The use of Foreign Trusts in financial planning can provide significant benefits to a client. As was discussed in Foreign Trusts and Legal Risks, (1) particularly important benefits can be derived utilizing Offshore Financial Centers whose laws are crafted to facilitate shelter from potential judgments and penal revenue assessments. But these benefits that can be so beneficial to a client also must be scrutinized for financial risks, be it credit, legal, or market risks. The ability to assert legal jurisdiction upon a Foreign Trust and the fiduciary (2) formulate an aspect of legal risk that is a part of that analysis. That legal risk embraces the implications of enforcement jurisdiction and the concept of the doctrine of comity among sovereign nations. Coupled with enforcement jurisdictional notions of one sovereign that seeks to override another’s domestic laws, as well as the doctrine of comity, is a related international concept of the Act of State Doctrine as it intertwines with international jurisdiction and enforcement of judgments.
Act of State Doctrine and Foreign Sovereign Immunity
In connection with considerations given to enforcement of judgments, it is appropriate to engage the concepts referred to as Sovereign Immunity (3) and the Act of State Doctrine. (4) These concepts are enforcement barriers in litigation. Equally important, the Act of State Doctrine impacts one of the vital considerations in the use of Offshore Financial Centers, currency controls. To adequately explain the Act of State Doctrine, it is helpful to contrast it with the doctrine of Foreign Sovereign Immunity.
Sovereign Immunity as it has evolved to this date (5) enables a sovereign to plead as a jurisdictional defense to a claim that it is immune from jurisdiction of foreign courts. The theory is that the executive arms of the governmental body possess the authority and mandate to deal with foreign affairs and it is not appropriate for courts to intervene when it involves the balancing of foreign relations and private interests. There are comity considerations. The Sovereign Immunity doctrine is a jurisdictional defense and a doctrine utilized by governments. It only can be asserted by the governmental body. There is no jurisdiction if there is Sovereign Immunity. (6)
The Act of State doctrine is distinguished from Sovereign Immunity because it is conceptually rooted in the competency of the court to hear a matter. This doctrine operates so as to confer a presumption of validity regarding certain acts of foreign sovereigns by rendering non-justiciable claims that challenge such acts. This judicially created doctrine is not truly jurisdictional; rather, it is a rule of decision pursuant to which an act meeting the definition is binding on the court. (7) It does not deal with the authority of the courts. Instead, it runs to the questions of its competence.
Act of State Doctrine.
The Act of State doctrine is designed to avoid judicial action that would impinge on the foreign relations of the United States. This doctrine ultimately derives from the separation of powers that is provided in the Constitution. Comity is its substance and is founded on forbearance and mutual sovereign respect. The defense is prudential and substantive and not jurisdictional. (8)
The particular significance of this doctrine with respect to Offshore Financial Centers is etched in sovereign ability to confiscate or expropriate property within its territory (9) and the imposition of currency controls. The Act of State Doctrine, unlike the Doctrine of Sovereign Immunity, can be asserted by both an individual and the sovereign. In the expropriation context, the Act of State doctrine facilitates the ability of a sovereign to nationalize a private enterprise by the use of an Act of State doctrine under the guise of property territorial notions.
The United States will recognize and give validity to sovereign acts by a nation when expropriating property within its territory. The reasoning is that a sovereign is entitled to make such acts within its territory and to not validate its actions would be viewed as a breach of foreign relations. A court pursuant to the Act of State doctrine will not examine the validity of the taking of property within its own territory by a foreign sovereign recognized by the United States in the absence of a treaty or other agreement. (10) This is the case even though the expropriation may be discriminatory, not for a public purpose, and not accompanied by prompt and reasonable compensation. This doctrine is applied in the face of the violation of United States public policy. (11) This continues to be a significant legal risk with respect to the use of Offshore Financial Centers and Financial Havens not bound by treaty or other agreement with the United States.
A second important impact of the Act of State doctrine is its assertion both by the sovereign and the individual in connection with the imposition of exchange controls. In the case of Callejo v. Bancomer, S.A., (12) the defendant bank asserted the Act of State doctrine prevented their financial institution from contractual currency obligations. The court first distinguished the commercial nature of its activities, finding that a claim of Sovereign Immunity was inapplicable.
However, it found that as a contractual obligation to make payment on a certificate of deposit in United States dollars, its action not to do so was defensible under the Act of State doctrine of the Mexican government in an imposition of currency control of the peso. (13) This is not perceived as a contractual defense of impossibility of performance but rather the recognition that an individual may plead as a prudential defense that the Act of State relieves them from the enforcement of the contractual obligation. (14) Individual as used in this context is a corporate entity as well.
A distinction can be drawn between currency control defenses that are an assertion of the Act of State doctrine and occasions when the doctrine is raised in extra-territorial circumstances. One case is the application within its sovereign, the other where it may have effects beyond its sovereign. In the case of Allied Bank Intern. V. Banco Creditor Agricola, (15) the court addressed currency controls that affected contractual obligations governed by law not within their territory.
