Imagine an international issuer with US branch offices selling private placement notes in the US to US institutional investors, with the notes governed by NY law and the issuer submitting irrevocably to NY jurisdiction. Now imagine that the issuer’s common shares are taken over by its government, which then asserts sovereign immunity in response to a noteholder lawsuit in New York. Surely the notes retain their character as private investments or, at a minimum, the “commercial activity” exception to the Foreign Sovereign Immunity Act (the FSIA) applies? Not so, according to the District Court for the Southern District of New York, in a decision now on appeal to the Second Circuit Court of Appeals. Fir Tree Capital Opportunity Master Fund v. Anglo Irish Bank, 2011 WL 6187077 (S.D.N.Y. Nov. 28, 2011), appeal docketed No. 11-5310 (2d Cir.) which can be found HERE.
If the Anglo Irish decision is upheld, holders of US notes issued by banks in other troubled economies, such as the other PIIGS countries1 should quickly undertake a legal review of their investment and consider whether Anglo Irish might also be applicable to them in the event of a bank nationalization. In addition, investors should be cognizant of the potential adverse liquidity of foreign bank paper and be wary of participating in new US issuances by any foreign issuer potentially subject to nationalization unless substantial protections are offered such as an up-front sovereign waiver, a US-based SPV to hold US assets or, at least, higher pricing to reflect greater risk.
In 2005, Anglo Irish Bank issued $200 million in private placement notes (the Notes) to a group of US institutional investors. While Anglo Irish is, self-evidently, an Irish bank, it had representative offices in the US, the Notes were payable in New York, the note purchase agreement (the NPA) was governed by NY law, and the bank submitted to the irrevocable jurisdiction of NY courts.
Anglo Irish was nationalized in 2009. Although not stated in the decision itself, Anglo Irish’s brief on appeal asserts that the two plaintiff funds (the Plaintiffs) did not purchase their Notes until after Anglo Irish was nationalized. (Anglo Irish’s appeal brief repeatedly reminds the Second Circuit that the Plaintiffs are Cayman hedge funds, as though it means they have a scarlet “C” stapled to their foreheads.) The lawsuit underlying the decision sought declaratory and injunctive relief as a result of Anglo Irish’s intention to sell off its US-based assets and merge with another entity. According to the Plaintiffs, the asset sale and the merger, if consummated, would breach various provisions of the NPA.
Anglo Irish moved to dismiss the litigation on several grounds. For the purposes of this blog entry, the most significant ground was that Anglo Irish was entitled to the protection of the FSIA and Plaintiffs could not overcome the presumption of immunity afforded to Anglo Irish under the FSIA. The Plaintiffs’ primary responses to the foregoing were that, first, Anglo Irish had waived immunity, and second, the asserted claims fell within the “commercial activity” exception to sovereign immunity under the FSIA.
Breaking down the Plaintiffs’ first response further, the Plaintiffs urged the court to find a waiver both under the US-Ireland Friendship Treaty and pursuant to the NPA itself. The Plaintiffs then argued the applicability of the commercial activity exception to FSIA immunity, based on the issuance of the Notes in the US, the proposed sale of all US-based assets and the direct effect in the US of Anglo Irish’s intended merger and foreign asset sales.
The Foreign Sovereign Immunity Act recognizes the strong presumption of sovereign immunity in the US in favor of foreign states. Under the FSIA, a “foreign state” includes any entity in which a foreign state owns a majority of the shares. Because, after nationalization, Anglo Irish clearly fell into this category, the Court quickly turned to the question of whether the Plaintiffs were entitled to any of the exceptions to sovereign immunity.
