Contours of Commercial Activity Exception of the Foreign Sovereign Immunities Act

Terenkian v. Republic of Iraq, 2012 U.S. App. LEXIS 19557 (9th Cir. Sept. 18, 2012):

Pentonville Developers, Ltd., and Marblearch Trading, Ltd., two Cyprus oil brokerage companies, sued the Republic of Iraq for unilaterally terminating two contracts for the purchase and sale of Iraqi oil. The district court held it had subject matter jurisdiction to hear this action notwithstanding Iraq's assertion of sovereign immunity under the Foreign Sovereign Immunities Act (FSIA), 28 U.S.C. § 1602 et seq., because the lawsuit fell within the "commercial exception" to that immunity. Because the lawsuit is not based upon commercial activity by Iraq in the United States nor upon an act in connection with such commercial activity having a direct effect in the United States, see 28 U.S.C. § 1605(a)(2), we hold that the district court erred in denying Iraq's motion to dismiss for lack of subject matter jurisdiction. ***

Pentonville Developers, Ltd., and Marblearch Trading, Ltd., are oil brokerage companies that are headquartered in and formed under the laws of Cyprus. Manuel Terenkian is the president and sole shareholder of both companies. Beginning in 2000, Pentonville and Marblearch commenced negotiations with Iraq under the auspices of the United Nations Oil for Food Program to enter into transactions for the purchase and sale of Iraqi oil.

In November 2000, pursuant to the Oil for Food Program requirements, Pentonville entered into a contract to purchase oil from the State Oil Marketing Organization (SOMO), a company formed under the laws of and wholly owned by the Republic of Iraq. A few months later, Marblearch also entered a contract to purchase oil from SOMO. As specified in the contracts, Pentonville agreed to purchase one million barrels of Kirkuk crude oil for the "Europe" market and two million barrels of Basrah light crude oil for the "USA/Far East" market. Marblearch agreed to purchase two million barrels of Kirkuk crude oil for "Europe and/or U.S.A." The contracts were to be performed in Iraq or Turkey, where title to the crude oil would pass to the purchaser. Pentonville and Marblearch agreed that payment for each cargo of crude oil would be made from the proceeds of an irrevocable documentary letter of credit directly into a United Nations escrow account. ***

In July 2003, Pentonville, Marblearch, and Terenkian (collectively referred to here as the plaintiffs) filed a complaint against the Republic of Iraq by and through SOMO. As amended in May 2007, the complaint alleged that after the Pentonville contract had been executed at the Permanent Mission of Cyprus to the United Nations in New York, Iraqi officials demanded that Pentonville pay SOMO additional fees that were not required by the contract. When Pentonville refused to make these payments, SOMO unilaterally canceled the contract. After Marblearch subsequently entered into a substantially similar contract, also executed at the Cyprus Mission in New York, the same scenario played out: Iraqi officials demanded additional payments, which Marblearch refused, and SOMO again canceled the contract.

***

The complaint also sets forth the alleged basis of the district court's subject matter jurisdiction over the Republic of Iraq, which plaintiffs alleged was the actual defendant in the suit. The "sole basis" for United States federal courts to obtain jurisdiction over a foreign state is the FSIA. Argentine Republic v. Amerada Hess Shipping Corp., 488 U.S. 428, 434 (1989). ***

Because the plaintiffs aimed their action at Iraq, they had the preliminary burden of establishing that Iraq was not entitled to immunity. See Meadows v. Dominican Republic, 817 F.2d 517, 522 (9th Cir. 1987). In an effort to do so, the complaint alleged that the "commercial exception" to sovereign immunity, set forth in § 1605(a)(2), was applicable. Section 1605(a)(2) provides:

(a) A foreign state shall not be immune from the jurisdiction of courts of the United States or of the States in any case-- ***

(2) in which the action is based [1] upon a commercial activity carried on in the United States by the foreign state; or [2] upon an act performed in the United States in connection with a commercial activity of the foreign state elsewhere; or [3] upon an act outside the territory of 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[.]

