Fifth Circuit Rules on State Responsibility for Government Instrumentalities

The Fifth Circuit recently rendered an important decision relating to international arbitration. The case of Bridas v. Turkmenistan (“Bridas II”) addressed the confirmation of an arbitration award. An Argentine corporation, Bridas, had contracted with a Turkmenistan government entity. The arbitrators rendered a $495 million award against the Turkmenistan government entity as well as against the Government of Turkmenistan itself. The last bit is the critical issue, for the Government of Turkmenistan was not party to the agreement, but was nonetheless found liable pursuant to the agreement. It thus raises the complicated issue of third party liability in the context of international arbitration agreements with sovereign entities.

The case had come up to the Fifth Circuit before. In 2003, the Fifth Circuit in Bridas I rejected all possible theories to bind the Government of Turkmenistan, save one—the theory of alter ego. Upon remand the district court considered the alter ego theory, and followed the Fifth Circuit’s mandate to balance twenty-one factors (yes twenty-one) in determining whether the Government of Turkmenistan was the alter ego for the contracting government entity. The district court ultimately concluded that the government did not exercise complete domination or extensive control over the government entity.

The Fifth Circuit in Bridas II reversed. It found that the alter-ego doctrine is only available if the owner exercised complete control over the corporation with respect to the transaction at issue and such control was used to commit a fraud or wrong that injured the party seeking to pierce the veil. The court had little difficulty finding fraud or injustice. Noting that the government entity was capitalized for the equivalent of only $17,000, it found that the Turkmen government manipulated the government entity to prevent Bridas from recovering any substantial damage award. This undercapitalization was also viewed as crucial in finding parental control over the subsidiary. “Despite some indicia of separateness, the reality was that when the Government’s export ban forced Bridas out of the joint venture, the Government then exercised its power as a parent entity to deprive Bridas of a contractual remedy. Intentionally bleeding a subsidiary to thwart creditors is a classic ground for piercing the corporate veil.”

Although Bridas II did not discuss international law, the decision appears consistent with Article 8 of the ILC’s Responsibility of States for Internally Wrongful Acts. That article provides that “the conduct of a person or group of persons shall be considered an act of the State under international law if the person or group of persons is in fact acting on the instructions of, or under the direction or control of, that State in carrying out the conduct.” Article 4 provides that “the conduct of any State organ shall be considered an act of that State under international law, whether the organ exercises legislative, executive, judicial or any other functions, [and] whatever position it holds in the organization of the State….” Likewise, the leading U.S. Supreme Court case on the subject, First Nat’l City Bank v. Banco Para El Comercio Exterior de Cuba (Bancec), strongly suggests that the key ingredient for ignoring the juridical separateness of government entities is a finding of control. The Supreme Court held in Bancec that if the government effectively controls the performance of the entity, the government can be bound by the actions of its instrumentalities.