United States: "Separate Entity" Rule Alive and Well in New York

In a much anticipated decision, New York's highest court, the Court of Appeals, confirmed on October 23, 2014, that the so-called "separate entity" rule continues to exist as a vibrant doctrine in the State of New York. Under the separate entity rule, a bank's branches in different jurisdictions are treated as "separate entities" for various purposes, including judgment enforcement.1 The court's decision in Motorola Credit Corp. v. Standard Chartered Bank,2 clears up some of the uncertainties created by that court's 2009 decision in Koehler v. Bank of Bermuda Ltd., and marks an important victory for the banking community.

Motorola had alleged that members of the Uzan family fraudulently diverted a substantial portion of a $2 billion loan from Motorola for their personal benefit. Motorola subsequently won a multibillion dollar judgment against the Uzans in the US District Court for the Southern District of New York. As part of its efforts to collect on this judgment, Motorola obtained a freeze order and served restraining notices pursuant to New York CPLR § 5222 on the New York branch of non-party Standard Chartered Bank (SCB), a non-US bank incorporated and headquartered in the United Kingdom. Although SCB had no assets of the Uzans at its New York branch, a search revealed that its United Arab Emirates branch held about $30 million in assets belonging to the Uzans. SCB froze the $30 million, but the UAE Central Bank—based on its view that SCB was not permitted to dishonor its obligation to repay the Uzan's UAE deposits based on an order originating from a non-UAE court—unilaterally debited $30 million from SCB's account with it.

Faced with the potential of double liability under US and UAE law, SCB requested relief from the freeze order. The bank argued that the restraining notice served on its New York branch was ineffective as to the assets held in the UAE branch under New York's separate entity rule. In response, Motorola argued that the separate entity rule had been overruled in Koehler. The US District Court agreed with SCB, but stayed release of the funds pending appeal. On appeal, the US Court of Appeals for the Second Circuit certified the question to the New York Court of Appeals.

The Court of Appeals, canvassing case law from lower New York and federal courts, concluded that the separate entity rule is deeply rooted in New York common law, going back nearly a century. Equally, if not more importantly, the Court of Appeals identified three principal policy reasons for maintaining the separate entity rule. First, the court recognized that applying freeze orders issued by US courts to assets located overseas would undermine international comity. Second, as "the facts of this case aptly demonstrate," the rule protects banks from unfair financial and regulatory repercussions abroad: it avoids competing claims on the same asset and thus eliminates the potential for double liability and it avoids placing banks in the "difficult position of attempting to comply with the contradictory directives of multiple sovereign nations." Third, the court explained that directing banks to process freeze orders with respect to foreign assets would impose an "intolerable burden" by forcing banks to identify and monitor assets in potentially numerous foreign branches. In so concluding, the Court of Appeals considered cases in which banks submitted affidavits explaining that computer systems in New York branches do not provide access to customer account information at head office or branches outside the United States. "Undoubtedly," the Court of Appeals summed up, "international banks have considered the doctrine's benefits when deciding to open branches in New York, which in turn has played a role in shaping New York's 'status as the preeminent commercial and financial nerve center of the Nation and the world.'"

Against this backdrop, the court then rejected Motorola's argument that its prior decision in Koehler abrogated the separate entity rule. In Koehler, the New York Court of Appeals held that pursuant to CPLR § 5225, a New York court may order a bank over which it has personal jurisdiction to deliver stock certificates owned by a judgment debtor to a judgment creditor, even if the certificates are located abroad in a non-US branch of the bank. A number of lower courts interpreting Koehler held that it implicitly overruled the separate entity rule. But in Motorola, the Court of Appeals explained that Koehler did no such thing. First, Koehler made no express reference to the separate entity rule. Second, Koehler addressed repatriation of stock certificates and, as such, was inapposite to the question of restraining deposit accounts.

Two judges dissented from the five-judge majority opinion in Motorola. The dissent argues that the separate entity rule is outdated and that the majority opinion cannot be reconciled with the court's ruling in Koehler. The dissent further flags the trend of "banks ... being held more accountable than ever for their actions vis-à-vis their customers," and characterizes the majority holding as an unwelcome "deviation" and a "step in the wrong direction."

On one level, Motorola is a welcome ruling in that it provides international banks doing business in New York with a higher degree of predictability that a New York freeze order will only be applicable to assets located in New York. And just as important, the decision should free banks from the expenses and burdens associated with investigating and applying freeze orders on a global basis. But on another level, the decision reveals a raging debate as manifested by the fundamental policy considerations invoked by the majority and the dissent. This debate reflects the broader disparity between those who increasingly believe that banks should insure against the misconduct of their customers (represented by the dissent in Motorola) and those who appreciate that doing so is not the proper role of a bank, especially in the face of the burdens international banks would be asked to bear. The majority ruling in Motorola certainly bodes well for the banking community; but the impassioned dissent should not be ignored. The dissent suggests that a not insignificant portion of the judiciary is prepared to reevaluate and challenge even long-standing norms in the banking industry as technology and social priorities evolve.

1 See our previous legal update, " New York Court of Appeals Issues Narrow Decision on Extraterritorial Asset Turnover While Legislature Considers Rolling Back Koehler.
2 __ N.E.3d __, 2014 WL 5368774 (N.Y. Oct. 23, 2014).

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