Hughes Hubbard & Reed LLP • A New York Limited Liability Partnership
One Battery Park Plaza • New York, New York 10004-1482 • +1 (212) 837-6000
Attorney advertising. Readers are advised that prior results do not guarantee a similar outcome. No aspect of this advertisement has been approved by the Supreme Court of New Jersey. For information regarding the selection process of awards, please visit https://www.hugheshubbard.com/legal-notices-methodologies.
May 17, 2019 – On February 27, 2019, the Supreme Court of the United States held that international organizations’ immunity from civil lawsuits in federal and state courts in the U.S. is not absolute; it is merely coextensive with the “restrictive” immunity currently afforded to foreign sovereigns. Such immunity is restrictive in that it permits lawsuits against foreign governments in American courts concerning commercial activity by those governments so long as there is a sufficient nexus to the U.S. While the decision, Budha Ismail Jam, et al. v. Int’l Finance Corp. (“Jam”),1 has received attention for the headlining issue of international organizations’ sovereign immunity, little to no attention has been paid to the potential impact of this decision on the efforts by Multilateral Development Banks (“MDBs”) to prevent, detect, and sanction corruption, fraud, and other sanctionable practices on MDB-financed projects, and the implications for contractors and individuals working on those projects. We expect this decision to spur increased prevention, detection, and enforcement efforts by MDBs, given that the logic of the Court’s decision arguably exposes MDBs to civil liability in U.S. courts for failing to detect and prevent sanctionable practices on MDB-financed projects. This would likely include increased scrutiny of bidders’ and contractors’ compliance programs on MDB-financed projects.
The International Finance Corporation (“IFC”) is a member of the World Bank Group. Since its establishment in 1956, the IFC has provided financing and financing services to the private sector in developing countries to drive economic growth, a role that complements the World Bank Group’s public sector operations (i.e., loans and grants provided by International Bank for Reconstruction and Development (“IBRD”) and International Development Association (“IDA”), collectively the “World Bank”). The IFC charges market-based rates for its loans and seeks market returns on its equity investments. Like other members of the World Bank Group, the IFC’s head office is in Washington, DC, although it operates across 100 countries. The U.S. is one of the IFC’s 184 shareholders and its largest (with 20.99% of its voting power).
In 2015, local farmers, fishermen, and a local government in Gujarat, India, sued the IFC in federal court in Washington, D.C., seeking damages and injunctive relief due to pollution from a coal-fired power plant. The plant was constructed and operated with a $450 million loan made by the IFC to a private Indian contractor.
The plaintiffs argued that the IFC failed to implement its environmental and social standards and failed to exercise its supervisory authority to protect the surrounding communities from harm. Specifically, the plaintiffs argued that: (1) the IFC expected the borrower to adhere to a set of performance standards to avoid, mitigate, and minimize the negative environmental and social risks and impact from the project; (2) these standards were included in the IFC’s loan agreement with the contractor; (3) the IFC has a review process for enforcing these standards; and (4) as concluded by an internal World Bank Group review, the IFC had failed to identify the relevant environmental risks and to adequately implement controls designed to mitigate these risks.
The internal review to which plaintiffs cited for support of their claims was conducted by the Compliance Advisor Ombudsman (“CAO”), the World Bank Group’s independent accountability mechanism. CAO had concluded in August 2013 that—among other shortcomings—the IFC’s environmental and social review “failed to ensure that [environmental and social] assessments adequately considered the risks and impacts of the project” and, accordingly, “IFC was not in a position to ensure the proper application” of certain environmental and social standards. Regarding specifically the project’s impact on the local marine environment, CAO found that “IFC’s process of [environmental and social] review was not appropriate to the nature and scale of the project or commensurate to risk . . . .” Finally, CAO found that the IFC “has not assured itself that the plant’s seawater cooling system [would] comply” with applicable IFC standards.
The IOIA & FSIA
In 1945, Congress enacted the International Organizations Immunities Act (“IOIA”). Under the IOIA, international organizations “enjoy the same immunity from suit and every form of judicial process as is enjoyed by foreign governments.”2 The IOIA also permits the President (e.g., by Executive Order) or an organization’s founding charter to modify the scope of immunity for any particular organization. When the IOIA was enacted, foreign governments typically enjoyed absolute immunity from suit, and U.S. courts looked to the U.S. State Department for confirmation regarding the scope of this immunity in particular cases.
