Abstract

“The Fund Agreement in the Courts” is the title of a series of publications by Sir Joseph Gold, who was General Counsel of the Fund until 1979 and is now a Senior Consultant to the Fund. The main theme of these publications is the recognition or nonrecognition of foreign exchange controls by domestic courts. This theme is now gaining a new momentum because of the debt crisis and will be the subject of these remarks.

“The Fund Agreement in the Courts” is the title of a series of publications by Sir Joseph Gold, who was General Counsel of the Fund until 1979 and is now a Senior Consultant to the Fund. The main theme of these publications is the recognition or nonrecognition of foreign exchange controls by domestic courts. This theme is now gaining a new momentum because of the debt crisis and will be the subject of these remarks.

I

At the end of World War II, when the Fund was established, most, if not all, countries maintained some form of exchange controls. Those controls were regarded as harmful to the growth of international trade and services. Therefore, one of the purposes of the Fund, set forth in Article I of its Articles of Agreement, is “(iv) To assist in the establishment of a multilateral system of payments in respect of current transactions between members and in the elimination of foreign exchange restrictions which hamper the growth of world trade.” In this respect, a fundamental distinction is made, in the Fund’s Articles, between controls on capital transfers and restrictions on the making of payments and transfers for current international transactions. The relevant provisions are Article VI, Section 3 and Article VIII, Section 2(a).

Article VI, Section 3 provides:

Section 3. Controls of capital transfers

Members may exercise such controls as are necessary to regulate international capital movements, but no member may exercise these controls in a manner which will restrict payments for current transactions or which will unduly delay transfers of funds in settlement of commitments, except as provided in Article VII, Section 3(b) and in Article XIV, Section 2. Article VIII, Section 2(a) reads as follows:

Section 2. Avoidance of restrictions on current payments

(a) Subject to the provisions of Article VII, Section 3(b) and Article XIV, Section 2, no member shall, without the approval of the Fund, impose restrictions on the making of payments and transfers for current international transactions.

The language of Article VIII, Section 2(a) is very explicit. It establishes a principle and some exceptions. The principle is that a member of the Fund is not allowed to impose restrictions on the making of payments and transfers for current international transactions. The concept of payments for current transactions is defined rather broadly in Article XXX(d), and the Fund has the power to determine whether specific transactions are or are not current for purposes of the Articles.

Article XXX(d) provides that

Payments for current transactions means payments which are not for the purpose of transferring capital, and includes, without limitation:

  • (1) all payments due in connection with foreign trade, other current business, including services, and normal short-term banking and credit facilities;

  • (2) payments due as interest on loans and as net income from other investments;

  • (3) payments of moderate amount for amortization of loans or for depreciation of direct investments; and

  • (4) moderate remittances for family living expenses.

The Fund may, after consultation with the members concerned, determine whether certain specific transactions are to be considered current transactions or capital transactions.

Given the principle in Article VIII, Section 2(a), the imposition of restrictions on the making of payments or transfers for current international transactions (referred to as “exchange restrictions”) is normally a breach of obligation under the Articles, and may give rise to sanctions under Article XXVI, Section 2, as would any other breach of obligation under the Articles.

However, there are exceptions to this principle. In some cases members are authorized, by the Articles themselves, to restrict current international payments. The most important provision in this respect is Article XIV, Section 2,1 which authorizes a member to notify the Fund of its intention to “maintain and adapt to changing circumstances the restrictions on payments and transfers for current international transactions that were in effect on the date on which it became a member.” On the basis of this provision, a distinction is made between the maintenance or adaptation of existing restrictions, and the imposition of new restrictions. The latter is subject to the prohibition in Article VIII, Section 2(a). Moreover, a member may renounce the benefit of Article XIV by expressly accepting the obligations of Article VIII. In that case, existing restrictions must be terminated.

The other, and even more important, exception to the prohibition of exchange restrictions in Article VIII, Section 2(a) is the power of the Fund to approve a restriction. Once approved, an exchange restriction is not a breach of obligation, at least for as long as the approval remains in effect. The Fund’s normal practice is to approve restrictions for a specified period. When the period ends, the approval lapses, unless it is renewed by the Fund. The Fund’s approval is normally explicit and takes the form of a decision adopted by the Executive Board. However, in the case of restrictions imposed for security reasons, a different procedure has been established: the member imposing the restriction must notify the Fund, and unless the Fund objects within 30 days, the restriction is deemed approved by the Fund. Under this special procedure, there is no fixed period of approval. However, the Fund may, at any time, terminate the approval.

In summary, not all exchange restrictions are a breach of obligation under the Fund’s Articles. If a member maintains or adapts a restriction under the transitional arrangements of Article XIV, or if the restriction is approved by the Fund under Article VIII, Section 2(a), there is no breach of obligation by the member.

It should also be noted that certain exchange control measures do not fall under the prohibition of Article VIII, Section 2(a): controls on capital transfers, on the one hand, as indicated above, and, on the other hand, measures that affect current payments without restricting the making of the payments. Examples of such measures, which are not prohibited by the Articles, are the verification that a payment is a genuine payment for a current international transaction (for instance, where an importer must show that there will be an actual shipment of goods from abroad), and a surrender requirement imposed on holders of foreign exchange (for instance, where an exporter must sell his foreign exchange earnings, within a given period of time, to the central bank of his country of residence).

There are many cases, therefore, where an exchange control measure is not prohibited by the Fund’s Articles. Those measures are intended to have an effect on private parties. Under the laws of the enacting state, those measures will be given effect. For instance, criminal sanctions will be imposed or contracts will be annulled or otherwise denied legal effects. The courts of the countries imposing those exchange controls will apply their own laws, including the sanctions they prescribe, when those laws are applicable, but a more difficult question is whether, and to what extent, the courts of other countries will recognize and enforce those foreign laws, at least in their civil sanctions, leaving aside the criminal sanctions, which are normally not enforced by foreign courts. For example, will a domestic court annul or refuse to enforce a contract on the grounds that it is contrary to the exchange control laws of another country?

