Sovereign Immunity Protects China from Paying $2.4B Debt to American Holders of Chinese Government Bonds

By Haggai Carmon

Gloria Bolanos Pons and Aitor Rodriguez Soria hold between them Chinese government bonds they believe to be worth almost $2.4 billion (interest plus principal upon 1960 maturation). U.S. District Judge Richard J. Howell, however, ruled that the money cannot be collected because the Foreign Sovereign Immunity Act protects China from prosecution in U.S. Courts.

The bonds were issued by the Chinese government in 1913. Under the Chinese Government Reorganization Loan Agreement, several international banks loaned the country GBP 25 million and issued bonds that amounted to the value of the loan. The bonds were secured by the tax money the Chinese government would raise from its citizens and residents.

No U.S. banks were part of the agreement because President Woodrow Wilson believed that the agreement infringed upon the sovereignty of the Chinese people. The bonds, therefore, were never payable in U.S. currency.

After the successful communist uprising in 1949, the new Chinese government – that of Mao Zedong – stopped paying interest on the bonds. The government defaulted on paying the principal as well.

The plaintiffs in the case claim to have purchased their 103 bonds from Pons’s father, though how he came to have them remains unclear. Either way though, the plaintiffs have calculated that the bonds are worth $2,392,194,873.

Among the exceptions to the immunity granted by FSIA is a commercial activity exception, and the plaintiffs argued that their case falls under the third part of this exception: “A foreign state shall not be immune from the jurisdiction of courts of the United States or of the States in any case in which the action is 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 caused a direct effect in the United States.”

Plaintiffs argued that because they had purchased the bonds in the U.S. and that some interest payments had been made in New York, and that they – U.S. citizens – suffered financial loss as a result of the default, that China’s act did indeed have a direct effect in the United States and was therefore not immune to the lawsuit.

The Judge writes: “The primary issue in this case is whether there is a direct effect in the U.S. when a bond negotiated, consummated and payable outside of the U.S. by non-U.S. parties is defaulted abroad, and then that default results in financial injury to an American after-market purchaser.” Citing several preceding cases, he concludes that “the mere fact of financial injury felt by the U.S. plaintiff does not satisfy the direct effects test.” If the bonds were payable in the United States, the direct effect commercial activity exception could be relevant, but the funds were supposed to be received abroad. (As per the bond agreement, interest and principal were payable only in London, Berlin, Paris, St. Petersburg and Yokohama.) The fact that payments stopped being made abroad and affected an American is not sufficient to prove a direct effect in the U.S.

Even if the interest was paid in New York to previous bond holders, as the plaintiffs claim, these payments were made in New York voluntarily. Whatever was done voluntarily aside, the default on payments which by contractual obligation were only payable abroad does not have a direct effect in the United States. China’s immunity stands.

Not only is China protected from the lawsuit by FSIA, the expiration of the statute of limitations was also mentioned by Judge Howell in his ruling.

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