10 Allocation and Sharing of Exchange Risks
  • 1 0000000404811396https://isni.org/isni/0000000404811396International Monetary Fund


The fluctuation of exchange rates has given rise to problems of allocating the advantage or disadvantage resulting from changes in exchange rates. In one situation, the problem is bilateral, arising between the parties to a transaction or series of transactions. In the case of disagreement between them on the appropriate exchange rate for settlement when there are two or more possible rates, the advantage that one party enjoys because of the rate that is chosen is matched by the correlative disadvantage suffered by the other party. This kind of problem arises in many forms between the parties to a contract. Sometimes, the judicial solution of a problem may depend on interpretation of the contract.1 In other cases, the outcome may depend on the interpretation of an international convention,2 or the way in which a particular legal concept, such as restitutio in integrum, is applied.3 In some cases, courts have relied on the proposition that a party should have taken steps to protect itself against exchange risk in accordance with the normal practice of the trade in which the transaction or transactions occur.4 It may even be possible to imply a term that a party is to behave in this way.

Bilateral Situations

The fluctuation of exchange rates has given rise to problems of allocating the advantage or disadvantage resulting from changes in exchange rates. In one situation, the problem is bilateral, arising between the parties to a transaction or series of transactions. In the case of disagreement between them on the appropriate exchange rate for settlement when there are two or more possible rates, the advantage that one party enjoys because of the rate that is chosen is matched by the correlative disadvantage suffered by the other party. This kind of problem arises in many forms between the parties to a contract. Sometimes, the judicial solution of a problem may depend on interpretation of the contract.1 In other cases, the outcome may depend on the interpretation of an international convention,2 or the way in which a particular legal concept, such as restitutio in integrum, is applied.3 In some cases, courts have relied on the proposition that a party should have taken steps to protect itself against exchange risk in accordance with the normal practice of the trade in which the transaction or transactions occur.4 It may even be possible to imply a term that a party is to behave in this way.

Technicality and Realism

The technicality, often extreme, of the rules of national law by which exchange risk is allocated between the parties to a contract is sharply illustrated by the decision of the English House of Lords in President of India v. Lips Maritime Corp.5 In July 1980, the Greek owner of a vessel chartered it to the Government of India as charterer for a voyage from Louisiana to India. Under clause 30 of the charterparty, freight and demurrage were to be calculated in U.S. dollars but were to be paid in sterling at the exchange rate ruling on the date of the bills of lading. At that date, the exchange rate was $2.37 to the pound sterling. Discharge of the cargo in India was completed with considerable delay. The parties were unable to agree on the amount of the charterer’s liability for demurrage, and the dispute was referred to arbitration. By the date of the umpire’s award the rate was $1.54 to the pound. The shipowner was awarded £10,232 as demurrage at the exchange rate of $2.37 per pound sterling, and £5,514 as special damages for the exchange loss calculated on the basis of the two exchange rates. The theory of the award was that clause 30 dealt with the amount of demurrage but not with damages for late payment, and that the charterer was under an obligation to settle and pay for demurrage within two months of the completion of discharge. The charterer had not paid within that period.

The rule of English common law is that loss is recoverable if it was reasonably within the contemplation of the parties at the time they made their contract. A creditor cannot obtain damages for late payment of a debt, on the principle that the court will not impute knowledge to the contracting parties that ordinarily a late payment of money will result in loss by the obligee. The rule applies, however, to general damages, that is, damages foreseeable as flowing naturally and probably from the breach of contract in the ordinary course of events. The rule does not apply to special damages, that is, damages foreseeable in the particular circumstances of the case because of special matters known to both parties at the time they made their contract. The arbitrator’s award was based on the conclusion that the loss occasioned by the depreciation of sterling was reasonably foreseeable by the parties, or within their actual or assumed contemplation, and that such loss was likely to occur if payment was not made at the appropriate time. The arbitrator considered the loss, therefore, to be special damages for the breach, calculated as of the date of the award.

The charterer was dissatisfied and appealed to the courts. The account of the subsequent history of the case can begin with the decision of the Court of Appeal. The court stated that the umpire had concluded that the parties knew or should have known that:

(a) it was the general expectation among businessmen that sterling would decline, particularly against the U.S. dollar;

(b) clause 30 was designed to protect the Indian Government as charterer against the depreciation of sterling between the date of the bills of lading and the due date for the payment of demurrage; and

(c) it was the almost invariable practice of Greek shipowners to conduct their business in U.S. dollars, so that if a sterling sum were paid late, the owner was likely to suffer a loss on exchanging sterling for dollars.

A lower court had held that none of these facts constituted special facts that were made known by the owner to the charterer; they were apparent to all other businessmen in the same trade. Therefore, the court refused to allow the recovery of special damages. The Court of Appeal held that this was too narrow a basis for decision. The question in each case was to determine what loss was reasonably within the contemplation of the parties when the contract was made. In dealing with this question, the court would not impute knowledge to the parties that damage flowed naturally from a delay in payment. But where there was evidence of what the parties knew, or ought to have known, were special circumstances, the court was in a position to determine what should be deemed to have been within their reasonable contemplation. For this purpose, the court was entitled to take account of the terms of the contract and of the surrounding circumstances, and to draw inferences about the parties’ actual or imputed knowledge. In drawing inferences, the court was not obliged to ignore facts or circumstances of which other people doing similar business might have been aware. The Court of Appeal concluded that the plaintiff had suffered a special, and not a general, loss as the result of delay in payment. The court awarded special damages based on the difference between the two exchange rates that were pertinent to the circumstances of the case.

