D.C. Circuit Limits Jurisdiction over Foreign States in Breach of Contract Claims

U.S. Army Soldier and Iraqi Army Soldier Shaking Hands by Sgt. Jeffrey Alexander, licensed under PDM 1.0

Circuit courts have split on the issue of what is required for a breach of contract to have a “direct effect” in the United States for the purposes of the Foreign Sovereign Immunity Act (FSIA) (a primer on foreign sovereign immunity is available here). Rulings in the Seventh and Eleventh Circuits impose a “place of performance” requirement—meaning that the contract must designate the United States as a place of performance—whereas rulings in the Second, Fifth, Sixth, and Ninth Circuits use less stringent requirements. Recently, the D.C. Circuit issued an opinion which clarifies its position in this split and demonstrates how difficult it can be to determine when a foreign government can be held liable for breach of contract.

After the invasion of Iraq, a Pennsylvania based contractor, Wye Oak Technologies, Inc., was awarded a contract to inventory and refurbish military equipment for the Republic of Iraq. The business relationship quickly soured and after five months of no payment from Iraq, Wye Oak’s president, Dale Stoffel, flew to Iraq to secure the $24 million owed to his company. Instead, he was “assassinated” by unknown culprits, and the company stopped operating in Iraq. In the twenty years that followed, Wye Oak pursued legal action against Iraq for breach of contract, winning two separate judgments only to have each vacated on appeal because of foreign sovereign immunity.

Foreign Sovereign Immunities Act

U.S. courts only have personal and subject matter jurisdiction over foreign governments as prescribed by the FSIA. In this case, the relevant parts of the statute are the three clauses of the “commercial activity exception,” which permit suits against foreign governments if they are based upon either: (1) “a commercial activity carried on in the United States by the foreign state,” (2) “an act performed in the United States in connection with a commercial activity of the foreign state elsewhere,” (3) “an act outside the territory of the Unites States in connection with a commercial activity of the foreign state elsewhere and that causes a direct effect in the United States.” If the exception is satisfied, the district court has subject matter jurisdiction and personal jurisdiction.

Litigation in Virginia and the Fourth Circuit

The case was originally brought in federal court in Virginia. Iraq moved to dismiss for lack of subject matter jurisdiction, lack of personal jurisdiction, and improper venue. The judge denied the motions to dismiss for lack of jurisdiction, holding that the commercial activity exception of the FSIA applied and that Iraq was therefore not immune from suit. However, the judge concluded the venue was improper and, rather than dismissing the case, transferred it to the U.S. District Court for the District of Columbia (DDC)—the default venue for actions against foreign states.

Iraq appealed the denial of the motion to dismiss for lack of subject matter jurisdiction (not contesting personal jurisdiction or venue) to the Fourth Circuit. Although district courts and their appellate courts usually lose jurisdiction over a case once it has been transferred, the Fourth Circuit recognizes an exception when “prior to transfer,” the district court has entered an “immediately appealable order.” On this basis, and because of the presumption that its decision would “become the law of the case in the transferee court,” the Fourth Circuit reviewed the order while the DDC stayed proceedings pending appeal. The Fourth Circuit then held the second clause of the commercial activity exception applied, meaning that the district court properly denied the motion to dismiss (allowing the litigation to proceed in D.C.).

The First Judgment in Favor of Wye Oak

After an eight-day bench trial in 2018, the DDC issued a judgment in favor of Wye Oak and awarded damages of almost $89 million. The district court concluded that it had jurisdiction by applying the “law-of-the-case” doctrine, which provides that a decision of a coordinate court in the same case should not be disturbed absent extraordinary circumstances. Even aside from the law of the case, the district court found the Fourth Circuit’s reasoning persuasive. The second clause of the FSIA’s commercial activity exception involves two inquiries: (1) is there a commercial activity by the foreign state? and (2) is the action “based upon” an act performed in the United States in connection with that commercial activity? The district court found in this case that contracting to inventory and refurbish goods is commercial, despite its connection to the military. As for whether the claim was “based upon” an act in the United States, the court cited Odhiambo v. Republic of Kenya (2014), in which the D.C. Circuit held that a suit is “based upon” on an act if the act establishes a fact without which the plaintiff will lose. In this case, Wye Oak had to establish they were fulfilling their contractual obligation by developing a computer program in the United States (contrary to Iraq’s assertions). Accordingly, the court held the suit was “based upon” this act, and this act was connected to Iraq’s commercial activity. Thus, the second clause of the commercial activity exception applied, and the court had the jurisdiction.

On appeal, the D.C. Circuit vacated the district court’s decision, holding that the law of the case doctrine did not apply because the two opinions addressed different questions of law. The Fourth Circuit had to determine whether Wye Oak’s allegations plausibly support a finding that the court had jurisdiction under the FSIA to resolve a motion to dismiss at the outset of the case, whereas the DDC was determining whether it had jurisdiction under the FSIA to issue a post-trial judgment.

The D.C. Circuit also disagreed with both the DDC’s and the Fourth Circuit’s reasoning. Although the D.C. Circuit agreed that Iraq’s activity was a commercial activity, the court held that the “act” at issue must be one “that the foreign state” performed in the United States rather than an act that the plaintiff, Wye Oak, performed in the United States. Additionally, the D.C. Circuit chided the district court’s failure to discuss OBB Personenverkehr AG v. Sachs (2015) which establishes that an action is only “based upon” an act when the act “constitutes the gravamen of the suit”—a test that this case “reasonably obvious[ly]” fails. Nevertheless, the D.C. Circuit remanded the case for further proceedings saying it is possible the facts of the case may support the application of the third clause of the commercial activity exception which grants jurisdiction if the act at issue “causes a direct effect in the United States.”