In order to find the answer to this question, one must turn both to the general rules of conflict of laws of the forum and to existing international treaties, it being understood that the general rules do not apply when a particular treaty governs the matter.

II

Starting with the general rules of conflict of laws, it is obvious that there is no uniform answer to the question of the recognition of exchange controls of foreign countries by domestic courts.

A number of systems are conceivable, with two extremes and a few intermediate approaches.

One extreme system is to deny any effect to any foreign law imposing exchange control measures, on the grounds that they are “public laws” or contrary to the public policy (ordre public) of the forum. Examples of this approach can be found in decisions of different national courts. It seems to be the position of courts in Switzerland and the Federal Republic of Germany.

Another extreme system, which seems to be rather theoretical, would be to recognize any foreign law whenever it declares itself applicable to the case at hand. There does not seem to be much support for this type of unlimited universal effect of foreign laws.

In between the two extremes, there is ample room for intermediate approaches. Various distinctions may be envisaged in the recognition of foreign exchange controls. Those distinctions can be used separately or cumulatively. Without even attempting to be exhaustive, at least three distinctions may be made.

The first distinction that comes to mind, at least to a lawyer’s mind, is the distinction between the law governing the making or performance of the contract and other laws. If, for instance, the exchange control provisions are part of the lex contractus or of the lex loci solutionis, they should be given effect; if they are not, they will not be given effect. Examples of this approach can be found in France, the United States, the United Kingdom, the Netherlands, etc. In those countries, the so-called public law nature of exchange control laws does not preclude their application between private parties. There is always the possibility, however, that a particularly offensive foreign law be declared inapplicable because it is repugnant to the public policy (ordre public) of the forum, but this would be only in exceptional cases.

A second distinction is between the laws the judge must apply because they govern the contract, and the laws he may take into consideration because of their mandatory nature (lois de police) and in view of all the circumstances of the case. It is the system of the famous Article 7 of the 1980 Rome Convention on the law governing contractual obligations. Not all countries, however, favor this discretionary recognition of foreign laws by the forum. We understand that the Federal Republic of Germany, when ratifying the Convention, did not incorporate this Article 7.

A third distinction is between foreign laws that are consistent with international treaties and foreign laws that are inconsistent with such treaties. It is found in many countries, including the United States (under the act of state doctrine). It is not always effectively applied, however, because lawyers and judges are not fully familiar with international treaties. For instance, when, in a civil case, a party argues that a contract is contrary to the exchange control law of a member of the Fund (other than the country of the forum), the question of consistency of the foreign law with the Fund’s Articles could be raised by the other party. The Fund would be prepared to answer such a question, but it is often not asked by the parties or the court, and the case is decided as if the issue of consistency of the foreign law with the Fund’s Articles had not even arisen. The question of consistency with international treaties is not limited to the Fund’s Articles. It arises also in the context of bilateral treaties or regional treaties, such as the Treaty of the European Economic Community, which, however, incorporates a special procedure for the determination of consistency of a member’s law with the Treaty (Article 177).

Recourse to conflict of laws principles for the recognition of exchange control laws of other countries can be illustrated with many cases from different countries. Perhaps one of the most recent and interesting cases is the decision of the Queen’s Bench Division (per Staughton, J.) in the case of the Libyan Foreign Arab Bank v. Bankers Trust Company2 (2 September 1987). The Libyan bank had opened an account with the London branch of Bankers Trust (a U.S. corporation whose head office is in New York). After the U.S. President’s Executive Order of January 8, 1986 freezing official Libyan assets, the London branch of Bankers Trust refused to comply with withdrawal instructions given by the Libyan bank. As a defense, Bankers Trust invoked the Executive Order, which applied to overseas branches of U.S. banks. Moreover, the account, which was denominated in U.S. dollars, was managed through transactions in New York. The British court held, however, that payment was due to the Libyan bank, on the grounds that English law was applicable to the account maintained with the London branch. Even if payment could not be made through the U.S. clearing system because of U.S. legislation, other means of payment could be found, according to the decision, in order to discharge Bankers Trust’s debt to the Libyan bank, such as payment in cash (dollars or sterling) or clearing outside the United States.

Leaving aside the rather complex discussion of the factual relations between the parties, the most interesting aspect of the decision is its strict reliance on the conflict rules of the lex fori—that is, English law. The principle was enunciated as follows:

Performance of a contract is excused if (i) it has become illegal by the proper law of the contract, or (ii) it necessarily involves doing an act which is unlawful by the law of the place where the act has to be done.

The judge found that English law was the law of the contract, because “[a]s a general rule the contract between a branch and its customer is governed by the law of the place where the account is kept, in the absence of agreement to the contrary.” As for the performance of illegal acts, the judge found that there was no provision under U.S. law prohibiting Bankers Trust from shipping dollars to its London branch where payment would be made, under English law, to the depositor and that U.S. law could not govern the discharge of Bankers Trust’s debt to the Libyan bank outside of the United States.

According to the decision, therefore, two laws are relevant to such cases: the lex contractus and the lex loci solutionis. It may be noted that, in accordance with English conflict rules, the court was prepared to recognize the effect of laws enacted after the making of the contract if they purported to apply to existing contracts. In other words, there is no vested right of the parties to the non-application of subsequent laws. This rule is particularly important in the field of exchange controls, where new laws often apply to the future performance of existing contracts, thus frustrating the expectations of the parties for reasons of public interest.

