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July 11, 1986


The opinion of the court was delivered by: SWEET


Plaintiffs Morgan Guaranty Trust Company of New York, Morgan Grenfell & Co., Limited, The Bank of Tokyo, Limited, The Governor and Company of the Bank of Scotland and Orion Royal Bank Limited (collectively "Banks") have moved for an order remanding this action to the Supreme Court of the State of New York pursuant to 28 U.S.C. § 1447(c) for lack of diversity jurisdiction as the Republic of Palau ("Palau") is not a foreign state within the meaning of the Foreign Sovereign Immunities Act, 28 U.S.C., §§ 1330, 1441(d) and 1603. *fn1" For the reasons set forth below, the motion is denied.

Prior Proceedings

 The Banks filed this action on December 17, 1985 in the Supreme Court of New York seeking to recover for an alleged $35 million default by Palau in connection with the financing of an electrical power plant on Palau. On January 21, 1986, Palau removed this action to federal court pursuant to 28 U.S.C. §§ 1441(d) and 1330 on the grounds that Palau is a "foreign state" with removal jurisdiction in the federal district court. On March 3, 1986 the Banks filed the instant motion which was orally argued on April 11, 1986.


 The Banks' motion to remand this action poses a single question whether -- Palau is a "foreign state" within the meaning of 28 U.S.C. §§ 1330, 1441(d) or 1603. This question requires the court briefly to outline the transitional political status of Palau as it relates to the designation of "foreign state" under these sections. The parties have no conflict as to facts relating to the status of Palau, although they differ strenuously as to the conclusion to be derived from these facts.

 Between World Wars I and II, the islands and atolls comprising Micronesia including Palau, were governed by Japan pursuant to a League of Nations Mandate. In 1947 the United States and United Nations Security Council entered into a Trusteeship Agreement which designated Palau as a "strategic trust" to be administered by the United States as part of the Trust Territory of the Pacific Islands. See Trusteeship Agreement for the Former Japanese Mandated Islands, July 18, 1947, 61 Stat 3301; T.I.A.S. No. 1665 (hereinafter "Trusteeship Agreement"). The Trust Territory included the administrative districts of Kosrae, Yap, Palau, Ponape, the Marshall Islands and Truk. *fn2" The Trusteeship Agreement vests the United States with administrative, legislative and judicial authority over the Trust Territories and requires the United States in Article 6(1) to "foster the development of such political institutions as are suited to the trust territory and shall promote the development of the inhabitants of the trust territory toward self government or independence ..."

 While the United Nations Trusteeship Council and the United Nations Security Council retained oversight of the Islands, the direct administrative authority over the Trust Territories was delegated by the United States Congress to the President and ultimately to the Department of the Interior. Exec. Order No. 11021, 27 Fed.Reg. 4409 (May 9, 1962). In 1968 the Secretary of the Interior established a local government for the Trust Territories (Secretarial Order 2918, 34 Fed.Reg. 157 (Dec. 27, 1968)) with executive power vested in a "High Commissioner" of the Executive Branch appointed by the President with advice and consent of the Senate, 2 Trust Territory Code 351, Vo. 1 (1980 ed.), 48 U.S.C. § 1681(a). The High Commissioner has the authority to appoint officials to the executive offices of the Trust Territory and may submit proposed legislation to the Congress.

 Order 2918 also established a local legislative branch or Congress of Micronesia consisting of a Senate and House of Representatives with the circumscribed authority to pass laws which are consistent with treaties or international agreements of the United States, laws of the United States expressly applicable to the Territory, Executive Orders, or Orders of the Department of the Interior. Every bill passed by the Congress can be vetoed by the High Commissioner and, if overridden by a two-thirds majority of the membership of both Houses, can be vetoed by the Secretary of the Interior. Order No. 2918, pt. III, § 13. For a complete discussion of the structure of the trust territory government, see Gale v. Andrus, 207 U.S. App. D.C. 76, 643 F.2d 826 (D.C. Cir. 1980); People of Saipan v. United States Dept. of Interior, 356 F. Supp. 645 (D.Hawaii 1973). Palau's designation as a "strategic trust" also grants the United States preferential treatment in economic and commercial relations with Palau, as well as granting the right to close-off portions of the Trust Territory or bar persons from the area, including the United Nations. Id. at 654, Trusteeship Agreement, Article I.