The Second Judgment in Favor of Wye Oak

Taking its cue from the D.C. Circuit, in 2022 after both parties submitted supplemental briefings, the DDC again issued a judgment in favor of Wye Oak and awarded damages on its contract claim, this time holding that there was jurisdiction under the third clause of the commercial activity exception.

Navigating the thorny issue of what constitutes a “direct effect” in a breach of contract claim against a foreign sovereign (though not mentioning the circuit split on the issue), the DDC rejected two theories advanced by Wye Oak but was persuaded by two others.

First, Wye Oak argued that Iraq’s nonpayment had a direct effect in the United States because money that was supposed to be deposited in a U.S. bank account was not. This argument failed because Iraq was not under any contractual obligation to make payments to the United States and Valambhia v. United Republic of Tanzania (2019) requires that for nonpayment to have a direct effect in the United States, the foreign sovereign “must have been bound under a contractual obligation . . .to make a payment in the United States.”

Second, Wye Oak argued that Iraq “targeted” the United States and intended its nonpayment to have a direct effect here. The facts did not support this allegation, the district court found. At best, they showed Iraq may have intended “a kind of indirect effect” on Wye Oak’s U.S. operations. If this sufficed, the court reasoned, the third clause of the commercial activity exception would apply to the “the vast majority” of large business deals between a U.S. company and a foreign sovereign.

Third, Wye Oak argued that Iraq’s nonpayment directly affected the flow of commerce between the United States and Iraq. Wye Oak cited McKesson HBOC, Inc. v. Islamic Republic of Iran (2001), in which the D.C. Circuit found that the Iranian government’s expropriation of a dairy farm had a direct effect in the United States by cutting off “the constant flow of capital, management personnel, and engineering data, machinery, equipment, materials and packaging between the two companies” and that the expropriation directly affected the U.S. plaintiffs’ roles as active investors. The DDC court was persuaded that Wye Oak’s operations, flow of services between the United States to Iraq, and plans to expand their business in the United States were affected in similar ways.

Fourth, Wye Oak argued that Iraq’s nonpayment directly affected “U.S. diplomatic and military operations” in the United States. After Iraq refused to pay Wye Oak’s invoices, Wye Oak engaged in correspondence with high-ranking U.S. government officials who took action on Wye Oak’s behalf. Again, the lower court was persuaded, finding that because Wye Oak was “closely connected to and supported by” the U.S. government, Iraq’s commercial activity involving Wye Oak was “inextricably tied up” with its relationship to the U.S. government and had a direct effect on it. Moreover, the court found that Iraq’s nonpayment delayed Iraq’s military readiness which in turn delayed the United States’ withdrawal from Iraq.

It appears the DDC was attempting to navigate a middle path on this issue. On one hand, it seems the DDC held that a breach does not cause a direct effect in the United States when the contract is open-ended and the plaintiff chooses the United States as the place of performance (unlike the Second, Fifth, Sixth or Ninth Circuits). But on the other hand, it seems the DDC held that a breach may cause a direct effect in the United States when—regardless of what was in the agreement—the breach forces the plaintiff to take actions in the United States or constrains what the plaintiff can do here (a more liberal reading than the Seventh or Eleventh Circuits).

The D.C. Circuit reversed, adopting a restrictive understanding of what constitutes a “direct effect” and taking a similar position to the Seventh and Eleventh Circuits. Instead of looking to McKesson (as the DDC did), which established that an interruption to the flow of commerce stemming from a breached contract is enough to show a direct effect in United States, the D.C. Circuit relied on Odhiambo which narrowed the ruling in McKesson and seems to add a “place of performance” requirement. Under Odhiambo, a breach of contract has a direct effect in the United States only if the contract “establishes or necessarily contemplates” the United States as a place where the contract was to be performed. In this case, because the terms of the contract were to be carried out abroad and all decisions that affected commerce were the result of Wye Oak’s “unilateral business judgment,” the D.C. Circuit found no direct effect in the United States. As for the effects on U.S. diplomatic efforts, the court held that, under Princz v. Federal Republic of Germany, only effects with “no intervening element” are ”direct.” Wye Oak’s decision to seek out government officials, the government officials’ decision to act on behalf of Wye Oak, and the government’s response to those overtures, were all intervening elements between the breach and the effect in the United States. Similarly, the court of appeals reasoned that effects of the breach on U.S. military efforts were not considered direct because there were “too many discretionary steps” made by “too many actors” reacting to “too many considerations” to trace directly to Iraq’s breach. After almost 20 years of litigation, the D.C. Circuit vacated the DDC’s judgment and remanded the case for dismissal.

Conclusion

Although this decision helps clarify prior D.C. Circuit rulings on breach of contract claims against a foreign government, the court did not mention the circuit split, making it difficult to know exactly where it stands in relation to its sister circuits. The Wye Oak case may have come out differently in the Second, Fifth, Seventh, or Ninth Circuits which have found direct effects in the United States resulting from a breach of contract that left the place of performance up to the plaintiff. However, it is unclear how far those courts are willing to allow the unilateral judgment of the plaintiff to determine where an effect is felt directly. Until the Supreme Court sheds light on this issue discrepancies between the circuits will likely remain.