The conflict of laws approach exemplified by the Bankers Trust case rests essentially on the premise that the role of a judge is to arbitrate disputes between private parties. There is a striking difference, in this respect, with the system in which the forum refuses to enforce foreign public laws, because in so doing the judge would become an agent of a foreign government. The distinction is attenuated, however, in the conflict of laws approach by the refusal to enforce foreign.laws contrary to the public policy (ordre public) of the forum.

In some legal systems, the importance of the public policy of the forum becomes so important as to obfuscate the application of conflict rules. This trend is particularly clear in the United States, where the solution of conflict of laws problems is often based on a balancing of the respective interests of the foreign state and the forum, on a case-by-case approach, rather than on abstract conflict rules of general application.

For instance, in Zeevi v. Grindlays Bank (Uganda) Ltd.,3 (June 16, 1975), the Court of Appeals of New York denied any effect to an exchange control law of Uganda, on the grounds in particular that

New York has an overriding and paramount interest in the outcome of this litigation. It is a financial capital of the world.... In order to maintain its preeminent financial position, it is important that the justified expectations of the parties to the contract be protected. Since New York has the greatest interest and is most intimately concerned with the outcome of this litigation, its laws should be accorded paramount control over the legal issues presented.

When determining the public policy of the forum, a U.S. court will pay particular attention to the acts of the executive and legislative branches of the federal government. It may even be willing to reverse a prior decision if it is demonstrated to its satisfaction that its own assessment of U.S. public policy is incorrect. For example, in Allied Bank International v. Banco Crédito Agricola de Cártago et al.,4 the U.S. Court of Appeals for the Second Circuit had, in a first decision, dismissed the creditor bank’s claims against Costa Rican debtors on the grounds that the Costa Rican exchange control laws were consistent with the law and policy of the United States; even if those laws affected claims within the United States—which excluded the application of the act of state doctrine—they had to be given effect for reasons of international comity (decision of April 23, 1984). Then the plaintiff (Allied Bank) filed for a rehearing of the case, and the U.S. Department of Justice submitted a brief as amicus curiae, arguing that the first decision was “based on a misunderstanding of the policy of the United States.” On rehearing, the Court reversed its earlier decision and gave judgment for the plaintiff (March 18, 1985).

Obviously, the solutions to the conflict of laws problems raised by exchange controls are far from uniform. This lack of uniformity may be unsatisfactory, but it is the usual consequence of the principle that conflicts of laws are resolved in accordance with the conflict rules of the lex fori. What is more surprising and less acceptable is that even where a treaty attempts to unify solutions with respect to the recognition of exchange controls, different interpretations of the treaty may result in a non-uniform application of the same provision. This is, however, the present unfortunate state of affairs with respect to the provision of the Fund’s Articles of Agreement that deals with the recognition of exchange control laws of members by the courts of other members.

III

At the Bretton Woods Conference of 1944, when the Fund’s Articles of Agreement were adopted, it was recognized that exchange controls could, within certain limits and in certain circumstances, contribute to the temporary solution of a member’s balance of payments problem. Restrictions on capital transfers were left to the sovereign decisions of members. Even restrictions on current payments could, it was believed, be a lesser evil than a protracted balance of payments disequilibrium. Moreover, recourse to those restrictions could limit the use of the Fund’s resources by members confronted with balance of payments problems. The Fund is a cooperative institution designed to help its members, but its resources are made up of taxpayers’ money and are not unlimited: hence the desire to find other—even distasteful—remedies to limit the amount of financial assistance from the Fund.

The problem of the recognition of exchange control laws was considered in that context at Bretton Woods. Various proposals were made, some relating to capital transfers, others to the maintenance of exchange rates within official margins. Eventually a compromise provision was adopted and was inserted in the Fund’s Articles of Agreement—almost paradoxically—immediately after the provision prohibiting restrictions on current payments.

This provision, which has given rise to an abundant legal literature but remains the subject of endless controversies, is Article VIII, Section 2(b):

Exchange contracts which involve the currency of any member and which are contrary to the exchange control regulations of that member maintained or imposed consistently with this Agreement shall be unenforceable in the territories of any member. In addition, members may, by mutual accord, cooperate in measures for the purpose of making the exchange control regulations of either member more effective, provided that such measures and regulations are consis-tent with this Agreement.

Only the first sentence is relevant to the present discussion. Read literally, it imposes an obligation on members: they must take the necessary steps, under their respective domestic laws, to give effect to the obligation prescribed in Article VIII, Section 2(b). For example, in countries where an international treaty has no direct effect in domestic law and is not binding on a judge, appropriate legislation must be passed to ensure the effective application of the provision by the courts. This is usually done, if necessary, when a country joins the Fund as a new member, and the obligation is set out as part of the membership legislation.

Article VIII, Section 2(b), by its own terms, is not a conflict rule. It does not designate a particular law as being applicable by the court. It does not designate the law governing the contract. All it does is require the court not to enforce a contract when the conditions prescribed by the provision are met. It is a substantive rule of private international law, with its own scope and sanction.

As early as 1949, the Fund realized that insufficient attention had been paid to this important new provision of international law, perhaps because it was rather unexpected for the charter of an international organization to contain a rule of private international law, perhaps also because the meaning of the provision was rather unclear. For instance, the concept of “unenforceability,” which is familiar to common law systems, has no precise equivalent in civil law systems, although it is not entirely unknown (“natural obligation,” gambling contracts, “prescription” of a right). Unenforceability is not a synonym for nullity: a valid contract may be unenforceable, in the sense that no judicial or other remedy will be available for its nonperformance.

