Introduction
Many readers have asked me to share some ideas on how to manage or mitigate currency risks through contracts. Others have asked me to write on how to minimise exposure to inflation when drafting or dealing with contracts. In this article I give some hints on how a party or parties may minimise the effects on currency changes or movement in commercial transactions.
Currency risks
Broadly a party or parties to a contract want to be protected so that any loss of value as a result of unfavourable changes in currency will not be their burden. Unfavourable changes in currency can be due to a number of reasons or factors such as the following:
- Policy changes. In Zimbabwe most people refer to currency changes made through the SI 33 of 2019. Governments always try to address economic and social problems by trying many things. Modifying policies around currency are some of the measures.
- Market conditions where an exchange rate may move in a manner that disadvantages some people. For example the exchange rate between the United States dollar and our local currency changes due to various reasons.
- Inflation. Inflation usually affects the value of a local currency. This may be a chicken and egg situation and a lay person may ask what causes the other? Inflation or loss of value by a currency?
- Shortage of a preferred currency. It is not a secret that in Zimbabwe most people and businesses prefer foreign currencies such as the United States dollar. It may very well happen that such preferred currency may be in short supply.
Contractual provisions on currency risks
In this article I only give some basic ideas. These are not exhaustive. Parties to an agreement or contract may agree to include these provisions.
Stating currency of the contract
It is common to find a clause which states the currency for the contract. Such provisions may go like “It is stated that the currency for this contract shall be the United States dollars” or “Regardless of the changes in the currency the currency for purposes of this contract shall be the South African rand”.
If there is a law that bans use of other currencies for example where the local currency is the sole legal tender it is doubtful whether the above provisions will suffice or stand.
Freezing or fixing of exchange rate
This provision may freeze or fix the exchange rate to be used. For example it may be agreed by the parties that regardless of future exchange rate movements the rate for purposes of the agreement or contract shall be a certain figure.
Sole responsibility over risk
Parties may also agree that any risk arising from currency changes shall be the responsibility of one party. For example if an exchange rate moves the debtor bears the risk. If on the other hand the amount due is eroded in real terms the risk rests with the creditor.
Sharing risk
Parties may agree to share risk in the event that the risk arising from exchange rate movements goes beyond a certain level. Sharing may in the form of parties agreeing on a sharing ratio. In extreme situations parties may agree to renegotiate the deal especially the price or payment of the balance.
Reduced contract tenure
The longer the tenure of the contract the more the uncertainty or risk due to currency changes. To minimise currency risks parties may agree to shorten the contract period. For example instead of a credit sale the seller may insist of full payment upon signing or reduce the credit period.
Make effectiveness or validity of agreement dependent on full payment
A seller may insist that there is no sale until the full purchase price is paid first. He or she may put a condition that the purchaser may pay deposits but the sale shall be effective only when the full purchase price has been paid. Some sellers may even defer signing an agreement of sale preferring to sign only when the full purchase price is available.
Goods versus cash
Depending with the situation and the economy a lender may want to decide whether to loan funds or physical goods, the latter whose value moves with changes in the economy. Repayment may be in the form of the goods or monetary equivalent of the goods at the time of repayment. The same may be worth considering in the event of a joint venture. A party to a joint venture may consider contributing goods or equipment instead of money which can eroded by the time of the joint venture is dissolved.
Hedging
Through sophisticated means parties may agree to some hedging mechanisms for example using derivatives.
Interest
Interest may assist a creditor to recover value in the event of loss of value due to inflation or unfavourable exchange rate movements.
Conclusion
Currency risks can be quite significant in a contract. There have been made court cases in Zimbabwe following currency changes that were implemented from 2019. A party to a contract should consult its financial and legal advisors for best protection.
Disclaimer
This simplified article is for general information purposes only and does not constitute the writer’s professional advice.
Godknows (GK) Hofisi, LLB(UNISA), B.Acc(UZ), Hons B.Compt (UNISA), CA(Z), MBA(EBS, Heriot- Watt, UK) is the Managing Partner of Hofisi & Partners Commercial Attorneys, chartered accountant, insolvency practitioner, registered tax accountant and advises on deal and transactions. He has extensive experience from industry and commerce and is a former World Bank staffer in the Resource Management Unit. He writes in his personal capacity. He can be contacted on +263 772 246 900 or gohofisi@gmail.com
