Sovereign immunity

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Why would an entity — regardless of its absolute executive power — think it should ever be entitled to claim immunity from suit or enforcement on a commercial contract?

There is no good reason, except “Percy, who’s Queen?

Now, a legal eagle can get a little hyperventilatey about sovereign immunity. It isn’t that bad — as long as you don’t mind your children being fed to crocodiles. Some things to bear in mind:

What sovereign immunity is

Sovereign immunity comes in two varieties, both relating to forms of litigation:

What sovereign immunity isn’t

It doesn’t void your contract altogether

Sovereign immunity can’t immunise a sovereign against parts of a commercial contract it has already performed, since the aggrieved commoner doesn’t have to take action to recover sums it has already been paid. If the sovereign pays a sum owed, it stays paid. Immunity can’t help the sovereign here. It cannot — by legal means — recover moneys it has paid, unless it takes court action, and doubtless your legal opinions will tell you that won’t work (and will operate to waive sovereign immunity anyway).[2]

In the context of an ISDA Master Agreement, therefore, all payments, collateral and initial margin a sovereign has already ponied up[3] before it decides to walk away, you get to keep. Your risk is the market movements from when the sovereign breaches your contract until you can close out your positions. Netting also works, because it is a self-help mechanism that doesn’t oblige you to take legal action to enforce it.

If the sovereign wants to dispute payments it has already made it can either (i) dangle your children over its crocodile pit and ask you what you plan to do — again this is extra-legal behaviour and the JC can’t really comment on it (other that to agree it is horrid); or (ii) proceed against you in a court of law in which case it will still need compelling arguments,[4] which on our theory won’t exist and it will have waived its sovereign immunity QED.

It isn’t ultra vires

Don’t confuse sovereign immunity with ultra vires — cue thunder crack at the mention of Orange County or Hammersmith and Fulham council and a dramatic look from our house gopher — for they are quite different things.

  • Ultra vires: If a contract is beyond your powers or capacity to enter into a contract in the first place then it is void ab initio; any payments you have made under that contract are also void and you may reclaim them[5], and you can appeal to the court system to do that. That is to say, ultra vires is an “intra-legal” measure, recognised, defended and enforced by the courts.
  • Sovereign immunity: Sovereign immunity is a different, “extra-legal” thing: it is to say “I am, quite literally, above the law: I am the law, and I do not have to subject myself to the judicial branch of my law — or anyone else’s law — unless I choose to.” This extends to being free from judicial intervention if I decide not to perform my contractual obligations, but it also means I cannot myself resort to the court process to make my counterparty perform its obligations. If I choose to go to court, then I subject myself fully to the courts as regards actions my counterparty wishes to bring against me.

Sovereign immunity and close-out netting

Does the fact that a counterparty may have, or may claim, sovereign immunity from legal proceedings before a foreign court (or its own courts, for that matter) invalidate a close-out netting clause?

We think not: the close-out mechanism does not require the intervention of any court to work: it is a self-help remedy. You terminate, net off and walk away.[6] To the contrary, it would only come before a court were the Defaulting Party to apply to the court to challenge its exercise. And you can’t have it both ways: a sovereign immunity right only avails you if you stay away from court. The moment Queenie puts the matter before a court she submits to the court and, Q.E.D., waives her immunity. Sorry, Your Majesty: I don’t make the rules.

Sovereign immunity under English law — a special case

The Sovereign Immunity Act 1978

The Sovereign Immunity Act 1978,[7] which provides (among other things) that a State is not immune as respects proceedings relating to a commercial transaction entered into by the State; or an obligation of the State which by virtue of a contract (whether a commercial transaction or not) falls to be performed wholly or partly in the United Kingdom.

It’s a bit nuanced, but not much. The commercial contracts exception allows a sovereign to be sued in the UK courts, but other part of the Act protect it against injunctions, the enforcement of judgments and arbitral awards.