The House of Lords reversed this decision. One ground was that the decision had been based on the fallacious assumption that a charterer is under a contractual obligation to settle and pay for demurrage within two months of the completion of discharge. A charterer does not pay demurrage as money payable for the exercise by him of a right to detain a chartered vessel beyond the stipulated lay days. Demurrage is not liability for a debt; it is liability in damages to which a charterer becomes subject because, by detaining a vessel beyond the stipulated lay days, he is in breach of his contract. Normally, voyage charters contain a demurrage clause that prescribes a daily rate at which the damages for detention are to be calculated. The effect is to quantify the damages, but not to alter the character of the charterer’s liability as a liability for damages for breach, even if the damages are quantified (“liquidated”). The owner’s claim for breach accrues day by day from the day when the detention begins. The charter in the instant case did not provide expressly or by implication that demurrage, instead of being payable daily after the lay days, was not payable until two months after the completion of discharge, even though to allow for the calculation of the necessary amount the common practice was to pay after an interval, which might, however, be less than two months. There was no independent breach of the charter because of the delay in payment of the damages.

The House of Lords held there was a contractual obligation to pay for demurrage, the breach of which gave rise to a claim for damages, but no independent claim for exchange losses because of delay in paying the damages. There was no such thing in English law as a cause of action in damages for the late payment of damages. The only remedy the law allows for delay in paying damages is the discretionary award of interest under statutory authority. The umpire was wrong in awarding special damages but correct in awarding interest. He was correct, furthermore, in holding that as demurrage is usually settled and paid for within two months, interest was payable only from the day following the expiration of that period.

Note that if the charter had provided for payment of the demurrage in U.S. dollars, the owners would not have suffered the exchange loss. Clause 30 of the charter, however, provided for payment in sterling at the exchange rate on the specified day, and the court held that the clause applied whenever payment was made. The consequence was that the owner was deprived of the profits it could have made by chartering the vessel anew after the lay days had ended. The decision takes no account of the prevalence of fluctuating exchange rates. It is also outside the stream of English case law that does take account of the fluctuation of sterling in order to preserve the reputation of London as a center for arbitration and of English law as a system adapted to commercial realities. The decision of the House of Lords was unanimous, but one member said that “I should for myself have preferred to reach a result which did not enable the charterer by delaying payment to take advantage of the decline of the pound against the dollar.”6 The decision has been severely criticized on the ground that it makes the recovery of special damages for exchange losses depend on an archaic distinction between the delayed payment of a debt and the delayed payment of damages for breach of contract.7 Important aspects of English law have been adapted to the conditions of fluctuating exchange rates, but more remains to be done in England and elsewhere.

Multilateral Situations


In another kind of situation, the problem is not the allocation of exchange risks between the parties to a transaction or transactions with each other but how to allocate exchange risks when a number of parties have entered into relations not with each other but with a single entity by means of separate transactions. The parties may have entered into their individual transactions as part of a joint design or there may be no such association among them. In either situation, the solution may be one that gives them equal or pari passu treatment by or on behalf of the single entity. As a consequence of the solution, one party will not receive an advantage over the other parties and none will suffer a correlative disadvantage. Parties may receive equal or pari passu treatment, however, only if they are considered by the law to belong to the same class. Issues of unequal treatment may arise between different classes. In the situations described in this chapter as bilateral or multilateral, equitable considerations may enter into the determination of how exchange risks are to be allocated.

In an English case,8 the court had ordered the liquidation in England of a corporation incorporated in the State of New York for which a scheme of arrangement had been approved in New York under the Federal Bankruptcy Code of the United States. For the purposes of a scheme of arrangement for the distribution of assets in England, the English court was asked to decide at what rate of exchange the claims denominated in U.S. dollars of creditors resident outside the United Kingdom should be translated into sterling. The issue was the date as at which the claims of these creditors were to be valued in terms of sterling: the date of the liquidation order; the date at which all liabilities could be ascertained and at which available assets could be distributed pro rata; the dates at which claims arose or proofs of claims were admitted; or some other date.

In view of the progressive depreciation of sterling, the shares of creditors with dollar claims would become larger the later the date of the exchange rate that was chosen. On behalf of these creditors, it was argued that as their claims were to dollars and not sterling, the latest possible date should be chosen. The court held that, in bankruptcy or liquidation proceedings, the principle is that liabilities have to be reduced to a single unit of account as of the same date so as to enable a pari passu distribution of available assets to be made to all claimants. The single unit of account in English proceedings can be nothing but sterling. The exchange rate must be the rate prevailing at the date on which the bankruptcy or winding up is ordered by the court and not on any other of the conceivable dates.

The court rejected the argument that the sterling value of dollar claims calculated in this way should be adjusted when dividends were paid. Even if the monetary value of a claim is unquantified, the creditor must estimate its sterling value when, before the liquidation order is made, he submits his proof. Later events, such as changes in exchange rates, cannot be taken into account, even though, when sterling is depreciating, creditors would enjoy the maximum advantage if the exchange rate prevailing at the latest feasible date were applied, which would be the date when dividends were paid.

The winding up of the corporation in the case was compulsory. The decision was followed in a later English case in which the winding up was voluntary.9 In the later case, a bank had lent an English company Swiss francs, and repayment was to be made in the same currency on November 5, 1971. Voluntary liquidation was deemed to have begun on September 28, 1971. The liquidators paid dividends in sterling to the creditors whose claims were in currencies other than sterling at the rate of exchange prevailing on September 28, 1971. Sterling began to depreciate against the Swiss franc after that date. All creditors, whether their claims were to payment in sterling or in another currency, received full payment on the basis of exchange rates on that date. A substantial amount of assets remained after these payments were made. The liquidators proposed to distribute the residue in partial satisfaction of claims to interest that had accrued after September 28, 1971. The bank protested, arguing that, on the basis of the rates of exchange when dividends had been paid, it had lost more than 40 percent of its claim, while the creditors with sterling claims had received 100 percent of their claims. A creditor with a claim in deutsche mark had received about the same return as the bank with its claim in Swiss francs, but a creditor with a claim in Italian lire had received approximately the whole of its claim because the lira had depreciated at about the same rate as sterling against the Swiss franc and the deutsche mark.

