Exchange rate risk is a common feature of cross-border commerce. Failing to document where that risk falls can have significant financial repercussions. Two recent cases illustrate this danger. They reveal how the court interprets relevant clauses and the default position if parties fail to include express terms. Several practical drafting lessons result from this.

(1) Procter & Gamble Co v. Svenska Cellulosa Aktiebolaget1 – the background facts

In March 2007, P&G agreed to sell its tissue towel business to SCA for 512 million euros. Among the assets sold were several European factories, including one in Manchester and another in Orléans, France. The parties agreed to delay the closing for these two factories. This was so P&G could remove proprietary technology not forming part of the deal.

During the transitional period, P&G was to sell products to SCA from Manchester and Orléans according to detailed terms. These terms included:

  • Fixed prices in euros for the products sold to SCA, taken from P&G's "firm plant budgets" for 2007/8. Those budgets gave prices in euros, although P&G incurred some listed costs items in sterling and other currencies.
  • Payments due in sterling for products made in Manchester and shipped to SCA.

SCA argued that the effect of these terms was that parties had agreed a fixed exchange rate for all payments due in sterling. SCA argued this was implicit in the agreed fixed prices. SCA also relied on an annotation at the foot of the “firm plant budgets” (annexed to the contract), which read "£/Euro of 1.49164". Taken together, SCA said this showed the parties intended this exchange rate to apply to all prices stated in euros and payable in sterling.

P&G denied there was any express or implied term incorporating a fixed exchange rate. It argued SCA had to provide the correct amount of the currency of payment (sterling) to cover the fixed euros price at the prevailing market exchange rate at the date each invoice fell due.

Was there an express term for a fixed exchange rate?

The court held there was no express term incorporating a fixed exchange rate at the annotated figure. The purpose of the annotated document was simply to set out the firm plant budgets. The annotation recorded the basis on which P&G had translated any sterling costs in those budgets into euros. The annotation was explanatory, not operative.

The judge also noted the parties had each employed experienced lawyers to meticulously document the deal. He thought it was unlikely they would document an important point such as an agreement for a fixed exchange rate in such a "casual, confusing and elliptical way".

Was there an implied term for a fixed exchange rate?

The court also rejected SCA's alternative argument that there was an implied term for SCA to pay sterling sums due at the annotated exchange rate. Having denied the annotation any effect as an express term, the court did not think there was any reason to give it a wider meaning by inference.

The judge also pointed to the dual function of money: it is both a means of measurement and a medium of payment. Here, the annotation related to calculation of the fixed prices, not payment. The dichotomy is important. The court said "an agreement to pay in a currency (the mode or currency of payment) different from the currency of measurement or account does not by inference or implication alter or affect the measurement of the obligation to pay. More especially, it raises no inference that the paying party will be invoiced in the currency of payment, nor that the parties have agreed any rate of exchange other than the market rate at the date of tendering payment".

Should the court rectify the agreement to provide for the fixed exchange rate?

SCA's final argument was that the court should rectify the contract to reflect the parties' intention for a fixed exchange rate. Again the court disagreed. Rectification can correct an error in the contract language. It is not available to add a term to the contract based on an alleged agreement in the pre-contractual negotiations. In any event, SCA failed to persuade the court on the evidence of the negotiations (admissible on the rectification claim but not to interpret the contract more generally) that the parties had ever agreed to a fixed exchange rate.

(2) Hess Corporation v. Stena Drillmax III Ltd2 – the background facts

The parties entered an agreement in September 2007 for Hess to charter Stena's drilling rig for five years from 2009. Hess had to pay sums due to Stena on a "pay first, dispute later" basis. It argued it had significantly overpaid the charter fees because of changes in the dollar-sterling exchange rate in the two years between entering the contract and its coming into operation.

The agreement required Hess to pay a "daily operating rate", invoiced in dollars. This rate comprised:

  • a fixed capital element, to remain "firm and fixed" throughout the life of the contract; and
  • an estimated operating costs element, "subject to adjustment" quarterly, to take into account the actual costs incurred by Stena. There were limits on the recalculation of some costs (such as a cap of 8% on any annual increase in personnel costs). Stena had to use reasonable endeavours to keep all components of the operating costs at reasonable levels, judged by industry standards.

A schedule to the contract itemised the operating costs. It expressed some costs in dollars, others in sterling, and adopted an assumed exchange rate of $2:£1 for converting sterling operating costs into dollars.

Clause 13.3.5 stipulated that, for invoicing purposes, the exchange rate published by the London edition of the Financial Times appearing immediately before the date of invoice applied.

Hess argued the FT rate applied to all sterling elements of the operating costs. This meant Hess had overpaid by $5 million due to exchange rate movements. Stena argued the FT rate only applied to the difference between the estimated and actual costs. This meant Hess had not overpaid.

What was the correct interpretation of the contract?

The exercise for the court was to indentify the parties' intentions. Relevant questions included: what risks did the contract aim to allocate by allowing adjustment of the operating costs? And what made business sense, taken in the context of the agreement as a whole? Stena argued the agreement was a fixed day rate contract. But, looking at the structure and context of the contract, it was clear the parties intended Stena to be able to recover changes in the operating costs in the daily rate calculations. This made business sense, given the delay between agreeing the contract rates in 2007 and the rig being deployed in 2009. It was also consistent with the fact the contract would run – and remuneration would be payable – for five years. The court accepted, against this background, that the parties intended the FT exchange rate to apply to all sterling operating costs.

Practical implications

These cases show that even sophisticated commercial parties can fail to agree on how to deal with exchange rate risk and to document their intentions unambiguously. Some useful practical points emerge.

  • The usual rules of contractual interpretation apply to exchange rate terms. The key is to determine the parties' intentions. The factual matrix against which the court can assess this is potentially wide. Hess shows the court may be more likely to accept the parties intended to adjust remuneration for exchange rate variations in a long-term contract. This is particularly so if the parties reach agreement a considerable time before the contract becomes operable. Of course, you can minimise the risk of the court not reflecting your intentions by spelling out the position clearly.
  • The court usually interprets a contract providing for prices to be fixed in one currency but paid in another as meaning the payer must provide the amount of the second currency needed to buy enough of the first currency to meet the debt. The calculation is made by reference to the market exchange rate at the date of payment. You need clear express provision for a different outcome.
  • Consider the pricing, invoicing and payment provisions of any draft contract and identify where exchange rate risk comes into play. In particular, consider any difference between money as a means of measurement and money as a means of payment. In P&G, SCA's negotiator admitted under cross-examination that he had not grasped this distinction. This was fatal to the claim for rectification based on common mistake. (There was no suggestion P&G had tried to take advantage of SCA's error. This also doomed any claim by SCA that it had made a unilateral mistake.)
  • Do not assume the court will imply an exchange rate, fixed or otherwise. As the judge said in P&G, "a court should be wary of implying or interloping a term that has the effect of altering … the allocation of an exchange rate risk, especially in a contract where it is inherent or bound to arise".