Sovereign immunity: Investors above the law?

Sovereign actors – state pension plans, sovereign wealth funds, and other arms of governmental entities – have long been powerful, strategic players in private equity. Sovereign wealth funds alone manage approximately $5.5 trillion of assets, and have added a record $750 billion in assets to their books in the last 18 months.  The primary driver behind this growth has been the large number of new sovereign wealth funds formed in the last two years. Whether as a fund investor, co-investor, joint venture partner or otherwise, a sovereign entity comes with its own unique set of issues and requirements. In particular, counterparties need to address thoughtfully the sovereign immunity afforded to, or claimed by, such entities.

Sovereign immunity protects a state and its institutions from legal action. At its core, the doctrine provides that a state cannot commit a legal wrong and may not be sued without its consent. This means that when a sovereign invests in or alongside private equity funds, sponsors can be left with limited legal recourse unless the issue of immunity has been considered from the outset and appropriate precautions agreed.

Fundamentally, it is of course important to identify whether a counterparty is, in fact, a sovereign. The doctrine is not one confined to nation states, government institutions and sovereign wealth funds. Sovereigns are not always immediately apparent and, crucially, often include federal and state pension funds. If a counterparty asserts sovereignty, a party should always request a representation confirming whether the entity concerned is entitled to immunity in the contemplated circumstances. Often sovereign immunity is only provided on a narrow basis and does not extend to commercial transactions as a matter of law. A sponsor should be wary of endorsing a blanket claim of sovereignty in a commercial setting.  

Once confirmed, a sponsor should always investigate (with local counsel where necessary) whether there is an option to waive the sovereign’s immunity. Contrary to what is often stated in negotiations, certain sovereigns can waive their immunity. Sovereign status is not necessarily immutable. A waiver can be obtained at investment by agreement – in the investor’s side letter – or a waiver may occur as a consequence of a sovereign’s conduct – for example, submitting to a jurisdiction if a defendant or instituting proceedings in a jurisdiction without expressly claiming immunity. Indeed, a sovereign entity may wish to confirm that its entry into a fund agreement, while representing a valid commitment to the sponsor, in no way fetters its immunity, to ensure no accidental waiver as a result of conduct. Finally, a sovereign’s submission to arbitration can, in certain jurisdictions at least, amount to a waiver of immunity with respect to the matters related to the arbitration. If a waiver is not forthcoming, a sponsor may wish to secure a representation as to the sovereign’s entitlement to immunity and limit any recognition of that immunity to the extent permitted by applicable law.

Clearly identifying the court in which any disputes will be determined is also important. A sovereign is unlikely to consent unambiguously to hearings in the typical jurisdictions referenced in fund governing documentation (Delaware, Cayman or New York), so negotiating a compromise position is often necessary to address the concerns of both parties. Such negotiations can sometimes be as simple as agreeing the jurisdiction of the fund documents is not exclusive, or may involve more detailed mechanics. For example, parties could agree that the sponsor may only take action against the sovereign in the sovereign’s local courts, but the sovereign must use the sponsor’s local courts to bring an action against the sponsor and its affiliates. If a sponsor does submit to an unfamiliar jurisdiction, the sponsor should consult local counsel to understand any unexpected consequences.  From the point of view of a sovereign entity, on the other hand, submission to another jurisdiction may require an analysis of the extent to which that other jurisdiction may or may not respect the sovereign’s immunity status. 

As this brief summary indicates, doing business as or with a sovereign entity presents a further set of issues, not always straightforward. Therefore both sponsors and sovereigns would be prudent to evaluate such issues at the outset of a given negotiation or transaction.  Time spent vetting such issues up front can help avoid expensive misunderstandings and pain later on.