The bank argued that the liquidators should have paid the dividends to it either in Swiss francs or in an amount of sterling equivalent to the value of the proportion of the debt in Swiss francs that was being paid. The amount of sterling should have been calculated at the rate of exchange prevailing on the date of payment. If, for example, a dividend represented 10 percent of total claims, the bank was entitled to 10 percent of the total loan of 18.5 million Swiss francs, calculated at the rate of exchange prevailing on the date of payment of the 10 percent. The court rejected the bank’s contention, on the ground that, if it were accepted, it would destroy the certainty about the distribution of assets that the liquidators’ practice guaranteed for all creditors.

One member of the court described liquidation as a “collective enforcement procedure.”10 A winding-up order (or its equivalent in a voluntary liquidation) was comparable to an order by the court authorizing execution of a judgment expressed in a foreign currency. The amount of the judgment had to be translated into sterling at the rate of exchange prevailing on the date the court orders execution. The judgment creditor was not able to propose the rate of exchange prevailing at a later date. The creditors were in the same position after the winding-up order had been made in a liquidation. Two members of the court, however, left open the question whether dividends to creditors whose claims had been to foreign (i.e., non-sterling) currencies could be recalculated on the basis of later exchange rates if, after all the claims of creditors had been satisfied, including claims to interest accruing after liquidation, assets remained that, in the absence of such recalculation, would go to the shareholders of the company.11

It is true that under English law since the Miliangos case, when a court orders the execution of a judgment expressed in a foreign currency, the exchange rate is the one prevailing at the date of the order. This choice is dictated by procedural requirements as the latest practicable date, but the choice is a surrogate for the date of actual payment. The assumption is that execution will be levied promptly. This assumption cannot be made in liquidation or bankruptcy proceedings, because there may be a prolonged delay between order and payment of dividends. The court’s analogy between the order in such proceedings and the order for execution in other proceedings can be questioned, but it may be that once again procedural requirements make the court’s choice of exchange rate unavoidable.

The case demonstrates that it may be necessary to decide not only which exchange rate is equitable among creditors but also what fairness requires as between creditors and shareholders. The question raised by the two members of the court implies that in some circumstances the court’s solution of the single date for all creditors may not be completely fair to creditors with claims to foreign currencies. In contests among creditors or between creditors and shareholders in bankruptcy or liquidation, the issue of what fairness requires cannot be resolved on the basis of fault. In cases in which the contest is between a creditor and a debtor who failed to pay on time, the element of fault can have weight.

An American case12 took a different approach to the question of the choice of exchange rate in a dispute among creditors in a bankruptcy proceeding. In this case, the concept of fault, in the form of responsibility for breach of contract, had decisive effect. An American corporation and a German corporation entered into a contract in 1974 for the supply of equipment by the German corporation. The consideration was expressed in deutsche mark, and the court in this case held that this was also the currency of payment. The American corporation failed to perform, and later, on October 31, 1975, filed a voluntary petition under Chapter XI of the U.S. Bankruptcy Act. The German corporation filed its proofs of claims in December 1975. On June 12, 1980, the bankruptcy court, acting in accordance with a stipulation agreed by both corporations and the creditors’ committee, allowed the German corporation’s claims at the U.S. dollar equivalent of a stated amount of deutsche mark.

There remained the question of the proper exchange rate for translating the deutsche mark amount into dollars. The creditors’ committee argued that the exchange rate should be the one prevailing on October 31, 1975, which the committee alleged was the date of breach. The German corporation contended that the exchange rate prevailing on the date of judgment (June 12, 1980) applied. On the former basis, the amount would be equivalent to approximately $4.325 million, while on the latter basis the amount would be equivalent to approximately $6.278 million. The creditors’ committee favored its solution because the assets were insufficient to discharge all claims in full, and with this solution more would be available for claimants other than the German corporation. The court endorsed the position taken by the German corporation, and a District Court in Massachusetts affirmed this ruling. The creditors’ committee appealed to the Court of Appeals for the First Circuit.

For this court, the fundamental question was the law under which the German corporation’s claims arose. The court held that if the cause of action arose entirely under foreign law, the judgment day rule must apply for selecting the exchange rate. A foreign claim in such a case became enforceable as the result of proceedings in the United States only when an American court gave judgment in favor of the claims. If, however, the cause of action arose entirely under American law, the breach day rule governed the choice of exchange rate. The bankruptcy court and the parties were in agreement that the German corporation’s claims arose entirely under American law.

The breach day rule, therefore, had to be applied, but the question still to be decided was when the breach occurred. The German corporation protested that to regard October 31, 1975, the date the petition was filed, as the date of breach was a fiction. The District Court had held that neither that date nor June 12, 1980, when judgment was given to allow the claims, was the correct date. May 9, 1980 was the correct date because it was the date on which the American corporation’s liability for breach became absolute as a result of the actual and final rejection of the contract for the purpose of administering the bankruptcy. The bankruptcy court’s allowance of the German corporation’s claims on June 12, 1980 had the effect of a final judgment on the merits under Chapter XI of the Bankruptcy Act, but that date was not the date of breach.

A French case13 shows that more than one exchange rate may be appropriate in bankruptcy proceedings when secured creditors are included in the body of creditors. A Dutch bank listed its claim, as required by French law, in the French bankruptcy proceedings of the French debtor. The claim was denominated in deutsche mark and secured by a mortgage on French real property. Under a French statute, claims denominated in a foreign currency must be translated into French francs at the exchange rate prevailing at the date of the adjudication in bankruptcy (règlement judiciaire). The listing of claims operated to prevent creditors from pursuing their claims by individual lawsuits. The court held that the prerogative of preferred creditors to collect their claims was placed only temporarily in abeyance.

