Contingent liability essentially refers to a potential liability that may occur, depending on the outcome of an uncertain future event. It is recorded in the accounting records if the contingency is likely and the amount of the liability can be reasonably estimated.[1]

Background

A contingent liability is a fiscal obligation which is dependent upon a specific but uncertain event that may or may not materialise in the future. They can be explicit i.e. defined by a legal contract, or implicit i.e. with no legal obligation but severe social or economic repercussions if not serviced. The more contingency liabilities a country has, the more its credit rating is adversely affected. Further, the materialisation of the risks creates a fiscal cost for the government thereby causing a strain on the sovereign balance sheet.[2]

The Drax International LLC case is an example of a contingent liability where the government terminated the contract with the supplier after it came out that proper procurement procedures were not followed in awarding the contract. Drax through their lawyers, Samukange Hungwe Attorneys, wrote to Natpharm arguing the termination of the controversial contract was unlawful.

"Our client concluded a contract for the supply and delivery of medical supplies with yourselves on 11th December 2019. Our client performed all its obligations in terms of the law," the letter from Drax addressed to an R. Mtombeni of Natpharm reads. "Our client learnt with shock that you purported to cancel the contract for the alleged public interest on 11th of June 2020.

"Our instructions are to indicate that your purported cancellation of the 11th June signed by one Mrs. F.N. Sifeku is null and void for the following reasons:

  • The purported cancellation appears founded on a directive from the Ministry of Health and Child Care, which is clearly outside the contractual procedures that govern the parties' relationship.
  • "The purported termination is allegedly in terms of section 89(b) of the Public Procurement and Disposal of Public Act (Chapter 22:23). The Act doesn't exist: the purported termination is not for any breach at the insistence of our client, hence the supposed ground of public interest is erroneous and unsupported by law; our client did not, in fact, breach the contract between the parties."

In the letter, Drax threatens to take further legal action against Natpharm with the London Court of International Arbitration. "Our client hereby gives notice of its intention to commence arbitration under the London Court of International Arbitration rules (LCIA). This route is being pursued on the basis that the purported cancellation is not only unlawful but was capriciously and unprocedurally done."[3] [4]

This case acts as an example of a contingent liability where the likelihood of Drax winning the case since the government went into the contractual agreement with the company through NatPharm and all of the related parties cited as interested in the case were not part of the agreement when it was signed. This likelihood of losing the case would mean the costs have to be reported as contingent liabilities.

Zimbabwe's Strategy to Reducing Contingent Liabilities

George Guvamatanga, the Permanent Secretary in the Ministry of Finance and Economic Development said that individuals with the right skills should be involved in the negotiations for deals or loans as badly negotiated deals are giving Treasury long-term accounting problems.

“A critical problem is inadequate legal coverage of contingent liabilities. In most cases it is limited to some aspects of explicit contingent liabilities for example loan guarantees. “I will tell you why we always have inadequate legal coverage because these transactions and deals are sometimes negotiated by people without the necessary skills. “You actually find instances where delegations of very high level, Government officials, including Ministers travelling on various reasons and come back with transactions poorly negotiated,” said Mr Guvamatanga.

“At the debt resource you are now placed in a situation where you can see that this transaction does not work, but it has already been negotiated and agreed at senior levels and you have no choice but to try and work with it. In most instances, we all know what follows, the contingency liabilities always materialise.”

In view of the dynamic debt management landscape, experts say it is important for debt managers, especially in the public sector, to stay abreast with pertinent developments in macroeconomic and financial management, including public debt management.

Mr Guvamatanga added that contingent liabilities posed a risk for the effective implementation of national fiscal policies. “The materialisation of contingent liabilities risks has direct adverse consequences on Government’s fiscal position. “The fiscal cost is invisible until they are triggered, thus they represent a hidden subsidy, blur fiscal analysis and can drain Government financing by increasing debt service obligations,” he said.

“Given the low fiscal space in most developing countries, this situation results in re-allocation of resources from capital and social projects towards debt service. “In addition, contingent liabilities could also crowd out social expenditures on health and education, hence affecting Government’s inclusion programmes.”




References

  1. Tawanda Musarurwa, [1], The Herald, Published: 7 May, 2019, Accessed: 14 August, 2020
  2. Godknows Nyangwa, [2], Zimbabwe Independent, Published: 14 February, 2020, Accessed: 14 August, 2020
  3. [3], allAfrica, Published: 14 July, 2020, Accessed: 14 August, 2020
  4. Moses Matenga, [4], Newsday, Published: 18 July, 2020, Accessed: 14 August, 2020