THE SCOPE OF ARTICLE 8 MANDATORY CHOICE-OF-LAW RULE

Introduction

The scope of the mandatory choice-of-law rule set forth in Uniform Commercial Code (UCC) section 8-110(a)(1), which provides that “[t]he local law of the issuer’s jurisdiction . . . governs . . . the validity of a security,”^[1] is one of the important issues in the ongoing dispute between Venezuela’s state-owned oil company Petróleos de Venezuela, S.A. (PDVSA) and holders of its now defaulted notes that were scheduled to come due in 2020 (the “2020 Notes”).

The 2020 Notes were issued under an indenture governed by New York law. PDVSA argued that UCC section 8-110(a)(1) should override the choice-of-law clause in the indenture, that the question of the validity of the Notes should be determined on the basis of Venezuelan law, and that the failure to obtain National Assembly approval in accordance with section 150 of the Venezuelan constitution, a provision that requires National Assembly approval of all contracts of “national public interest,” renders the notes invalid under UCC 8-110(a)(1). The noteholders, on the other hand, responded that UCC section 8-110(a)(1) should not override the New York choice-of-law clause in the indenture because constitutional provisions of the type pointed to by PDVSA are outside the scope of UCC section 8-110(a)(1).

The United States District Court for the Southern District of New York decided in favor of the noteholders. On the choice-of-law question, the district court held that the validity of the 2020 Notes is governed by New York law and agreed with the noteholders that whether the 2020 Notes violated the Venezuelan constitution is outside the scope of “validity” in the context of UCC section 8-110(a)(1).^[2] That decision is currently under appeal to the United States Court of Appeals for the Second Circuit.

Professor Carl Bjerre, in his article Investment Securities, argues that the court misinterpreted the UCC and that the 2020 Notes’ alleged violation of the Venezuelan constitution renders them invalid.^[3] We disagree with Professor Bjerre’s interpretation. We note, but do not discuss further in this article, that the “issuer’s jurisdiction” is a term of art defined in UCC section 8-110(d) as “the jurisdiction under which the issuer of the security is organized or, if permitted by the law of that jurisdiction, the law of another jurisdiction specified by the issuer.”^[4] As such, if permitted by the domestic laws of the issuer’s jurisdiction of organization, New York will be deemed to be the issuer’s jurisdiction by virtue of the choice-of-law provision in the indenture. In this article, we instead focus on the scope of “validity” as used in UCC section 8-110(a)(1) and offer an interpretation that is consistent with the UCC’s drafting history and policy goals. In doing so, we explain why the constitutional issue raised by PDVSA is outside the scope of “validity” as used in UCC section 8-110(a)(1).

I. The Limit of Validity as Used in UCC Section 8-110(a)(1)

“Validity” in the somewhat archaic UCC parlance “refers to the issue that lawyers today would probably describe as whether issuance of the securities had been ‘duly authorized’”^[5]—i.e., whether the issuer’s corporate actions are in accordance with the law of the issuer’s jurisdiction governing such matters.^[6] Such law is normally found in the corporate law of the issuer’s jurisdiction, which also governs the issuer’s charter, bylaws and other organizational documents. Article 150 of the Venezuelan constitution is not this type of law and therefore has no impact on the “due authorization” analysis.^[7] Professor Bjerre acknowledges that in a scenario where the laws of State B applies to an indenture but UCC section 8-110(a)(1) results in the laws of State A determining “validity,” not all laws of State A that relate to issues of enforceability of an obligation would fall within the “validity” analysis, citing usury laws of State A as an example of laws that would be excluded. However, Professor Bjerre nevertheless seeks to expand the universe of laws that would fall within the ambit of the UCC section 8-110 “validity” analysis beyond the narrower corporate laws applied by the district court. These attempts are misguided.

A. Bjerre’s Artificial Distinction between Enforceability Requirements of General Applicability Relating to the Nature of the Obligations and Requirements Going to the Nature of the Obligor and its Internal Processes.

Professor Bjerre seeks to establish two potential lines of distinction between included and excluded laws. First, he argues it may be “useful to characterize validity requirements as going to the nature of the obligor and its internal processes on one hand, and on the other hand enforceability requirements of general applicability as going to the nature of the rights and obligations purportedly created, irrespective of the nature of the obligor and its processes.”^[8] Applying that type of distinction, he claims that Article 150 “would seem clearly to be a provision about the obligor and validity, and thereby to fall within the ambit of UCC section 8-110(a)(1).”^[9] Professor Bjerre does not further justify that statement other than on a “rough and intuitive basis.”^[10] However, Professor Bjerre is overstating the application of his own created dichotomy. Article 150 is not “a provision about the obligor and validity”; instead, it imposes an external parliamentary process applicable to any contract that is deemed a contract of national public interest rather than implicating any internal processes of the obligor.