Courts have construed this commercial activity provision to have three independent clauses, and have used different criteria for each of the three separate clauses to assess a claimed exception. See, e.g., Am. W. Airlines, Inc. v. GPA Grp., 877 F.2d 793, 796-97 (9th Cir. 1989) (applying a "nexus" requirement to the first clause); Siderman de Blake v. Republic of Arg., 965 F.2d 699, 709 (9th Cir. 1992) (applying a "material connection" requirement to the second clause); Adler v. Fed. Republic of Nigeria, 107 F.3d 720, 726-27 & n.4 (9th Cir. 1997) (applying a "legally significant acts" test to the third clause). Citing only the third clause, the complaint alleged that the plaintiffs may seek monetary damages from Iraq because it conducted "an act outside the territory of the United States in connection with a commercial activity of the foreign state elsewhere and that act cause[d] a direct effect in the United States." § 1605(a)(2). In their subsequent motion for a default judgment, the plaintiffs argued that the district court had jurisdiction "because the contracts in this action contemplated the purchase of oil, some of which was intended for distribution in the United States," meaning that "Iraq's unilateral cancellation of the contracts resulted in a 'direct effect' in the United States."***

In their opposition to the motion to dismiss, the plaintiffs raised two new bases for abrogating Iraq's sovereign immunity. Relying for the first time on the first clause of § 1605(a)(2), the plaintiffs argued that because both contracts at issue were executed in New York, their claims arose out of a commercial activity undertaken by the foreign state which was carried on in the United States. They also argued, again for the first time, that because payment was to be made into the United Nations escrow account at the Banque Nationale de Paris, Iraq's alleged breach of the contracts had the "direct effect" that payments were not deposited in a New York bank. ***

Where a defendant claims only "that the allegations contained in a complaint are insufficient on their face to invoke federal jurisdiction," ... we treat the challenge as "any other motion to dismiss on the pleadings for lack of jurisdiction," Holy See, 557 F.3d at 1073. We therefore determine whether the complaint alleges "sufficient factual matter, accepted as true, to 'state a claim to relief that is plausible on its face.'" Ashcroft v. Iqbal, 556 U.S. 662, 678 (2009) (quoting Bell Atl. Corp. v. Twombly, 550 U.S. 544, 570 (2007))***.

If the defendant instead makes a factual attack on subject matter jurisdiction, the defendant may introduce testimony, affidavits, or other evidence to "dispute[ ] the truth of the allegations that, by themselves, would otherwise invoke federal jurisdiction." Safe Air for Everyone, 373 F.3d at 1039. Under these circumstances, "no presumptive truthfulness attaches to plaintiff's allegations." Holy See, 557 F.3d at 1073 (quoting Roberts v. Corrothers, 812 F.2d 1173, 1177 (9th Cir. 1987)) (internal quotation marks omitted). "The plaintiff then has the burden of going forward with the evidence by offering proof that one of the FSIA exemptions applies." Siderman, 965 F.2d at 708 n.9 (quoting Meadows, 817 F.2d at 522-23); see also Gates v. Victor Fine Foods, 54 F.3d 1457, 1463 (9th Cir. 1995). Once the plaintiff has presented such evidence, the defendant bears the burden of proving by a preponderance of the evidence that the exception to sovereign immunity does not apply. Siderman, 965 F.2d at 708 n.9 (quoting Meadows, 817 F.2d at 522-23). Even where the material facts are disputed, the trial court may still evaluate the merits of the jurisdictional claims. ***

In this case, Iraq made fact-based challenges to plaintiffs' assertion of jurisdiction, and both parties submitted documentary evidence to the district court. On appeal, we must determine whether plaintiffs have carried their burden of offering proof that one or more FSIA exceptions to sovereign immunity are applicable, and Iraq has carried its burden of proving that no exception identified by the plaintiffs is applicable. We review the district court's legal rulings de novo and its factual findings for clear error. ***

Plaintiffs relied on the first and third clauses of the "commercial activity" exception to sovereign immunity as set forth in § 1605(a)(2).

A

The first clause of § 1605(a)(2) makes an exception to a foreign state's sovereign immunity in a case "in which the action is based upon a commercial activity carried on in the United States by the foreign state." The FSIA provides definitions for some of these key terms. A "commercial activity carried on in the United States by a foreign state" means a commercial activity "having substantial contact with the United States." 28 U.S.C. § 1603(e). A "commercial activity" is "either a regular course of commercial conduct or a particular commercial transaction or act." 28 U.S.C. § 1603(d). The Supreme Court has held that a foreign state engages in commercial activity only where it exercises "those powers that can also be exercised by private citizens," or when it acts "in the manner of a private player within the market," but not when it exercises those powers "peculiar to sovereigns." Saudi Arabia v. Nelson, 507 U.S. 349, 360 (1993) (quoting Weltover, 504 U.S. at 614) (internal quotation marks omitted). In determining whether an activity is "commercial," a court must determine the activity's commercial character "by reference to the nature of the course of conduct or particular transaction or act, rather than by reference to its purpose." Id. at 359 (quoting § 1603(d)) (internal quotation marks omitted). "Thus the relevant question 'is whether the particular actions that the foreign state performs . . . are the type of actions by which a private party engages in trade and traffic or commerce.'" Lasheen, 603 F.3d at 1170 (alteration in original) (quoting Weltover, 504 U.S. at 614). There is no dispute that the contracts in question are commercial in nature.

