Home > Resource Centre > Publications > Publication

Doing business with foreign states can be very attractive for Canadian firms. States can award lucrative contracts on a scale uncommon in the business world. However, with the prospect of great rewards comes the risk of great losses. One of the most important issues a potential investor must consider before investing is how to resolve potential disputes, as obtaining legal recourse against foreign states can be difficult.

Foremost among the obstacles to a legal remedy against a state is state immunity. State immunity is a long-standing principle of international law under which states are immune from the jurisdiction of each other's courts. Since under international law all states are equal, courts of one state should not sit in judgment over the conduct of another state. This concept has been referred to as comity between states.

State immunity is no longer absolute. Certain exceptions have become generally accepted in international practice, and have been codified in national legislation governing foreign state immunity, offering some protection to investors doing business with states. Before entering into a business relationship with a state, however, an investor must understand the potential risks, and how best to guard against them.

THE CANADIAN STATE IMMUNITY ACT

Foreign state immunity in Canada is governed by the State Immunity Act[1] ("SIA"). Under the SIA, a foreign state is immune from the jurisdiction of any court in Canada unless one of the enumerated exceptions applies. Notably, these exceptions include cases where:

• the proceedings relate to any "commercial activity" of the foreign state, or
• the state has waived immunity by expressly submitting to the court's jurisdiction.

Even if a foreign state fails to defend itself in legal proceedings, Canadian courts must give effect to state immunity.

WHAT IS A "FOREIGN STATE"?

When doing business with a foreign state, one often concludes the contract with a ministry or department of the foreign government, or with a state-affiliated entity, rather than with the state itself. These distinctions can have a significant impact on the legal recourses available to the creditor.

Under the SIA, "foreign state" includes the government and departments of the foreign state, as well as those of any political subdivision of the foreign state, such as a province. It also includes any "agency of the foreign state". However, the immunity of agencies differs in several important respects from that of states.

Under the SIA, "agency of a foreign state" means "an organ of the foreign state [that is] separate from the foreign state." An "organ" of a foreign state is an entity that is identified with the state and that performs state functions, such as a government ministry or department. (Some characteristics typical of state organs are that their board members are appointed by the government, their employees are civil servants, they do not control their daily operations or own their assets, and they cannot directly conduct commercial transactions on their own initiative.)

An agency, while still sufficiently connected to the state to be an organ, is nonetheless legally distinct from the state. For example, state-owned companies are often considered "agencies of a foreign state" where the state has a great degree of control over them. Foreign state agencies can claim fewer benefits of state immunity: for example, property belonging to agencies is not immune from seizure, and the procedural requirements to sue an agency are more flexible than for states.

WHAT IS THE COMMERCIAL EXCEPTION?

From the investor's perspective, one of the most important exceptions to state immunity is the exception for commercial activity. The SIA provides that a foreign state is not immune from proceedings relating to any "commercial activity" of the foreign state. The rationale is that where a state acts like a private businessperson or investor, it should be subject to the same liabilities as a private party.

The Supreme Court of Canada addressed the interpretation of "commercial activity" in Re Canada Labour Code.^[2] It held that in order to characterize a given state activity, it is essential to view the activity in its entire context. Both the nature of the activity and its purpose may be relevant.

Neither the SIA nor the case law provides clear or simple criteria against which to measure the commerciality of state activity. Each case turns on its particular facts. Canadian courts have held the following activities by a foreign state or agency to be "commercial activity":

• entering into a contract with an agent for film distribution, sales, and licensing;
• entering into a contract for construction of a state's pavilion at an international exhibition, where the state was granted commercial concessions at the pavilion;
• ownership and licensing of drug patents;
• owing wages under an employment contract;
• holding a current account and entering into a safekeeping agreement with a bank;
• operating, managing and maintaining the Panama Canal for profit;
• carrying bulk cargo by ship;
• promoting commerce with the foreign state; and
• renting a building formerly used as a consulate.

By contrast, the following activities have been held not to be "commercial activity":

• hiring an architect to create sketches for the state's pavilion at an international exhibition, where the pavilion was not built and no evidence was adduced to show what it was to be used for;
• building state highways;
• dismissing an employee for reasons of national security;
• general oversight and operation of labour relations on a military base;
• appointing or dismissing a state's consular representative; and
• purchasing property for a consular representative's official residence.