Therefore, even under Professor Bjerre’s proposed dichotomy, Article 150 falls squarely into the category of generally applicable laws that fall outside the scope of the UCC section 8-110 “validity” analysis. Professor Bjerre attempts to characterize Article 150 as a provision that “does indeed deal with a procedural requirement (approval by the National Assembly) for the issuance of securities by Venezuelan issuers, so long as the issuance is a national public interest contract.”^[11] However, this argument misses the mark. What’s relevant is not that Article 150 can capture the issuance by a corporation and that Article 150 imposes some kind of procedural requirement, but rather that Article 150 is not limited to issuance of particular types of corporate issuers and the procedures addressed in Article 150 are not internal to the corporation.

B. Bjerre’s Faulty Reliance on UCC Section 8-202 To Broaden The Scope of Validity

Professor Bjerre, in his article, also seeks justification for his broadened scope of “validity” by referring to other sections of the UCC, but these attempts to support his interpretations are also misguided.

Specifically, Professor Bjerre points to UCC section 8-202(b), which gives certain purchasers a defense against an issuer’s assertion that its securities are not valid, with special rules for claims involving “the violation of a constitutional provision.”^[12] There is no question that UCC section 8-202 provides important color in respect of the UCC section 8-110(a)(1) validity analysis, and official commentary to section 8-110 points to section 8-202 for additional gloss. However, Professor Bjerre overstates his case when he leaps on the reference to a violation of a constitutional provision in section 8-202(b)(1) to bolster his broad interpretation of “validity” under section 8-110(a)(1). The section 8-202(b)(1) reference to “constitutional provision” does not include provisions of the type set forth in Article 150 of the Venezuela constitution. As the official comment to section 8-202 explains, this reference is motivated by a line of cases where municipal bonds were issued in violation of state constitutions setting numerical limits on debt issuances.^[13] Given this context, evaluating the validity of a security against any kind of constitutional provisions, as Professor Bjerre does, inappropriately expands the scope of “validity” beyond the ambit of UCC section 8-110(a)(1).

C. Bjerre’s Misguided Analysis of the distinction made in UCC 8-110(d) Between Validity and The Remaining Choice of Law Categories in UCC 8-110(a)

Professor Bjerre also leapt on to section 8-110(d)’s special treatment of “validity” as contextual evidence that “validity” as used in section 8-110(a)(1) broadly implicates the local laws of Venezuela, but this analysis is flawed.

The mandatory choice-of-law rule contained in UCC section 8-110(a) applies to five categories:

The local law of the issuer’s jurisdiction, as specified in subsection (d), governs: (1) the validity of a security; (2) the rights and duties of the issuer with respect to registration of transfer; (3) the effectiveness of registration of transfer by the issuer; (4) whether the issuer owes any duties to an adverse claimant to a security; and (5) whether an adverse claim can be asserted against a person to whom transfer of a certificated or uncertificated security is registered or a person who obtains control of an uncertificated security.^[14]

Section 8-110(d) of the New York UCC defines the “issuer’s jurisdiction” in the first sentence as “the jurisdiction under which the issuer of the security is organized or, if permitted by the law of that jurisdiction, the law of another jurisdiction specified by the issuer that the issuer’s jurisdiction” and provides authority for New York companies to select such different law for all the categories in Section 8-110(a) other than validity: “[a]n issuer organized under the law of this State may specify the law of another jurisdiction as the law governing the matters specified in subsection (a)(2) through (5).”^[15]

While Professor Bjerre recognizes that the second sentence of subsection (d) does not directly apply to PDVSA because it is not organized in New York, he highlights the “conspicuous absence” of “validity” from the authorization granted to New York companies to specify a different law than New York law in subsection (d) and reads this as support for a broad interpretation of “validity,” which would rope in laws such as Article 150 of the Venezuelan constitution.^[16] But this reading is misguided.