The courts have also explained what it means for an action to be "based upon" a commercial activity. According to the Supreme Court, the phrase "based upon" is "read most naturally to mean those elements of a claim that, if proven, would entitle a plaintiff to relief under his theory of the case." Nelson, 507 U.S. at 357; see also id. ("An action is based upon the elements that prove the claim, no more and no less." (quoting Santos v. Compagnie Nationale Air France, 934 F.2d 890, 893 (7th Cir. 1991) (internal quotation marks omitted))). Thus a court must begin its analysis "by identifying the particular conduct" on which the plaintiff's legal action is "based." Id. at 356. That "particular conduct" must be a "commercial activity" as defined by the Act, although "the first clause of § 1605(a)(2) [does not] necessarily require[ ] that each and every element of a claim be commercial activity by a foreign state." Id. at 358 n.4.

Finally, the requirement that the commercial activity be "carried on in the United States," § 1605(a)(2), means that the lawsuit itself must be based upon the foreign sovereign's commercial activity within the United States. Even if the foreign sovereign regularly conducts other commercial activity in the United States, if that activity "has no connection with, or relationship to, the conduct which gave rise to plaintiff's cause of action" it "will not suffice" to abrogate sovereign immunity under this first clause. Gen. Elec. Capital Corp. v. Grossman, 991 F.2d 1376, 1383 (8th Cir. 1993) (quoting Gould, Inc. v. Mitsui Mining & Smelting Co., 947 F.2d 218, 221 (6th Cir. 1991)) (internal quotation marks omitted); see also Am. W. Airlines, 877 F.2d at 797 (upholding sovereign immunity because the commercial acts in the United States were not the "specific acts that form the basis of the suit" (quoting Joseph v. Office of the Consulate Gen., 830 F.2d 1018, 1023 (9th Cir. 1987) (internal quotation marks omitted)).

Moreover, the commercial activities in the United States must be significant ones. See Grossman, 991 F.2d at 1384. For example, while a foreign nation's contract negotiations, including a meeting, and telephone and wire communications, are commercial activity in the United States, they are insufficiently significant to meet this exception. See id. at 1383-84. Similarly, where a plaintiff's claim was based on activities in Saudi Arabia (and sounded in tort rather than contract), the plaintiff could not abrogate the foreign nation's sovereign immunity under the first clause of the FSIA by pointing to preliminary commercial activities in the United States. See Nelson, 507 U.S. at 357-58.

In sum, in order for a foreign state to lose its sovereign immunity under the first clause of § 1605(a)(2): (1) the foreign state's commercial activity in the United States must be the basis of (i.e., a necessary element of) the plaintiff's claim; and (2) that commercial activity must be significant and have substantial contact with the United States.

B

The third clause of § 1605(a)(2) creates an exception to a foreign state's sovereign immunity in a case in which the plaintiff's lawsuit is based "upon an act outside the territory of 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." Instead of requiring that the legal action be "based upon" commercial activity, as in the first clause, this clause allows the legal action to be based on an act outside of the United States so long as the act was taken "in connection with a commercial activity of the foreign state."

In analyzing the third clause, courts have focused on the language requiring that the act which forms the basis of the lawsuit cause "a direct effect in the United States." In interpreting this language in Weltover, the Supreme Court held that an effect is "direct" "if it follows 'as an immediate consequence of the defendant's . . . activity.'" 504 U.S. at 618 (alteration in original) (quoting Weltover, Inc. v. Republic of Arg., 941 F.2d 145, 152 (2d Cir. 1991)); see also Adler, 107 F.3d at 726-27.5 We have explained that a consequence is "immediate" if no intervening act breaks "the chain of causation leading from the asserted wrongful act to its impact in the United States." Lyon v. Agusta S.P.A., 252 F.3d 1078, 1083 (9th Cir. 2001); see also id. at 1083 n.3 (holding that the relevant meaning of "immediate" in this context is "'acting or being without the intervention of another object, cause, or agency'" (quoting Webster's Third New International Dictionary 1129 (1986)); Guirlando v. T.C. Ziraat Bankasi A.S., 602 F.3d 69, 75 (2d Cir. 2010) (stating that "'the requisite immediacy' is lacking where the alleged effect 'depend[s] crucially on variables independent of' the conduct of the foreign state" (alteration in original) (quoting Virtual Countries, Inc. v. Republic of S. Afr., 300 F.3d 230, 238 (2d Cir. 2002)).

