are widely viewed in the financial industry to be "risk free" investments. See Charles J. Woelfel, Encyclopedia of Banking and Finance 1171 (1994).
2 28 U.S.C. § 1602 et seq.
3 H.R. Rep. No. 94-1487, at 31 (1976), reprinted in 1976 U.S.C.C.A.N. 6604, 6630.
4 See EM Ltd. v. Republic of Arg., 473 F.3d 463, 473 (2d Cir. 2007) ("EM I") (Congress intended Section 1611(b)(1) "to provide an incentive for foreign central banks to maintain their reserves in the United States"); Paul L. Lee, Central Banks and Sovereign Immunity, 41 Colum. J. Transnat'l L. 327, 376 (2003) (noting that Section 1611(b)(1) appears to have been developed to avoid the "potential difficulties" that central banks would face if their assets were subject to attachment under the provisions of Section 1610(b)).
5 Callejo v. Bancomer, S.A., 764 F.2d 1101, 1107 (5th Cir. 1985) (citations omitted).
6 Compare 28 U.S.C. § 1604 with id. § 1609.
7 28 U.S.C. § 1603(a).
8 See El–Fad'l v. Central Bank of Jordan, 75 F.3d 668, 671 (D.C. Cir. 1996 (Central Bank of Jordan an instrumentality of a foreign state); Commercial Bank of Kuwait v. Rafidian Bank, 15 F.3d 238, 239 (2d Cir. 1994) (Central Bank of Iraq was instrumentality of a foreign state); Shapiro v. Republic of Bolivia, 930 F.2d 1013, 1017 (2d Cir. 1991) (Central Bank of Bolivia an instrumentality of a foreign state); Harris Corp. v. Nat'l Iranian Radio and Television, 691 F.2d 1344, 1346 (11th Cir. 1982) (Bank Melli, the Central Bank of Iran, was instrumentality of a foreign state).
9 See S&S Machinery Co. v. Masinexportimport, 706 F.2d 411, 414 (2d Cir.), cert. denied, 464 U.S. 850 (1983) ("State-owned central banks indisputably are included in the § 1603(b) definition of 'agency or instrumentality'.").
10 See Kelly v. Syria Shell Petroleum Dev. B.V., 213 F.3d 841, 849 (5th Cir. 2000) (oil well operator was entitled to immunity under FSIA as organ of Syria); Corporation Mexicana de Servicios Maritimos v. M/T Respect, 89 F.3d 650, 655 (9th Cir. 1996) (government-controlled entity created to manage and distribute government owned natural resources was "organ" of state for purposes of FSIA); see also Ernest T. Patrikis, Foreign Central Bank Property: Immunity From Attachment in the United States, 1982 U. Ill. L. Rev. 265, 272-73 (1982).
11 See H.R. Rep. No. 94-1487 at 16 (1976), reprinted in 1976 U.S.C.C.A.N. 6604, 6614.
12 Adler v. Federal Republic of Nigeria, 107 F.3d 720, 728 (9th Cir. 1997); Drexel Burnham Lambert Group v. Comm. Of Receivers for A.W. Galadari, 12 F.3d 317, 325 (2d Cir. 1993), cert. denied 511 U.S. 1609 (1994).
13 Commercial Bank of Kuwait v. Rafidian Bank, supra, 15 F.3d at 244 (mistaken belief by Central Bank that it enjoyed sovereign immunity is not sufficient ground to vacate default). See also FSIA Section 1608, 28 U.S.C. § 1608 (providing that no default judgment shall issue unless plaintiff establishes his claim or right to relief).
14 See 28 U.S.C. § 1603(d).
15 "The courts would have a great deal of latitude in determining what is a 'commercial activity' for purposes of this bill." H.R. Rep. No. 94-1487 at 16 (1976), reprinted in 1976 U.S.C.C.A.N. 6604, 6615.
16 504 U.S. 607 (1992).
