Redressing Devaluation Caused contract Imbalance

On October 11, 2017, the National Bank of Ethiopia (NBE) devaluated the birr by 15Pct against the basket of major hard currencies. According to the press briefing given by Yohannes Ayalew, vice governor of the NBE, the motive behind the devaluation was to encourage exports and attract investment.

As revealed later in the explanatory note attached to the bill introduced to parliament regarding federal government supplementary budget, this time around, the NBE’s measure was a means to raise money and contribute to windfall tax that was later earmarked to make significant contribution to the budget.

Predictably, the devaluation resulted in corresponding increase in the price of import of goods, services, and equipment. Acconding to data collected by the writer from local markets in the immediate aftermath of the devaluation, most commodities witnessed a price increase of 15Pct to 20Pct.

The devaluation also gave rise to the relative price surge of imported goods and equipment in stock, and locally manufactured goods, services, and equipment. A significant amount of birr was generated in commercial banks that are in possession of foreign currency as a result of the change in the exchange rate. 75Pct of this currency was subsequently appropriated by the Ethiopian Revenue and Customs Authority as windfall tax and transferred to government coffers. The remaining amount of such revenue, along with other incomes of each bank, will, in due course, be subjected to a 30Pct income tax.

As birr is devalued by 15Pct, depositors who put their money in banks anticipating interest gain lose. Business persons who, prior to the devaluation, entered long term contractual commitments to build private and public apartments, industrial complexes, roads; and those engaged in the supply of goods, materials, and equipment imported from abroad were suddenly exposed to the grim reality of sustaining losses of at least 15Pct.

This is not the first time businesses operating in Ethiopia suffered from the aftermath of devaluation. For instance, as a result of the 20Pct devaluation on August 1, 2010, businesses relying on the purchase of foreign goods and services to supply local customers sustained great losses. Immediately after the devaluation in 2010, businesses were advised to swallow “the bitter pill of devaluation,” as described by the late Prime Minister Meles Zenawi.

To my knowledge, similar advice has not been officially prescribed with respect to the sudden change in the balance of contracts. The Ministry of Finance and Economic Cooperation (MoFEC) has however, instructed businesses that signed agreements prior to the devaluation to abide by and observe their contractual obligation or risk being blacklisted.

Undoubtedly, the balance of contractual prices agreed between the parties prior to the devaluation for the supply of goods and services have been significantly upset to the detriment of the debtor. This has resulted in the obligation assumed by the debtor to be more onerous and burdensome than it was in the pre-devaluation period. Accordingly, the devaluation calls for contractual price revision, otherwise the risk of non-performance becomes imminent.

Countries around the world have, in the past, attempted to deal with such problems through judicial and legislative measures. For instance, during post World War I period, both Germany and France were faced with the challenge of tackling the problems of devaluation and its effects. These measures consisted of judicial and legislative means.

The dollar value of the German mark jumped from pre-WWI amount of four marks to an astronomical 4.2 trillion marks in 1923. Faced with this nightmare, courts first refused to grant any relief to the burdensome contract enforcement imposed on parties. When the performance of contracts under such circumstances generated economic ruin, they began to adapt and be more flexible. In those days, the concept of impossibility was extended to economic impossibility. Accordingly, courts started to order the revision of prices fixed in contracts under the theories of “fair equivalence of performance” and “changed condition.”

Finally, courts introduced the theory of revalorization, which imposed on the creditor, the responsibility to pay a price commensurate with the depreciation of the currency. On the other hand, the French Conseil d’Etat adopted the principle of imprevision, which is a modified form of economic impracticability but only limited to government contractors. French courts adopted the principle of lesion which provides “for the rescission (of the contract) unless the ‘creditor’ offers the consideration to…the true value.” Legislative intervention was also made to tackle such problems, for instance, by increasing rent.

These post war judicial and legislative measures, however, could not provide lasting equitable solutions and address contractual controversies. In fact, the situation resulted in endless litigation that threatened the security of trade and led courts to involvement that amounted to “making contracts for the parties.”

Drawing lessons from the judicial and legislative predicaments and experiences of Western Europe, the drafter of the Ethiopian Civil Code formulated the explicit principles that “the court may not vary a contract or alter its terms on the grounds of equity except in such cases as are expressly provided by law.” The drafter of our Civil Code, Professor Rene David, justified this fundamental principle by underlining that “the only remedy for a party to an inequitable contract is to request the invalidation of the contract on the grounds of a defect in the consent.”  He further argued that even though variation of contracts by parties is always possible “the threat of such an action might lead the other party to compromise and modify by agreement to unfair clauses in the contract. The courts themselves can only invalidate an inequitable contract; they cannot modify it,” he concluded.

Some of the arguments in favour of preventing court intervention are that revision of contractual price leads to never-ending litigation, that courts would be submerged and paralyzed, security of trade will be destroyed and that judges are not qualified to make economic assessments.

The foregoing principles and arguments stand firm for contracts signed between private parties only. This leaves no other option than to resort to private mechanisms to redress the imbalance through mutual negotiations, amicable settlement, and even recourse to arbitration. Contractual commitments must remain intact despite price increase or decrease on account of inflation, devaluation, depreciation, and appreciation.

