Sovereign Immunity Analysis in Subscription Credit Facilities
Subscription credit facilities (a "Facility") are a popular form of financing for private equity and similar investment funds ("Funds"). The Facility's lenders (the "Lenders") are granted a security interest in the uncalled capital commitments of the Fund's limited partners (the "Investors"), and the Lenders rely on the Investors' obligations to fund capital contributions as the primary source of repayment for the Facility. Governmental pension plans, state endowment funds, sovereign wealth funds and other instrumentalities of foreign and domestic governments are frequent Investors and may possess certain sovereign immunity rights against enforcement proceedings rooted in the common law concept that "the King can do no wrong."1
Sovereign immunity in its purist form could shield a governmental entity from all liability—including enforcement by a Lender seeking to collect uncalled capital commitments contractually owed by the governmental Investor to the Fund. Thus, as Lenders evaluate the creditworthiness of governmental Investors for inclusion in a Facility's borrowing base, it is essential for Lenders to understand how sovereign immunity may impact the enforceability of such Investors' capital commitments.
Governmental Investors must be evaluated on a case-by-case basis to ascertain if any sovereign rights apply and, if so, whether such Investor has effectively waived its immunity (thereby waiving its ability to raise sovereign immunity as a defense in subsequent litigation). This Legal Update sets forth the basic legal framework of sovereign immunity in the United States relevant to a Facility.
BASIS OF IMMUNITY
At its most basic level, the doctrine of sovereign immunity provides that the government cannot be sued in its own courts unless it has consented to waive its sovereign immunity. As it relates to governmental Investors organized under the laws of the United States or a political subdivision thereof (a "US governmental Investor"), the doctrine of sovereign immunity comes in two flavors: (i) sovereign immunity of the US federal government2 and (ii) sovereign immunity of state governments and their agencies and instrumentalities.3
Sovereign immunity of the US federal government is a concept that has existed in US jurisprudence since the country's founding.4 Through the Tucker Act5, however, it is well settled that the US federal government has waived sovereign immunity with respect to any express or implied contract (subject to certain exceptions).6
State governments historically enjoyed broad immunity, but in recent decades have become subject to suits in their own state courts for contract claims. Most states recognized common law sovereign immunity, and some codified it in their state constitutions. The Eleventh Amendment to the US Constitution also protects a state from being sued in federal court or in the court of another state without its consent. 7However, recognizing the inequities of such a rule in the commercial context, most states (through their constitutions, legislatures or high courts) have eroded the sovereign immunity of state governments to permit actions based on contractual claims. In those states, a claim for breach of contract may be heard before the state courts of that state (or, if applicable under the state's law, by another body or through a similar administrative process). Only a minority of states continue to reserve sovereign immunity in this context.
The doctrine of sovereign immunity also protects certain foreign governments (including political subdivisions, agencies and instrumentalities thereof) and international organizations of a quasi-governmental nature, such as the United Nations, against claims in US courts. While the Foreign Sovereign Immunities Act of 1976 (the "FSIA") generally shields such Investors from the jurisdiction of US federal and state courts, it provides an exclusive basis and means to bring a lawsuit against a foreign sovereign in the United States for certain commercial claims (as discussed below).8
WAIVERS OF IMMUNITY—US INVESTORS
There are three ways that sovereign immunity is generally waived by US governmental Investors: (i) An Investor expressly and unequivocally waiving such immunity in a writing that can be relied upon by the Lenders (e.g., a side letter provision running to the benefit of the Lenders or an "Investor Letter" delivered to the Lenders in connection with the Facility),9(ii) A statute enacted by the applicable governing legislature that explicitly waives immunity for contract claims in commercial transactions, such as the Tucker Act10 in the case of the US federal government, or (iii) Controlling case law, typically from a federal or the applicable state's highest court, that precludes governmental Investors from effectively raising sovereign immunity as a defense to contractual claims.
WRITTEN WAIVERS FROM INVESTORS
There are a few potential types of written waivers. The best case scenario for Lenders is an explicit written waiver from the Investor or an express statement that sovereign immunity does not apply. This may be found, for instance, in a side letter or in an Investor Letter, where the subject Investor typically: (i) Acknowledges and agrees that, to the extent it is entitled to sovereign immunity now or at any time in the future, it irrevocably waives such immunity to the fullest extent permitted by law and/or (ii) Represents that it is not subject to, or cannot claim, immunity from suit in respect of contractual claims to enforce its obligations under the Fund's limited partnership agreement and its subscription agreement.11
A second form of written waiver is an implicit waiver. With an implicit waiver, the Lenders receive an affirmative representation that the Investor is subject to commercial law and that its performance under the Fund's limited partnership agreement, the subscription agreement and the Investor Letter (if applicable) constitutes a private and commercial act, not a governmental act. While this form of waiver is not as strong as an explicit waiver, it puts the Investor at a severe disadvantage when distinguishing itself from a private actor in the marketplace and when attempting to argue that it should be entitled to immunity as a governmental actor (note: the comfort afforded by this waiver to a Lender certainly pivots on whether applicable law has abrogated immunity for commercial transactions).