The receiver argued that the effect of the listing was that the preferred creditor’s claim had to be translated into francs at the exchange rate specified by the statute and that the claim could be processed only on the basis of this calculation. The court held, however, that the bank was entitled to realize on its security, and that, if the claim was not fully satisfied in this way, it was to be deemed satisfied pro rata at the exchange rate prevailing at the date of actual payment of the proceeds. This solution accorded with the principle of French law that the exchange rate for translating a foreign currency debt into French francs is the rate prevailing at the date of actual payment.

The bank could prove for the unsatisfied balance of the claim as an unsecured debt in the bankruptcy at the exchange rate specified by the statute. This conclusion was based on the principle that satisfaction of the secured debt as a whole was guaranteed by the agreement between the bank and the debtor. The bank’s rights were not prejudiced by the fact that the claim had been listed at the French franc equivalent at the date of the adjudication order. That requirement was necessary to give the creditors as a whole a complete picture of the debtor’s financial position.

In Canadian bankruptcy proceedings14 a creditor filed its claim with a reservation on the applicable exchange rate. The creditor was resident in Germany and claimed an amount payable under a number of contracts with a Canadian debtor. The debts were expressed in deutsche mark. The creditor calculated its claim on the basis of the rate of exchange between that currency and the Canadian dollar prevailing at the date proof was submitted of the claim in the bankruptcy proceedings, but the creditor reserved the right to adjust the amount in accordance with exchange rates in effect on the dates when dividends were paid by the trustee in bankruptcy.

The court held that under Canadian bankruptcy legislation the claims of creditors are to be determined at the time the trustee files with the official receiver the insolvent person’s proposal for a compromise with creditors, provided that the proposal is accepted by the creditors and ratified by the court. This date, the court held, determined the applicable rate of exchange as well, unless there was a compelling reason to depart from it.

The court considered this solution equitable because the proposal, if made effective, was a new contract that operated as a novation of the contracts under which claims arose. The court must have thought that this rationale was technical rather than equitable, because the court supported its conclusion with another justification. Under the new contract, dividends were payable at fixed dates, so that the creditor could have entered into a forward contract for the purchase of deutsche mark, with the Canadian dollars the creditor would receive from the trustee, at the rate of exchange at the date of entry into the forward contract.

In this case also, the court seems to have doubted whether the single date was completely fair, but the court disposed of its doubt by pointing out that the creditors with claims to foreign currencies could have protected themselves against exchange risk.15 This assertion is questionable if successive forward exchange contracts would be required because of the length of the period over which dividends would be paid. If the Canadian dollar was depreciating against the deutsche mark in that period, the creditor would not be able to assure itself of complete protection.

It has been seen that exchange rates may provoke contests between creditors with claims in the currency of the forum and creditors with claims in foreign currency as well as contests between creditors and shareholders. It has been seen also that questions of fairness may arise between preferred and ordinary (nonpreferred) creditors. The English Law Commission has examined the law relating to claims to share in a fund.16 The Commission had considered in a working paper whether a preferable solution in cases of the liquidation of a company and in bankruptcy would be translation of a foreign currency obligation into sterling at the exchange rate prevailing at the latest practicable date. This date would probably be the date of each occasion on which a dividend was paid or, more likely, when it was declared. The rationale of this solution would be that it corresponded more closely to the spirit of the Miliangos case and therefore would produce a fairer result for creditors with claims in foreign currency, particularly in the many cases in which the process of liquidation or bankruptcy was protracted. The Commission rejected this solution in both its working paper and its final report, preferring the solution applied by the courts in the case of the liquidation of a company, whether solvent or insolvent, and in a bankruptcy. The solution is that the exchange rate is the one prevailing at the date of the resolution to wind up the company if the liquidation is voluntary, the date of the winding-up order if the court orders the winding-up, or the date of the receiving order in the case of bankruptcy.

The Uniform Foreign-Money Claims Act drafted by the U.S. National Conference of Commissioners on Uniform State Laws was approved in the summer of 1989, subject to subsequent editing and the inclusion of comments, and was recommended for enactment in all States of the United States. The Act as thus proposed has dealt with the problem of exchange rates in a “distribution proceeding.”17 That concept is defined18 as a judicial or nonjudicial proceeding for the distribution of a fund in which one or more foreign money claims is asserted and includes an accounting, an assignment for the benefit of creditors, a foreclosure, the liquidation or rehabilitation of a corporation or other entity, and the distribution of an estate, trust, or other fund. The concept covers cases in which a limited fund of assets must be shared pro rata among a class of claimants in circumstances in which usually the fund will be insufficient to satisfy the claims in full.

The Act declares in the first sentence of Section 8 that the exchange rate prevailing at or near the close of business on the day the distribution proceeding is initiated governs all “exchanges of foreign money” in a distribution proceeding, which undoubtedly means all translations of such currency into U.S. dollars. Exchanges in the sense of exchange transactions do not take place in these proceedings. Section 8 provides in a second sentence that a claimant making a foreign currency claim in a distribution proceeding must assert its claim in the named foreign currency and show the amount of U.S. dollars resulting from the translation at the exchange rate prevailing at the date the proceeding was initiated.

The Act does not include a provision that appeared in the draft of January 23, 198919 to deal with one of the contests among parties, which, it has been seen from the preceding discussion of some of the cases, can arise when some of the claims are in a foreign currency. The draft provided that if a foreign money claim had priority over claims of a lower class, and a depreciation of the dollar occurred after the translation had been made, an adjustment might be in order. The adjustment would be made if, because of the depreciation, the creditors with foreign money claims would not receive the same percentage of their claims as the creditors with dollar claims. The creditors with foreign money claims would receive a supplementary distribution to equalize the percentage if money remained in the fund before a distribution was made to claimants of a lower class. It can be assumed that this proposed provision was too contentious to be retained.

