German Constitutional Court Rules on Necessity in Argentine Bondholder Case

On May 8, 2007, the German Constitutional Court (the "Bundesverfassungsgericht") handed down a decision on the question of whether Argentina could invoke necessity under general international law as an affirmative defense against claims brought in German courts by private individuals for the country's default on sovereign bonds in early 2002.[1] While the Court accepted that necessity was recognized as precluding the wrongfulness of a breach of international law, it held that "currently no rule of general international law can be ascertained entitling a State, vis-à-vis private individuals, to suspend the performance of due obligations for payment arising under private law by invoking necessity based on an inability to pay".[2] Judge Lübbe-Wolff, dissenting, countered that a general principle of law existed that allowed a State to suspend the fulfillment of its payment obligations to the extent necessary to protect elementary concerns of the bien commun, such as the protection of the life and health of its citizens.[3]

The decision, one of only a few dealing with necessity under international law, is the first to raise the question whether necessity can be invoked in domestic court proceedings as a defense to the breach of a private law contract entered into with private individuals. The decision is also likely to be of interest in the multiple pending and impending investment arbitrations against Argentina in which necessity plays a central role as an affirmative defense against the alleged breach of various bilateral investment treaties ("BITs").

Background

As a reaction to its economic crisis in 2001/2002, Argentina passed an "Emergency Law" that abolished the convertibility of the Peso to the U.S. Dollar, transformed all internal U.S. dollar denominated claims at a one-to-one ratio into Peso and abrogated tariff adjustment clauses.[4] Shortly after this so-called "pesification" Argentina also declared a default on its foreign debt and stopped servicing its sovereign bonds. As a consequence, various foreign investors have initiated investment arbitrations, mainly before the International Centre for Settlement of Investment Disputes (ICSID), and asserted violations of Argentina's BITs. Bondholders have initiated suits before domestic courts with varying degrees of success.[5] In both situations, Argentina's main defense relies on necessity under international law.

Whether an economic emergency and the inability to pay allow the use of a necessity defense is a controversial issue in international law. Only recently, three inconsistent ICSID awards based on the United States-Argentina BIT have been handed down in this context. [6] While accepting that a severe economic crisis could under extraordinary circumstances exempt a State from observing its international obligations under necessity, the Tribunal in CMS Gas Transmission Company v. Argentina rejected this plea on the grounds that Argentina had contributed to the crisis and disposed of other ways to react to it.[7] The Tribunal in LG&E Energy Corporation v. Argentina, by contrast, exempted Argentina from State responsibility on virtually identical facts for a limited period of time.[8] The Tribunal in Enron v. Argentina, finally, largely followed the earlier CMS award.[9]

Thus, the decision of the Bundesverfassungsgericht was expected to shed further light onto the unsettled law of economic necessity. The Court was called to render a decision as to whether necessity under general international law as invoked by defendant Argentina could suspend the repayment of sovereign bonds that were governed by German law.[10] Instead of clarifying matters, however, the Court added another layer to the debate: the question of whether a State can rely on necessity as a defense for the breach of private law contracts with private individuals in domestic court proceedings.

The Majority's Decision

As a first step, the Court confirmed that necessity is recognized under customary international law as precluding the wrongfulness of a breach of international law. With reference to the decisions by the International Court of Justice in the Case Concerning the Gabcíkovo-Nagymaros Project and Legal Consequences of the Construction of a Wall in the Occupied Palestinian Territory and the judgment of the International Tribunal of the Law of the Seas ("ITLOS") in The M/V "Saiga" (No. 2), the Bundesverfassungsgericht also accepted that Art. 25 of the International Law Commission's Draft Articles on State Responsibility ("ILC Draft") constituted an adequate codification of customary international law.[11] However, a majority of seven judges concluded that it could not find a rule of general international law that permitted a State to invoke necessity in relation to private individuals in order to suspend fulfilling due payment obligations.[12]

In the Court's view, both state practice and opinio juris were missing in order to conclude that such a rule existed under customary international law.[13] In particular, the majority refused to view the practice of international courts and tribunals as sufficient evidence to conclude that necessity under international law could be invoked in relationships that were governed by domestic private law. It decided that decisions by the ICJ and ITLOS did not constitute relevant practice in this context, as they concerned inter-State proceedings exclusively governed by international law. Similarly, investor-State disputes under investment treaties, such as the CMS and the LG&E rulings, were considered inconclusive because the investor, although acting as a private individual, alleges violations of a BIT and therefore invokes a violation of international law and does not bring a private law claim.[14] Similarly, the Bundesverfassungsgericht concluded that the decisions by various international courts and tribunals in the Serbian Loans Case, the Russian Indemnity Case and the decision in French Company of Venezuelan Railroads, which all dealt with the defense of necessity albeit in inter-State proceedings, "could not serve as evidence for the evaluation of State practice for invoking necessity directly against private individuals".[15]

Furthermore, the Court determined that it could not deduce a general principle of law from domestic legal orders that recognized the prerogative of States to invoke necessity against claims based on domestic private law. In so ruling, it relied on an unpublished (to date) expert opinion by Prof. August Reinisch that concluded that domestic courts in various countries did not follow a uniform approach in treating a State's inability to pay as an excuse for serving its sovereign debt.[16] Due to the alleged lack of uniformity in the domestic legal orders the Court considered itself incapable of finding that necessity constituted a general principle of law which would allow a State to suspend its payment obligations towards private individuals.