Footnote 5. In reaching this conclusion, the [Supreme] Court rejected earlier judicial interpretations, which had held based on legislative history that an act must be both "substantial" and "foreseeable" in order to have a "direct effect" in the United States. Weltover, 504 U.S. at 617-18.

***

Satisfying the requirement that an effect be "immediate" and thus "direct" is not sufficient by itself to satisfy the "direct effect" prong of the commercial activity exception, however, because the effect must also be more than "purely trivial" or "remote and attenuated." Weltover, 504 U.S. at 618. In considering this factor, a court must "'look to the place where legally significant acts giving rise to the claim occurred' in determining the place where a direct effect may be said to be located." Adler, 107 F.3d at 727 (quoting United World Trade, Inc. v. Mangyshlakneft Oil Prod. Ass'n, 33 F.3d 1232, 1239 (10th Cir. 1994)); see also id. at 727 n.4 (citing cases and noting that the Second, Tenth, and Eighth Circuits apply the "legally significant acts" test); Gregorian v. Izvestia, 871 F.2d 1515, 1527 (9th Cir. 1989) (to establish a direct effect, the plaintiff must show that "'something legally significant actually happened in the U.S.'" (quoting Zedan v. Kingdom of Saudi Arabia, 849 F.2d 1511, 1515 (D.C. Cir. 1988))).

Following this reasoning, courts have held that a mere tangential effect in the United States from a breach that occurs elsewhere does not constitute a "direct effect" as contemplated in the third clause of § 1605(a)(2). See, e.g., United World Trade, 33 F.3d at 1237-39 (finding no direct effect when a foreign nation's cancellation of an otherwise non-U.S. contract meant that foreign currency no longer needed to be transferred to a U.S. bank to be converted into dollars); see also Adler, 107 F.3d at 726-27 (noting that "mere financial loss by a person--individual or corporate--in the U.S. is not, in itself, sufficient to constitute a 'direct effect'"). As the Tenth Circuit explained, "[t]he requirement that an effect be 'direct' indicates that Congress did not intend to provide jurisdiction whenever the ripples caused by an overseas transaction manage eventually to reach the shores of the United States." United World Trade, 33 F.3d at 1238. Moreover, we may not interpret § 1605(a)(2) "in a manner that would give the district courts jurisdiction over virtually any suit arising out of an overseas transaction in which an American citizen claims to have suffered a loss from the acts of a foreign state." Id. at 1239.

On the other hand, when a foreign sovereign breaches a contract by failing to complete a contractual obligation that must be performed in the United States, such a breach is sufficient to be a direct effect in the United States. See, e.g., Weltover, 504 U.S. at 618-19. In Weltover, Argentina issued bonds and agreed to repay certain bondholders by making deposits into those bondholders' New York banks as the bonds matured. Id. at 609-10. When Argentina breached its obligation to make those payments, the bondholders sued in New York district court. Id. at 610. The Supreme Court held that Argentina's act of rescheduling the maturity dates on the bonds, which was the basis of the plaintiffs' breach of contract action in the United States, had a direct, non-trivial effect in the United States. Id. at 618-19. As the Court explained, "[b]ecause New York was . . . the place of performance for Argentina's ultimate contractual obligations, the rescheduling of those obligations necessarily had a 'direct effect' in the United States: Money that was supposed to have been delivered to a New York bank for deposit was not forthcoming." Id. at 619; see also Adler, 107 F.3d at 727 (holding that, because the plaintiff had instructed Nigeria to make payments to the plaintiff's account in New York, "New York was the place of performance of Nigeria's ultimate contractual obligation," and "its failure to satisfy that obligation necessarily had a direct effect in the United States").

Accordingly, there is an exception to a foreign sovereign's immunity under the third clause when (1) an act outside the United States forms the basis of the plaintiffs' lawsuit (i.e., constitutes an element of a claim that if proven would entitle a plaintiff to relief on his theory of the case); (2) the act is taken in connection with a foreign sovereign's commercial activity; (3) there is a direct connection between the act and the effect, without any intervening object, cause, or agency; and (4) the effect of the act is legally significant and non-trivial.