A third variation of waiver language common in the Facility market involves neither an explicit nor an implicit waiver, but rather, mitigating language. Even if there is a side letter provision that expressly reserves the Investor's sovereign immunity, there are common formulations of related mitigating language in the Facility market that may also be included, such as a statement by the governmental Investor that despite its express reservation of sovereign immunity, such immunity does not in any way limit the Investor's obligations to make capital contributions under the Fund's limited partnership agreement and its subscription agreement. While this seemingly contradictory language is not really a waiver at all, to the extent it is included in a side letter provision (or other writing running to the Lenders' benefit)12, it provides some comfort to the Lenders that the Investor has agreed to fund its capital contributions. The Facility market generally accepts this language, but, as is the case with any form of written waiver, only after a careful review of the underlying law to determine whether the applicable Investor could nonetheless potentially raise a successful sovereign immunity defense in the context of a Facility.
STATUTORY WAIVERS
While it is ideal for Lenders to receive a written waiver as discussed above, some Investors are unwilling (or unable as a matter of law) to provide such a waiver. US governmental Investors will frequently reserve their Eleventh Amendment rights in a side letter; hence, it is very important to carefully review and vet governmental immunity provisions in side letters against applicable law to determine whether there is, nonetheless, an effective waiver. With respect to commercial contract claims, many states have waived sovereign immunity for a suit in the state's "home" court via their state constitution, statute or case law.
Several states, including California and New York, have passed statutes explicitly waiving sovereign immunity with respect to contractual claims.13 In these states, a plaintiff may proceed against the state government in that state's "home" court (notwithstanding that the Fund's limited partnership agreement (or equivalent) might provide for venue in another jurisdiction, such as Delaware or New York) just as if it were proceeding against a private citizen. If obtainable, in the Investor's side letter, Lenders should seek an explicit statement from the Investor acknowledging that the Facility qualifies under the applicable sovereign immunity waiver statute of that state. An example of such language would be: "Each of the Partnership Agreement, the Subscription Agreement and the Investor Letter constitute a contract within the meaning of [insert applicable state statute (e.g., Cal. Gov. Code Section 814, New York Court of Claims Act §8 (L. 1939, c 860), Section 12-201, State Gov. Article, Ann. Code of Maryland and ORS Section 30.320)]."
These state statutes often contain a specific set of requirements and procedures that must be complied with in order to bring suit against the Investor and obtain a judgment. For example, statutes that waive sovereign immunity for contractual claims often require that a claimant show that the contract was validly authorized and entered into by the governmental Investor.14 Additionally, it is not uncommon for such statutes to require that a claimant bring the claim within a certain period of time and in a particular venue, often a certain county or an administrative law court within the applicable state.15
COMMON LAW WAIVERS
Some state high courts have rendered decisions eliminating sovereign immunity with respect to contractual claims. For example, the South Carolina Supreme Court held that when the state enters into a contract, the state implicitly consents to be sued and waives its sovereign immunity to the extent of its contractual obligations.16 Similarly, the Missouri Supreme Court held that sovereign immunity does not apply to breach of contract claims against state agencies.17 The Virginia Supreme Court held that sovereign immunity is not a defense to a valid contract entered into by a duly authorized agent of the state.18 State courts, like state legislatures, have taken varying approaches with respect to the procedures and timelines that must be followed for a claimant to bring an action based on a contractual claim.19
Given the variations among state statutes and state case law with respect to waivers of sovereign immunity, it is prudent for Funds, Lenders and their respective counsel to examine each individual state's statute and case law on a case-by-case basis.
MINORITY STANCE—NO WAIVER
A minority of states have bucked the trend to waive sovereign immunity for contractual claims and thus leave Lenders at risk of enforcement uncertainty if a governmental Investor of that state defaults in its obligation to fund its capital commitment.
