By Yasmine BERRAHOU, Alexandra DUFOUR, Salomé ROUCEL, University of Montpellier, Centre du Droit de l'Entreprise, Program of Master 2 "Droit du Commerce International"
International contracts are subject to currency risks as they are likely to involve different currencies, be it that of the parties or another currency they have agreed upon. The date of conclusion of the contract may not be the date of payment, which could lead to the final price being fixed at a later date. Given the volatility of the currency market, particularly in recent months, the value of the designated currency is likely to have dropped or risen in the meantime, resulting in one of the parties paying more than it had anticipated. This was highlighted in January 2015 with Swiss companies which faced important setbacks after the recent fluctuations of the Euro-Swiss Franc rate.
In this context, firms can be exposed to a diversity of currency risks. Several contractual mechanisms are at their disposal to provide them with the appropriate protection.
Currency risks can exist in two main situations namely the extinction and the fluctuation of a currency.
1. Currency extinctionOn 1 January 1999, the Euro was substituted to the national currencies and became the single currency of the then eleven European Union Member States. When a country decides to join the euro zone, issues relating to the extinction of its national currency arise.
These questions remain important as countries are still joining the euro zone. The last three countries to have joined are the Baltics: Estonia in January 2011, Latvia in January 2014 and Lithuania in January 2015.
To solve this issue, the EU Council considered that "it is a generally accepted principle of law that the continuity of contracts and other legal instruments is not affected by the introduction of a new currency". As a consequence, in most of the countries, a legal "continuity of contracts" principle is applicable which provides that a contract cannot be challenged by the change of currency. Thus, according to the legal security principle, a full fungibility principle is required between the Euro and national currencies. However, countries may experience increased prices which should be anticipated by companies in order to adjust and rearrange existing contracts. Parties could think about inserting hardship provisions in the event it should occur.
2. Currency fluctuation
Currency fluctuation is the result of floating exchange rates which occur in most major economies. Since the exchange rate of one currency to another can be volatile, it can result in a depreciation of the currency in which assets are denominated.
The risk of currency relates to several exposures. Exposure refers to the extent to which external environmental contingencies affect a company's performance. Authors have identified three main types of exposures resulting from currency fluctuation:
"Transaction exposure" happens when unexpected changes in exchange rates occur between the time the financial obligation - denominated in foreign currency - is incurred and the time it is due, causing the final price to differ.
"Translation exposure" deals with a company's consolidated financial statements. They can be affected by exchange rate movements as the consolidation process involves the translation of foreign assets from foreign to domestic currency. It can have an impact on the company's reported earnings and therefore its stock price.
"Economic exposure," also known as operating exposure results from the impact of unexpected currency fluctuation on a company's future cash flow and market value by weakening its competitiveness. For instance, a foreign company exporting its products or services in a depreciated currency will be in a position to lower its prices, which will subsequently increase its competitiveness on the market.There has been a recent illustration in Switzerland of the impact of unexpected currency fluctuations on firms. On 15 January 2015, the Swiss Central bank (SCB) announced the abandonment of the Swiss Franc-Euro cap introduced in September 2011. From that date onwards, a Euro was buying 1.20 Swiss Francs. After the announcement, the value of the Euro against the Franc fell to almost parity. Zurich being the seat of many multinationals, essentially involved in overseas transactions and exportations and trading in different currencies, companies have had to assert the impact of the currency rise on their Euro transactions. Following the announcement, the biggest Swiss groups showed down results:
Swatch -14,68%Zurich - 9%Nestle -7.46%UBS -8.73%Credit Suisse -10%One first downfall occurred in connection with the merger deal between the French company Lafarge and the Swiss company Holcim whose shares went down 11.4% following the announcement. At the same time, Lafarge shares went up 4.53% in Paris. Two main issues were raised regarding this merger:
The transfer of 5 billion Euros worth of assets requested by the European Commission could suffer from the fluctuations of the Swiss Franc since some of them were denominated in this currency.
The 130.000 employees and their representatives started protesting to make sure the merger would not be at the detriment of their social rights.A second downfall was the collateral risk felt by employees of Swiss companies which have an important exportation activity such as the pharmaceutical or watchmaking industries. These companies have experienced a drop in their competitiveness as the price of their goods increased. This could lead to either reduced salaries or dismissal of employees. Furthermore, the Swiss Minister of Economy announced that companies suffering from the exchange rate fluctuations could apply "partial unemployment." Most companies consider that cross-border workers are able to convert their salaries in Euros which makes them less likely to suffer from the exchange rates and therefore ideal "candidates" for dismissal or salary reduction.
When entering into contracts with high financial value or long-term contracts, a company may want to cover, or at least abate, the heightened risk of inflation deriving from the volatility of the currency market.
1. Choice of currency and date provision A company may choose the currency in which it wants to receive payment. It can choose to receive payment exclusively in its national currency. However, the other party may be reluctant to undertake a contract quoted in a currency other than their own. This currency can either be fixed invariably (by choosing a fixed date) or be subject to conversion.
"The seller is entitled to have the price expressed either in X or in Y and to opt for the currency value at the date of the contract, at the date of the commercial invoice, or at the date of payment. If a date is not provided for in the contract, the date of payment shall prevail as the date of conversion."2. Currency option provision A company may include a clause that permits to switch from one currency to another. If the designated currency goes below or above a certain rate, the price will be paid in the second currency.
