Current Legal Issues Affecting Central Banks, Volume I

INTERNATIONAL MONETARY FUND

• Publisher: INTERNATIONAL MONETARY FUND
• Year: 1992
• eBook ISBN: 9781557751423

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Chapter 1 The Fund Agreement in the Courts

FRANÇOIS GIANVITI

“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.

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 automat...

Table of contents

• Cover Page
• Title Page
• Copyright Page
• Contents
• Introduction
• 1 The Fund Agreement in the Courts
• 2 Developing a Market for the Official SDR
• 3 The Role of the BIS in International Monetary Cooperation and Its Tasks Relating to the ECU
• 4 History of the Debt Crisis
• 5 New Proposals for the Debt Crisis
• 6 World Bank Cofinancing and Recent Developments with Respect to the Heavily Indebted Countries
• 7 Roundtable Discussion of the Debt Crisis
• 8 Sovereign Immunity and Central Bank Immunity in the United States
• 9 The Settlement of Disputes Regarding Foreign Investments: The Role of the World Bank, with Particular Reference to ICSID and MIGA
• 10 Deposit Insurance: Current Problems and Proposals
• 11 Commercial Bank Liability Under the Law of the United States for Deposits in Foreign Branches That Are Subject to Expropriation or Exchange Restrictions Imposed by Sovereign Governments
• 12 Banking Secrecy: Coping with Money Laundering in the International Arena
• 13 Deregulation of Banking: A Worldwide Phenomenon
• 14 The Legal Barrier Between U.S. Investment and Commercial Banking: Its Origins, Application, and Prospects
• 15 Stability of Financial Markets: Federal Reserve Responsibility?
• 16 The Basle Concordat: International Collaboration in Banking Supervision
• 17 Risk-Based Assessment of the Capital Adequacy of Commercial Banks
• 18 The Legal Framework for Islamic Banking: Pakistan’s Experience
• 19 Proposed Article 4A of the Uniform Commercial Code
• 20 The Work of the United Nations Commission on International Trade Law in Electronic Funds Transfers
• 21 The Proposed UNCITRAL Convention on International Bills of Exchange and International Promissory Notes
• Appendices
• Notes
• Biographical Sketches
• Footnotes