The New State Capitalism and Foreign Sovereign Immunity

As governments play an increasingly aggressive and direct role in capitalist economic systems (the “new state capitalism”), the line between sovereign and commercial conduct may become more difficult to draw for the purposes of foreign sovereign immunity. For example, Switzerland acted in some ways like a private investment bank when it negotiated a 2023 deal for one Swiss bank, UBS, to buy another Swiss bank, Credit Suisse. But unlike a private party, Switzerland had an array of governmental tools at its disposal, which it allegedly used to pressure Credit Suisse to agree to terms that Switzerland wanted. In the end, the deal involved Credit Suisse writing down to zero its additional tier one (“AT1”) bonds, leading angry bondholders to sue. Was Switzerland’s conduct within the “commercial activity” exception to the Foreign Sovereign Immunities Act (“FSIA”), thus permitting it to be sued in in New York?

Background

Credit Suisse AG & UBS were once the two largest Swiss banks – and commercial rivals. But by the early 2020s, Credit Suisse had been in slow decline for nearly two decades, partly due to various regulatory violations. The March 2023 U.S. banking crisis, which affected the banking market across the world, appears to have been the last straw for Credit Suisse. By March 15, its collapse seemed imminent – absent outside intervention.

Switzerland stepped in. Within four days it “brokered” an acquisition of Credit Suisse by UBS (the largest private bank in the world). Switzerland behaved much as an investment bank might do, but with heavy-handed tactics. Switzerland allegedly told Credit Suisse’s CEO: “You will merge with UBS and announce Sunday evening [March 19^th] before Asia opens. This is not optional.” To facilitate the acquisition, the Swiss National Bank gave Credit Suisse over $50 billion in emergency loans, provided over $200 billion in increased liquidity to the parties, guaranteed over $9 billion of potential losses for UBS, allegedly threatened a government takeover if the deal did not go through, and passed domestic regulatory measures and legislation to implement the deal, purportedly designed to bypass shareholder approval.

In addition, over $16 billion of Credit Suisse’s previously-issued debt securities, AT1 bonds, were written down to zero and canceled by Switzerland. Bondholders left with a worthless investment allege that the write-down violated the AT1’s terms, and they sued Switzerland in the Southern District of New York for conversion and tortious interference with a contractual relationship. Judge Dale E. Ho had to decide if Switzerland was immune from suit under the FSIA.

Questions & Some Answers

Readers may wonder – as I did – why the bondholders are suing Switzerland for conversion and tortious interference, rather than UBS (as the successor to Credit Suisse) for breach of contract. The short answer: they are suing UBS in other litigation and they are also suing  Swiss government agencies in Swiss administrative courts; some bondholders are also seeking relief from Switzerland under bilateral investment treaties. The longer (or at least more complex answer): it is not clear that cancelling the bonds actually violated their terms. It appears that these bonds were riskier than other A1 bonds, which may well have been reflected in the price. And the purchasers were sophisticated financial players.

In any event, the foregoing facts relate to the question of “commercial activity” and sovereign immunity because in my view, it is far easier in practical terms to show that the commercial activity exception is satisfied in cases for breach of contract. Indeed, the UN Convention on the Jurisdictional Immunities of States and Their Property has an exception for “commercial transactions,” which is very closely linked to commercial contracts. Although the FSIA uses broader language – “commercial activity” – plaintiffs often have a hard time showing that tort claims fit within the exception.

In this matter, UBS is being sued for breach of contract, not Switzerland. Switzerland is being sued for unfairly converting that property (the bonds) to new owners or causing the breach of the contract. Right out of the gate, that kind of conduct is likely to be deemed sovereign, not commercial.

The Court’s Decision

It is unsurprising, then, that Judge Ho held that Switzerland was immune in Creditincome Ltd v. The Swiss Confederation. But the reasoning in this generally strong opinion was not, in my view, fully persuasive.

At issue is 28 U.S.C. § 1605(a)(2) which provides (in its third clause) that a foreign sovereign is not immune from a suit based “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.” “Commercial activity” is unhelpfully defined by 28 U.S.C. § 1603(d) as “a regular course of commercial conduct or a particular commercial transaction or act.” The question in this case is whether Switzerland’s role in facilitating the UBS/Credit Suisse merger was “commercial activity.”