17 Id. at 609-10.
18 Id. at 615.
19 Id. at 614.
21 "[T]he bill would codify the so-called 'restrictive' principle of sovereign immunity. . . [u]nder [which] the immunity of a foreign state is 'restricted' to suits involving a foreign state's public acts (jure imperii) and does not extend to suits based on commercial or private acts (juri gestionis)." H.R. Rep. No. 94-1487 at 7 (1976), reprinted in 1976 U.S.C.C.A.N. 6604, 6605.
22 See id. at 614. See also Corzo v. Banco Central de Reserva del Peru, 243 F.3d 519, 525 (9th Cir. 2001) (Central Bank's "act of granting or denying exchange rate compensation is clearly a sovereign activity, and it is therefore not subject to suit in the United States on this particular claim.").
23 See 28 U.S.C. § 1605(a)(1).
24 See, e.g., Gates v. Victor Fine Foods, 54 F.3d 1457, 1465-66 (9th Cir.), cert. denied, 116 S. Ct. 187 (1995); Eckert Int'l v. Government of Fiji, 32 F.3d 77, 80 (4th Cir. 1994).
25 See 28 U.S.C. § 1610(a).
26 See Aurelius Capital Partners v. Republic of Arg., 584 F.3d 120, 132 (2d Cir. 2009), cert. denied 130 S. Ct. 1691 (Mar 1, 2010) ("[T]he property that is subject to attachment and execution must be 'property in the United States of a foreign state' and must have been 'used for commercial activity' at the time the writ of attachment or execution is issued.") (emphasis in original);Af-Cap v. Chevron Overseas (Congo) Ltd., 475 F.3d 1080, 1094 (9th Cir. 2007) (Congolese property located in the Congo that was "'integral to' but not 'used for' commercial activity in the United States does not meet the requirements of Section 1610(a)").
27 See 28 U.S.C. § 1610(d) (referring to "attachment prior to entry of judgment").
28 See Weston Compagnie de Finance et d'Investissement v. República del Ecuador, 823 F. Supp. 1106, 1111 (S.D.N.Y. 1993); Banque Compafina v. Banco de Guatemala, 583 F. Supp. 320, 322 (S.D.N.Y. 1984).
29 See Concord Reinsurance Co. v. Caja Nacional de Ahorro y Seguro, No. 93 Civ. 6606, U.S. Dist. LEXIS 2964, at *5 (S.D.N.Y. Mar. 15, 1994) (insurance and economic development agency not a Central Bank under FSIA).
30 See Ministry of Def. Support for the Armed Forces of the Islamic Republic of Iran v. Cubic Def. Sys., Inc., 385 F.3d 1206, 1223 (9th Cir. 2004), vacated on other grounds, 126 S. Ct. 1193 (2006) (embracing central banking functions test); Weston supra, 823 F. Supp. at 1112 (construing the phrase "held for its own account" as requiring an inquiry into whether the property in such account was held or used in connection with "central banking activities"); Banque Compafina,supra, 583 F. Supp. at 322 (same). See also H.R. Rep. 94-1487, at 31 ("held for its own account" requirement is satisfied where the central bank funds in question are "used or held in connection with central banking activities, as distinguished from funds used solely to finance the commercial transactions of other entities or of foreign states").
31 See EM I, supra, 473 F.3d at 480.
32 See id. at 479.
33 See id. at 482.
34 See EM Ltd. v. Republic of Arg., Nos. 03 Civ. 2507(TPG), 03 Civ. 8845(TPG), 05 Civ. 2434(TPG), 06 Civ. 6646(TPG), 06 Civ. 7792(TPG), 2010 WL 1404119, at * 1 (S.D.N.Y. Apr. 7, 2010) ("EM II").
35 Id. at *26-30.
36 Id. at *32.
37 Id. at *31-32.
39 See EMI, supra, 473 F.3d at 473 (Congress developed Section 1611(b)(1) "to shield from attachment the U.S. assets of foreign central banks, many of which might be engaged in commercial activity in the United States while managing reserves and engaging in financial transactions, and to provide an incentive for foreign central banks to maintain their reserves in the United States"); Weston, supra, 823 F. Supp. at 1112 ("28 U.S.C. § 1611(b)(1)... is an exception to § 1610, providing for immunity from attachment that would otherwise be allowed by § 1610").