Legal tender is money that, if tendered by a debtor in payment of his monetary obligation, may not be refused by the creditor. Thus, the legal tender is a notion associated with the discharge of monetary obligation by “payment.” When the banknote of a currency is designated as legal tender, it will ordinarily be accompanied by nominalism. This paper considers how confusing the role of national currency has become by examining how the legal tender, a traditional core concept of national currency, has lost its importance at present.
The Supreme Court of the United States considered the authority of determining legal tender as a component element of currency power (in the Legal Tender Cases [Knox v. Lee and Parker v. Davis], 79 U.S. (12 Wall.) 457 (1871). Since the power is within the exclusive jurisdiction of the state issuing a particular currency, a monetary obligation expressed in that currency cannot escape from the reach of this regulation (lex monetae). The state can also replace the currency by a new one and fix the conversion rate of the old currency in relation to the new as has been done recently in the European Union.
However, the utility of the concept of legal tender may have to be reassessed because monetary obligations are now increasingly discharged by account settlement without any “tender” of currency.
Traditional Role of National Currency
Traditionally, monetary sovereignty was an important element of a nation’s sovereignty. The economic well-being of a nation rested in part on the stability of the currency which the nation maintained. Its monetary authority controlled the supply of credit and geared the economy to its maximum potential. The legal tender rule, therefore, accompanied the mandatory nominalism. Regardless of a change in the purchasing power, the monetary obligation expressed in the domestic currency was discharged by tendering the same amount.
Thus, for example, the insertion of a gold clause in a contract, which indexed the amount to be paid to the amount of gold that was obtainable at the time of the accrual of the monetary obligation, was regarded as an unacceptable challenge to the governmental authority to gear the national economy.
In 1933, the Congress of the United States adopted a joint resolution declaring that the gold clause was against public policy and that monetary obligations expressed in U.S. dollars would be discharged by tendering the same amount in U.S. dollars (48 Stat. L. 113, 31 U.S.C., §§ 462, 463 (1933)). This resolution was broadly respected internationally for monetary obligations payable in U.S. dollars: in essence a philosophy similar to art. 8(2)(b) of the Articles of Agreement of the International Monetary Fund prevailed.
Forgery of national currency was a serious offense. Wherever committed, it was a challenge not only to the monetary sovereignty of a nation but also to the foundation of the international monetary order. Thus, the U.S. Supreme Court even assumed it to be an international obligation of sovereign states to enact penal provisions against counterfeiting and other crimes regarding foreign money (United States v. Arjona, 120 U.S. 479, 7 S. Ct. 628 (1887)). In 1929, under the auspices of the League of Nations, the International Convention for the Suppression of Counterfeiting of Currency was adopted to cope with international counterfeiting bands (112 Treaty Series 372 (1931)). The legislative jurisdictional reach of a nation could be extended against an offender abroad regardless of the nationality of the offender (e.g., Japanese Criminal Code, art. 2 (4)). The monetary sovereignty was very strong.
Since the national currency was closely linked to the national economy, the use of a foreign currency for domestic transactions, whether as a unit of payment or as a unit of account, was, as a matter of principle, incompatible with the role of the national currency. For international cases where monetary obligations were expressed in foreign currencies, some countries even insisted that all monetary claims of foreign origin had to be asserted in domestic currency in court, while others prescribed that the obligor had an option to pay in domestic currency at the exchange rate on the day of payment. The home currency rule was particularly strong in common law countries, e.g., Manners v. Pearson & Son, [1898] 1 Ch. 581 (C.A.); Re United Railways of Havana & Regla Warehouses Ltd., [1961] A.C. 1007; and Die Deutsche Bank filiale Nurenburg v. Humphrey, 272 U.S. 547 (1926).
Changes After the Floating Exchange Rate System
However, under the floating exchange rate system coupled with the penetration of a philosophy in support of the freedom of capital transfers, commercial concerns realized that the protection of their transactional value is left to themselves in this unpredictable world of exchange rates. This reality was recognized by court. For example, a clause in a “domestic” loan agreement in pounds sterling which indexed the amount to be repaid to the Swiss franc was sustained in the United Kingdom in Multiservice Bookbinding Ltd. and Others v. Marden, [1978] 2 All E.R. 489 (Ch.D., 1977). In this loan agreement, which was payable after 10 years, it was provided that, if the exchange rate between pounds and Swiss francs differed more than 3 percent on the day previous to the date when the repayment was due, the amount repayable in pounds would be adjusted accordingly. When the due date came, the exchange rate of the pound to the Swiss franc was about one-third (i.e., from about 12 Swiss francs to about 4 Swiss francs). This meant that the borrower had to pay about three times as many pounds on the principal alone. The court did not accept the argument that this clause was against public policy, being unequitable and unconscious, and emphasized that the person providing the financing was entitled to ensure that the real value of what he financed would be maintained.