To clarify the meaning of Article VIII, Section 2(b), the Fund adopted an interpretative decision on June 10, 1949.5 The decision was adopted under a provision (Article XVIII, now Article XXIX) which confers upon the Fund the power to interpret its own Articles; those interpretations, which are decisions of the Fund, are binding on all members. The decision explained the scope and meaning of the unenforceability of contracts in Article VIII, Section 2(b): when the conditions specified in the provision are met, a court may not order the performance of the contract or award damages for its nonperformance. The decision also stated that Article VIII, Section 2(b) applied regardless of the law governing the contract or its performance, and that the recognition of a member’s exchange control regulations could not be denied on the ground that they were contrary to the public policy (ordre public) of the forum, if they were consistent with the Fund’s Articles.

The decision ended with the following two sentences:

The Fund will be pleased to lend its assistance in connection with any problem which may arise in relation to the foregoing interpretation or any other aspect of Article VIII, Section 2(b). In addition, the Fund is prepared to advise whether particular exchange control regulations are maintained or imposed consistently with the Fund Agreement.

The first sentence means that the Fund was prepared to provide further clarification, upon request, of the meaning of Article VIII, Section 2(b). It has not been implemented, however, because no such request has been made.

The second sentence is an invitation to inquire about the consistency of exchange control regulations with the Articles. Over the years, many inquiries have been received in connection with cases pending before the courts of member countries. They have always been answered by the Fund.

The 1949 interpretation has left unanswered a number of questions of interpretation. With the benefit of hindsight, although one may deplore the incompleteness of the decision, it must be concluded that it was probably wise not to try to answer those questions at an early stage. Law develops in mysterious ways, and the price to be paid for its growth is uncertainty and confusion, at least for a while. At a certain point, however, confusion must come to an end, lest the concept of law itself disappear.

There is already so much literature on the meaning of Article VIII, Section 2(b) that attempting even to summarize it would be futile. Only a few salient points can be mentioned.

Probably the most controversial issue is the meaning of “exchange contracts.” According to many commentators, an exchange contract can only be a contract for the exchange of currencies. This so-called literal interpretation has been adopted by the courts of the United Kingdom and the majority of U.S. courts. Yet everybody recognizes that in “exchange control regulations,” the term exchange has a much broader meaning. Similarly, the expression “foreign exchange” does not mean an exchange of currencies abroad, but rather foreign currency. The term “exchange,” therefore, has several meanings, only one of which is an exchange of currencies. Another meaning is currency in an international context. On that basis, other commentators have proposed a broader interpretation of the concept of exchange contracts which would include all contracts involving international payments or transfers and domestic contracts payable in foreign exchange: sales, loans, deposits, etc. It has even been suggested that an exchange contract is a contract affecting the foreign exchange resources of a country, including a baiter of goods or services, even if no monetary obligation was created by the contract. This very broad—probably too broad—interpretation has been adopted by courts in France and the Federal Republic of Germany. The result of those different interpretations is that whereas Article VIII, Section 2(b) is of practically no effect in British and U.S. courts (for instance, its application was not even considered in the recent Bankers Trust case discussed above), the same provision is often applied in other countries, particularly in Germany. The contrast is particularly striking as the principle in German law, outside the scope of Article VIII, Section 2(b), seems to remain the nonrecognition of foreign exchange control laws.

A second issue is the meaning of “involving the currency” of a member. Those who believe that an exchange contract is an exchange of currencies conclude that the currencies involved are those that are the subject matter of the exchange. There is a slight problem, however, in that the provision speaks of the currency involved in the singular, while an exchange of currencies necessarily involves two currencies. Those who support a broader interpretation of exchange contract usually agree that the term currency does not only designate the currency of payment, because a payment in foreign currency has an even more immediate effect on a member’s exchange resources than a payment in domestic currency. Those commentators, and the courts that endorse their opinion, conclude that a member’s currency is involved when the member’s exchange resources are affected by the contract. Then the question becomes: When are a member’s exchange resources affected by a contract? Different tests have been proposed: payment from assets within a member’s territory, payment by or to a resident of the member, and transaction affecting the member’s balance of payments. The balance of payments test itself is not always clear, because it may refer either to an accounting system, which is neither uniform nor immutable, or to the underlying transactions, which may or may not be captured by the accounting system. In other words, the purposes of the balance of payments statistics are not necessarily the same as those of exchange control regulations: some operations may be recorded purely for purposes of information or may be left out simply because their recording would be too cumbersome. This does not mean that the former would affect a member’s exchange resources, or that the latter would not.

A third question is the meaning of “exchange control regulations.” Does this concept include only the restrictions on current payments referred to in Article VIII, Section 2(a), which are subject to approval by the Fund? Does it also include restrictions maintained under Article XIV on current payments, exchange measures that are not restrictions, and even restrictions on capital transfers maintained under Article VI, Section 3? The use of different terms in two successive provisions (Article VIII, Section 2(a) and (b)) implies that the concepts are not identical, and “regulations” is a broader concept than “restrictions.” Moreover, the terms “maintained or imposed consistently with” the Articles in Section 2(b) confirm that not only restrictions “imposed” under Section 2(a) come within the scope of the provision. Some commentators have argued that measures imposed for reasons other than the protection of a member’s exchange resources, such as freezing orders of enemy property, are not exchange control regulations within the meaning of Article VIII, Section 2(b). There is no doubt, however, that these exchange restrictions are within the jurisdiction of the Fund and subject to approval under Article VIII, Section 2(a).

A fourth question is whether a court should recognize the exchange control regulations that were in force when the contract was entered into or the regulations in force at the time of the proceedings. Both opinions have been advocated: the first one on the ground that the parties that had entered into a lawful contract could not later be deprived of their rights by a supervening regulation, the second one on the ground that the paramount interest of a member should take precedence over those of private parties. Moreover, under the second analysis, if the regulation is abrogated or ceases to be consistent with the Fund’s Articles between the making of the contract and the judgement of the court, Article VIII, Section 2(b) will not apply.