A comment on Section 8 recognizes that the administrative necessity to compute pro rata amounts makes it necessary to translate currencies in distribution proceedings into a single currency. The exchange rate chosen is the one prevailing when the proceeding was initiated, which is different from the date applicable to judgments in litigation. The commentary on Section 8 approves the basic English decision discussed earlier in this chapter.20

It does not follow that the use of a single date will necessarily be disadvantageous to a creditor or that the use of a later date than one related to an early stage of bankruptcy or liquidation proceedings will necessarily be advantageous to a creditor. These propositions are illustrated by a German case.21 In the course of bankruptcy proceedings, the plaintiff asserted against the liquidator a claim for an amount of Swaziland emalangeni. On the day when the bankruptcy proceedings were initiated, the rate of exchange was one lilangeni equaled DM 1.599. The bankruptcy law of Germany permits the debtor and the nonpreferred creditors to enter into an agreement for satisfaction of the debts that takes the place of a compulsory distribution of the debtor’s assets. An agreement was concluded that permitted an initial settlement of 40 percent of the claims to be taken into account in the further proceedings for settlement. The liquidator paid the plaintiff this proportion of her claim at the exchange rate on the date of payment, namely, one lilangeni equaled DM 0.9855. The plaintiff sued for the balance of the 40 percent calculated at the exchange rate prevailing when the bankruptcy proceedings were initiated. Alternatively, the plaintiff sought a declaration of the full amount of her claim calculated in deutsche mark at that exchange rate less the amount of deutsche mark she had been paid as if received by her at the same rate.

The court (Landgericht, Cologne) noted that as a first step under the bankruptcy law, art obligation in a foreign currency must be translated into deutsche mark at the exchange rate prevailing when bankruptcy proceedings are initiated. Only if this translation is confirmed during the proceedings or as a term of an agreement between debtor and creditors does the original claim disappear by becoming transformed into a debt in deutsche mark. Confirmation during the proceedings in this case had not occurred.

The question then was whether the exchange rate claimed by the plaintiff had been confirmed by the agreement that had been made. The court found no express term to this effect and refused to imply one. A reason for rejecting an implied term was the unlikelihood that the creditors intended by their agreement to deny the liquidator the opportunity to exercise his authority under the law to pay on the basis of the exchange rate prevailing at the date of payment. The court’s assumption seems to have been that creditors with claims to foreign currency would have wanted the liquidator to exercise this power if the exchange rate at the date of payment was more favorable to them than at the date when the bankruptcy proceedings had been initiated. Similarly, it should not be assumed that the debtor was willing to give up his option to pay on the basis of an exchange rate more favorable to him. It was precisely this power, however, that the liquidator was entitled to exercise, and had exercised, by paying on the basis of the exchange rate prevailing at the date of payment, a rate that was less favorable to the plaintiff. The liquidator was able to exercise this power because the plaintiff’s claim retained its quality as a foreign currency claim in the circumstances of this case.

On the plaintiff’s alternative claim, the court held that her claim would indeed be translated into deutsche mark on the basis of the exchange rate prevailing at the date when the bankruptcy proceedings were initiated. The plaintiff’s claim, however, could not be specified in the original amount, because 40 percent had been settled under the agreement.

The court’s reasoning has been criticized.22 In the negotiation of an agreement for the purpose of the bankruptcy law, all participants are keenly interested in having a clear picture of the magnitude of the debtor’s obligations. The participants will not have this information if foreign currency obligations are involved unless they are translated prior to conclusion of the agreement. This interest cannot be swept aside by arguing that to apply an exchange rate that precedes the date of conclusion of the agreement would deprive the debtor of his option to pay at the exchange rate prevailing on the date of payment. An option of the debtor to decide when to pay should not entitle him to choose the exchange rate at which the translation of a foreign currency claim is to be made. Furthermore, in order to determine that the condition that creditors holding a sufficient amount of claims concur in a proposed agreement is satisfied it is necessary to apply the exchange rate prevailing at the date when the bankruptcy proceedings were commenced.

Other Claims to Share in a Fund

The insolvency cases discussed in this chapter resemble various other situations in which there are a number of claimants who seek satisfaction of their claims from a single fund that is, or may be, inadequate to meet their claims in full. These other situations do not involve insolvency. For example, under legislation of the United Kingdom relating to merchant shipping, a shipowner who faces or expects to face a number of claims arising from the same casualty can bring an action for a decree limiting the total amount of his liability. If he succeeds and the total of the claims exceeds the established limit, dividends will be paid in sterling from the fund. If a claimant proves his claim in a non-sterling currency, it is necessary to decide the date of the exchange rate that is to be applied for translating the claim into sterling. An English judge has said that the situation was “a form of statutory insolvency” and that therefore the precedents of the winding-up of a company should be followed.23 The analogy would lead to adoption of the exchange rate prevailing at the date of the court’s decree authorizing the limitation of liability.

The English Law Commission has endorsed the view that the appropriate exchange rate when a limitation fund is established under merchant shipping legislation is the rate prevailing at the date of the decree authorizing establishment of the fund. For other claims to share in a fund, the Commission concluded that no satisfactory general rule could be formulated for selecting the appropriate exchange rate.24

It will be recalled that the U.S. Commissioners on Uniform State Laws have concluded that the applicable exchange rate in all distribution proceedings is the rate prevailing at or near the close of business on the day the proceeding is initiated. As a distribution proceeding can be either judicial or nonjudicial, the rule would apply even though judicial proceedings are not instituted, but then there might be controversy about the date on which nonjudicial proceedings are deemed to be instituted for the purpose of the rule.

World Bank’s Currency Pooling System

The World Bank has had to deal with a problem of allocating exchange risks that falls into the second of the two categories described earlier in this chapter, that is to say, the situation in which a number of parties have entered into relations with a single entity by means of separate transactions. The Bank’s objective has been to equalize exchange risks for all borrowers from it.25 At one time, the Bank’s resources were derived mainly from loans it negotiated in the private capital market of the United States. The Bank has departed from this practice and has diversified its borrowing by raising resources in medium-term and long-term maturities in other major capital markets as well. Over the two decades of the 1970s and 1980s, some 85 percent of the Bank’s resources were derived from borrowing. Of the borrowings by the Bank outstanding at the end of 1988, more than 90 percent had been raised in U.S. dollars, Japanese yen, Swiss francs, deutsche mark, and Netherlands guilders.