Established rules of statutory construction dictate that we read similar provisions in the same way.^[17] Therefore, given the narrow scope addressed in clauses (2) through (5), clause (1) should similarly be interpreted narrowly. Such reading makes sense because all of the specified categories relate to corporate actions. Clauses (2) through (5) address specific questions relating to the issuer’s “duties and liabilities with respect to registration of transfer” and “whether an adverse claim can be asserted against a purchaser to whom transfer has been registered.”^[18] Interpreting the reference to “validity” as encompassing constitutional provisions of general applicability such as Article 150 confers an inappropriately broad scope to clause (1) compared to clauses (2) through (5). In fact, Official Comment No. 2 to Section 8-110 explains that:

Subsection (a) provides that the law of an issuer’s jurisdiction governs certain issues where the substantive rules of Article 8 determine the issuer’s rights and duties. Paragraph (1) of subsection (a) provides that the law of the issuer’s jurisdiction governs the validity of the security. This ensures that a single body of law will govern the question addressed in Part 2 of Article 8, concerning the circumstances in which an issuer can and cannot assert invalidity as a defense against purchasers. Similarly, paragraphs (2), (3) and (4) of subsection (a) ensure that the issuer will be able to look to a single body of law on the questions addressed in Part 4 of Article 8, concerning the issuer’s duties and liabilities with respect to registration of transfer.

In other words, the scope of each of the provisions in UCC Section 8-110(a) relates narrowly to the issues addressed in the relevant part of UCC Article 8. Litigating an alleged violation of provisions such as Article 150 requires a U.S. court to interpret the constitution of a foreign country, which analysis necessitates nuanced political and policy issues and is further complicated by Venezuela’s subsequent political turmoil and retroactive actions by the country’s legislative body.^[19] Requiring in-depth analysis of the entire spectrum of foreign law rather than just a narrow set of corporate authority provisions introduces uncertainty around instruments of finance and commerce, an approach contrary to the express purposes of the UCC.^[20] Limiting the scope of “validity” to matters specific to corporate action and procedural requirements of external law, in contrast, is consistent with the maxim noscitur a sociis, i.e. “a word is known by the company it keeps.”^[21] In light of the foregoing, the court in the PDVSA Case correctly concluded that compliance with Article 150 of the Venezuelan constitution was outside the scope of the “validity” analysis under UCC section 8-110(a)(1).^[22]

II. Professor Bjerre’s Evidence Supports the Opposite of His Conclusion

Professor Bjerre seeks support for his arguments from external sources such as third-party opinion practices in commercial transactions and the internal affairs doctrine, but these sources in fact undermine his argument that “validity” encompasses laws such as Article 150 of the Venezuelan constitution.

As he rightly points out, “validity,” understood as a matter of “due authorization,” is typically assumed or narrowly opined on in legal opinions addressing matters of due authorization in commercial transactions.^[23] In proposing that matters of validity entail a broader scope than internal corporate processes, he is insinuating that opinion practice fails to address the key question of validity because counsel generally refrains from opining on matters of such a broad scope.^[24] The assumption of due authorization in opinion practice, however, is because “due authorization” is typically addressed in separate capacity opinions, the scope of which is limited to internal corporate processes. As explained in the Fitzgibbon and Glazer treatise on legal opinions, a source also quoted by Professor Bjerre: “[T]he ‘duly authorized’ opinion requires that the proper body or bodies within the company approved the agreement in the manner required by the corporation law of the state in which the company was incorporated and the company’s charter and bylaws and that the approvals remain in effect on the closing date. The opinion does not address the possible need for government approvals or approvals by a third party.”^[25] Professor Bjerre argues that existing opinion practice supports his view of a broad meaning of “validity” and “due authorization,” but the full quote cited above illustrates that matters of “due authorization” is limited to corporate actions, which is contrary to his argument.

Professor Bjerre’s formulation of the internal affairs doctrine, similarly, undermines rather than supports his argument that Venezuelan law applies to the PDVSA notes. He describes the internal affairs doctrine as “recogniz[ing] that only one State should have the authority to regulate a corporation’s internal affairs—matters peculiar to the relationships among or between the corporation and its current officers, directors, and shareholders—because otherwise a corporation could be faced with conflicting demands,”^[26] which in fact supports the narrower interpretation of “validity.” The internal affairs doctrine articulates that “validity” relates to “the relationships among or between the corporation and its current officers, directors, and shareholders”—i.e., the internal processes of a corporate entity, which Article 150 of the Venezuelan constitution does not implicate.

III. Conclusion

The plain language of the UCC, the history of and purpose behind the UCC, opinion practice in commercial transactions and the principles underlying the internal affairs doctrine all point to a narrow definition of validity that focuses on corporate actions and corporate law, not broad rules of general applicability like Article 150 of the Venezuelan constitution. Interpreting “validity” as encompassing any and all kinds of constitutional violations, as Professor Bjerre does, stretches its meaning beyond the plain text and the statutory context of the UCC, thereby “swallow[ing] whole any choice-of-law analysis involving the formation of a contract for securities.”^[27]