Judge Ho relied on the Supreme Court’s analysis of the “commercial activity” exception in Republic of Argentina v. Weltover (1992). The Weltover Court noted that under the statute, the commercial activity determination hinges not on the purpose of a state’s actions, but instead on the nature of the conduct: if a state exercises only “those powers that can also be exercised by private citizens,” as opposed to powers that a state/sovereign actor alone could exercise, its conduct is commercial. Argentina’s issuing of standard debt securities (bonds) was deemed “commercial activity” because any bank could issue substantially similar bond instruments.

The plaintiffs alleged that Switzerland’s role in facilitating the transfer was essentially the same role that investment banks take in a standard large merger. The court disagreed. It highlighted four actions that it reasoned were essentially sovereign in nature: (1) Switzerland monitored Credit Suisse’s financial situation for months and had contingency plans in place for a potential nationalization of the bank, in case a private acquisition were to fall through; (2) Switzerland provided over $250 billion in state funds to both parties throughout the transaction, an amount that far surpasses the typical capital expenditure by investment banks in this scenario (“The scale [of loans provided] is so dissimilar as to render the difference categorical, rather than simply one of degree.”); (3) Switzerland did not so much facilitate a transaction as force it through (“Investment banks take directions, not give them.”); and (4) Switzerland passed national legislation (the emergency directive to write down the AT1 bonds) specifically designed to facilitate the transaction.

The district court acknowledged that many of Switzerland’s actions were effectively equivalent to those of a private investment bank but reasoned that conduct is “commercial” only if the state exercises only “powers that can also be exercised by private citizens.”  If Switzerland engaged in any conduct exclusive to a sovereign, the commercial activity exception does not apply.

Analysis

As a whole, I think the court interpreted the commercial activity exception too narrowly. Switzerland’s power to impose its terms arose in part from Credit Suisse’s dire financial position and Switzerland’s ability to put a great deal of money on the table to make the deal work. But a major almost-bankrupt corporation in great immediate distress cannot negotiate the terms of its buyout, whether facilitated by Switzerland or some other entity. The court’s reasoning (based on Weltover dicta) that just the involvement of a large amount of money and leverage from Switzerland would render the conduct non-commercial seems too broad.

Rather than analogizing to Weltover, the better comparison may be Saudi Arabia v. Nelson (1993). Saudi Arabia ran a hospital, which was a commercial activity, but the conduct in question was the government’s use of the police power to retaliate against an employee who alleged called out unsafe hospital practices. The employee sued for battery, false imprisonment, and other torts. The Court concluded that the commercial activity exception did not apply because the hospital’s commercial activity was not the basis for Nelson’s claim. Similarly, it appears in this case that Switzerland’s allegedly wrongful conduct – the basis for the conversion and other tort claims – is the very conduct that is best described as unique to sovereigns, such as the legislative action that was apparently necessary to cancel the bonds. To be sure, the Nelson case was based on the first prong of the commercial activity exception, and this case involves the third prong. The first prong requires that the claim is “based upon commercial activity,” while the third prong only requires that the claim be based upon action “in connection” with a “commercial activity.”   Nonetheless, if the primary wrong for which redress is sought is something more like a government expropriation – as is arguably the case here – it is not at all clear that we should classify the case as coming within the commercial activity exception.

Finally, the court’s opinion seems to incentivize states to take a hands-on, active approach to manage large financial transactions. In other words, state run capitalism might help protect against suits abroad. Following the court’s reasoning in this case, for example, had Switzerland acted more passively by merely suggesting terms of the deal to each party or otherwise acting as a standard broker/negotiator, it seems unlikely that they would have been afforded immunity.

Conclusion

Tort cases brought under the commercial activity exception of the FSIA have not fared well. Whether the tortious conduct is false imprisonment by Saudi Arabia, clandestine surveillance and espionage by Qatar, hostage taking by Iran, or negligence by Austria in operating a railway, courts tend to find the exception inapplicable. The decision in Creditincome Ltd v. The Swiss Confederation rejecting the commercial activity exception fits comfortably with this precedent. The facts of the case, along with the court’s reasoning, suggest, however, that ramped-up government involvement in private deals may create difficult questions of foreign sovereign immunity in the years to come.