Agreements by the World Bank to lend to its developing country members and their agencies are denominated in U.S. dollars, because the agreements are not fully funded when the Bank makes commitments. As a result, the Bank has not been able to specify in a loan agreement which currencies it will disburse under the agreement. The Bank has the discretion to determine the currencies it will disburse and the order in which it will recall currencies for repayments.26 It has been impossible for the Bank to make disbursements to all borrowers in the same currencies or in equal proportions in each currency. Even if it had been possible in principle to make disbursements and call for repayments in proportionate amounts of all the available currencies, the inconvenience and additional cost would have been considerable. Repayment obligations in many more than the five currencies mentioned above as the primary currencies borrowed by the Bank have been outstanding under loans by the Bank, mainly because members have made share capital available for lending by the Bank. As a result, more than 40 currencies have been outstanding at the same time under loan agreements made by the Bank.

The World Bank passes on to borrowers the exchange risks associated with the currencies that are lent. The Bank has followed a policy of not exchanging, on its own behalf, borrowed currencies in order to obtain other currencies. Diversified borrowing by the Bank and its disbursement policies had produced unequal exchange risks for borrowers when measured by a common denominator, because of changes in the exchange rates of the currencies disbursed by the Bank under its loan agreements. To provide equitable treatment for borrowers notwithstanding the difficulties summarized here, the Bank instituted its Currency Pooling System for loans negotiated on or after July 1, 1980, with an option for borrowers to bring into the System a portion of any loan that was undisbursed on July 1, 1980 under loan agreements outstanding on that date.

The purpose of the System is to distribute exchange risks equally among borrowers. By means of an ingenious accounting technique, the System achieves the same result and the same impact of changes in exchange rates that would have been extremely difficult, and perhaps impossible, to achieve by actual transactions conducted each time in all the currencies disbursed by the Bank. In effect, the System redistributes in the accounts each day all the currencies in the System. The redistribution is made equiproportionally to all outstanding loans. The set of currencies that a borrower owes as the result of a loan by the Bank is a function of the selection of currencies for disbursements and repayments under all loans; the set is not determined by each loan in isolation from other loans. Each loan continuously has the same notional currency composition as every other loan whatever the actual disbursements and repayments may be under an individual loan agreement.

For example, suppose at the inauguration of the System there were only two borrowers, Patria and Terra, and two currencies lent, deutsche mark and yen, between which the exchange rate was 70 yen per deutsche mark. Patria receives a disbursement of 70 million yen and Terra a disbursement of 1 million deutsche mark. Under the System, each borrower would owe 50 percent of the aggregate U.S. dollar equivalent of 70 million yen and 1 million deutsche mark. This example is, of course, simplistic, because the daily recalculations are complicated by the number and amounts of currencies involved, but the principle is the same notwithstanding the complexities: members owe not specific currencies but a share in the pool expressed in terms of U.S. dollars. Thus, in the example cited above, the Bank could call for repayment in full by Patria in deutsche mark and by Terra in yen.

Equal treatment for all borrowers does not mean that the System changes the impact of exchange rates on all loans taken together. The effect of changes in exchange rates on total outstanding loans on any date is the same as it would be in the absence of the System. In other words, the System is not a mechanism to modify or manage exchange risk but to ensure that all loans and all borrowers are affected equally by changes in exchange rates and therefore bear the same risks.

The System can be described in another way: it is a technique for indexing principal and interest payments under loans by the World Bank to reflect changes in exchange rates that occur over the life of the loans. The index is constructed by using changes in exchange rates between one day and the next, weighted in accordance with the amounts of the various currencies in the System on the given day. Percentage changes in the index during any period represent, in the absence of disbursements or repayments during the period, corresponding changes in the obligations of each member measured in the unit of account of the System. Movements in exchange rates change the percentage shares of the various currencies in the index but not the weights of the currencies. Only actual transactions can change the weights.

The U.S. dollar is the unit of account for the System. The choice is purely arbitrary, because anything else could have been chosen for the purpose. The reason for the choice that has been made is that the World Bank and its members tend to rely on the dollar as a denominator for expressing combinations of amounts of various currencies. The dollar as unit of account does not change the amounts of currencies to be used in repayments by borrowers. The amounts would be the same if measured in any other currency or in the SDR as the unit of account.

The Currency Pooling System has permitted a simplification of practice in the repayment of loans. Before the System was established, a borrower had to repay in the currencies, and in the amounts of each, disbursed to it under the loan agreement. Since the establishment of the System on July 1, 1980, the Bank undertakes to lend an amount in various currencies equivalent to a specified amount of U.S. dollars, and repayments are made by borrowers in a single currency that is determined by the Bank on the occasion of each repayment. The amount is calculated as the U.S. dollar equivalent, as of the contractual due date of repayment, of the proportion the repayment bears to the total amount of outstanding loans subject to the System. The choice of this date ensures that other members do not suffer a detriment or enjoy a benefit as the consequence of a failure by a member to repay on time. On the date on which payment is due, various currencies equivalent in value to the amount of repayment cease to be included in the total amount of the System, whether or not repayment is made on time. The currencies and the amounts withdrawn are not changed subsequently, for example when a delayed repayment is made.

Other Policies of World Bank

The fact that the Currency Pooling System does not eliminate exchange risk for borrowers in terms of each borrower’s domestic currency has induced the World Bank to decide that the volatility of the effective cost of borrowing from the Bank could be reduced by maintaining a balanced plan of currencies outstanding on loan. An appropriate plan will reduce risk by reducing susceptibility of the Currency Pooling System to changes in exchange rates. Announcement of the details of such a plan will make it easier for borrowers to predict and manage their exchange risk on loans subject to the System. The plan, which is being phased in and will be in full operation by June 30, 1991, consists of targets for relationships among the amounts of currencies outstanding on loans. That is to say, for each dollar on loan, there are equivalents expressed as so many units of each of the main currencies borrowed by the Bank. The target ratios are 1 U.S. dollar for every 125 Japanese yen and 2 deutsche mark for a basket of deutsche mark, Swiss francs, and Netherlands guilders. These five currencies amount to 90 percent or more of the total value of the currency pool. The other amount of up to 10 percent represents capital subscriptions of other currencies released for lending and permits a small amount of flexibility in borrowing.