Alabama's state constitution, for instance, precludes the state (even by act of its legislature) from waiving immunity, although it provides for an administrative mechanism for claims to be made.20 Another example is Texas: the Texas legislature's explicit consent (through a statute or resolution) is required for any waiver of sovereign immunity.21 To date, the only waiver relevant to the Facility context that the Texas legislature has enacted is narrow in its scope and covers only limited types of local government entities.22
WAIVERS OF IMMUNITY—NON-US INVESTORS
Foreign governments and their instrumentalities are also frequent Investors, often with sizable capital commitments. Lenders should carefully review such Investors' creditworthiness, as well as the procedural requirements for enforcement of their capital commitments, including with respect to immunities.
The general premise of the FSIA is that a foreign government has immunity and cannot be sued in the United States. There are, however, three exceptions to this rule that are relevant in the Facility context. First, there is an exception for waivers where the Investor has expressly waived immunity by contract, including any such waivers that arise from language in applicable international agreements.23 Second, there is an exception for implied waivers where the Investor (i) agrees in a choice of law provision to be "governed by" US law,24 (ii) agrees to arbitration with the expectation of enforcement of an award in the United States,25 (iii) affirmatively files a suit or responds to a pleading without raising an immunity defense26 or (iv) has signed an international convention permitting the enforcement of an award in the United States27. Third, there is a "commercial activity" exception.28
Under the commercial activity exception, a claimant may sue a foreign government in a US court when the claim is based on (i) a commercial activity carried on in the United States by the foreign government, (ii) an act by the foreign government that is performed in the United States in connection with a commercial activity outside the United States or (iii) an act by the foreign government that is performed outside the United States in connection with commercial activity that occurs outside the United States, if such action "causes a direct effect" in the United States.29
Absent an express written waiver, a valid submission to jurisdiction in the United States or an agreement to binding arbitration,30 non-US governmental Investors in the context of a Facility should fall into the commercial activity exception.
In Republic of Argentina v. Weltover Inc,31 bond holders sued the Government of Argentina for breach of contract. The US Supreme Court articulated the applicable legal standard: "[w]hen a foreign government acts, not as a regulator of a market, but in the manner of a private player within it, the foreign sovereign's actions are 'commercial' within the meaning of the FSIA." Argentina argued that that the commercial activity exception did not apply because (i) the issuance of sovereign debt should not constitute commercial activity and (ii) the alleged breach did not have a "direct effect" on the United States. The Court disagreed on both counts. First, the Court concluded that the issuance of the bonds was of sufficient commercial character. Second, the Court rejected the argument that the FSIA required the direct effect to be "substantial" or "foreseeable," instead concluding that it need only follow "as an immediate consequence" of the sovereign's activity. Despite the fact that none of the bondholders were situated in New York, the Court held that the effect was direct because New York was the designated place for payment.32
Similarly, a California district court recently held that a sovereign wealth fund that invested in a US asset was not immune from US court jurisdiction, as its conduct fell squarely within the commercial activity exception under the FSIA.33
These cases are certainly helpful precedent for Lenders.
SATISFACTION OF A JUDGMENT AGAINST A SOVEREIGN ENTITY
Even if a governmental Investor has effectively waived sovereign immunity by one of the means identified above, the process of enforcing a judgment against a governmental Investor merits additional discussion.
First, side letter provisions may prescribe a particular jurisdiction (other than New York or Delaware) for litigation or a means of alternative dispute resolution (e.g., binding arbitration by the International Chamber of Commerce or similar body). Such provisions, along with any similar requirements under the state's law that may require claims to be brought before a particular court or administrative body, will affect how a Lender should pursue the Investor.
Further, once a judgment is obtained from the proper tribunal, satisfying a judgment against a governmental Investor may differ from satisfying a judgment against a private person. Due to public policy concerns, some government entities that do not enjoy immunity from suit may nonetheless argue they are effectively exempt from monetary judgments.34 In these cases, a Lender can initiate enforcement proceedings but may not be able to collect on a judgment. In other cases, payment of the judgment may require that a specific appropriation be made by the appropriate legislative body of the governmental Investor, or statutory limits may exist on the amount of the judgment that may be satisfied.
For example, in Kentucky, while the state has waived its sovereign immunity with respect to contract claims, damages are capped at twice the amount of the original contract.35 Certain states, including West Virginia, Louisiana and Connecticut, require the special approval of the legislature or some other administrative body before paying a claim.36 A Lender needs to be familiar with these types of particularities.
Seeking satisfaction of a judgment against a foreign governmental Investor that has defaulted on its capital commitment poses an additional set of issues, including a determination of whether such Investor has any commercial assets in the United States upon which a Lender can levy in the event the governmental Investor does not voluntarily settle a judgment awarded to the Lender. If the foreign governmental Investor does not have any commercial assets within the United States, the Lender may need to go abroad to seek enforcement of its judgment. Enforcing a US judgment abroad requires an analysis of whether the applicable foreign court will respect the judgment of the US court and if not, how such foreign court will rule if contractual liability needs to be re-litigated.