This case and the subsequent appeal demonstrate a court’s reluctance to intervene where the Act of State doctrine may be contrary to the law that should govern. In the application of this extra-territorial concept, the situs of debt will override the Act of State doctrine when the act serves to alter certain legal relations between parties regarding an obligation by having the effect of extinguishing the legal right to repayment.
The extraterritorial limitation turns on the situs of property at the time of its purported taking. The contractual right to receive repayment from banks in accordance with an agreement is the property. The Act of State doctrine is only applicable if, when the decrees of currency control are imposed, the debt has a situs in the sovereign. Where the situs of the property is not deemed in the sovereign, the Act of State doctrine is not a valid defense. (16)
Sovereigns offshore should be understood to be in the business of attracting banks and investors seeking those offshore advantages. Blanket statements that a particular Financial Haven or Offshore Financial Center has no currency controls or exchange controls and no treaty agreements can be misleading and inaccurate. Exchange controls of a sovereign can be imposed and subject to these international law defenses. Property can be expropriated when there is not a treaty. The hybrid nature of political and legal risks is inherent in each of these transactions and one must be alert to them to adequately understand the assurances that these financial centers proclaim. These blanket assurances are not effective guarantees against subsequent, unanticipated sovereign reversals.
1. Foreign Trusts and Legal Risks, TaxConnections, December 24, 2013, Blogosphere.
2. Trustee of Foreign Trust and Enforcement Jurisdiction, TaxConnections, January 6, 2014, Blogosphere.
3. See generally, 6/Foreign Sovereign Immunity, Born and Westin, International Civil Litigation In United States Courts, 1992, Kluwer Law and Taxation Publishers, Deventer, The Netherlands.
4. See generally, 8/The Act of State Doctrine, Born and Westin, International Civil Litigation In United States Courts, 1992, Kluwer Law and Taxation Publishers, Deventer, The Netherlands.
5. This doctrine commenced with an “absolute immunity” concept which denied any jurisdictional notions regardless of the type of activity in which the sovereign was engaged. Because governments engaged in commercial activities, the doctrine evolved from absolute immunity to a modern doctrine of restrictive theory. The immunity of a sovereign continued, provided however, the commercial activities will subject a sovereign to jurisdiction. (Foreign Sovereign Immunities Act of 1976, 28 U. S. C. Sections 1602 – 1611, 1982 and as subsequently amended) This doctrine is quite complex involving numerous subtle issues, such as central banks and encompasses the actual constitutional national structure of nations. This is of particular significance because the foreign exchange can be owned by the government and held by a central bank, or held by the central bank and owned by the central bank. Section 1603(b) of the Foreign Sovereign Immunity Act of 1976, and as thereafter amended. Section 1611 (b) and 1611 (b) (1) of this act states that “…not withstanding the provisions of Section 1610 of this chapter, the property of a foreign state shall be immune from attachment and from execution, if – (1) the property is that of a foreign central bank or monetary authority held for its own account, unless the bank or authority, or its present foreign government has explicitly waived its immunity from attachment in aid of execution …”.
6. See Callejo v. Bancomer, S. A., 764 F.2d 1101 (5th Cir. 1985). This intertwines the sovereign immunity concept with the Act of State Doctrine. The court found that there were jurisdictional requisites, but decided not to entertain the matter because of the Act of State Doctrine.
7. Allied Bank International v. Banco Creditor Agricola De Cartago, Banco Anglo Costarricense and Banco Nacional De Costa Rica, 757 F. 2d 516, at page 520 (1985).
8. Allied Bank Inter. v. Banco Creditor Agricola, 566 F. Supp. 1440 (1983); See Iam v. Opec, 649 F. 2nd 1354 (9th Cir. 1981), cert. denied, 454 U. S. 1163, 102 S. Ct. 1036, 71 L. Ed. 2nd 319 (1982). See also, Banco Nactional Cuba v. Sabbatino, 376 U. S. 398, 84 S. Ct. 923, 11 L. Ed. 2nd. 804 (1964).
9. Banco National de Cuba v. Sabbatino, 376 U. S. 398, 84 S. Ct. 937, 11 L. Ed. 2d. 804 (1964).
10. Callejo v. Bancomer, S. A. , 764 F. 2d 1101 (5th Cir. 1985).
11. Allied Bank Intern v. Banco Creditor Agricola, 757 F. 2d 516 (2nd Cir. 1985). On appeal, this case was affirmed but not on the concept of the Act of State Doctrine. The courts displayed a discomfort with foreign relations and comity and chose to discuss restructuring of debt, looked to the purpose of the exchange controls and the effort of the Costa Rican government to facilitate an orderly outflow of foreign exchange.
12. 764 F.2d 1101 (5th Cir. 1985).
13. See generally, Republic of Iraq v. First National City Bank, 353 F.2d 47 (2nd Cir. 1965); Libra Bank Ltd. v. Banco Nacional de Costa Rica, 570 F. Supp. 870 (1983).
14. Allied Bank Intern. v. Banco Credito Agricola, 757 F. 2d 516 (2nd Cir. 1985).
15. 757 F. 2d 516 (2nd Cir. 1985).
16. See Libra Bank Ltd. v. Banco Nacional de Costa Rica, 570 F. Supp. 870 (1983).
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