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05 July 2011

Managing the implications of the Court of Final Appeal's provisional ruling that foreign Sovereigns enjoy absolute immunity from Hong Kong court proceedings.

On 8 June 2011, the Democratic Republic of the Congo (the Congo) successfully resisted the enforcement of two arbitral awards rendered against it (the Awards) on grounds of State (or sovereign) immunity. In Democratic Republic of the Congo v FG Hemisphere Associates LLC [2011] HKCFA 41, a 3:2 majority of the Court of Final Appeal (CFA) has provisionally held that State immunity covers not only sovereign acts but also the State's commercial activities.

Significantly, the majority further held (in the context of enforcement proceedings) that a foreign State cannot waive its immunity by way of an agreement with a private party in advance of any proceedings in the Hong Kong courts; State immunity can be waived only after the jurisdiction of the Hong Kong courts has been invoked (i.e. after the commencement of proceedings). On the facts, the majority held that the Congo had not waived its State immunity.

The majority judgment is provisional, as certain questions relating to the interpretation of the Basic Law of Hong Kong have been referred by the CFA to the Standing Committee of the National People's Congress (Standing Committee) before a final judgment is rendered. We await to see if the Standing Committee's interpretation will reflect the view of the Government of the People's Republic of China (China), that absolute immunity prevails in Hong Kong.

This decision has ramifications for parties who have dealt, or who intend to deal, with foreign States or State-affiliated entities and who intend to enforce agreements in the Hong Kong courts or execute foreign judgments or arbitral awards against property located in Hong Kong. In-house transactional lawyers in particular will need to consider the implications we discuss below, which include paying closer regard to whether the State entity they are dealing with is likely to be regarded as part of the State for the purposes of immunity, and seeking creative ways to secure performance by a State entity where an immunity applies.

The decision also has implications for the doctrine of Crown immunity (that is, the immunity from suit in Hong Kong enjoyed by the Chinese government and its emanations.

We cover in this bulletin: (a) the decision in FG Hemisphere and the Hong Kong law on State immunity in light of this decision; (b) the implications of this decision for parties intending to deal with a foreign State or State-affiliated entity; and (c) the Hong Kong law on Crown immunity.

What was at issue in this case?

State immunity versus Crown immunity

FG Hemisphere concerns the proper scope of State (or sovereign) immunity; the doctrine that foreign States are immune from Hong Kong court proceedings. The relevant doctrine where China or a China-affiliated entity is involved is not State immunity, but the related doctrine of Crown immunity. We will discuss the effect of FG Hemisphere on Crown immunity further below.

Absolute versus restrictive State immunity

The CFA had to consider whether a foreign State's immunity from enforcement in the Hong Kong courts was absolute, extending to the State's public as well as commercial activities ("absolute immunity"), or restrictive, covering only a State's public activities ("restrictive immunity"). Hong Kong's constitution under the Basic Law and its relationship with China came under consideration, because it was submitted that Mainland China applies the doctrine of absolute immunity.

Waiver of immunity

A further distinct question is whether and how a foreign State can waive immunity. A key issue that the CFA had to decide was whether the Congo waived its State immunity from enforcement by submitting to arbitration under arbitration rules requiring satisfaction of an award.

Facts

In essence, FG Hemisphere concerns an attempt by a distressed debt trader, FG Hemisphere Associates LLC (FG), to enforce the Awards through the Hong Kong courts against assets of the Congo located in Hong Kong. FG had in 2004 obtained the rights under the Awards from the original claimant, who had provided finance to the Congo. FG thereafter sought to enforce the Awards against any available assets of the Congo worldwide.

In the meantime, China and the Congo entered into a development scheme for the finance and construction by China of infrastructure in the Congo, in return for the right to exploit certain Congolese mineral resources. Under these arrangements certain Chinese corporations were obliged to pay "Entry Fees" to the Congo. These arrangements, including the obligation to pay the Entry Fees, were announced to the Hong Kong Stock Exchange. Following this announcement, FG sought to enforce the Awards in the Hong Kong courts against the Entry Fees payable to the Congo, which FG contended represented an asset of the Congo located in Hong Kong.

The Congo, relying on State immunity, contested the jurisdiction of the Hong Kong courts to hear the matter. The Hong Kong Court of First Instance (CFI) held that the Congo enjoyed State immunity and declared that it did not have jurisdiction to hear FG's application for leave to enforce the Awards. FG successfully appealed to the Court of Appeal (CA), who held by a 2:1 majority that foreign States only enjoyed restrictive immunity before the Hong Kong courts, and therefore the CFI had jurisdiction to determine FG's application for leave to enforce the Awards. The CA further held that, had it been necessary to decide, the Congo had not waived its State immunity from enforcement. The CA reasoned that an agreement to submit disputes to arbitration under rules requiring satisfaction of an award or participation in an arbitration were not sufficient to constitute a waiver of immunity from enforcement in itself.