These are at least some of the basic questions that have agitated scholars, puzzled their readers, and been differently answered by the courts of member countries.

As long as the general trend was toward the gradual elimination of exchange controls because of the improvement in members’ balances of payments, it could be expected that those questions would disappear before being answered. Now that the debt problem has taken on the proportions we know and may even worsen, recourse to exchange controls may be a better solution than the accumulation of arrears.

Therefore, these questions have emerged again and will have to be answered if exchange controls become an instrument for the solution of the debt problem. The Fund’s staff has given some thought to the matter and recently expressed some views on the meaning of Article VIII, Section 2(b). Those views will be presented by Mr. Pierre Francotte.

APPENDIX Article VIII, Section 2(b)

Unenforceability of Exchange Contracts

Unenforceability of Exchange Contracts: Fund’s Interpretation of Article VIII, Section 2(b)

The following letter shall be sent to all members:

The Board of Executive Directors of the International Monetary Fund has interpreted, under Article XVIII6 of the Articles of Agreement, the first sentence of Article VIII, Section 2(b), which provision reads as follows:

Exchange contracts which involve the currency of any member and which are contrary to the exchange control regulations of that member maintained or imposed consistently with this Agreement shall be unenforceable in the territories of any member.

The meaning and effect of this provision are as follows:

1. Parties entering into exchange contracts involving the currency of any member of the Fund and contrary to exchange control regulations of that member which are maintained or imposed consistently with the Fund Agreement will not receive the assistance of the judicial or administrative authorities of other members in obtaining the performance of such contracts. That is to say, the obligations of such contracts will not be implemented by the judicial or administrative authorities of member countries, for example by decreeing performance of the contracts or by awarding damages for their nonperformance.

2. By accepting the Fund Agreement members have undertaken to make the principle mentioned above effectively part of their national law. This applied to all members, whether or not they have availed themselves of the transitional arrangements of Article XIV, Section 2.

An obvious result of the foregoing undertaking is that if a party to an exchange contract of the kind referred to in Article VIII, Section 2(b) seeks to enforce such a contract, the tribunal of the member country before which the proceedings are brought will not, on the ground that they are contrary to the public policy (ordre public) of the forum, refuse recognition of the exchange control regulations of the other member which are maintained or imposed consistently with the Fund Agreement. It also follows that such contracts will be treated as unenforceable notwithstanding that under the private international law of the forum, the law under which the foreign exchange control regulations are maintained or imposed is not the law which governs the exchange contract or its performance.

The Fund will be pleased to lend its assistance in connection with any problem which may arise in relation to the foregoing interpretation or any other aspect of Article VIII, Section 2(b). In addition, the Fund is prepared to advise whether particular exchange control regulations are maintained or imposed consistently with the Fund Agreement.

Decision No. 446-4

June 10, 1949

COMMENT

PIERRE FRANCOTTE

I. Introduction

Article VIII, Section 2(b) of the Fund’s Articles of Agreement provides that “[e]xchange contracts which involve the currency of any member and which are contrary to the exchange control regulations of that member maintained or imposed consistently with this Agreement shall be unenforceable in the territories of any member.”

The preceding paper focused on the main interpretations of various aspects of Article VIII, Section 2(b) that have been proposed by legal scholars or applied by the domestic courts of countries that are members of the Fund. In my presentation, I would like to summarize the main elements of the interpretation that would be favored by the Fund staff and to point out the potential effects of such an interpretation on the problem of developing country debt. Indeed, Article VIII, Section 2(b) could have a significant impact on litigation involving defaults under international loans, such as those made by commercial banks to developing countries. Specifically, when a debtor fails to pay its foreign creditors because of the exchange controls of a member country, Article VIII, Section 2(b) may, in some circumstances, prevent the enforcement of the creditors’ claims in court. Whether Article VIII, Section 2(b) will affect the outcome of the litigation depends, in particular, on the following:

(1) whether the interpretation given to Article VIII, Section 2(b) by the court before which the creditor has filed his lawsuit and, in particular, whether that court interprets the terms “exchange contract” as including loan contracts; and

(2) the consistency or inconsistency of the exchange controls with the Articles of the Fund. If the exchange controls are not consistent with the Articles, they are not protected by Article VIII, Section 2(b), and the court will not be obliged to declare the loan unenforceable under that provision. If the exchange controls are consistent with the Fund’s Articles, Article VIII, Section 2(b) is apt to apply (if the other conditions for its application are met) and the court may be compelled to declare the loan unenforceable.

The potential impact of an interpretation of Article VIII, Section 2(b) such as the one favored by the Fund staff would depend on its application by the courts of countries that are Fund members. In this connection, it is important to note that the existing lack of uniformity of interpretation among the courts could be remedied through the adoption by the Fund of an authoritative interpretation of Article VIII, Section 2(b).

Accordingly, in the following sections of this paper, I will discuss the need for broader uniformity of interpretation of Article VIII, Section 2(b) by the courts and the potential role of an authoritative interpretation by the Fund in this respect (Section II); I will present the main elements of the Fund staff’s interpretation of that provision (Section III); and I will briefly explain the role of the Fund’s power to approve exchange restrictions in this respect (Section IV), before offering some brief concluding remarks (Section V).