Hitherto, the World Bank has given priority to borrowing and disbursing currencies with low nominal interest rates so as to keep down the rate of interest payable by borrowers on loans by the Bank, and so as to enable the Bank to invest rather than disburse borrowed currencies on which high yields could be earned. The effect had been a substantial decline in the proportion of U.S. dollars outstanding under loans by the Bank. For the many borrowers that measure their ability to pay debt service by reference to the currency of their export proceeds or U.S. dollars, this decline had increased the burden of their obligations when other currencies in the System appreciated sharply against the dollar, although the depreciation of the other currencies against the dollar had been beneficial for borrowers. Whether the burden had been heavier or lighter from time to time, the result had been a high degree of volatility in terms of dollars.

It would be impractical for the Bank to determine the package of currencies that would minimize risk for each borrower, because the package would depend on the borrower’s comprehensive economic position and external relations, which in any event change over time. To allow each borrower to choose the currency or currencies of disbursement under the Bank’s loan agreements would create complications for the Bank and would not necessarily serve the interests of borrowers as a whole.

The alternative adopted by the Bank, therefore, is a set of predetermined targets for the currency composition of the Bank’s borrowings and the loans it makes. Reasonable stability in the currency composition is an objective. The targets relate to the main currencies borrowed by the Bank. The three European currencies tend to move together in the exchange markets. The speed with which the initial targets can be reached will depend on the volume and timing of new disbursements and repayments.

Expression of the targets as fixed ratios among the units of currencies has advantages over fixed percentage shares for each currency (or the group of European currencies) in the total value of outstanding loans by the World Bank. For example, the Bank’s borrowing plans need not be adjusted each time there is an important change in exchange rates. The numbers of units will not vary with changes in exchange rates, but the percentages in the total will vary when valued in terms of the dollar or any other currency. The targets can be adjusted at intervals that will not undermine the stability of the plan. It will be apparent that many of the considerations that are relevant for putting such a plan into effect are similar to those that enter into determination of the method of valuation of a composite unit of account like the SDR.

Self-imposed limitations on the freedom of the Bank to determine the currencies it will borrow may tend to increase the cost of borrowing and therefore the rate of interest to be charged on loans by the Bank. Borrowing so-called strong currencies—namely, currencies other than the U.S. dollar—was considered justifiable because of the relatively low interest rates payable by the Bank. When determining which currencies other than the dollar should be borrowed, the Bank took account of the prospective appreciation of the exchange rates for the other currencies against the dollar and the extent to which these exchange rates would negate the differential between interest rates on the currencies to be borrowed and the interest rate on the dollar.

Movements in exchange rates have created another problem for the World Bank. The maintenance of adequate reserves is an important objective of the Bank’s financial management. The ratio between reserves and loans is a prudential indicator of the Bank’s ability to absorb losses under loan agreements while still preserving the capital paid in by shareholders. In recent years, the Bank had aimed at a reserves-to-loans ratio of 10 percent, but achievement of this target had been hampered by the sensitivity of the ratio to fluctuations in exchange rates. The difficulty resulted from the fact that the currency composition of reserves differed from the currency composition of outstanding loans. For example, the proportions of the U.S. dollar and various other currencies had been much larger in reserves, and the proportions of such currencies as the yen and the deutsche mark much lower, than the proportions of these currencies in outstanding disbursements under loans. As a result of this mismatch, depreciation of the U.S. dollar in recent years had caused the reserves-to-loans ratio to fall below the target notwithstanding large annual allocations to reserves.

Article IV, Section 2(d) of the World Bank’s Articles empowers the Bank to use its earnings or to exchange them for other currencies required in the operations of the Bank without restriction by the members whose currencies are offered by the Bank. In February 1950, however, the Bank decided to retain earnings in the currencies in which they were earned. The original rationale for this decision was that the Bank as an international organization conducts its operations in the currencies of all members and Switzerland and therefore has no need to arrange for the exchange of resources derived from capital, borrowings, and earnings for other currencies. (Borrowed funds, but not other resources, were sometimes exchanged: at the same time the Bank entered into forward exchange contracts in order to reacquire the currency the Bank had lent.)

The original rationale of the policy on the retention of earned currency established in the days of the par value system is unpersuasive in present conditions. Having changed its policy, the Bank can now arrange a close correlation between the currencies in its reserves and the currencies outstanding in loans, and can engage in exchanges for this purpose. Net income may be reduced as a result, but future exchange rates might compensate for this reduction, and in any event the policy of reducing risk may be seen to strengthen the Bank’s finances. It is hoped that the management of reserves will ensure by the beginning of June 1991 that the ratio of reserves to loans in any year will stay within 20 basis points of what the ratio would have been with perfect alignment.

Chapter 9 of this monograph discusses the reasons why the model of the composition of the SDR has not been chosen for solving the problem that has arisen in applying Article II.6(a) of the GATT. The question can be asked whether the composition of the SDR would be appropriate for establishing targets for the currencies in the World Bank’s lending program. There are reasons why the model of the SDR would be inappropriate. The volume of currencies available for borrowing in the capital markets is not among the factors taken into account in determining weights in the SDR basket, but this factor is relevant to the Bank’s ability to provide currencies to borrowers.