The judgments in the CFA

Majority judgment

The Congo successfully appealed to the CFA. Somewhat unusually for this court, the decision was not unanimous, with a bare majority of 3:2 judges favouring the Congo. The majority judgment of Chan and Ribeiro PJJ and Sir Mason NPJ provisionally held that:

  1. Absolute State immunity applies in Hong Kong, meaning that there is no exception relating to a foreign State's commercial activities. As a matter of legal and constitutional principles, Hong Kong could not apply a doctrine of State immunity that differed from the rest of China.
  2. The Congo had not waived its immunity from enforcement in the Hong Kong courts, whether by agreeing to arbitrate disputes pursuant to arbitral rules requiring satisfaction of an award or by submitting to the jurisdiction of the arbitrator once a dispute had arisen; an unequivocal submission to the jurisdiction of the forum State at the time when the forum State's jurisdiction to enforce is invoked against the impleaded State is required.

In light of the above, the majority provisionally held that the Congo is immune from FG's enforcement proceedings before the Hong Kong courts. This judgment is provisional, as the majority decided to refer certain questions relating to the interpretation of Hong Kong's Basic Law to the Standing Committee before rendering a final judgment.

We await to see if the Standing Committee's interpretation of the Basic Law will reflect the Chinese government's view that absolute immunity prevails in Mainland China and Hong Kong. Our discussion below is predicated on the assumption that the CFA will uphold the provisional findings and render a final judgment based on substantially the same reasons.

Minority judgment

Mr Bokhary PJ and Mr Mortimer NPJ delivered separate minority judgments in which they disagreed with the main points of the majority judgment and held that:

  1. Restrictive immunity was part of Hong Kong's common law before the handover in 1997 and therefore continues to apply in Hong Kong thereafter.
  2. The issues before the CFA did not involve interpretation of the Basic Law, and therefore there was no justification for referring any questions to the Standing Committee.
  3. A foreign State may waive State immunity before Hong Kong court proceedings have commenced, and therefore a contractual waiver can be effective.

Implications of the majority judgment

As a consequence of the majority judgment, a private party who intends to deal with a foreign State must take into account the general immunity enjoyed by the foreign State from Hong Kong court proceedings in respect of the transaction (even where it is a commercial transaction) and from enforcement actions in the Hong Kong courts against property of the foreign State situated in Hong Kong. (There are limited exceptions to this immunity, which we will deal with below.)

Implication 1: When dealing with a foreign State-affiliated entity, consider whether it is part of the "State"

The application of absolute State immunity under Hong Kong law means that it is crucial for a private party dealing with a foreign State-affiliated entity to consider whether that entity is part of the "State" for the purposes of State immunity. The State itself and the head of the State will certainly enjoy State immunity in the Hong Kong courts. Fortunately, contracts with the State itself are relatively rare in practice.

Contracts with a State-affiliated entity such as a State-owned enterprise or a State-run project development entity or trade board are far more common. In determining whether a particular foreign State-affiliated entity is part of the foreign State, the Hong Kong courts may be required to follow the Chinese government's position on that issue (which can be ascertained by way of the certification procedure set out in Article 19(3) of the Basic Law). This approach seems consistent with the majority's reasoning in FG Hemisphere that Hong Kong could not apply a doctrine of State immunity that differed from the rest of China. The CFA, however, did not authoritatively rule on this issue and it remains unsettled.

We do not believe the Chinese government has conclusively stated its position on whether or in what circumstances foreign State-owned entities would be regarded as part of the foreign State for the purposes of State immunity. Some guidance is given by the Chinese government's position in respect of Chinese State-owned entities, which is that Chinese State-owned entities do not enjoy State immunity as they are independent legal persons with their own rights and with the capacity to sue and be sued in court. This is evident from submissions the Chinese government made to the New York courts in a 1979 case, [1] the submissions of a Chinese State body to the Hong Kong courts in the Crown immunity case in 2010 (discussed further below), [2] and various academic opinions.

If the Chinese government adopts a position in respect of foreign State-owned entities that is consistent with its position on Chinese State-owned entities, there is a good chance that it will regard a foreign State-owned entity as not part of the foreign State if the entity is an independent legal person with its own rights and with the capacity to sue and be sued in court. However, it remains to be seen whether the Chinese government will adopt this position if a foreign State-owned entity is sued in the Hong Kong courts.

