Written by Youssef Emam
The Egyptian Pound (“EGP”) has been suffering against the US Dollar (“USD”) recently. In this regard, it is estimated that the EGP has lost more than 50% of its value against the USD since March 2022. Notably, the EGP has hit various new lows since the decision of the Central Bank of Egypt (“CBE”) to liberate the currency price according to the free market forces.
Unsurprisingly, this local currency depreciation, along with other crises on the international scene, have affected the economic cycle, and the supply chain in Egypt. The questions which impose themselves in this respect are: What are the effects of such depreciation on the contractual arrangements? How is the event of a currency depreciation classified under the Egyptian law? Is there any special treatment applicable on the construction contracts? How can parties to a contract avoid the effects of such on-going uncertainty regarding the EGP’s exchange rate?
You will certainly find an answer to the above questions, and more, in this article by Shehata & Partners (“S&P”).
2. The Force Majeure Theory
Force majeure was principally defined as an Act of God (i.e., natural occurrence), such as a fire, flood, and other natural disasters. However, parties to contracts have over the time expanded the list of acceptable force majeure events to cover uncontrollable, man-caused actions that may render a party’s performance impossible or impracticable, which includes, for instance, wars, labor strikes, or acts of terrorism.
Under the jurisprudence of the Egyptian Court of Cassation, an event may qualify as a force majeure if it (i) cannot be anticipated at the moment of signing the contract, (ii) cannot be avoided, (iii) results from an external factor, and most importantly (iv) renders the performance of the obligations under the contract impossible.
Logically, the currency depreciation is not satisfying point (iv) in the above paragraph, as a mere change in the market price of raw material or labor – occasioned by currency depreciation – from what it was at the time of executing the contract only results in a possibility of a reduction in the profit margin, and not an impossibility or impracticability to produce or supply (i.e., no impossibility to perform). That said, currency depreciation cannot automatically trigger a force majeure clause in a contract under Egyptian law.
3. The Exceptional Circumstances Theory
The general rule under Art. 147 of the Egyptian Civil Code (“ECC”) is that the contract is the law of the parties. Nevertheless, the exception is mentioned in the very same article, which established the famous theory of exceptional circumstances, which is the counterpart of the Hardship Theory applicable under common law systems.
Under the theory of exceptional circumstances, the judge may amend the contract in case of general exceptional circumstances that could not be expected, through modifying the obligations, in order to be reasonable in light of these circumstances, and to be not onerous to the debtor. This rule is in fact a public policy that cannot be deviated from by agreement between parties to a contract.
For an incident to qualify as an event of exceptional circumstances, some conditions shall be met:
- Being of general character.
- Being unanticipated by the parties when signing the contract.
- Occurring after the signature of the contract.
- Rendering the performance of the contractual obligations onerous to the debtor.
By applying the above conditions on the on-going currency depreciation, a judge may consider it an event of exceptional circumstances, as long as the debtor is able to prove that his contractual obligations became onerous, and that performing the contract as is will be threatening him with massive unbearable losses. However, the judge’s powers in this stance are limited to amending the contract to be more reasonable given the special circumstances.
4. Special Focus on Construction Contracts
Undoubtedly, construction contracts are one of the most contractual arrangements affected by the on-going currency depreciation. This is due to the international edge involved in these contracts, namely, the foreign contractors or owners, and the importation of machinery and raw materials from abroad. Nevertheless, Egypt’s construction sector is set for a multiyear boom despite inflation and the depreciating currency, taking into consideration that the Egyptian construction industry market size was valued at USD seventy (70) Billion in 2022, which is why we should put this specific contract under the spotlight, to understand how it may be affected by a currency depreciation in the Egyptian local market.
In this regard, the Cost-Plus-Fee pricing system will be irrelevant, as the contractor is reimbursed by the owner for the actual cost of performing the work, which will automatically reflect any cost increase related to labor, machinery, or raw materials. The main persistent issue lies within the Lump Sum pricing system, in which the contractor is responsible for completing the project within the agreed-upon fixed cost set forth in the contract, regardless of other external factors. In the latter case, can the contractor raise a claim for increasing the price on the basis of currency depreciation? Especially when the contract price is paid entirely in the local EGP currency?
4.1 Lump Sum Construction Contracts
In fact, the Egyptian legislator has curated a special treatment for lump sum contracts in Article 658 of the ECC. As a general rule, a contractor, who is a party to a Lump Sum construction contract, may not claim an increase in the contract price by any means, even in the cases of significant increases in labor, supplies, and other costs.
However, article 658(4) of the ECC provided for the exception, which is considered a direct application of the theory of exceptional circumstances explained above. Article 658(4) stated that if, as a result of exceptional events of a general character, which could not be foreseen at the time the contract was concluded, the economic equilibrium between the respective obligations of the owner and of the contractor breaks down, and the basis on which the financial estimates for the contract were computed has consequently disappeared, the judge may grant an increase of the price or order the termination of the contract.