Finally, the Court pointed out that the literature diverged as to whether necessity under international law could be invoked in private law relationships.[17] As a consequence, the Court's majority concluded that it could not ascertain the existence of a rule that would allow Argentina to suspend its payment obligations vis-à-vis the private bondholders. It also left it unresolved under which circumstances, if any, economic crises qualified under the necessity defense.[18]

The Dissenting Opinion by Judge Lübbe-Wolff

Judge Lübbe-Wolff issued a forceful dissent disagreeing with the majority's conclusion. Apart from rejecting the admissibility of the proceedings before the Constitutional Court for mootness in view of the termination of Argentina's economic crisis, she disagreed concerning the alleged inapplicability of necessity to the relations between a State and an individual. In her view, the majority failed to recognize that necessity could not only form part of customary international law, but also constituted a general principle of law that entitled a State to give precedence to certain duties to its citizens over the repayment of monetary obligations, even if these obligations are governed by private law.[19]

Based on State practice and the precedent of international courts, she concluded that economic necessity has always been recognized as a general principle that permitted a State to suspend its payment obligations vis-à-vis private individuals. She particularly emphasized that the State practice documented by the ILC during its work on the Draft Articles suggested that necessity has been available as a matter of principle, independent of the legal source of the claims asserted against a State.[20] This was also the view expressed in the Russian Indemnity Case where the arbitrators emphasized that force majeure was available in international law just as it was available in private law. Similarly, the decisions in French Company of Venezuelan Railroads, Société Commerciale de Belgique and Dickson Car Wheel Company presupposed, in Lübbe-Wolff's view, that necessity constituted a general principle of law and was not limited to inter-State relationships.[21] Instead of distinguishing between different legal spheres, these decisions confirmed that the "object and purpose of necessity would not support that a debtor State would be less protected against its foreign private creditors as against another State".[22] Lübbe-Wolff further bolstered her position by arguing that international human rights law as ius cogens prevented the enforcement of payment obligations in a way that would cause, aggravate or prolong a State's inability to discharge its most elementary duties vis-à-vis its citizens.[23]

She also considered the application of necessity in investor-State arbitration as a counterargument against the majority's position that necessity was inapplicable in the relationship between a State and an individual and pointed out that diplomatic protection cases essentially presented causes of action that were fundamentally identical with the underlying private law claims.[24] For her, the distinction between international and domestic law in the bondholders cases made little sense as the debtor State, by invoking necessity in the domestic court proceedings would merely "assert the international law entitlement vis-à-vis the forum State to give precedence in the case of an emergency to the maintenance and reestablishment of its function as a State".[25]

Finally, Lübbe-Wolff pointed out that most other States, including Italy and the United States, accepted the State's sovereign immunity, suspended domestic court proceedings to allow the foreign sovereign to restructure its foreign debt, or granted broad enforcement immunity with respect to property that was used in order to fulfill its duties as a sovereign vis-à-vis its citizens.[26]

The dissenting opinion outlines a strong case that economic necessity constitutes a general principle of law that entitles a State to invoke it vis-à-vis private individuals in relationships governed by domestic law. As a limitation upon necessity, Lübbe-Wolff did, however, support that courts should apply strict scrutiny in determining whether the facts of a case give rise to economic necessity. The debtor could not be accorded a margin of appreciation as to whether an economic emergency existed.[27] In addition, she stated that it was indisputable that the consequences of necessity are limited to suspending a State's obligations.[28]

Conclusion

The Court decision will undoubtedly incite discussion as to whether necessity and possibly other defenses under the ILC Draft Articles on State Responsibility will be available against claims by private individuals or restricted to inter-State relations. The majority vote is surprising given that States have traditionally been able to use sovereign immunity to isolate themselves completely from suits by private persons in foreign countries. Accordingly, the lack of State practice that the Court determines is possibly less a matter of the substantive law, but rather due to the lack of standing of private individuals in international law dispute settlement. This is also the position taken by the dissent that points to the widespread acceptance of necessity as a general principle applicable both in inter-State relations as well as between States and individuals. After all, if international law permits States to completely divest private individuals from any court protection based on sovereign immunity, the argument can be made that the lesser scope of necessity can be invoked against claims by private individuals if sovereign immunity is waived.

Undoubtedly, the decision, which displays a strict dualist perspective on the relationship between international and domestic law, will fuel debates of a more theoretical nature. While Lassa Oppenheim in the early 19th century still posited that "[t]he Law of Nations and the Municipal Law of the single State are essentially different from each other",[29] one can witness a growing dissolution of the strict boundaries between international and municipal law. International human rights law, for example, is based on the notion that international law can create rights of individuals against the State, international criminal law follows the premise that individuals are directly subject to obligations arising there under.

To be sure, the impact of the decision of the Bundesverfassungsgericht on investment treaty arbitrations will probably be less dramatic. As the Court itself pointed out, investment treaty arbitration are proceedings under international law where the investor invokes rights and obligations that are also vested in its home State.[30] In addition, the decision does little to clarify the requirements and elements of an economic state of necessity. In this regard, the dissenting opinion might lead the way.

About the Author
Stephan W. Schill, an ASIL member, is a Ph.D. candidate at Johann Wolfgang Goethe-Universität Frankfurt am Main, Germany. Beginning in fall, he will clerk at the International Court of Justice sponsored by New York University School of Law. He is admitted to practice law in Germany.

Footnotes