II. Uniformity of Interpretations by Courts and Authoritative Interpretation by the Fund

The purpose of an interpretation of Article VIII, Section 2(b) by the Fund would be to remedy the existing lack of uniformity in the interpretation of the provision by the courts of Fund members. An interpretation by the Fund could be expected to achieve a large measure of uniformity among members’ courts, because it would be binding on all members, including their courts. This follows from the Fund’s power under its charter (Article XXIX(a)) to make authoritative interpretations of its Articles. The Fund has adopted such authoritative interpretations several times in the past, including an interpretation of some aspects of Article VIII, Section 2(b) in 1949. This interpretation did not attempt, however, to clarify the meaning of some other important elements of the provision, such as the concept of “exchange contract.”

Uniformity of interpretation would be desirable, because the existing disparity has, one way or another, an adverse effect on not only the members that give effect to other members’ exchange controls pursuant to Article VIII, Section 2(b) but also the members that resort to such exchange controls and the Fund itself.

(1) The lack of uniformity is obviously not beneficial to the members whose courts apply a broad interpretation of Article VIII, Section 2(b). Indeed, these countries carry a greater share of the burden associated with the obligation under Article VIII, Section 2(b) than the countries where a narrow interpretation is applied, because the former give effect to foreign exchange controls pursuant to Article VIII, Section 2(b) in cases where the latter do not. On the contrary, the lack of uniformity operates to the advantage of the countries where a narrow interpretation prevails, but such a situation is unlikely to continue indefinitely, particularly if Article VIII, Section 2(b) becomes more of a factor than it has been so far in litigation involving international loans. If this happens, the burden associated with the obligation under Article VIII, Section 2(b) would become more concrete for the countries that apply a broad interpretation, with the result that they might be tempted to switch to a narrow interpretation or, worse, to apply a two-tier approach: a broad interpretation in favor of the exchange controls of the countries that, like them, apply a broad interpretation, and a narrow interpretation with respect to the exchange controls of the countries that apply a narrow interpretation. Arguably, such a turn of events would be to the disadvantage of the countries that applied a narrow interpretation.

(2) The existing lack of uniformity also creates problems for the countries that need to resort to exchange controls, because it undermines the efficiency of these exchange controls abroad. As a result, these countries may, in order to achieve the desired effect, make these exchange controls more restrictive overall than they would otherwise have been. All parties would suffer from this, as the multilateral system of payments would become more restrictive, or at least more controlled, than it needed to be.

(3) Finally, the disparate interpretations of Article VIII, Section 2(b) by domestic courts are obviously not to the Fund’s benefit, if only because it undermines the Fund’s standing to have each country decide for itself what the scope of its obligation under Article VIII, Section 2(b) is. Article VIII, Section 2(b) was never meant to be interpreted in such different ways by different members.

All these considerations point to the need for a uniform interpretation by members, and only an authoritative interpretation by the Fund can be expected to produce that result.

III. The Main Elements of the Interpretation of Article VIII, Section 2(b) by the Fund’s Staff

Exchange Control Regulations

Under Article VIII, Section 2(b) only regulations that constitute “exchange control regulations” are protected by Article VIII, Section 2(b). The staff defines “exchange control regulations” as regulations pertaining to the acquisition, holding, or use of foreign exchange AS such, or to the use of domestic or foreign currency in international payments or transfers as such. This definition of exchange control regulations is very much in line with what most central bankers would consider to be exchange control regulations for their own purposes. It recognizes, for instance, that not every regulation that somehow affects payments in some indirect way should be regarded as an exchange control. Thus, while an import quota has an effect on external payments, in the sense that it constrains the amount of imports that must be paid for, it is regarded as a trade restriction, not as an exchange control. While it will generally be rather clear whether a given regulation is an exchange control regulation or not, there are some cases where a close analysis is necessary, as the following examples show.

Exchange Controls Imposed for Security Reasons

Occasionally, countries control payments for what can be called security reasons—for example, through freezes of assets or so-called “trade with the enemy” regulations. The question arises whether these controls cease to be protected by Article VIII, Section 2(b) on the grounds they are motivated by security reasons and not by balance of payments or similar reasons. The answer, in the opinion of the Fund staff, is that these controls do not cease to be protected by Article VIII, Section 2(b) because they were imposed for security reasons. The definition of exchange control regulations set forth above is not based on the motives for the regulations, which are often difficult to ascertain, but on their effects. This is the approach that the Fund takes with respect to exchange restrictions (which are a subgroup of exchange control regulations). Under Article VIII, Section 2(a), exchange restrictions may not be imposed by a member without the approval of the Fund, and the Fund made it clear as early as 1952 that even exchange restrictions imposed for security reasons are subject to the Fund’s approval. (The same decision of 1952 set out a special procedure for the approval of these restrictions.)

Therefore, under this definition of exchange control regulations, exchange controls imposed for security reasons are protected by Article VIII, Section 2(b) under the same conditions as any other exchange controls.

Governmental Arrears

The question of whether a measure constitutes an exchange control may arise also with respect to payments defaults by governments. There may be a variety of reasons why a debtor, public or private, fails to pay its foreign creditors. Sometimes a debtor cannot pay its foreign debts because its government rations foreign exchange or even prohibits the payment of foreign debts. In those cases, the debtor’s arrears are due to exchange controls. As a consequence, Article VIII, Section 2(b) would be relevant. In other cases, the debtor may be unwilling to repay one of its creditors, for instance because it disputes the creditor’s claim, or it may be unable to pay because it lacks the resources to buy the necessary foreign exchange. In those cases, the arrears are not due to any exchange controls of the government, but rather to the debtor’s own decision or situation; accordingly, Article VIII, Section 2(b) would be of no help to the debtor.