 Over the past fifteen years Palau has moved towards independence with the goal of ending the trusteeship rule of the territory, as have several other Pacific Trust Territory Islands. Pursuant to the Secretary of Interior Order No. 3039, 44 Fed.Reg. 28116 (May 14, 1979) entitled "Recognition of Governmental Entities under Locally-Ratified Constitutions in the Trust Territory of the Pacific Islands," Palau adopted a constitutional form of government, which became effective on January 1, 1981. The constitution provides for an executive branch with a popularly elected president and vice president, a bicameral legislature, the Olbiil Era Kelulau (the "OEK") comprised of a Senate and House of Delegates, and a unified judiciary.

 Exercising its constitutional mechanisms, Palau has demonstrated attributes of sovereignty both before and after adopting the Compact. The declaration of Eric S. Basse, Assistant Attorney General of Palau, establishes that Palau has negotiated commercial and diplomatic treaties and agreements with several nations on a government-to-government basis, primarily concerning the management of Pacific Island Fisheries, but also concerning environmental protection treaties and grant agreements with foreign nations. Also pursuant to the constitution adopted in 1981, Palau has joined several international organizations in its own right, including the South Pacific Commission and the Forum Fisheries Agency. Palau has also created a national postal system, and has a national flag. Under its constitution, it has jurisdiction over bankruptcies, admission and exclusion of aliens, patents, copyrights and public lands.

 The second drive of this twofold path towards independence has been the establishment of a relationship of independent "free association" with the United States, as defined in United Nations General Assembly Resolution 1541 (Dec. 5, 1960), 15 U.N.GAOR Supp. (No. 21), U.N. Doc. A/4684 (1960), whereby Palauans would exercise their own sovereignty and would not become United States citizens. See Matter of Bowoon Sangsa Co., Ltd., 720 F.2d 595, 600 (9th Cir. 1983). On January 10, 1986, Palau and the United States signed a Final Compact of Free Association (the "Compact") which was ratified In a Palauan plebiscite on February 24, 1986. The terms of the Compact establish Palau's independent sovereignty and equal diplomatic status in the international community. The Compact must be approved by the President of the United States and both Houses of the United States Congress, and the United Nations must consent to modify or eliminate the Trusteeship Agreement.


 On January 21, 1986 Palau removed this action from New York State to Federal District Court in reliance upon portions of the Foreign Sovereign Immunities Act ("FSIA"), 28 U.S.C. §§ 1330, and 1441(d) governing removal of actions to the federal court. Section 1330(a) governing original jurisdiction provides:

 The district courts shall have original jurisdiction without regard to amount in controversy of any nonjury civil action against a foreign state as defined in section 1603(a) of this title as to any claim for relief in personam with respect to which the foreign state is not entitled to immunity either under sections 1605-1607 of this title or under any applicable international agreement.

 Section 1441(d) governing removal for the same grounds also incorporates section 1603(a) as the definitional referent for removal jurisdiction under these sections:

 Any civil action brought in a state court against a foreign state as defined in section 1603(a) of this title may be removed by the foreign state to the district court of the United States for the district and division embracing the place where such action is pending. Upon removal the action shall be tried by the court without jury.

 28 U.S.C. § 1441(d).

 The parties dispute whether the Republic of Palau is a "foreign state" entitled to original or removal jurisdiction in a federal forum. According to the Banks, Palau's status as a Trust Territory of the Pacific Islands deprives it of the status of "foreign state" until the termination of the Trusteeship Agreement. Several federal courts have upheld this view of Palau's political status in various statutory contexts, concluding that the United States so limited the authority of Palauan local government that Palau was "functionally governed" by the United States. In World Communications Corp. v. Micronesian Telecommunications Corp., 456 F. Supp. 1122 (D. Hawaii, 1978), a Hawaii corporation and citizen brought an action against a corporation organized under the Trust Territory of the Pacific Islands, basing jurisdiction on the diverse citizenship of the parties. Dismissing the action for lack of jurisdiction, the court concluded:

 Plaintiffs contend that the Trust Territory was a "foreign state" within the meaning of 28 U.S.C. § 1332(a). This court has previously rejected the characterization of the Trust Territory as a foreign country in People of Saipan, supra. . . In light of similar considerations, I now hold that the Trust Territory is not a "foreign state" within the meaning of 28 U.S.C. § 1332.

 Id. at 1124.

 The district court of Hawaii arrived at the same conclusion five years earlier in People of Saipan v. United States Department of Interior, supra, 356 F. Supp. 645 (D. Hawaii, 1973) relied upon by the court in World Communications, supra. In People of Saipan, the court held, inter alia, that the Trust Territory government is not immune ...

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