In 1977, the United States quietly repealed the 1933 Congressional Resolution which prohibited the gold clause (Public Law 95-147, 91 Stat. 1227).
Germany prohibited indexation clause by Law (No. 3) of 1948 but abolished the law in 1998 on the ground that the monetary sovereignty has been transferred to the European Union. Note that Germany had also prohibited the use of the ECU clause domestically until then. The combined use of a unit of account and unit of payment in international transactions is of course an indexation. A creditor often wishes to secure the value of his monetary claim by linking the determination of its sum due at the time of payment to a certain unit whose value may be more stable than the currency of payment. As well known, until recently, ECU was often used as such a unit of account in order to minimize the risk of volatility in the foreign exchange rate.
However, in reality, private ECU became to be used as if it were a unit of payment (hence a currency) in transactions which called for monetary settlement through bank accounts. That development was a beginning when the legal tender rule started losing its significance.
Moreover, parallel to the freedom of international capital transfers under the floating exchange rate system, domestic account holding in foreign currencies has become permitted in major countries. To this reality, courts of major countries responded by abandoning the home currency rule for international cases. In a leading case in the United Kingdom, Milangos v. George Frank (Textiles) Ltd., [1976] A.C. 443 (1975), the court upheld the claim to pay in Swiss francs as agreed in the contract after emphasizing the parties' need to adapt to changes in the international monetary system and to the necessity of commerce. Meanwhile, the traditional breach day rule for determining the exchange rate for conversion has also been shifted to the actual payment date rule, thus leaving the determination of the exact amount to be paid in pounds to the foreign exchange rate on the day of actual payment.
In the United States, Restatement 3rd, Foreign Relations Law of the United States, § 823 (1987), still maintained the home currency rule as the principle, only permitting to a court the discretion to render judgment in a foreign currency. However, the 1989 Uniform Foreign Money Claims Act, § 7(a) provides that the judgment in a foreign currency is the principle when the parties previously agreed to a foreign currency as the unit of payment, and in Mitsui & Co. v. Oceantrawi Corp., 85 Cir. 8008 (MGC) (S.D.N.Y. 1995), the federal court entered judgment in foreign currency for the first time, and emphasized the policy considerations of freely permitting parties to international commercial contracts to select the currency in which to transact business and bear currency fluctuation.
France still maintains the home currency rule for judgment, but since the court has already changed the rule on the conversion date of a foreign currency claim to the French franc from the breach date to the actual payment date, it can be regarded as tantamount to the practical abolition of the home currency rule.
In Germany, money debt expressed in a foreign currency may be payable in domestic currency and the payment date rule applies for conversion (BGB, § 244). In Japan, the Supreme Court, in obiter dictum, also confirmed that the rule in article 403 of the Civil Code, which provides an option to the obligor to pay in domestic currency at the exchange rate then prevailing, meant the option to convert on the actual payment date (29 Minshu 1029, July 15, 1975). However, the main issue in this Japanese case was whether a foreign creditor who held a claim in foreign currency could make the claim in Japanese yen in Japanese court. Since the yen was rapidly gaining strength, the earlier the foreign currency was converted to yen, the greater the amount in yen was than the amount in yen which the creditor would have obtained on the actual date of payment. Under such circumstances, the court held that the creditor in foreign currency may make a claim in Japanese currency under an expanded interpretation of article 403 and that the conversion date was the date when the trial was concluded. It may have been that, in order to tackle the delicate question of how to calculate the proper amount of damages in case of breach, particularly when the exchange rate was significantly changing, the court considered an equitable path to be the middle way, i.e., between the date when the claim was made and the date when payment was actually made.
In this context, it may be noted that the Principles of European Contract Law of 1998 provides, after stating a rule similar to German BGB art. 244, “[i]f the debtor has not paid at the time when payment is due, the creditor may require payment in the currency of the place where payment is due according to the rate of exchange prevailing there either at the time when payment is due or at the time of actual payment” (art. 7:108(2)(3)). The UNIDROIT Principles of International Commercial Contracts of 1994 also takes a similar approach (art. 6.1.9). It may be of interest that these provisions were modeled upon article 41 of Geneva Uniform Law on Bills of Exchange of 1930, and article 36 of Uniform Law on Cheques of 1931.
Impact of Globalization on the Money Market
In the days when economic interaction among states was mostly through traditional trade in goods, each state could determine its monetary and fiscal policies primarily based on their impact on the domestic economy. The foreign exchange policy was, of course, important for the maintenance of a favorable balance of payments position for current payments, but it could be formulated as relatively distinct from other policies. However, under the present system, monetary and fiscal policies, such as on taxes, public expenditures, and the prime rate, would be immediately interwoven into the exchange rate before their impact was felt within the confine of the nation’s boundaries. Consequently, the effect on domestic economy which previously could have been anticipated by a proper implementation of those policies is no longer assured. The scope of a government’s maneuverability in the management of its economy has thus been seriously narrowed.