While business transactions with a foreign state will often fall under the commercial exception, it is nonetheless wise to ensure against any potential immunity claim through an appropriately drafted contractual waiver of immunity, as explained below.

OBTAINING AND EXECUTING JUDGMENTS

Even where state immunity is lifted in respect of a proceeding, a foreign state may be immune from any remedies to enforce a judgment in favour of a creditor. A foreign state's property in Canada is generally immune from seizure unless, notably, the state waives its immunity in respect of that property or the property is used for a commercial activity.

As noted above, property of a foreign state agency is not immune from seizure. However, there may be little property in Canada belonging to the agency as opposed to the foreign state itself.

A court may not issue an injunction or order specific performance of a contract against a foreign state. A court may, however, order such remedies against an agency of a foreign state.

PRECAUTIONS AND POTENTIAL REMEDIES WHEN DEALING WITH FOREIGN STATES

Parties doing business with foreign states or state-related entities should always contractually ensure that all applicable foreign state immunities are waived to the greatest extent possible. Something that may seem like a commercial activity to an investor at the beginning of a contractual relationship might later be characterized by the state as part of its sovereign functions. It is always more prudent to rely on a contractual waiver than on subsequent characterization of the contract.

Investors should insist that the contract provide that the state expressly submits to the jurisdiction of Canadian courts in case of any dispute - though such an attornment by a state to the jurisdiction of another state's courts is, typically, difficult to obtain. Where the contract provides for arbitration, the arbitration clause should further specify that the foreign state waives its immunity for purposes of the registration, enforcement and execution of the award.

When entering into a contract with a foreign state-related entity, the nature of that entity - organ, agency, or other - and its precise relationship with the foreign state should be specified in the contract. It may not be at all clear to a Canadian court whether the entity in whose name the contract was signed is distinct from the foreign state, and if so, how. Where there is any doubt, a foreign state or agency may take advantage of it.

It may also be useful to waive immunity in respect of execution on foreign state property located in Canada, so that there are assets that can be seized in satisfaction of a judgment. However, as such a waiver must be in respect of particular assets, it may be of limited use unless there is foreign state property that is always located in Canada. More commonly, a creditor will have to argue at the time of seizure that the property was used for a commercial activity.

In certain cases, a dispute may arise as a consequence of sovereign actions that contravene the protections afforded to foreign investors under bilateral or multilateral investment treaties - such as the guarantee of fair and equitable treatment or the protection against unlawful expropriation.

In general, by providing for international arbitration (as opposed to litigation before national courts) as a means of resolving investment disputes, investment treaties allow for more bases of foreign state liability than the commercial exception of the SIA. Issues about comity toward a defendant foreign state which a court would have to address are also dispensed with, and an investor need not be concerned about receiving fair treatment in a foreign court. In all instances it is worthwhile for investors to determine whether they and their investments are covered by such treaties.[3]

CONCLUSION

While doing business with foreign states and state entities can be commercially attractive, investors must use caution. The SIA creates significant obstacles to investors wishing to pursue legal proceedings or execute judgments or awards in Canada against foreign states and state entities. Investment treaties may provide important protections not otherwise available to investors; nevertheless, in all cases Canadian investors should obtain legal advice tailored to their particular situation prior to signing a contract with a foreign state, in order to minimize the risk of not being able to obtain compensation for any losses suffered as a result of actions of the foreign state or state entity.

[1].    R.S.C. 1985, c. S-18.

[2].    [1992] 2 S.C.R. 50.

[3].    However, execution in Canada of any award in favour of the investor will still require showing that the seized property falls under one of the exceptions to immunity. The subject of investment treaties is addressed in greater detail in the Ogilvy Renault information bulletin called "Extra Protection for Canadians Investing Abroad".

 The purpose of this document is to provide information as to developments in the law. It does not contain a full analysis of the law nor does it constitute an opinion of Ogilvy Renault LLP or any member of the firm on the points of law discussed.

© Ogilvy Renault LLP 2006 - All Rights Reserved

 Back to Publications

Contacts

Richard L. Desgagnés
Montréal
514.847.4431
rdesgagnes@ogilvyrenault.com
Profile

Stephen L. Drymer
Montréal
514.847.4606
sdrymer@ogilvyrenault.com
Profile

Azim Hussain
Montréal
514.847.4827
ahussain@ogilvyrenault.com
Profile

Martin J. Valasek
Montréal
514.847.4818
mvalasek@ogilvyrenault.com
Profile