In 1976, Congress enacted the Foreign Sovereign Immunities Act (“FSIA”). The FSIA adopted—consistent with then-recent changes in State Department policy—a restrictive theory of foreign governments’ immunity. In particular, “commercial activity” was excepted:
A foreign state shall not be immune from the jurisdiction of courts of the United States or of the States in any case . . . . in which the action is 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 . . . .3
The FSIA defines “commercial activity” as —
Either a regular course of commercial conduct or a particular commercial transaction or act. The commercial character of an activity shall be determined by reference to the nature of the course of conduct or particular transaction or act, rather than by reference to its purpose.4
In other words, the fact that there might be a public-interest purpose to an activity does not prevent the activity from being “commercial.”
Lower Court Review
The U.S. District Court for the District of Columbia rejected the plaintiffs’ claims against the IFC. The District Court concluded that it was bound by existing D.C. Circuit Court of Appeals precedent that afforded international organizations absolute immunity—such as they had at the time of IOIA’s enactment in 1945—and, accordingly, the District Court held that the IFC enjoyed absolute immunity under the IOIA. In relevant part, the circuit court precedent interpreted the IOIA as granting international organizations the same immunity—absolute—that foreign sovereigns enjoyed at the time Congress enacted the IOIA, 1945, notwithstanding the fact that in 1976 Congress restricted foreign sovereigns’ immunity under the FSIA. The U.S. Court of Appeals for the D.C. Circuit agreed.
U.S. Supreme Court Review
The Supreme Court reversed and remanded in a 7-1 opinion. The Court held that the language in the IOIA granting international organizations “the same immunity from suit . . . as is enjoyed by foreign governments” is best understood as a dynamic standard whose meaning moves in tandem with the current scope of immunity enjoyed by foreign governments. Looking to the ordinary meaning of the words “as is” and Congress’s use of those words in other legislation, the Court likened this provision of the IOIA to other statutes “that use similar or identical language to place two groups on equal footing.” In contrast, other provisions of the IOIA that “defined immunities in a static way” used “non-comparative language” to do so. As foreign sovereigns’ immunity changes, so does international organizations’ immunity.
The Court suggested that its decision would not expose international development banks to “excessive liability.” The Court expressed a view that “it is not clear that the lending activity of all developmental banks qualifies as commercial activity within the meaning of the FSIA.” But such a statement—in obiter dicta—does not preclude some or all of the activities of other development banks from satisfying the FSIA’s definition of commercial activity (particularly given the FSIA’s admonition, in defining “commercial activity,” that the nature of the conduct or transaction is determinative, not its purpose). The Court noted that “even if an international development bank’s lending activity does qualify as commercial,” the FSIA would still require that such activity have a “sufficient nexus to the United States” (paraphrasing the FSIA section excerpted above) and that “the ‘gravamen’ of a lawsuit” cannot be “tortious activity abroad” (presumably interpreting the above definition of “commercial activity” to exclude such claims). The Court pointed to the “serious doubts” raised by the U.S. Government as to whether even the particular case before it would clear these hurdles on remand, given that the conduct occurred in India and the claim sounded in tort.
Thus, there remains considerable uncertainty regarding how the Court’s holding will affect the underlying claims.
Potential Impact on MDBs’ Prevention, Detection, and Enforcement Efforts
Regardless of the outcome in the particular lawsuit against the IFC, however, the decision confirms that international organizations have no immunity for commercial activities with a sufficient U.S. nexus, absent special exemptions in the organizations’ charters or granted by the President. The articles of agreement of the IFC, along with those of the IBRD, and IDA, do not expand the scope of sovereign immunity. Rather, each recognizes that suits may be brought against the organization in member countries (which includes the U.S.) and that final judgments may be executed against them. Similar language is found in the charters of African Development Bank (“AfDB”), Asian Development Bank (“AsDB”), European Bank for Reconstruction and Development (“EBRD”), and the Inter-American Development Bank (“IDB”), although the charters of the AfDB and the AsDB limit actions to ones concerning the exercise of their borrowing powers.
There are several potential parallels between the IFC’s implementation of the environmental and social standards underlying the Supreme Court’s decision and MDBs’ efforts to prevent, detect, investigate, and prosecute corruption, fraud, coercion, collusion, or obstruction (which the MDBs define as “Sanctionable Practices”).
First, MDBs generally expect that recipients of their funds adopt specified ethical standards and require that they refrain from engaging in Sanctionable Practices. The AfDB, AsDB, EBRD, IADB, and members of the World Bank Group implement a standard anti-corruption strategy (the Uniform Framework for Preventing and Combating Fraud and Corruption) to prevent and deter Sanctionable Practices in projects they finance. As with the IFC’s powers to revoke funding for failure to comply with the standards, MDBs can revoke or refuse funding where they find evidence of Sanctionable Practices in their projects.