Meanwhile, the development of electronic fund transfers has revolutionized the means for discharging a monetary obligation. People now tend to include the application of such accounting techniques in the definition of “payments,” and this is called the “global payment system.” The European Union completed this picture by nonissuance of paper money but allowing the euro to circulate in the virtual world at present and be settled in bank accounts.
Traditionally, it was explained that control over the supply of credit in an economy was in the hands of its monetary authority. The amount of currency which was placed in circulation was important because of its direct link to “payment.” Even in account settlements, if they were confined within the national boundary, the monetary authority could maintain their grip. This was the basis on which nations' monetary authorities could exercise their control over the supply of credit. However, the overwhelming spread of account settlements on a global scale now often bypasses central banks.
Moreover, since the settlement of monetary obligations is now mostly through adjustments in accounts not requiring any settlement in cash, it is no longer necessary to be expressed in any national currency unit as long as an agreed formula exists on how it will be recalculated into other currency units when such need arises. Thus, for example, the ECU, a monetary but noncurrency unit of account, was constantly used as a unit of account until recently, and now EC regulations attempts to shift this unit of account to the monetary status, i.e. euro.
The UNCITRAL Model Law on International Credit Transfers of 1992 provides in its definitional section that “funds” or “money” include credit in an account kept by a bank and include credit denominated in a monetary unit of account that is established by an intergovernmental institution (art. 2(h)). Envisaged at the time of its adoption was, of course, a private ECU account Therefore, the new EC regulation that assimilates ECU designation in a contract to the money designation is not a surprise. Reflecting upon such development, the 1998 resolution of the International Law Association confirms that the matter is within the confine of lex monetae, hence no new legislation is necessary even in non-European countries to attain the same result in that regard.
Traditionally, it was conceptually inconceivable to consider the domestic currency, which is the legal tender, able to become an object of purchase or sale. On the other hand, foreign currencies were commodities in the foreign exchange market. Only when foreign currencies assumed a payment function in the international transaction were they treated as money. However, such foreign exchange transactions now take place in a third country which is a part of the global money market. Moreover, the liberalization of financial services with unrestricted capital movement will make it difficult even to identify, for legal purposes, the location (situs) of an account when a bank maintains branches throughout the world and the account is accessible from any place. The traditional approach to legally identify (or designate) the location of an account and to subject the account to the lex situs have already invited many confusing judicial decisions. As the presence of currency becomes more and more virtual, the traditional thinking that a bank account has a physical location may have to be abandoned as unnecessary and misleading. The world seems to continue to suffer from the residue of the territoriality based traditional jurisprudencial thinking. This is also a hotly debated issue in relation to pledging of securities kept in registers by Euroclear.
The present tendency for national currencies to lose their important function at each of their home countries and the consequent decline of the home currency rule in courts seem to have already reduced the importance of posing the question of whether foreign currencies are commodities. Today national currencies themselves are speculated on in exchange markets as if they were commodities together with securities. Governments accordingly intervene in the markets by selling or purchasing their own currencies in an endless game with banks, dealers, and speculators. This occurred as the legal tender rule and the accompanying nominalism have become less meaningful.
In the transactional law sphere, this state of affairs constantly calls for a new analysis of the relationship between the manner of calculating damages resulting from the breach of a monetary obligation, the currency to be used for the measurement, and its conversion date.
The Principles of European Contract Law simply indicate that “[d]amages are to be measured by the currency which most appropriately reflects the aggrieved party’s loss” (art. 9:510). The UNIDROIT Principles of International Commercial Contracts states that “[d]amages are to be assessed either in the currency in which the monetary obligation was expressed or in the currency in which the harm was suffered, whichever is more appropriate” (art. 7.4.12). Thus, the courts will continue to be confused. The court nevertheless has to maneuver under traditional legal formulae one way or another influenced by the residue of nominalism. They are not to be blamed because the courts have no jurisdiction to speak out on the appropriateness of the monetary system itself.
The prevalence of “account settlements” also makes obsolete the traditional meaning of the “legal tender” rule since the credit and debit of an account need no longer be in any national currency unit. Moreover, as the account settlements in the fund transfers in multi-country locations increase and as shifting the location of financial activities from one jurisdiction to another becomes easier, traditional money aggregates have lost information value to national monetary authorities. This phenomenon also has implications for the control of liquidity, a traditional concern of central banks. This challenge is further strengthened by the increase in the number of countries that honor “a foreign currency clause” in purely domestic contractual arrangements.
If we are really committed to the healthy development of the globalization of the economy, one of the first enquiries we have to make is how to reestablish a reliable measure of monetary value. This can start with a serious reexamination about the raison d'etre of each national currency perhaps before concentrating on “dollarization or not.”