Contracting out

The parties can contract out of this in writing: Section 3(2) provides, “This section does not apply if the parties to the dispute are States or have otherwise agreed in writing.” This can create problems for the verbally incontinent amongst our brethren. For is deleting a proposed contractual waiver of immunity in a draft of the contract, so that the executed contract is silent on the point, enough to mean the parties have “agreed otherwise in writing”? If you are feeling robust, you might think not. But what if you have removed that provision, from an industry standard form, by stating in a separate schedule that the contractual waiver is disapplied?

This is quite the metaphysical question: The two actions ought really to be the same; the difference only one of format. But in one case the resulting contract has nothing at all to say about sovereign immunity; in the other, the record of thrust and counter-thrust remains in the fossil record. What could a positive statement that an (admittedly redundant) contractual waiver is disapplied mean, if not that the statutory waiver should not apply either?

Contractual waiver of sovereign immunity

The great question of whether one should specifically exclude sovereign immunity from a commercial contract governed by English law.

Spoiler: No.

Twist: Industry-standard commercial contracts[8] do anyway. This creates more problems than it solves.

General

Waiving sovereign immunity is a faintly stupid thing to do if your commercial contract happens to be governed by English law, since the Sovereign Immunity Act 1978 excludes any immunity of a state to a commercial contract. Now, to be sure, here arises a great opportunity for the chicken lickens in your litigation department to pipe up. “What if,” they will say, “the sovereign ignores the exclusive jurisdiction clause, and takes action against you in its own court? What then, say ye?”

You got me. But hang on a minute: can you really launch an action in your own court and, by the same lights, claim immunity from suit? Is this not having your Brexit cake and eating it too? And even if it isn’t[9] we are talking here about a sovereign who has, with the complicity of its own court system, already ignored one term of your contract (exclusive jurisdiction). Why would it respect the rest any way?

Sovereign immunity and the Cassanova problem

The fact that (unless agreed otherwise) Sovereign Immunity generally doesn’t apply to commercial contracts doesn’t stop industry standard commercial contracts purporting nonetheless waive that immunity which, in a ghastly ironic turn, makes sovereign immunity more likely to apply. For you may be sure agents, when representing sovereigns, will protest they do not have their client’s authority to waive its sovereign privileges. They will find themselves compelled, by the terms of their agency, to insist the waiver is deleted.

Now in the architecture of the ISDA Master Agreement this involves writing in the Schedule, something like “Section 13(d) shall not apply to Party A or Party B”. Is this mere silence on the matter, or is it an explicit agreement to contract out of it?

Had the ISDA Master Agreement only had the sense to shut up about sovereign immunity in the first place, there would have been no problem: what the eye don’t see the chef gets away with.

This will still be the stance you find yourself having to adopt. “I am not agreeing that sovereign immunity applies,” you will find yourself maintaining to the insistent gaze of your credit officer. “I am simply not saying that it doesn’t apply.”

This falls short of what the Sovereign Immunity Act 1978 requires for sovereign immunity to kick in. Hold that confident smile until it hurts.

See also

References

  1. Sovereign immunity does of course cover non-contractual disputes and infractions — the drunken ambassador who seeks to avoid prosecution for running over a local fishwife on his way back from a saucy cabaret is the paradigm case, but it is not relevant to the JC so we shall not speak of it.
  2. To be sure, a bossy sovereign can park its tanks on your lawn, waterboard you, and throw your children to its pet crocodile, but this is an extra-legal act, not a legal one and the JC cares not one whit for practical, extra-legal acts. What can one say about them, other than, “that was horrid”?
  3. Assuming you can persuade a sovereign to pony up initial margin of course.
  4. If the sovereign is in a developed country. If in Somalia, maybe not so much, but there your problem is not sovereign immunity so much as trading in Somalia.
  5. But — quid pro quo, Clarice — any profits you have made you must also disgorge.
  6. Only if you are still owed money might you seek a court’s assistance, but that is post netting debt recovery, when you were still owed money after netting had worked its wristy magic.
  7. https://www.legislation.gov.uk/ukpga/1978/33
  8. E.g.,the ISDA Master Agreement and the 2010 GMSLA.
  9. SIT DOWN AT THE BACK with all your talk about counterclaims and enforcement of judgments.