Furthermore, Switzerland is an important capital market in which the World Bank has been able to borrow Swiss francs on favorable terms, but the Swiss franc is not included in the SDR basket. The SDR weights are reviewed, and, if necessary, adjusted at intervals of five years, but these periods might not be the periods the Bank favored for adjusting its targets. The Bank might wish to depart from the periods of the SDR model and make adjustments justified by changing circumstances. It could be embarrassing to have to meet the objection that stability in the currency composition of loans was being sacrificed by adherence to the SDR model.

A Third Situation of Risk

Official action to allocate exchange risks under the influence of equitable considerations may be taken in circumstances that do not fall into the categories of bilateral contracts or the multilateral situations discussed so far (discrete contracts of many parties with a single entity whether under a common design or without such a design). An example of official action outside these categories can be cited from Spanish law. The official action in this example, however, was in response to a single change in exchange rates and was not designed to deal with the permanent fluctuation of exchange rates.

Over the weekend of February 10–11, 1973 intense consultations were conducted among various countries in an effort to solve the problem of flight from the U.S. dollar, principally into the deutsche mark. A spirit of crisis had erupted and had led to the closure of exchange markets in many countries. On February 12, 1973 the U.S. Government announced its intention to seek congressional approval of a 10 percent reduction in the par value of the dollar. Congress did not act until September 12, 1973, and the IMF concurred in the change in par value with effect at 12:01 a.m. Washington, D.C. time on October 18, 1973. The announcement of February 12, 1973, however, had an immediate impact in the exchange markets, and this effect was indeed the objective of the announcement. The exchange markets reopened promptly after February 12, 1973. A new pattern of exchange rates emerged.

Spain adopted Decree-Law No. 2/1973 of February 19, 1973 to provide equitable relief under contracts for export or import entered into before February 9, 1973 in which the U.S. dollar was the currency of payment and in which the nominal amounts were fixed. Losses suffered by exporters were to be compensated from gains enjoyed by importers because of the change in the exchange rate for the dollar against the peseta between February 10, 1973 and the date of payment. The bank designated to pay dollars on behalf of an importer had to retain the peseta surplus and, instead of returning it to the importer, had to deposit it in a fund with the Bank of Spain, from which exporters were compensated. The decree-law defined the categories of imports and exports giving rise to the receipts and disbursements to which the scheme applied.

The Supreme Court of Spain considered the scope of the law in 1984.27 An importer had entered into a contract on January 11, 1973, and to discharge its obligation, the importer, at the same time, borrowed almost $2 million from a bank. The import was made on January 15, 1973. In due course, the importer repaid the nominal amount of the loan in depreciated dollars. The Spanish Administration argued that the amount of the importer’s gain was subject to the decree-law, on the ground that if there had been no import there would have been no loan. The court held that the import and the loan were legally independent of each other, that the importer’s gain was derived from the loan and not from the import, and that loan contracts were not among the transactions to which the decree-law applied. The bank was the party prejudiced by the importer’s repayment, but the bank was not entitled to compensation under the decree-law. The bank had to bear the loss under the Commercial Code, because it had failed to protect itself by providing for revision, in accordance with fluctuations in the exchange rate, of the terms relating to repayment or to the interest rate.


See, for example, Glafki Shipping Co. S.A. v. Pinios Shipping Co. No. 1 (The “Maira”) (No. 2) [1985] 1 Lloyd’s Rep. 300; The Times (London), December 1, 1989, p. 42.


See, for example, Les Rapides Savoyards Sàrl and Others v. Directeur General des Douanes el Droits Indirects (Case 218/83) [1985] 3 C.M.L.R. 116 (Court of Justice of the European Communities).


Third Restatement, Article 823. See also George Veflings Rederi A/S v. President of India, etc. [1979] 1 All E.R. 380.


Re Canadian Vinyl Industries Inc. [1978] 29 C.B.R. 12 (Quebec); Isaac Naylor & Sons Ltd. v. New Zealand Co-operative Wool Marketing Association Ltd. [1981] 1 NZLR 361.


[1987] 3 All E.R. 110.


Ibid., p. 118.


F.A. Mann, Note, “Recovering Currency Exchange Losses,” Law Quarterly Review (London), Vol. 104 (January 1988), pp. 3–6.


Re Dynamics Corporation of America and Another [1972] 3 All E.R. 1046; [1976] 2 All E.R. 669.


Re Lines Bros. Ltd. [1982] 2 All E.R. 183


Ibid., p. 189. See also pp. 194–95, 198–99.


Ibid., pp. 195–96, 199.


In re Good Hope Chemical Corporation, 747 F.2d 806 (1984).


Banque de Bary v. Marti et Ciauque, Tribunal de Grande Instance de Montbéliard, November 17, 1981 (Recueil Dalloz Sirey (1982), pp. 648–52).


Re Canadian Vinyl Industries, Inc. [1978] 29 C.B.R. 12 (Quebec).


For proposed changes in Canada’s bankruptcy law, see British Columbia Report, Chapter IV, B.4. (f), p. 31.


English Law Commission’s Report, paragraphs 2.22–2.26, 3.34–3.44, 6.2(8)–10.


Section 8.


Section 1(4).


Section 7 of the January 23, 1989 draft.


Re Lines Bros. Ltd. (see footnote 9 above).


LG Köln, Urteil vom 16 September 1987 (20 O 60/86) – WM 1988, 802; WuB VI B. § 69 KO 1.88 (WuB/9.88, 1229).


Ibid., Note by Reinhard Welter, at WuB/9.88, 1230.


The Despina R [1978] 1 Q.B. 396, at pp. 415–16.


See footnote 16 above.


World Bank, Annual Report 1979 (Washington, 1979), pp. 28–29.


World Bank, General Conditions Applicable to Loan and Guarantee Agreements (Washington, January 1, 1985), Article IV, Sections 3 and 4.


Maria Teresa Echezarreta Ferrer, Note, “Derecho Económico International: 1. Obligaciones en Moneda Extranjera,” Revista Española de Derecho International (Madrid), Vol. 38, No. 1 (1986), pp. 359–61.