03 Nov 2009

DOLLAR/DIRHAM DE-PEGGING: A POSSIBLE CONTRACTUAL REMEDY

Authored by: Michael Webb

DOLLAR OR DIRHAM DE-PEGGING: A POSSIBLE CONTRACTUAL REMEDY

Against a background of persistent speculation that the current peg between the US Dollar and the UAE Dirham may be removed or changed, it is worth considering what contractual rights or remedies might be available if this were to occur.

In brief:

  • Under typical sophisticated long-term supply contracts, a removal or amendment of the Dollar/Dirham peg may be capable of amounting to an “event of government action or inaction” (as defined)
  • To the extent that such event of government action or inaction reduces the revenue received by a party, such party may be entitled to claim an adjustment of the payments made to it under the contract so as to maintain its net economic return
  • Any such claim(s) would be subject to procedures set out in the contract, including any de minimis rules.

Introduction
There has, historically, been a fixed exchange rate of 1 US Dollar equalling 3.678 UAE Dirhams. In the event that this fixed exchange rate was removed or amended, the result could have a material adverse effect on a party’s revenue stream flowing from a supply contract where, for example, costs are incurred in one currency and revenue is earned in another.

The Legal Position
Before embarking upon an analysis of typical contractual provisions, it is necessary to establish how, and by whom, the Dollar/Dirham peg would be removed or amended. The starting point is the UAE Constitution which governs legislative, executive and jurisdictional matters between the UAE at a federal level (the Union) and the individual Emirates constituting the Union.

Article 120 (6) and (13) of the Constitution provides, in translation, that:

“The Union shall have exclusive legislative and executive jurisdiction in the following affairs:

(6) Union finance.

(13) Currency board and coinage.

Article 121 of the Constitution provides, in translation, that:

“Without prejudice to the provisions of the preceding Article, the Union shall have exclusive legislative jurisdiction in the following matters: … banks.”

Article 122 of the Constitution gives the individual Emirates jurisdiction in all matters not assigned to the exclusive jurisdiction of the Union by Articles 120 and 121 of the Constitution.

We next turn to Federal Law No. 10 of 1980 which establishes the UAE Central Bank and makes certain provisions in relation to the monetary system and the organisation of banking.

Article 62 provides, in translation, that:

“The official exchange rate of the Dirham shall be determined by federal decree on the proposal of the majority of the Board [of the Bank]…. The said decree shall be considered to be effective from the date on which it is issued.”

The consequence of the above legislative provisions is that any removal or amendment of the Dollar/Dirham peg will be enacted at a Federal level, rather than at the individual Emirate level. This may assume significance, as described later in this article.

Contractual Provisions
Long term supply contracts, such as those common in the power and water industry, typically contain provisions under which relief might be sought by a party in the event of unforeseen circumstances, such as ”force majeure” or “government action or inaction”.

A contract may list a number of circumstances as constituting events of government action or inaction. Such list may be exclusive, or may be qualified by a phrase such as “includes but is not limited to”. One of the common circumstances constituting an event of government action or inaction is a change in law.

However, a typical provision will expressly state that some of the circumstances constituting an event of government action or inaction must result from the action or inaction of a ”governmental instrumentality” of a Government of one of the Emirates, rather than a governmental instrumentality of the federal UAE Government. It would therefore be a matter of contractual construction whether a change in law amounts to an event of government action or inaction if enacted at the federal level, rather than the Emirate level.

As concluded earlier, a removal or amendment of the Dollar/Dirham peg would require a UAE federal decree, issued upon a recommendation of the Board of the UAE Central Bank.  Subject to the wording of individual contractual provisions, such circumstances may amount to a change of law and therefore an event of governmental action or inaction.

A party seeking relief as a result of governmental action or inaction will typically need to establish that, as a result of such governmental action or inaction, it has incurred increased cost.  Cost may typically be defined as follows:

“Cost” means, with respect to any event of government action or inaction, any cost or expense …….. resulting from, or otherwise attributable to, such event of government action or inaction, that is incurred or suffered by [the party] and not otherwise covered by the receipt of insurance proceeds (which costs or expenses may include without limitation (i) capital costs, (ii) financing costs, (iii) costs of operation and maintenance and (iv) costs of axes imposed on or payable by [the party], or (v) reduction in the revenue received by [the party]).”

In the example above, if a removal of the Dollar/Dirham peg resulted in a reduction in the revenue received by a party, that party would have a right to seek relief by invoking any price adjustment procedure set out in the relevant contract. Such a procedure would typically include:

  • The giving of notice identifying the event of government action or inaction and the net amount of cost involved
  • The parties meeting to discuss the matter and endeavouring to agree on an pricing adjustment in order to secure the same net economic return to the claimant party as if such costs had not been incurred
  • In default of agreement between the parties, the matter being referred to a third party expert for determination
  • A de minimis rule, whereby a claim can only be asserted by a party when its aggregate claim exceeds a certain financial threshold.

Conclusion

As highlighted in the In brief section above, under a typical sophisticated long term supply contract, a removal or amendment of the Dollar / Dirham peg may be capable of amounting to an event of government action or inaction.  Any party which incurs increased costs or receives a reduction in revenue as a result may be entitled to claim an adjustment of the payments made to it under the contract, so as to maintain its net economic return, but always subject to the procedures set out in the contract, including any de minimis rules.