Implication 2: If the foreign State-affiliated entity is or may be part of the foreign State, consider whether any international treaties apply

As State immunity may be waived by way of international treaties between sovereign States, when dealing with a foreign State, it is relevant to consider whether any treaties apply. For example, China is a party to the 1969 International Convention on Civil Liability for Oil Pollution Damage, under which China and other signatory States waived any immunity from the jurisdiction of foreign courts in lawsuits against their State-owned vessels in relation to commercial activities in certain circumstances. Further, China has entered into bilateral investment treaties (BIT) with a number of States, and these may be relevant to the waiver of immunity.

Implication 3: Contractual waivers of State immunity by a foreign State are not enough when it comes to enforcement proceedings of arbitral awards

In the context of enforcement proceedings, the majority in FG Hemisphere held that because the concept of State immunity concerns relations between States, it can be waived only by an international treaty as between the States, or in the face of the court once its jurisdiction is invoked. Thus, waiver clauses in contracts with foreign States are unlikely to be given effect by Hong Kong courts when enforcement of a foreign judgment or award is sought. Nevertheless, waiver clauses may be useful if enforcement is sought in other jurisdictions and should not be abandoned. Given that FG Hemisphere was concerned with enforcement of an award against a country which is not a party to the 1958 New York Convention on Recognition and Enforcement of Foreign Arbitral Awards (the NYC), it is possible that the outcome would have been different had Congo ratified the NYC, because it could be argued that an implied waiver of State immunity was contained in an international treaty.

From an arbitration perspective, the majority judgment is an authority on a narrow point – that of enforcement and execution of awards against foreign States in Hong Kong courts. (Though separate processes, the terms "enforcement" and "execution" have been subsumed in the term "enforcement" in this Bulletin.) In particular, it does not affect the widely recognised notion that by submitting to arbitration in Hong Kong (or at some other venue), a State (or a State-affiliated entity) consents to the jurisdiction of the arbitration tribunal to determine the issues falling within the scope of the pertinent arbitration agreement.

Further, it would be surprising if the judgment in FG Hemisphere was to affect the supervisory jurisdiction of the Hong Kong courts in respect of arbitration proceedings involving States that are seated in Hong Kong. The majority in the CA's judgment confirmed that the submission of a foreign State to arbitration operates to remove State immunity from the first stage of arbitration in which the national courts exercise supervisory jurisdiction. This reflects the position under international law (cited by the majority in the CFA judgment).

When it comes to enforcement of an award against a foreign State in the Hong Kong courts, it makes no difference whether the award was made in Hong Kong or somewhere else. Submission to arbitration will not, without more, constitute a waiver of immunity before the Hong Kong courts for the purposes of enforcement. This is the position in many other jurisdictions.

Implication 4: Do not confer exclusive jurisdiction on the Hong Kong courts when contracting with a foreign State; choose arbitration or certain other foreign courts instead

In light of the decision in FG Hemisphere, an exclusive jurisdiction clause in favour of the Hong Kong courts in an agreement between a private party and a foreign State is not advisable. Depending on the circumstances it may be advisable, from the private party's perspective, for the agreement to include: (i) a submission to the jurisdiction of the courts of a non-Hong Kong jurisdiction that adheres to the restrictive immunity doctrine, that recognises contractual waivers of State immunity or (ii) an arbitration agreement providing for a seat in a NYC country.

Implication 5: Choosing Hong Kong law as the governing law of the contract should have no effect on the scope of State immunity

Will specifying Hong Kong law as the governing law of the contract confer immunity on the foreign State even where proceedings are brought in another jurisdiction? This will partly depend on the law of the foreign jurisdiction. However, as a matter of principle, the doctrine of State immunity governs the jurisdiction of the Hong Kong courts, not the rights and liabilities of parties under a contract. Put another way, the extent to which a State will be able to claim State immunity is a matter of law of the forum where proceedings are commenced, as opposed to the governing law of the contract. Therefore it is difficult to see on what basis a foreign court could hold that a foreign State enjoys State immunity just because a contract is governed by Hong Kong law.

Implication 6: Some factors an in-house transactional lawyer will need to consider in structuring a deal with a foreign State

A transactional lawyer acting for a private party dealing with a foreign State will need to consider the implications we set out above. Further, the lawyer may need to adopt creative solutions to work around the unavailability of Hong Kong court proceedings and the general inability to enforce against assets of foreign States located in Hong Kong. The precise solution adopted will depend on the type of deal and the ingenuity of the private party and its lawyers. One solution may be for the private party to insist on a performance bond provided by an independent bank to secure performance of a contract. In circumstances where a private party may in the past have taken non-possessory security over a foreign State's property in Hong Kong to secure performance of an obligation, the private party may now need to take possessory security over that property to avoid needing to go to the Hong Kong courts to enforce that security.