Thus, the same conditions of the theory of exceptional circumstances shall exist in order to qualify the event as an event of exceptional circumstances. Though, the special feature concerning the application of the theory in case of lump sum construction contract is that the judge is not only empowered to modify the obligations to be more reasonable, but he is also allowed explicitly either to increase the contract price, or to terminate the whole contract.
4.2 Construction Contracts Involving a Governmental Entity
Governmental construction contracts, of administrative nature, are by default subject to the new Public Contracting Law No. 182 of the year 2018. Fortunately, it is much easier to get remedies for a currency depreciation event under this new law, even in the case of lump sum contracts.
Under article 47 of the Public Contracting Law, in governmental contracts whose duration is 6 months or more, the governmental contracting entity is obliged, at the end of each 3 contractual months, to review the price of the contract, and to increase, or even decrease, the contract’s price, according to the changes that have taken place in the price of items of the contract.
The above article seems to completely exclude the application of the theory of exceptional circumstances, as the review of contract is obligatory every 3 months, whenever the contract’s duration is 6 months or more. However, the theory may still come into application when the contract’s duration is less than 6 months.
More surprisingly, the Egyptian government has been attentive to the currency depreciation and its effects on the governmental contracts. This appears in the Law of Compensations related to Public Construction, Service, and Supply Contracts No. 84 of the year 2017, which was originally promulgated to compensate parties to the governmental contracts, who were affected by the economic measures taken between March and December of 2016 (i.e., when USD price soared from 7.7 EGP to 18.1 EGP).
The same law was revisited by the Egyptian parliament, and an amendment was introduced in December 2022, aiming to create a more comprehensive and permanent legal framework when it comes to the effects of harsh economic measures on the government contracts.
4.3 FIDIC Red Book Construction Contracts (Second Version of 2017)
The FIDIC 1999 Red Book has been in widespread use for nearly two decades, which is why it was updated in 2017, to reflect new trends and developments in the huge construction industry. In this regard, the Second Edition of FIDIC’s standard Conditions of Contract for Construction (hereinafter referred to as “FIDIC”) has provided for some special clauses that may come into play in case of currency depreciation.
The whole clause 18 of the FIDIC tackles the issue of exceptional events, which are conditioned by the following: (i) being beyond a party’s control; (ii) the party could not reasonably have provided against before entering into the contract; (iii) having arisen, such party could not reasonably have avoided or overcome; and (iv) is not substantially attributable to the other party.
An exceptional event under the FIDIC contracts may allow a party to raise a claim for an extension of time (EOT), or for additional costs (i.e., prolongation costs). Further consequences may include optional termination by the injured party in case the execution of work is prevented for a continuous period of 84 days (Sub-clause 18.5), in addition to releasing the parties from further performance if the applicable law allows so (Sub-clause 18.6).
We, at S&P, usually stresses on the importance of avoiding currency exchange rate risks by including tailored provisions in all contracts, especially those involving overseas transactions. That said, parties may agree on different types of clauses to mitigate currency fluctuation risks, as follows:
- Freezing Clause: Aims to freeze the exchange rate at a certain level when concluding the contract.
- Shared Risk Clause: Provides for sharing the currency risks between the parties by stating that a loss caused by a fluctuation of more than X% over a certain course of time shall be equally supported by all the parties.
- Currency Option Clause: Allows for switching from one currency to another, meaning that whenever a currency goes below or above a certain benchmark, the price shall be paid in another currency.
- Insurance Clause: Obliges all parties to insure against any potential currency exchange rate risks.
- Explicit Force Majeure or Exceptional Circumstances Clause: States explicitly that a currency depreciation at a certain rate shall qualify as a force majeure event or an exceptional circumstances event.
To achieve the maximum protection, some of the aforementioned clauses might be combined. For example, parties may desire to combine an insurance clause with a shared risk clause.
It goes without saying that the current EGP depreciation has affected the entire economy. Under the Egyptian law, this event may not qualify as force majeure event, but it may be, upon satisfying certain conditions, considered as an exceptional circumstances event, leading to reviewing the obligations of the parties to a contract by the competent judge. Further, obtaining a relief in case of currency depreciation may be easier when we are tackling governmental construction contracts compared to private Lump Sum or to FIDIC contracts. Nevertheless, there are some solutions that can be adopted to avoid currency exchange contractual risks at the time of entering such agreements.
If you were impacted by the currency depreciation, or you would like to tailor your contract to mitigate any current or future currency depreciation risks, don’t hesitate to contact S&P, to get your on-target piece of legal advice.