PRACTICAL CONSIDERATIONS
The good news is that Facilities have been around for many years and anecdotal evidence from active Lenders in the market indicates that there have been no material governmental Investor defaults, despite significant budget issues faced by many governmental Investors during recent financial crises (such as the Global Financial Crisis). Additionally, there are practical reasons mitigating the likelihood that a state pension fund or other governmental Investor would renege on its commitment to fund capital contributions. These include the often severe default penalties found in Fund limited partnership agreements, the bad publicity such Investor would likely receive and the damage the default might cause to the Investor's credit rating and reputation in the market. Thus, while the potential for such an Investor to claim immunity when a Lender exercises default remedies is nonetheless real and must be considered in connection with formulating each Facility's borrowing base, the practical likelihood of this happening with frequency in practice may be remote.
CONCLUSION
There are numerous avenues by which governmental Investors have waived sovereign immunity with respect to commercial contracts. While there are complex legal issues surrounding the interplay between the doctrine of sovereign immunity and the capital commitments of governmental Investors, Funds, Lenders and their respective counsel have vetted many of these issues in connection with prior investments and often have the analysis readily available. Accordingly, after careful review and, if necessary, appropriate drafting of waivers, Lenders typically receive the comfort they need to include the majority of such Investors in the borrowing base. However, as no two jurisdictions are the same and the law continues to evolve, it is important for both Funds and Lenders to evaluate governmental Investors individually and stay current on sovereign immunity analysis.
1 See 5 Kenneth Culp Davis, Administrative Law Treatise 6-7 (2d. ed. 1984) (quoting William Blackstone’s Commentaries Book III, Chapter 17 (1765-1769)).
2 Gray v. Bell, 712 F.2d 490, 507 (D.C. Cir. 1983).
3 Local government and municipalities, however, are generally not entitled to sovereign immunity, although this is a question of state law and may vary from state to state.
4 See Cohens v. Virginia, 19 U.S. 264 (1821).
5 28 U.S.C. §1491.
6 The Tucker Act applies only to agencies funded by Congressional appropriation. The Federal Reserve Bank, for instance, is therefore excluded.
7 See Hans v. Louisiana, 134 U.S. 1 (1890), Blatchford v. Native Village of Noatak, 501 U.S. 775 (1991) and Alden v. Maine, 527 U.S. 706 (1999) (establishing that the immunity extends to state court). See also Franchise Tax Bd. v. Hyatt, 139 S. Ct. 1485 (2019) (establishing that a state cannot be sued in the state court of another state without its consent).
8 28 U.S.C. §§ 1330, 1332, 1391(f), 1441(d), and 1602-1611.
9 Investor Letters are no longer common requirements in the Facility market, aside from a Facility for a fund-of-one or SMA, a Fund with an otherwise highly concentrated investor base, and certain other, limited circumstances. Outside of those contexts, a side letter provision is the more-typical form for a written waiver.
10 28 U.S.C. §1491.
11 In transactions where Lenders receive Investor Letters and Investor opinions as a condition to including a particular governmental Investor in the borrowing base, it is best practice that the Investor’s counsel opine, among other things, that the Investor has effectively waived sovereign immunity or that such Investor does not enjoy sovereign immunity in connection with its obligation to fund capital contributions to the Fund.
12 Given the risks to a Lender that are associated with an Investor’s reservation of sovereign immunity, it is recommended that Funds and Lenders coordinate early on in the process to review side letters for sovereign Investors, so that they can try to negotiate a full waiver or other mitigating language into the side letter before it is signed.
13 NY Ct of Claims Act §8 (L. 1939, c 860); Cal. Gov. Code §814.
14 See Or. Rev. Stat. §30.320, which requires a government agency to be “acting within the scope of its authority”.
15 For example, New York has vested exclusive jurisdiction in the New York Court of Claims for actions brought against the state of New York (See NY Ct. of Claims Act §8 (L. 1939, c 860)). Michigan, Pennsylvania, West Virginia, Ohio and Connecticut are among other states that have established judicial bodies to hear claims against the state (See Mich. Comp. Laws. Ann. 600.605 & 600.6419(1); 62 Pa. Consol. Stat. §§1721-1726; W. Va. Code §14-2-1; Ohio Rev. Code §2744.01 et seq.; and Ct. Gen. Stat. §4.142). In order to bring an action against the state of New Mexico under its statutory waiver of contractual immunity (N.M. Stat. Ann. §37-1-23), a plaintiff must (i) bring the claim within two years from the time of accrual, (ii) show that the contract is legally enforceable by pleading the basic elements of contract claims—offer, acceptance, consideration and mutual assent (See Hartbarger v. Frank Paxton Co., 115 N.M. 665, 669 (1993))—and (iii) show that the governmental entity was not acting outside of its designated authority or power (See Spray v. City of Albuquerque, 94 N.M. 199, 201 (N.M. 1980)).