The Irish American Friendship Treaty provides, as relevant here, that publicly-owned or controlled American and Irish enterprises are not entitled to sovereign immunity with respect to commercial and other business activities.2 This is clearly a waiver of sovereign immunity, but it begs the question as to the scope of the waiver. At first reading, it suggests that an Irish entity is amenable to suit in the US by any person with whom it engaged in commercial activities in the US. The Court, however, sided with Anglo Irish’s narrower reading, holding that the Friendship Treaty waives immunity only as to suit by US persons against an Irish publicly-owned entity engaged in commercial activities in the US. While the original holders of the Notes were all US institutional investors, the Plaintiffs are Cayman Islands entities, and the District Court agreed with Anglo Irish that Cayman entities were not entitled to the benefit of the treaty waiver.
This is a tough one. While treaties often limit their applicability to citizens, if that was the intent here the Friendship Treaty could have said so in clear terms. As can be seen in endnote 2, however, the Friendship Treaty focuses on a waiver of immunity from suit, etc. “to which privately owned and controlled enterprises are subject.” If US jurisdiction is present, non-US citizens can sue private Irish companies in the US, so why can’t non-US citizens sue a public Irish company that comes within the Friendship Treaty?
The Court resolved another interesting issue in Anglo Irish’s favor, which can be phrased as follows: When a foreign state takes over a private enterprise, is the state bound by the waivers previously agreed by the private enterprise? In this particular case, the NPA expressly submitted Anglo Irish to US jurisdiction for litigation concerning the NPA, but the Court held that only the state entity can waive its own immunity and it cannot be bound by a waiver of a private company that the state subsequently nationalized.
The Court then turned its attention to the “commercial activity exception” to the FSIA. On the face of it, the issuance of the Notes in the US was unquestionably a commercial activity, the intended sale of US-based assets in alleged breach of a covenant unquestionably comprised commercial activity in the US, and the intended merger and asset sales in Ireland in alleged breach of a covenant had a direct effect in the US.3 In fact, the Court agreed with the Plaintiffs that the issuance of the Notes constituted commercially activity in the US. However, the Court disagreed that such activity came within the scope of the commercial activity exception.
First, the Court concluded that the commercial activity exception only applied to activity by the foreign state, not to activity by its private predecessor. This has some surface appeal although, as discussed below, it has frightening implications.
Second, the Court ducked the implications of the planned sale of Anglo Irish’s US-based loan portfolio by concluding that the sale would not actually violate the NPA. This aspect of the decision is very troubling, not as to the proper interpretation of the NPA (as to which this blog expresses no view) but as to the stage of the litigation. The Court was considering a motion to dismiss as a matter of law, not a factual dispute, the Plaintiffs had not yet been permitted any discovery and there had been no evidentiary hearing. It may well be that an evidentiary hearing would have led to the same result but, absent a remand from the Second Circuit, the Plaintiffs never will get that hearing.
Third, the Court was willing to concede that a payment failure would likely have the requisite “direct effect” in the US but, since Anglo Irish remained current on interest payments, the increased risk of future non-payment did not have such an effect. This is another difficult one, as it is effectively saying that Anglo Irish could sell everything it owes in the US, thus virtually guaranteeing a subsequent payment default, simply because there was not a current payment default.
Without expressing a view as to which side should or will win in the Second Circuit,4 a victory for Anglo Irish could have substantial implications. Foreign banks come to the US market all the time, but now US investors need to focus not only on credit quality but also on systemic banking risk. Even then, who in 2005 (when the Anglo Irish Notes were issued) could ever have imagined a banking crisis in Ireland? As noted by the Wall Street Journal in November, 2010: “For a decade, Ireland was the EU’s superstar,” and it was only in 2008 that “the party ended.”5
Stating this more broadly, an investor purchases securities in the US issued by a foreign issuer, but then is barred by sovereign immunity from suing the issuer in the US if the issuer is subsequently nationalized. Investors can consider and guard against many risks when making investment decisions, including the potential for default, but how does an investor take into consideration the possibility that its issuer will be nationalized in the future, and does this possibility extend to any nationalized issuer rather than just commercial banks? If this is the law, then this risk should be emblazoned in capital letters on all solicitation materials in the US from now on whenever the issuer is a foreign entity. If this is not the law, hopefully the Second Circuit will say so in no uncertain terms.