Motorola Limits Restraints on Banks: The New York Court of Appeals Recharges the “Separate Entity Rule”

In a decision that will resonate in the financial services industry, the Court of Appeals recently reaffirmed the continued application of the “separate entity rule” in New York. In applying this rule, the Court held that a judgment creditor cannot restrain assets located in a foreign bank, based solely on the service of the foreign bank’s New York branch, if the assets are held in a branch outside of New York. This decision, Motorola Credit Corp. v. Standard. Chartered Bank,[1] puts to rest debate over whether the Court of Appeals had intended to vitiate the separate entity rule in the 2009 decision, Koehler v. Bank of Bermuda Ltd.,[2] and gives foreign banks greater assurance that their New York branches will not serve as a conduit allowing judgment creditors access to the bank’s accounts around the world. For U.S. banks, the decision was significant in what the Court chose not to decide. The Court expressly declined to determine whether the separate entity rule applies in the domestic context. This includes situations where an order is served on a New York branch of a U.S. bank in an effort to reach accounts held at other branches within New York or elsewhere in the United States. Thus, U.S. banks must look to lower court case law to determine the applicability of the separate entity rule in various domestic situations.

The Separate Entity Rule

Similar to other states, New York law provides various devices that parties can employ in an effort to secure assets of an adversary both before and after a judgment. For example, Article 62 of New York’s civil rules allows a party, in certain circumstances, to attach, pre-judgment, the property of an adversary and prevent the property’s transfer while a case is pending. Article 52 of those rules provides, among other things, a mechanism for the enforcement of a judgment against assets of the judgment debtor in the possession or custody of a non-party.[3] These devices, however, all too often ensnare banks in litigation that they have no connection to other than maintaining an account of one of the litigants. This involvement can be costly, time consuming, and subject the bank to competing claims.

New York’s separate entity rule has provided some relief to banks attempting to comply with orders related to third-party litigation served on their various branches. This rule provides that – for the purposes of obtaining pre-judgment attachments and post-judgment restraining notices and turnover orders over bank accounts – each bank branch is a separate entity and that in order to reach a particular bank account, the branch of the bank where the account is maintained must be served.[4] Thus, even when a bank garnishee with a New York branch is subject to personal jurisdiction, foreign branches of the same bank will be treated as “separate entities.” As a result, a restraining notice or turnover order served on a New York branch of a foreign bank will only be effective for assets held in accounts at that branch and will not affect assets in the bank’s foreign branches.

The separate entity rule is rooted in the common law dating back to a 1916 decision by New York’s Appellate Division.[5] While the New York Court of Appeals did not expressly expound on the rule in the many decades that followed its introduction, the rule was widely accepted by lower appellate and trial judges in both the state and federal courts.[6] Hence, the rule became “a firmly established principle of New York law, with a history of application both before and after the 1962 adoption of the CPLR.”[7]

The continued application of the separate entity rule, however, was thrown in doubt when the Court of Appeals issued Koehler v. Bank of Bermuda Ltd. in 2009. While the Koehler case did not directly discuss the rule, its reasoning certainly touched upon its underlying basis. In Koehler, a judgment creditor obtained an Article 52 turnover order directing a garnishee bank located in Bermuda to relinquish stock certificates belonging to a judgment debtor. The stock certificates were physically held at the bank in Bermuda. The Bermudian bank had a New York subsidiary and had consented to personal jurisdiction. The Court of Appeals affirmed the lower court’s authority to issue the order. The Court reasoned that “the Legislature intended CPLR article 52 to have extraterritorial reach” and that “the key to the reach of the turnover order is personal jurisdiction over a particular defendant.” Because the bank conceded that the New York courts had personal jurisdiction over it, the turnover order was properly directed at the stock certificates in Bermuda.

Given the Koehler Court’s recognition of a New York court’s “extraterritorial reach” over a foreign asset based on personal jurisdiction over the bank at issue, the continued application of “separate entity rule” was put in question. Many commentators and some courts concluded that the separate entity rule was dead, implicitly killed off by Koehler. In October 2014, however, the Court of Appeals breathed new life into the rule in Motorola v. Standard Chartered, a decision highly anticipated in the financial services industry.

Motorola v. Standard Chartered

The Motorola case involved a $2 billion loan made by Motorola to a Turkish telecommunications company with the purpose of financing the company’s expanding business. Unbeknownst to Motorola, the family that controlled the Turkish company redirected much of the money to themselves and to entities that they controlled. After discovering the misappropriation, Motorola brought suit and eventually obtained a $3.1 billion judgment. In an effort to collect on the judgment, Motorola served a restraining order on the New York branch of a foreign bank headquartered in the United Kingdom – Standard Chartered. Standard Chartered, which had no involvement in the loans at issue, did not locate any property belonging to the Turkish borrower or its owners at its New York branch. A worldwide search of its branches, however, turned up approximately $30 million located in the bank’s United Arab Emirates branches. Standard Chartered froze the assets in the foreign branches in accordance with the restraining order, but thereafter sought relief from the court, arguing, among other things, that the separate entity rule limited the order’s scope to assets located in accounts at the New York branch that was served and that it could not affect funds located in foreign branches.