"Prices provided for at the date of signature of the contract are quoted in X. In the event X goes above or below the rate in effect at the date of signature of the contract, prices will be quoted in Y."However, this type of clause can be affected by consumer law. On 30 April 2014, the European Court of Justice ruled on a provision providing that the price of a loan would, at the date of conclusion of the contract, be fixed at the Swiss Franc buying rate but that the loan settlements in Hungarian Forints could unilaterally be fixed at the Swiss Franc selling rate by the bank. The court held that this provision fell into the scope of national legislations on abusive clauses and could consequently be substituted by national judges for a national disposition in order to restore equilibrium between parties and maintain the validity of the contract.
3. Risk bearing provisionContracting parties may decide to have the currency risk allocated solely to either one of them.
"Prices expressed in X are converted on the basis of the official exchange rate at the date of signature of the contract. The buyer shall support any loss caused by a fluctuation of the exchange rate occurring until the complete performance of the contract. The loss shall be calculated on an annual basis."4. Shared risk provision
Parties may decide to include a provision to share the currency risks by providing that a loss caused by a fluctuation of more than P% over the course of a year will be equally supported by them.
"Prices provided for at the date of signature of the contract are set in accordance with the exchange rate operative on that day. A currency fluctuation of more than P% over a year from the date of signature of the contract to the date of delivery, impacting the price, shall be equally supported by both parties."5. Freezing provision
Parties can decide to include a provision to freeze the exchange rate when concluding the contract.
"Notwithstanding any exchange rate fluctuation, the parties agree that the price shall be settled in X, on the basis that 1X equals 1Y."6. Tunnel provision or trigger provision
Another way of limiting the exchange rate risk is to include a provision in the contract allowing for an upward or downward revision of the price triggered when a preset level is reached.
"If the parity between Y and X, based on a 1Y equals zX rate, varies by more than P%, the price shall be automatically and accordingly adjusted."7. Indexation provision
Another very popular technique is the use of an index, which consists in linking movements of rates to the performance of an index. Parties need to be careful regarding the index they wish to choose as it is sometimes regulated. In France for instance, articles L. 112-1 and following of the Monetary and Financial Code deal with indexation. Case law on these articles requires a direct link between the chosen index and the object of the contract or the parties' field of activity. Indexes considered too broad, i.e. which can be used in all contracts, will not be acceptable.
8. Insurance provision
Parties may prefer to have the currency risk supported by a third-party by resorting to an insurer. Each party may subscribe to an insurance, which will support any change in the price caused by a currency fluctuation in its entirety, in exchange for a fee.
9. Force majeure and hardship provision
Force majeureCould the risk of monetary fluctuation be prevented with a force majeure provision? A force majeure provision limits the liability of the parties in case of non-performance of the contract resulting from the occurrence of certain events beyond their control. To avoid termination of the contract for breach, parties who have been prevented from performing their contractual obligations by certain events shall be excused. The regime differs from country to country. Under French law, force majeure is an event that is "unforeseeable, unavoidable and external that makes execution impossible." Even though parties will define the events which qualify for this regime, they essentially have to be reasonably unforeseeable and disrupt the performance of the contract. However, it can hardly be argued that monetary fluctuations are unforeseeable. Only the extent of the fluctuations is unforeseeable. Besides, they presumably do not prevent the contract from being fulfilled, they only make it more onerous to perform. This may not be enough to qualify for force majeure, especially as parties could prevent the interference with a monetary clause, thus exercising the required "prudence, diligence and care" expected of international business people. As a side note, such clauses are very strictly admitted by arbitrators, notably ICC arbitrators who uphold this defense only in extreme cases.
Hardship clauseCould the parties limit the currency risk with a hardship provision? Such a provision places an obligation on the parties to renegotiate if unexpected events were to alter the equilibrium of the contract. An important fluctuation in currency rate could well be responsible for one of the parties being burdened with a financial obligation heavier than anticipated, resulting in an imbalance. The difference with a monetary clause resides mainly in the obligation to renegotiate as opposed to the automatic response of the monetary clause
This QuickCounsel outlines the importance of foreseeing exchange rate risks by including provisions in a contract between parties involved in overseas transactions. Using a hardship clause may not be precise enough. For optimum hedging, some of the aforementioned provisions could be combined. For instance, it could be possible for a seller to combine a shared risk provision with an insurance.
- J. M. MOUSSERON, Technique contractuelle, 4e éd. Ed. Francis Lefebvre, avec le concours de P. MOUSSERON, J. RAYNARD et J.B. SEUBE, 2010, pp. 203-216
- F. TERRE, Ph. SIMLER et Y. LEQUETTE, Droit civil: les obligations, 10e éd. Dalloz, Paris, 2009, p. 585, n° 582
- Les Echos, « Franc suisse : les frontaliers s'enrichissent mais redoutent des retours de bâton » http://www.lesechos.fr/pme-regions/actualite-pme/0204089768595-franc-suisse-les-frontaliers-senrichissent-mais-redoutent-des-retours-de-baton-1084314.php
- Articles L. 112-1 and following of the Monetary and Financial Code http://www.legifrance.gouv.fr/affichCode.do;jsessionid=DE0712C102AC83365152B64A51A00172.tpdila07v_2?idSectionTA=LEGISCTA000006169846&cidTexte=LEGITEXT000006072026&dateTexte=20150213
- Sonja A. Kruisinga, (Non-)conformity in the 1980 UN Convention on Contracts for the International Sale of Goods, Intersentia nv, 2004, p. 139
- Mark Augenblick and Alison B. Rousseau, Force Majeure in Tumultuous Times: Impracticability as the New Impossibility, The Journal of World Investment & Trade 13, 2012 http://www.pillsburylaw.com/siteFiles/Publications/BylinedArticleForceMajeureinTumultuousTimesJournalofWorldInvestmentTrade031312.pdf