The question of whether or not a default results from an exchange control becomes more complicated when the debtor is the government, because, in that case, the debtor is also the potential regulator. The Fund has had to deal with a related question, namely, whether these sovereign defaults constitute exchange restrictions under Article VIII, Section 2(a), and it has concluded that governments’ defaults are not exchange restrictions. Accordingly, nonpayments by governments of their own debts are not subject to the Fund’s approval, nor can they be approved by the Fund. The rationale for this analysis is that Article VIII, Section 2(a), which provides that a member may not “impose” exchange restrictions, assumes two entities: the government that imposes the restriction and another entity (for instance, a private corporation or a public enterprise) on which the restriction is imposed. Therefore, a government could not properly be regarded as “imposing an exchange restriction” on itself under Article VIII, Section 2(a). In line with this reasoning, the staff’s understanding is that governmental nonpayments of debt are not exchange control regulations: a government could not be regarded as “imposing exchange control regulations” on itself for purposes of Article VIII, Section 2(b) any more than it could be regarded as imposing exchange restrictions on itself for purposes of Article VIII, Section 2(a).

This means that a government that fails to pay its foreign creditors cannot invoke Article VIII, Section 2(b). It does not mean, however, that Article VIII, Section 2(b) is automatically irrelevant to sovereign debts. For instance, if the government, rather than not paying the debt at all, pays its creditors on an account in its own territory and then blocks the transfer of the balances from this account, this would not be a case of nonpayment (which would not be an exchange control), but one of a blocking of transfers by the creditors after payment was made (which would be an exchange control). In such an instance, therefore, Article VIII, Section 2(b) could be invoked by the debtor government, provided, of course, that all the other conditions for the application of Article VIII, Section 2(b) are also met.

Exchange Contracts

According to Article VIII, Section 2(b), only the contracts that can be characterized as “exchange contracts” must be declared unenforceable by the courts.

It is on the meaning of exchange contract that domestic courts differ the most. The courts of some countries follow a narrow interpretation of exchange contract: only contracts of exchange of two currencies are exchange contracts. Under this interpretation, only the exchange controls that deal with exchanges of currencies can possibly benefit from Article VIII, Section 2(b). This is obviously a very small part of all exchange controls, to the point that, under this narrow interpretation, Article VIII, Section 2(b) becomes practically meaningless. In particular, the exchange controls that prohibit or control loan contracts are not protected by Article VIII, Section 2(b). In other countries, the courts consider that any contract that affects the balance of payments of the member is an exchange contract. The test of “affecting the balance of payments” better suits the needs of economists, however, than those of lawyers and courts, because it represents only a statistical reality and not a clear legal criterion. In that sense, the balance of payments test for Article VIII, Section 2(b) is less than fully satisfactory. It seems clear, however, that international loan contracts fall into the category of exchange contracts under that broad interpretation and that, therefore, exchange controls dealing with these contracts may be protected by Article VIII, Section 2(b).

The staff’s interpretation of exchange contracts is not limited to exchanges of currencies, as specified in the narrow interpretation, and it does not use the balance of payments test of the broad interpretation applied by some courts.

Indeed, the staff has come to the conclusion that the interpretation limited to contracts for the exchange of currencies is not consistent with the text of Article VIII, Section 2(b) as interpreted on the basis of established principles of interpretation of treaties. This conclusion is based on the text of Article VIII, Section 2(b) and, in particular, on the meaning of the word “exchange” that appears in both “exchange contracts” and in “exchange control regulations”; on the context in which Article VIII, Section 2(b) appears and, specifically, on the relationship between Article VIII, Section 2(a) and Article VIII, Section 2(b); as well as on the legislative history of the provision including the proposals and discussions that took place at Bretton Woods in 1944. The staff would define an exchange contract as a contract that provides for either a payment or transfer of foreign exchange or an international payment or transfer (i.e., a payment between a resident and a nonresident, or a transfer of funds from one country to another). It follows that any contract that provides for a payment in foreign exchange is automatically an exchange contract even if it is between two residents. In this case, the relevant criterion is the use of foreign exchange for the payment. In addition, any contract that provides for a payment between a resident and a nonresident is also an exchange contract, whether the payment is in foreign exchange or local currency. Under this alternative test, the relevant fact is that the payment is international; it is not important whether it is made in foreign currency or in local currency, because in both cases it must be expected that a conversion in foreign currency will occur. So defined, exchange contracts do include international loan contracts.

Involvement of the Currency

Under the staff’s interpretation of Article VIII, Section 2(b), international loans are exchange contracts, and regulations on payments under these loans are exchange control regulations. This does not mean, however, that any exchange control that regulates any payment of foreign debt is necessarily protected by Article VIII, Section 2(b). The exchange contract is unenforceable under Article VIII, Section 2(b) only if it “involves the currency” of the member imposing the exchange controls. Thus, Article VIII, Section 2(b) requires some kind of “contact” between the country imposing the exchange controls and the contract that these exchange controls purport to regulate. The contact that is required is that the contract “involve” that particular member’s currency.

The meaning of “involvement of the currency” depends on the interpretation given to the terms “exchange contract.” Those who consider that an exchange contract is a contract for the exchange of currencies generally conclude that a member’s currency is involved if it is one of the currencies that are exchanged. In contrast, those who define exchange contracts as contracts affecting the member’s exchange resources generally do not give a separate meaning to the words “involve the currency”: the phrase “exchange contracts which involve the currency of any member” is read as a whole to refer to contracts affecting a member’s balance of payments or exchange resources. This latter interpretation begs the question of which criteria should be used to determine when a member’s balance of payments is affected. As noted above, the balance of payments test is a rather vague criterion, which is apt to be understood differently in different countries, depending perhaps on their accounting practices concerning their balances of payments. Alternative tests could, therefore, be considered.

The Currency of Payment

One possible test would be the currency of payment: a member’s currency would be involved if it were used as the currency of payment under the contract. There are two main problems with this test.