Possible exceptions to the immunity of the foreign State before the Hong Kong courts may exist in respect of a dispute regarding title to land in Hong Kong, and in respect of trust funds or money lodged in the domestic jurisdiction for the payment of creditors. It remains to be seen whether the Chinese government will recognise these exceptions.

The relevance of Crown immunity

As mentioned above, where China or a China-affiliated entity is involved, it is the doctrine of Crown rather than State immunity that is of relevance. Crown immunity was recently considered by the CFI in Intraline Resources v Hua Tian Long [2010] HKEC 603, which held that China could invoke Crown immunity in Hong Kong court proceedings regardless of whether the transaction in dispute was commercial in nature. We dealt with this decision in our bulletin dated 17 June 2010: "Court confirms that 'Crown immunity' may be invoked by PRC State entities in Hong Kong proceedings". (Note that the Government of the Hong Kong SAR is generally not immune in respect of proceedings before the Hong Kong courts due to the operation of the Crown Proceedings Ordinance (Cap. 300).)

Is the Chinese State-affiliated entity part of the Chinese State for the purposes of Crown immunity?

In determining whether a Chinese State-affiliated entity is part of the Chinese State, the better view is that Hong Kong courts will not be required to follow the Chinese government's position. Rather, the Hong Kong courts will primarily consider the extent of control the Chinese government has over the entity, and whether the entity exercises powers independently from the government. The objects and function of the entity are also relevant, though not as material.
It remains to be seen whether the Hong Kong courts will regard a Chinese State-owned enterprise to be part of the Chinese State for the purposes of Crown immunity. However, the submissions by counsel for the China State entity in Hua Tian Long appears to suggest that, as far as the Chinese government is concerned, State-owned enterprises owned through the State-owned Assets Supervision Committee (SASAC) should not be regarded as part of the Chinese State. By those submissions, counsel drew a distinction between the Guangzhou Salvage Bureau (the defendant in that case), which she asserted had Crown immunity, and State-owned enterprises owned through SASAC, which she asserted did not on the basis that those enterprises "enjoy powers of independent management and freedom from interference, with ownership of its assets and the capacity independently to assume civil liabilities".

Waiver of Crown immunity

Significantly, the CFI noted that both counsel accepted that "the same principles governing the waiver of sovereign immunity should govern the question of waiver of crown immunity".

Given the majority's view in FG Hemisphere that State immunity cannot be waived in advance by a waiver clause in a contract, there is doubt whether waiver clauses in contracts with relevant China-affiliated entities are an effective means of waiving that entity's Crown immunity in proceedings before the Hong Kong courts. Parties dealing with Chinese State-affiliated enterprises can take comfort from those English cases in which State-owned enterprises have been held not to be part of the State, although the facts and circumstances of each individual case will require examination.

Depending on the circumstances it may be advisable, from the private party's perspective, for the agreement to include: (i) a submission to the jurisdiction of the courts of a non-Hong Kong jurisdiction that adheres to the restrictive immunity doctrine and that recognises contractual waivers of State immunity; or (ii) an arbitration agreement providing for a seat in a NYC country.

Conclusion

As a result of FG Hemisphere, private parties dealing with foreign States or State-affiliated entities that are considered to enjoy State immunity cannot rely in Hong Kong court proceedings on: (i) the commercial nature of the transaction to argue that State immunity does not arise; or (ii) a contractual waiver of State immunity to argue that the immunity has been lost.
From a foreign State's perspective, invoking State immunity in proceedings arising from a commercial transaction risks damaging its market reputation and credibility, potentially increasing future transaction costs. It is relevant to note that FG is a fund which bought Congo's sovereign debt in the secondary market. It may be that a foreign State will differentiate, as a matter of its policy, between claimants who are its original counterparties and sovereign debt traders.

The implications of the CFA's judgment in FG Hemisphere should be taken into account in any credit and counterparty risk analysis before entering into a contract with a foreign State. The risk profile of existing contracts with foreign States whose assets are predominantly located in Hong Kong may also need to be re-evaluated.

fn[1] Scott v. People's Republic of China, No. CA3-79-0836-D (N. D. Tex. filed 29 June 1979).

fn[2] Intraline Resources v Hua Tian Long [2010] HKEC 603.