International Law - Foreign Sovereign Immunities Act - Ninth Circuit Holds That Nonpayment in the United States by Counterparty Is Not a Direct Effect of Foreign State's Breach of Contractual Duties to Be Performed Abroad
The Foreign Sovereign Immunities Act of 1976(1) (FSIA) is the exclusive means by which a U.S. court can assert jurisdiction over a foreign sovereign, (2) including the sovereign's instrumentalities and majority-owned corporations. (3) Under the FSIA, "a foreign state shall be immune from ... jurisdiction," unless the state falls within an enumerated exception, (4) the "most significant" of which is the commercial exception. (5) This exception denies sovereign immunity for claims based:
 upon a commercial activity carried on in the United States by the foreign state; or  upon an act performed in the United States in connection with a commercial activity of the foreign state elsewhere; or  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. (6)
Sovereign immunity for commercial acts has become particularly relevant with the rise of firms that are majority state owned, especially in emerging markets. (7) Recently, in Terenkian v. Republic of Iraq, (8) the Ninth Circuit held that the commercial exception did not apply to a state-owned Iraqi oil company's breach of a contract to deliver oil because, under the circuit's narrow "legally significant act" test, the oil company's breach did not have a direct effect in the United States. (9) The legally significant act test, however, is muddled. Courts are inconsistent about which facts must be legally significant, and as a result, the test's fit with the FSIA and Supreme Court precedent is unclear. Further, the phrase "legally significant" is itself ambiguous. In light of these issues and a circuit split over the proper "direct effect" test, Congress or the Supreme Court should reject the legally significant act test.
After Iraq invaded Kuwait in 1990, the United Nations imposed a trade embargo on Iraq. (10) In 1995, the United Nations set up the Oil for Food Program: Iraq could sell a limited amount of oil, but payments had to be deposited into a U.N. escrow account in New York and used almost exclusively to meet the humanitarian needs of the Iraqi population. (11) Pursuant to this program, in 2000 and 2001 two Cypriot oil brokerages owned by Manuel Terenkian contracted to buy oil from the State Oil Marketing Organization (SOMO), an Iraqi firm wholly owned by Iraq. (12) Under the contracts, the brokerages agreed to accept delivery in Iraq or Turkey; the United States was listed as a possible destination for the oil. (13) According to Terenkian, after each of the two contracts had been signed in New York, Iraq demanded more money and, when Terenkian refused, SOMO cancelled each contract. (14) Terenkian, along with the brokerages, sued Iraq by and through SOMO in a California federal court for breach of contract. (15)
Iraq moved to dismiss, claiming sovereign immunity. (16) At various times, Terenkian asserted four reasons to apply the FSIA's commercial exception: Under the exception's first clause, Iraq had carried on commercial activity in the United States because (1) under Oil for Food, the United Nations administered the contracts in New York and (2) the contracts were executed in New York. (17) Under the exception's third clause, Iraq's breach had caused a direct effect in the United States because (3) the breach prevented payment from occurring in New York and (4) the breach prevented the delivery of oil, some intended for U.S. distribution. (18) The district court denied Iraq's motion, concluding that the third clause of the commercial exception applied: Iraq's alleged breach caused a direct effect in the United States by preventing Terenkian from paying in New York. (19) The court also transferred the case to the District of Columbia, holding that venue was improperly laid. (20) Under the collateral order doctrine, Iraq appealed the denial of the motion to dismiss. (21)
The Ninth Circuit reversed, vacated the transfer, and remanded with instructions to dismiss. …