16 Hodges v. Rainey, 533 S.E. 2d 578, 585 (S.C. 2000). Similarly, a 2017 Florida court case determined that “[w]here the government has entered into an express written contract that it is statutorily authorized to enter, sovereign immunity cannot protect it from the same contract rules that govern the performance of the express written contract obligations of a private party to a contract.” Dept. of Transportation v. United Capital Funding Corp., 219 So.3d 126, 135 (Fla. App. 2 Dist. 2017). Colorado has also abrogated sovereign immunity for contract claims. See Wheat Ridge Urban Renewal Authority v. Cornerstone Group XXII, L.L.C., 176 P.3d 737 (Colo. 2007).
17 Kunzie v. Olivette, 184 S.W. 3d 570 (Mo. 2006).
18 Commonwealth v. AMEC Civil, LLC, 699 S.E. 2d 499, 516 (Va. 2010).
19 Supra note 15.
20 Article 1, §14 of the Constitution of Alabama. See also Matthews v. Alabama Agric. & Mech. Univ., 716 So. 2d 1272 (Ala. Civ. App. 1998); Code of Ala. § 41-9-62(a)(4).
21 Tex. Gov't Code Ann. § 2260.007.
22 Tex. Loc. Gov‘t Code Ann. §§271.151–.160; El Paso Education Initiative, Inc. v. Amex Properties, LLC, 564 S.W.3d 228 (Tex. App. 2018). Thus, Texas governmental Investors are often excluded from a Facility’s borrowing base or, in some cases, are subject to a hurdle condition.
23 Harris Corp. v. Nat’l Iranian Radio & Television, 691 F.2d 1344 (11th Cir. 1982).
24 Marlowe v. Argentine Naval Commission, 1985 WL 8258 (D.D.C. 1985).
25 Process and Industrial Developments Limited v. Federal Republic of Nigeria, No. 21-7003 (D.C. Cir. 2022).
26 See, e.g., Drexel Burnham Lambert v. Committee of Receivers, 12 F.3d 317 (2d Cir. 1993).
27 See transport Wiking Trader v. Navimpex Centrala Navala, 989 F.2d 572 (2d Cir. 1993).
28 28 U.S.C. §1605(a)(2). For more information on when the FSIA applies and how to determine whether an activity qualifies as “commercial”, please consult our Legal Update, “Recent Decision in Jones v. PGA Tour Sheds Light on the Limits of Foreign Sovereign Immunity”.
29 28 U.S.C. §1605(a)(2).
30 In order to limit their exposure to US courts, it has been our experience that a number of foreign sovereigns will submit to binding arbitration with the Fund or a Lender.
31 504 U.S. 607 (1992).
32 Id. at 619.
33 Jones v. PGA Tour, Inc., 22-cv-04486-BLF (N.D. Cal. Apr. 3, 2023). While US courts have not held that investing in a Fund is inherently commercial, the cases involving investment activity have generally been construed as “commercial.”
34 See Section 31452 of the California County Employees Retirement Law (Cal. Gov. Code §31450 et seq.), which suggests that the assets of a California county retirement system are generally exempt from levy, execution, assignment, and any other collection process. Notwithstanding the express language of Section 31452 and a lack of certainty related thereto, we think there are good arguments that Section 31452 was intended to protect the pension benefits of the underlying beneficiaries from garnishment and not to shield a California county pension fund from liability for breach of contract.
35 Ky. Rev. Stat. Ann. 45A.245 et seq.
36 See W. Va. Code § 14-2-3 (An award by the Court of Claims is a recommendation by the court to the legislature, and is not binding); La. Const Art. XII, §10 (provides for the appropriation of funds by the legislature); and Ct. Gen. Stat. §4.158-160 (for claims in excess of $7,500, the Claims Commissioner may either (i) grant the claimant permission to sue the state agency, in which case the state has waived sovereign immunity or (ii) recommend payment of the claim to the General Assembly, in which case the Assembly may accept, modify or reject the recommendation. Upon rejection, the Assembly may authorize the claimant to sue, or it may reject the claim altogether.).