There are always various drafting techniques and mechanisms during the drafting of contracts that can contain, or at least minimize, losses incurred by anticipated or unanticipated occurrences. Short and long term losses or imbalances can be addressed if parties to a contract are supported by knowledgeable legal professionals. A copy/paste approach, and the use of unsubstantiated contract templates that are not modified to fit the desired and specific purpose, invariably lead to a devastating end.

While the Ethiopian Civil Code prevents courts from meddling in the affairs of contracting parties resulting from the devaluation of the birr, it highly encourages private contracting parties to negotiate, and even submit to arbitration to tackle the difficulties that arise. Contracting parties should introduce price adjustment to offset inequity on an existing contract or enter into new contractual agreements.

There may be resistance to readjusting the unbalanced contract but the simple logic that one party cannot act to benefit the other at his own detriment, should also not be forgotten. Contracts are easily enforceable where parties are in balanced situations. Therefore revision of existing or new contracts would have to be accepted by both parties.

 What about contracts that involve government organs or state administrative bodies? Public bodies are major buyers of works, goods, and services in the Ethiopian context. Most public procurements last for long periods of time and would be affected by devaluation. What has Ethiopian law provided to redress the imbalance, notwithstanding the alleged position maintained by the MoFEC?

The law provides a different approach where one of the parties is a government or state administrative body. Devaluation is one of the numerous measures and acts undertaken by a government. As a result, government organs or administrative bodies and their subdivisions, whether federal or local, “in addition to the power to conclude contracts, can enact rules that apply to all. It cannot be admitted in a code based on the principle of equality of contracting parties that such general rules could upset the equilibrium of the contract to the detriment of a person who contracted with the government,” David writes in his commentary. Accordingly, article 1767 of the Ethiopian Civil Code provides exceptional remedy that allows courts to intervene in order to maintain equilibrium in contracts upset by a unilateral act of devaluation introduced by the central bank upon the decision of the government.  The intervention of the court, he noted, would “ensure that the equilibrium of the contract, upset by the unilateral act of one of the contracting parties, is re-established.”

In order for the court to intervene on contracts made with public authorities, the unilateral act of the government should be made by its “regulatory act” and must be “an assertion and special prerogative of public power.” Undoubtedly, the act of devaluating the birr is a special prerogative of the Ethiopian government and not one endowed to a private party. This justifies the court’s involvement to modify the contract. The modification that might be introduced might be for instance, reducing the obligation of the affected party to offset the imbalance by downsizing the scope of the contract, compensating for the damage sustained, and so on.

As mentioned above, the measure for the devaluation of the birr is a measure of “general application” originating from the legal mandate provided to the NBE pertaining to “issuing directives relating to transaction in foreign exchange, gold or silver.” However, the devaluation measure fell short of providing detailed rules to prevent disruption in public and private contracts and even to safeguard the interests of the government. When a government devaluates its local currency against foreign currency, the act must among other things, “include provisions dealing with contracts in force. Legislation on control of foreign currency ought to say what happens to clauses in existing and future contracts that provide for payment of in foreign currency.”

Contracting parties attempt to exercise various methods to contain business risks associated with depreciation or appreciation of currencies that might occur independently from public authorities’ actions or legislative decisions. In most developed countries, the obligation of parties on money debt is not necessarily assessed only in terms of local currency but on the basis of prevailing index of the prices for goods or services. This safeguards parties from currency instability and depreciation. Under Ethiopian contract law, we have such safeguards under article 1749. In other cases where it is allowable, parties also enter contracts on the basis of more stable foreign currency to avoid sudden changes in prices. However payment can only be made in local currency unless allowed by law, or by the NBE.

Like in the previous devaluation, the NBE was oblivious to such issues; now, we have plethora of controversies arising from contractual relations that involve settlement of obligation by a foreign currency.  While the money that might be acquired from devaluation would have to be earmarked to offset the imbalance of contracts made with the government, the revenue raised on the latest devaluation was also made to augment the supplementary budget of the federal government. This budget, meant to be used to rehabilitate victims of mass evictions that resulted from ethnic strife, and to procure electronic materials prompted this writer to speculate that devaluation can also raise government revenue while ruining a contracting party.

As I indicated above, Ethiopian businesses have legal remedies to obtain compensation and could exercise their right to overcome the fallout of the recent devaluation despite the purported resistance of public bodies. While court meddling of the contractual imbalance created from devaluation is justified, the desirable means to limit the modification to an acceptable level is important. According David, “the best way to avoid the necessity of court modification of administrative contracts is to include a clause in the contract providing for third party arbitration in the situation dealt with by article 1767.” Similarly, the famous and prestigious law scholar, Professor George Krzeczunowicz notes, “arbitration is a convenient customary institution which reduces court litigation and should be encouraged. It is also useful among merchants where, e.g. arbitral submissions of the chambers of commerce are practiced.”

6th Year . February 16  – March 15 2018 . No.58


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