The first is that it would, in practice, limit the benefit of Article VIII, Section 2(b) to the few countries whose currencies were used for international payments (the United States, the Federal Republic of Germany, Japan, etc.). The countries that most need to resort to exchange controls, the developing countries, would practically never be protected by Article VIII, Section 2(b), since their currencies are very rarely used as currencies of payment in international contracts, particularly loan contracts. As a result, if the test of currency of payment were applied, Article VIII, Section 2(b) would provide protection for countries that generally did not need it, because they did not impose exchange controls, and not provide protection for the countries that most needed to resort to such controls.

The other problem is that it would impose on all countries the obligation to give effect to other members’ exchange controls that have effects that could be considered extraterritorial. A country could regulate any payment in its currency, even by a nonresident to another nonresident, and even if it were effected with assets located outside of that member’s territory. The only necessary “contact” required under Article VIII, Section 2(b) would be that this member’s currency was the currency of the contract.

Tests of Residence and Location of Assets

In most countries, exchange controls regulate the transactions that involve their residents or that involve assets located in their territories. These two criteria could be used to define the concept of “involvement of the currency” in Article VIII, Section 2(b). A country’s currency would be involved, and therefore its exchange controls would be protected by Article VIII, Section 2(b), if either

(1) one of the parties to the contract was a resident of that country. For instance, in the case of a loan by a New York commercial bank to an Argentine public enterprise, the currency of the country of the debtor (Argentina) would be involved as well as the currency of the country of the creditor (the United States), or

(2) the contract is to be performed with assets located in that country’s territory. For example, if the loan to the Argentine enterprise by the commercial bank in New York contemplated the making of a payment with assets held by the Argentine debtor on an account of the debtor with a bank in Frankfurt, the currencies of Argentina, the United States, and the Federal Republic of Germany would all be involved for purposes of Article VIII, Section 2(b), and their exchange controls, if any, regulating such loans could all be protected by the provision. In contrast, the currency of payment of the loan would not be relevant to determining whether a member’s currency was involved.

Conditions for Application of Article VIII, Section 2(b)

When must the conditions for the application of Article VIII, Section 2(b) be met: at the time the contract is concluded or at the time the enforcement of the contract is sought from the court? In view of the purpose of Article VIII, Section 2(b), which is to allow some protection, in certain circumstances, to countries that need to impose exchange controls, it seems clear that the conditions should be met when the court is called upon to apply Article VIII, Section 2(b). It is then that the question of the need and justification for protection of the member’s balance of payments is relevant, rather than when the contract was concluded.

It follows that

(1) If a contract was prohibited by a member’s exchange controls when it was concluded, but these exchange controls were removed before the contract was performed, the court should not apply Article VIII, Section 2(b) in favor of these now-extinguished exchange controls. Indeed, the removal of these exchange controls shows that the member country no longer considered them necessary to protect its balance of payments.

(2) If the opposite happened—that is, if the exchange controls were introduced after the contract was concluded but before its performance—the court should apply Article VIII, Section 2(b) in favor of these exchange controls (provided that all the conditions for the application of Article VIII, Section 2(b) were met at that time).

(3) If a contract regulated by the exchange controls of a member country is concluded between a resident of that country and a nonresident, but the resident moves to another country and ceases to be a resident of the country imposing the exchange controls before the performance of the contract, the test of residence of the parties (discussed in the preceding subsection) would cease to be met and the contract would cease to involve that member’s currency on that account. Accordingly, the member country’s exchange controls would not be protected by Article VIII, Section 2(b) (unless the payment were to be made with assets located in that member’s territory, in which case the requirement of “involvement of the currency” would be met under that alternative test).

IV. Approval of Exchange Restrictions by the Fund

It is also at the time the court must apply Article VIII, Section 2(b) that the exchange controls of the country must be consistent with the Fund’s Articles. As I said earlier, some exchange controls, namely those that constitute exchange restrictions in the sense of Article VIII, Section 2(a), may be imposed by a member only if and while they are approved by the Fund.

If a member imposes such exchange restrictions without the approval of the Fund, these restrictions, which are also exchange controls, are not protected by Article VIII, Section 2(b) because they are not consistent with the Fund’s Articles.

The approval of an exchange restriction is given by the Executive Board of the Fund on the basis of certain criteria it has set out: the restriction must be needed for balance of payments reasons; it must be temporary; and it must not discriminate between Fund members. The approval is generally given for a short period (around one year), and it may be renewed.

This means that, at least for those exchange controls that require the Fund’s approval, the Executive Board is able, by giving or withholding approval, to control, on a case-by-case basis, whether Article VIII, Section 2(b) is going to apply in favor of these exchange controls.

The Executive Board’s decision must, of course, not be arbitrary, and all members of the Fund must be treated in a uniform manner. Subject to these requirements, however, the Executive Board may decide in each case whether or not to give approval, in the light, inter alia, of the circumstances of the country imposing the exchange control.

V. Conclusion

Clearly, the staff’s interpretation of Article VIII, Section 2(b) goes beyond the narrow interpretation applied by the courts of some members. This is because this narrow interpretation cannot, in the staff’s view, be reconciled with the text of Article VIII, Section 2(b) as interpreted in accordance with established principles of interpretation. The scope of Article VIII, Section 2(b), as interpreted by the staff is, however, not unlimited. In the context of the debt problem in particular, it should be emphasized that the staff’s interpretation affords substantial safeguards for the international financial community against an unjustified or unrestrained application of Article VIII, Section 2(b), whether they derive from the proposed interpretation of the provision itself or from the power of the Executive Board effectively to decide whether exchange controls that constitute exchange restrictions will be protected by Article VIII, Section 2(b), by approving or not approving them on a case-by-case basis.