On December 29, 2011, the U.S. Court of Appeals for the Fourth Circuit released its decision in Wye Oak Technology, Inc. v. Republic of Iraq, 2011 WL 6825271 (4th Cir. 2011). Wye Oak is the latest — but by no means the only — case in which a foreign government attempted to evade its commercial obligations by invoking the Foreign Sovereign Immunities Act, 28 U.S.C. Sections 1602-11 (“FSIA”). This article will report on the Wye Oak case and thereafter will discuss how a private company can protect against the possible pitfalls of doing business with foreign governments.

In 2004, Wye Oak and the Iraqi Ministry of Defense (“IMOD”) entered into a contract for the refurbishment and disposal of Iraqi military equipment. The contract identified Wye Oak as IMOD’s broker for inventorying military equipment, determining which equipment could be salvaged and selling the remainder for scrap. Wye Oak claimed that it performed as required under the contract but received no payment. Therefore in July 2009, Wye Oak sued the Republic of Iraq, but not IMOD, in the United States District Court for the Eastern District of Virginia for breach of contract. Iraq responded with a motion to dismiss pursuant to Fed. R. Civ. P. 12(b)(1). The basis for Iraq’s motion was its claim that because it was a sovereign nation it was immune from suit pursuant to the FSIA.

Iraq argued that it was not a party to the contract between Wye Oak and IMOD. It asserted that IMOD “was and continues to be a separate and independent legal person from … the Republic of Iraq … with separate legal identity, including … liability under any contracts entered into by [IMOD].” Wye Oak at *4. The district court denied Iraq’s motion and ruled that under the FSIA, Iraq and IMOD “are treated one and the same.” The district court also found that this case fell within the commercial activities exception to the FSIA, but did transfer the case to the United States District Court for the District of Columbia. An appeal was taken to the Fourth Circuit Court of Appeals.

The FSIA provides that “a foreign state shall be immune from the jurisdiction of the courts of the United States and of the states except as provided in sections 1605 to 1607 of this chapter.” 28 U.S.C. § 1604. The main exception to FSIA immunity is the “commercial activities” exception found in 28 U.S.C. § 1605. Therefore, there were two separate questions before the court of appeals. First, are Iraq and IMOD legally separate persons under FSIA jurisprudence? If so, Iraq’s motion to dismiss would be sustained, because it was not a party to the original contract and, therefore, could not be liable for IMOD’s breach. Second, were the activities that were performed pursuant to the contract sufficient to bring the contract within the commercial activities exception, which would result in Iraq being subject to personal jurisdiction?

The Fourth Circuit answered the first question by holding that Iraq and IMOD are not legally separate entities under the FSIA. The FSIA applies not only to a foreign state, but also to that state’s components. The component at issue here was Iraq’s armed forces under the umbrella of IMOD. “Armed forces are as a rule so closely bound up with the structure of the state that they must in all cases be considered as the ‘foreign state’ itself, rather than a separate ‘agency or instrumentality’ of the state.” Wye Oak at *8. As a result, Iraq was a proper defendant in this lawsuit.

Turning to the second question, the Fourth Circuit ruled that “Wye Oak has presented sufficient facts to support a reasonable inference that Iraq, through IMOD, engaged — pursuant to the contract — in the preparation for sale and sale of scrap metal in Iraq — a commercial activity.” Wye Oak at *8. This holding relied in part on the Supreme Court’s holding that “a foreign state engages in commercial activity where it acts ‘in the manner of a private player’ within a market.” Saudi Arabia v. Nelson, 507 U.S. 349, 360 (1993) (quoting Republic of Argentina v. Weltover, Inc., 504 U.S. 607, 614 (1992)). The Fourth Circuit found that Wye Oak had performed sufficient work in the United States for the commercial benefit of Iraq so as to fall within the FSIA’s commercial activities exception. As a result, the judgment of the district court was affirmed and Wye Oak’s lawsuit was permitted to proceed.

When Wye Oak entered into its contract with IMOD, it probably did not anticipate the legal nightmare that has ensued. Eighteen months after having filed its lawsuit — and presumably after paying significant legal bills — Wye Oak has not yet even begun discovery on the merits of its claim. Even assuming that it is successful in obtaining a judgment, enforcing it could be problematic. Companies that are considering doing business with foreign governments need to understand the unique risks that accompany such transactions. Here are a few of those risks, along with some suggestions for mitigating them.

I. Foreign Sovereigns are More Than Just Governments

28 U.S.C. § 1603 defines a “foreign state” as including both political subdivisions of the foreign state and “agencies or instrumentalities of a foreign state.” In order to be deemed an agency or instrumentality of a foreign state, the entity must be a separate legal person, corporate or otherwise; it must either be an organ of the foreign state or the foreign state must be the majority owner; and it cannot be a United States’ citizen or created under the laws of any third country. 28 U.S.C. § 1603(b). Many large companies, such as airlines, energy companies, banks and shipping lines, are owned by foreign governments. Therefore those companies fall within the definition of “agency or instrumentality” set forth above. The first question to be determined, therefore, is the ownership structure of the entity with which you are contemplating doing business. You might be dealing with a foreign state and not even know it.

II. Can You Defeat the Foreign State’s Immunity From Lawsuits in the United States Pursuant to the FSIA?

The default position of the FSIA is that foreign states are immune from lawsuits in United States’ courts. 28 U.S.C. § 1604. To overcome that position, a plaintiff must be able to demonstrate that its case falls within the exceptions provided in 28 U.S.C. §§ 1605-07. The exception most commonly claimed is the “commercial activities” exception codified at § 1605(a)(2). There are three different ways in which actions by foreign states can be deemed “commercial activities.” The lawsuit must be based upon:  

  • a commercial activity carried on in the United States by the foreign state;
  • an act performed in the United States in connection with a commercial activity of the foreign state elsewhere; or
  • an act performed outside the United States in connection with a commercial activity of the foreign state elsewhere and that act causes a direct effect in the United States.  

The best and most effective method of obtaining the benefits of the commercial activities exceptions to the FSIA is to build that concept into the contract itself. To the extent possible, a private company should always insist that the contract with a foreign sovereign include a statement that the subject matter of the contract will be deemed a commercial activity as defined by the FSIA.

III. Remember the “Golden Rule”

It is one thing to be able to sue and obtain a judgment against a foreign sovereign. It is quite another to be able to enforce it, especially outside the United States. There is no uniform international body of law (such as a United Nations Convention) regarding the enforcement of foreign judgments. 1 The prudent private entity will negotiate appropriate security measures, such as letters of credit, that are held by reputable third parties that are subject to U.S. law.

IV. Carefully Research and Draft the “Disputes” Clause of Your Contract

It is very important that an entity proposing to contract with a foreign sovereign research how disputes can be resolved. You, of course, will want to have all disputes resolved in United States courts and based upon the law of the United States. Some foreign sovereigns are not permitted to enter into contracts that are subject to foreign laws. Others cannot agree to submit to the jurisdiction of courts in the United States. Still others will say these things during negotiations in an effort to obtain a “home court” advantage. There is no substitute for doing one’s homework on these issues. Entering into contracts with foreign sovereigns can result in unpleasant surprises for their contractual partners. The time to learn about these possible surprises is before one signs the contract. Afterward is far too late.