***

We now apply these principles to this case to determine whether Iraq has met its burden of showing that neither of the exceptions to sovereign immunity contained in the first and third clauses of § 1605(a)(2) applies. ***

[E]ven assuming that plaintiffs provided evidentiary support for th[eir] factual allegation, their legal argument is wrong: execution of a contract in the United States alone, without more, is not sufficient to satisfy the first clause of § 1605(a)(2). The mere happenstance that a contract is executed at a location within the physical boundaries of the United States, by itself, is not sufficient to constitute a significant activity or a substantial contact for purposes of the first clause of § 1605(a)(2). Rather, as noted by the Supreme Court in a different but related context, a court should consider less formalistic indicia, such as "prior business negotiations with future consequences which themselves are the real object of the business transaction." Burger King Corp. v. Rudzewicz, 471 U.S. 462, 479 (1985). Here, plaintiffs have not alleged that substantial prior contractual negotiations, or indeed any activity related to formation of the contracts other than their execution, occurred within the United States. Cf. Grossman, 991 F.3d at 1383-84 (holding that a meeting and communications by wire and telephone were insufficiently significant to meet the exception in the first clause of § 1605(a)(2)). Nor did the contracts require Iraq to undertake any activities in New York. Further, the contracts designated Baghdad as the locale for arbitration of any disputes and provided that the contracts would be construed and governed in accordance with the laws of Iraq. Under these circumstances, the mere signing of the contract in New York (assuming that Iraq did so) is insufficient to meet the test for a commercial activity carried on in the United States by Iraq for purposes of § 1605(a)(2).***

The plaintiffs argue that Iraq's breach of the contracts had multiple direct effects in the United States. Specifically, the plaintiffs allege that under the contracts, some of the oil intended for purchase was meant for the U.S. market and payment for any oil purchased was to be made by deposit into a New York bank account. Due to the cancellation of the contracts, plaintiffs argue, the oil never reached the United States, and the money was never paid in New York. Therefore, the plaintiffs allege that their complaint is based on Iraq's breach of the two contracts, which resulted in a "direct effect" in the United States.

We reject this argument because the alleged effects in the United States, the non-deposit of payments for oil in a New York bank (due to the non-purchase of the oil) and the non-sales of the non-purchased oil to potential customers in the United States, do not constitute direct effects as defined in § 1605(a)(2) and subsequent case law. While the cancellation of the contracts directly precluded plaintiffs from buying oil, the non-deposit of payment for the oil in a New York bank was merely an indirect effect of Iraq's breach and is not the "legally significant" act that gave rise to the plaintiffs' claim, which is based on the breach, not the non-deposit of payment. See Adler, 107 F.3d at 727 (a court must "'look to the place where legally significant acts giving rise to the claim occurred' in determining the place where a direct effect may be said to be located" (quoting United World Trade, 33 F.3d at 1239)). Iraq's breach may have had ripple effects in New York and elsewhere, including depriving a New York bank of the use of funds that might have been deposited in the bank at some future point, but a potential financial loss by an entity in the United States is not, in itself, sufficient to constitute a direct effect. See id.

Weltover and Adler are not to the contrary. Those cases held that the foreign sovereign's failure to perform its obligation to make certain payments necessarily had a direct effect in the United States where the foreign sovereign's place of performance was the United States. See Weltover, 504 U.S. at 619 ("Because New York was thus the place of performance for Argentina's ultimate contractual obligations, the rescheduling of those obligations necessarily had a 'direct effect' in the United States . . . ."); Adler, 107 F.3d at 730 ("Nigeria was obligated to make payment in New York. Nigeria's acts had a direct effect in the United States."). But here, Iraq had no obligation to perform in the United States; the contracts required Iraq only to deliver oil to the possession of the plaintiffs in either Iraq or Turkey, and the act that forms the basis of plaintiffs' lawsuit, Iraq's cancellation of the contracts, occurred in Iraq. See Guirlando, 602 F.3d at 76 ("The decision by a foreign sovereign not to perform is itself an act, but it is not an act in the United States; it is an act in the foreign state."). While the failure of the breaching party to perform a contractual obligation in the United States is a "direct effect," see Weltover, 504 U.S. at 618-19, here, by contrast, there was neither a failure by Iraq to perform in the United States nor any other legally significant event in this country.

Nor is there any immediate connection between Iraq's cancellation of the contracts and the failure of oil to reach customers in the United States. While the contracts generally indicated that the United States was one of several intended markets for the oil, neither Pentonville nor Marblearch had assumed any contractual obligation to U.S. buyers. Many additional steps remained, including such fundamental requirements as finding potential U.S. purchasers and negotiating mutually acceptable agreements. Indeed, the only evidence that plaintiffs' had identified any potential purchasers of oil at all appeared in Terenkian's declaration (submitted into evidence by Iraq), which indicated that he was in discussions with an Italian refinery. ***Accordingly, because no legally significant act had a direct effect in the United States, we hold that Iraq has met its burden of showing that the third clause of 28 U.S.C. § 1605(a)(2) does not apply.

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