Second, analogous to the premise underlying the plaintiffs’ arguments against IFC, MDBs have adopted controls designed to ensure compliance with their prohibition of Sanctionable Practices. MDBs have adopted administrative systems to prevent, detect, investigate, and prosecute Sanctionable Practices by companies or individuals working on MDB-financed projects. MDBs have generally established internal units to investigate allegations of Sanctionable Practices. MDBs have, and often exercise, audit rights to ensure that fund recipients are not engaging in Sanctionable Practices, and MDBs engage in educational and communications efforts to inform contractors and the public about MDB enforcement. Companies or individuals found to have engaged in Sanctionable Practices face significant consequences, including restitution, debarment (which may be permanent or for a specified period, and applied with or without conditions), or both.
In some ways, MDBs’ enforcement efforts regarding Sanctionable Practices allow them even greater ability to oversee compliance than the IFC had in the context of the environmental and social standards at issue in the Jam litigation. The IFC’s environmental and social standards are directed towards IFC’s own clients. By comparison, MDBs’ expectations regarding Sanctionable Practices often broadly extend beyond direct counterparties. For public-sector projects, MDBs require that borrowers, beneficiaries, bidders, contractors, agents, subcontractors and sub-consultants, service providers, and suppliers, and the personnel of these actors, agree not to engage in Sanctionable Practices. For private sector development institutions, such as the IFC and the IDB’s IDB Invest, these requirements broadly extend to borrowers, direct and indirect investee companies, sponsors, consultants, and service providers, and the beneficiaries of financial guarantees.
Additionally, MDBs’ anti-corruption policies allow them to issue administrative sanctions against this broad group of actors for their involvement in any of the Sanctionable Practices. This sanctions tool is unavailable, for example, to the CAO, which is focused on the environmental and social performance of IFC and MIGA (rather than the culpability of third parties). In addition, unlike with the CAO, certain MDBs wield supervisory authority for the compliance programs of these sanctioned third parties. For example, the World Bank Group’s sanctions procedures allow the Integrity Compliance Officer to monitor a debarred party’s compliance program to meet certain standards prior to releasing the party from debarment.
A significant question will be whether the loans or grants issued by the World Bank Group and other MDBs are sufficiently “commercial” to pull MDBs’ conduct out from immunity. It is not implausible, however, that a future court determines that granting loans or grants is commercial activity—particularly when viewed, as required by the FSIA, without reference to the purpose of the loan or grant. Particularly regarding MDB loans, the loans have commercial terms and there is an expectation of repayment. Regarding the U.S. nexus requirement, are decisions regarding loans or grants—or regarding the controls over Sanctionable Practices—sufficiently connected to the U.S.? For the World Bank Group and other MDBs or international organizations headquartered in Washington, D.C., the answer could very well be yes, and potentially so for other MDBs based on financial support from the U.S. or based on the language of their charters or the sources of funding for particular projects.
How might MDBs React to Jam?
If MDBs are now exposed by Jam to potential liability in U.S. courts for failing to prevent Sanctionable Practices, how might they react? First, they might conduct more proactive or aggressive compliance due diligence on contractors as part of the “no-objection” processes for potential contract awards, particularly if contractors might otherwise point to their receipt of a “no-objection” letter from an MDB as an implicit blessing of the contractor’s compliance program. Second, they might increase their efforts to detect and prevent Sanctionable Practices, namely through the more-frequent and more-assertive exercise of their existing audit rights, supplemented potentially by outsourcing the exercise of their audit rights to third party professionals or vendors. They might also engage in greater communications and educational efforts concerning MDBs’ expectations for contractors’ compliance programs (such as the World Bank’s Integrity Compliance Guidelines). Third, they might increase their current level of investigations and prosecutions for Sanctionable Practices, seeking to enhance their deterrent effect.
Any or all of the above potential reactions would cause contractors on MDB-financed projects to face greater scrutiny regarding their own compliances processes and procedures, particularly regarding (but not necessarily limited to) how they compete for and execute MDB-financed projects without engaging in Sanctionable Practices. Should the Jam decision encourage future plaintiffs to test the contours of MDB liability, overlying these potential developments could be increased litigation activity and further court decisions.
It will accordingly be well worth watching MDBs’ and plaintiffs’ responses to Jam. Current or potential MDB contractors would be well advised to monitor these developments closely and consider whether they should prepare for greater MDB scrutiny of their compliance programs going forward.
* * * *