In opposition, Motorola asserted that the separate entity rule was abrogated by the reasoning in Koehler. Additionally, Motorola posited that a primary reason for the rule was to prevent banks from being overburdened with having to inform its numerous branches of the various orders served on each branch. [8] Motorola argued that the rise of centralized banking and advancements in communications technology had ameliorated this burden, rendering the rule unnecessary.

The Court of Appeals disagreed with Motorola and held that the separate entity rule still survived in New York. Relying heavily on the common law acceptance of the rule, the Court held that the underlying reasons for the rule, for the most part, still exist today. In particular, the Court noted that “the separate entity rule promotes international comity and serves to avoid conflicts among competing legal systems.” The Court further reasoned that the rule was justified because it helps avoid the possibility of double liability in separate jurisdictions (where foreign branches are subject to various legal and regulatory regimes), which it identified as a “significant concern.” And while the Court acknowledged Motorola’s suggestion that technology eases the burden of informing foreign branches of a New York order, the Court found that there still are practical difficulties and significant costs associated with managing a global search for a judgment debtor’s assets.

The Court then went on to distinguish Koehler. First, the Court noted that there was no direct discussion of the separate entity rule in Koehler because, according to the Court, the foreign bank did not raise the issue. Second, the Court reasoned that the separate entity rule, as it has been applied by New York courts, would not have applied to the bank in Koehler because “that case involved neither bank branches nor assets held in bank accounts” (rather it involved stock certificates that were physically held at the foreign bank). Unlike Koehler, Motorola involved more common aspects of international banking. And, “[a]s a longstanding common-law doctrine, the separate entity rule functions as a limiting principle in the context of international banking, particularly in situations involving attempts to restrain assets held in a garnishee bank’s foreign branches.” Thus, the Court held that Koehler did not decide the applicability of the separate entity rule and that the Motorola holding was, therefore, not inconsistent with that prior decision. It should be noted that Koehler’s basic holding – that a foreign bank subject to personal jurisdiction in New York may be required to turn over physical assets of customers (e.g. paper stock certificates) pursuant to a post-judgment turnover order – was not overruled.

Impact of the Decision on Foreign and Domestic Banks

Motorola v. Standard Chartered confirms that, in the international banking context, a New York court should treat each branch of a foreign bank as a separate entity and that in order to reach a particular bank account, the branch of the bank where the account is maintained must be served with the applicable order. This rule, of course, is welcome news to foreign banks which now have a greater ability to avoid being pulled into complex disputes simply because they maintain a branch in New York. Conversely, the rule reinforces a high hurdle for parties seeking to enforce a judgment by seizing assets in foreign bank accounts. In light of Motorola, a judgment creditor will need to go through the time and expense of obtaining court orders in the foreign jurisdiction where the relevant bank account is located.

The Motorola decision also has implications for U.S. banks. The Court, in a footnote, acknowledged that the separate entity rule has been applied by some courts in domestic contexts whereby a New York order served on a New York branch of a U.S. bank was held to apply only to accounts located at the branch that was served and not to other domestic branches of the same bank. As an example, the Court cited to Dampskibsselskab v. Sabre Shipping Corp., which held that, under the separate entity rule, a warrant of foreign attachment served on a New York branch located in the Eastern District of New York was insufficient to affect funds deposited at a branch of the same bank located in the Southern District of New York.[9] Nevertheless, the Court expressly declined to determine whether the separate entity rule should be applied in domestic contexts. The Court stated that “[i]n this case, we have no occasion to address whether the separate entity rule has any application to domestic bank branches in New York or elsewhere in the United States. The narrow question before us is whether the rule prevents the restraint of assets held in foreign branch accounts, and we limit our analysis to that inquiry.”

Although the Court of Appeals has remained silent on the issue of applying the separate entity rule in domestic contexts, lower courts have expounded on it. In several cases issued prior to the Motorola decision, courts generally applied the separate entity rule to the branches of domestic banks. An exception, however, was developed out of the Southern District of New York. Under this exception, courts have held that the separate entity rule will not apply where: (1) a restraining notice is served on the bank's main office; (2) the bank's main office and branches are within the same jurisdiction; and (3) the bank branches are connected to the main office by high-speed computers and are under the centralized control of the main office.[10] If these factors are met, the service of a restraining notice on the main branch will be effective on other branches within the same jurisdiction. It should be noted, however, that courts have refused to apply this exception if one or more of the above prerequisites are not met.[11]

In sum, the treatment of banks in the area of attachments, restraining notices, and turnover orders has been somewhat fluid under New York law. Motorola has given additional clarity as to the continued application of the separate entity rule, but a fair degree of uncertainty still exists in certain circumstances. Foreign banks should feel secure that their foreign accounts will not be exposed to New York attachments, restraining notices, and turnover orders based solely on the existence of a New York branch. Nevertheless, foreign banks subject to personal jurisdiction in New York should be aware that Koehler was not overruled and that physical assets (e.g. stock certificates) in their possession may be subject to New York post-judgment orders. U.S. banks should take comfort in the fact that the Motorola Court chose not to disturb case law that has applied the separate entity rule to domestic branches, yet be aware of exceptions to the rule that have been developed and the historical willingness of lower courts to contour the rule independent of appellate direction.[12] What is certain, however, is that a financial institution looking to limit its exposure when served with pre- and post-judgment orders over bank assets is well advised to seek counsel regarding the nuances of this area of law.