The Sovereign Immunity Defense and its Implications for Arbitration

The doctrine of sovereign immunity originates from international law. It is based on the principle that States would be severely hindered if it would be possible for them to be sued in the courts of other States. However, the application of this doctrine is disputed. Originally, the only option was to have absolute sovereign immunity whereby States cannot be sued for any of their acts. The narrow approach of absolute sovereign immunity later evolved into what has become known as common law immunity, a concept that is favored and applied by the majority of States. This doctrine stipulates that States are immune from their actions in an official capacity but not when it comes to any acts of a commercial nature. This development stems from the evolution of the concept of a State. Traditionally, a State was thought of as a unit that would conduct foreign affairs and defend its citizens. Over time however, States have developed and are now also involved in other activities such as commercial transactions.Common law immunity supporters argue that States have chosen to enter the marketplace and conduct activities that they hope will render a profit. As a result, if States are to enjoy the benefits of being a market player, they must also be prepared to deal with the consequences and should be subject to legal action if they do not fulfill their duties to the same standards as private enterprises.

The doctrine of common law immunity has been developed over time and has been applied by state courts as well as arbitral tribunals in a number of cases. One example is the case of Trendtex Trading Corporation (“Trendtex”) v. Central Bank of Nigeria (“CBN”) which was heard in the English Court of Appeal. In this case, the CBN issued a letter of credit to Trendtex in order to assist with a contract to sell a certain amount of concrete to an English company. However, the CBN decided against making payment under the letter of credit, which forced Trendtex to take legal action. In the original decision, it was decided that the CBN was an arm of the State and therefore could not be sued. On appeal, a new ruling was issued which stated that the CBN had been created especially as a separate entity from the State, and even if it had been part of the State, the contract related to a commercial transaction. Thus, the court ruled that the CBN could be sued.

By contrast, an example where the traditional interpretation of sovereign immunity has been used is the recent case of FG Hemisphere Associates LLC (“FGHA”) v. Democratic Republic of Congo (“DRC”). Here, FGHA’s predecessor had entered into agreement with the DRC to finance electricity generation facilities. However, the DRC had defaulted on its repayments relating to this project. The dispute was submitted to arbitration on the condition that once an award had been rendered, neither party would take any action to challenge the enforcement of that award. The DRC did not participate in any of the two arbitrations that were conducted on this basis and awards were made in favour of FGHA in both. When the FGHA came to enforce the award in Hong Kong, it was disputed whether the DRC could plead a defense of absolute sovereign immunity against the enforcement action of FGHA. The Hong Kong Court of Appeal decided that the correct position in Hong Kong was to follow the common law immunity doctrine, thus not admitting the sovereign immunity defense. The DRC then appealed to the Hong Kong Court of Final Appeal and the court by a majority of 3-2 overturned the decision of the lower court, ruling that the absolute sovereign immunity doctrine should be applied and admitting the sovereign immunity defense.

There is a crucial difference between these two cases - in the first case, the CBN was ruled to be a separate entity from the State. Hence, the sovereign immunity doctrine could not be applied. However, in the second case, the respondent was the DRC itself which strengthened the applicability of the sovereign immunity doctrine to the DRC.

In the context of arbitration, it is therefore specifically important that individuals and businesses, when concluding contracts with entities that may have a connection to a State, conduct a thorough review of how far there is a direct association between the entity and the State. Certain factors will be important in this respect. Firstly, there is a need to investigate the founding legal basis of the entity. Secondly, it is vital to analyse whether the entity is directly mentioned in any legislation. If so, the intent behind the regulation of the entity should be investigated. Thirdly, the corporate structure of the entity should be evaluated in order to see how much control the State has over the entity’s day to day operations. Fourthly, the legal agreement that the two parties conclude must be analysed in order to see if it can be classified as an exception to the sovereign immunity doctrine. For example, a sales contract could be seen as a commercial transaction and thus may be outside the limits of the sovereign immunity doctrine. Finally, the applicable rule on sovereign immunity in the relevant legal system/s needs to be evaluated. Once answers emerge to these questions, it is possible to evaluate the likelihood that the specific entity may be able to utilise the sovereign immunity doctrine should legal problems arise in the future.