The eventual departure of one or more countries from the Eurozone, and reversion to national currency(ies) is no longer unlikely. It may still be too early to evaluate with any certainty the specific legal impacts of any such departure from the European Monetary Union on contracts entered into between parties in a departing member state and parties in other jurisdictions, whether within or without the European Union, but even at this preliminary stage, the adoption of procedures to assess potential exposure to any Eurozone exit or breakup may now be prudent.
Even observers sympathetic to the Euro project have begun to view the eventual departure of one or more countries from the Eurozone, and reversion to national currency(ies), as no longer unlikely. The various treaties and arrangements which brought the Euro into being, however, do not explicitly contemplate either forced or voluntary departure of one or more member states from the European Monetary Union (each, a “departing member state”). The circumstances of any such departure could be decisive in determining its effects on commercial and financial arrangements relating to the currency of departing member states.
It may still be too early to evaluate with any certainty the specific legal impacts of any such departure from the European Monetary Union on contracts entered into between parties in a departing member state and parties in other jurisdictions, whether within or without the European Union (EU). Member states and European bodies alike may be able to agree an orderly modification of currency arrangements. Any such agreement will of course have a major effect on the legal and commercial implications of any departure.
Assessing General Exposure
Even at this preliminary stage, however, the adoption of procedures to assess potential exposure to any Eurozone exit or breakup may now be prudent.
Businesses with substantial exposures within the Eurozone may wish to undertake a general review of their potential geographic exposure in order to identify their high risk assets, transactions and relationships.
These include the currency-related risks inherent in the form and location of:
- Material assets and properties
- Significant subsidiaries and affiliates
- Bank loans, bond issues and other significant financial transactions
- Hedging arrangements
- Cash deposits and cash sweep arrangements
- Custodial and trustee arrangements
- Commercial arrangements with customers and suppliers
- Joint ventures and other long-term cooperative relationships
- Intra-group financing and funds flow arrangements
In addition, with respect to the material contracts relating to these currency-related risks, the following elements should at this stage be identified and catalogued for later analysis:
- Governing law
- Jurisdiction (exclusive or non-exclusive)
- Definition of “Euro” or relevant currency of payment
- Place of payment
- Place of performance
- Domicile or place of incorporation of counterparties
- Location of counterparties’ assets and property
- Nature and location of security
- Centre of main interest of counterparties, for purposes of local insolvency risk
Basic legal issues: Currency of Payment/Continuity of Contract/Lex Monetae
Certain basic legal issues are likely to be common to virtually all cross-border contractual relationships. As noted below, various product-specific issues will also arise in respect of particular types of contracts.
Currency of payment
If an agreement provides that a party in a departing member state is required to make payments in Euro, must payment invariably be made in Euro? The answer will depend on the specific terms of the contract, including the law governing the agreement, the application of the principle of lex monetae (discussed below), the jurisdiction where disputes are to be adjudicated and the presence of a “currency of payment” or “place of payment” term in the agreement. The non-departing member state party may be in the most favorable situation if the agreement is governed by a law other than that of the departing member state, disputes are submitted to the exclusive jurisdiction of a non-departing member state court or arbitral tribunal, the currency of payment is defined as the single currency introduced pursuant to Eurozone treaties and regulations, and payment is required to be made outside a departing member state. If the governing law of the contract is a departing member state’s law or the court hearing the dispute is in a departing member state, as a practical matter it is more likely that payment in the new local currency will be allowed.
A contract which stipulates that the place of payment is within a departing member state may be problematic if the jurisdiction for dispute resolution is within the EU, albeit outside a departing member state, since even if the court determines that the parties intended that payments be made in Euro, EU conflicts of law rules may lead the court to recognize the redenomination law of a departing member state with the result that the obligation to pay in Euro is unenforceable. The court hearing the dispute could alternatively decide that it should not apply departing member state law if the member state in question has breached its EU treaty obligations by unilaterally leaving the Eurozone.
Even if a judgment in Euro is obtained outside a departing member state, the issue will arise as to the practical enforceability of any such judgment against a departing member state party. In the case of debtors having assets outside a departing member state, enforcement may be possible (although an issue could arise if the contract required payment in a departing member state). With respect to assets of the party located in a departing member state it is more doubtful that a departing member state’s court would enforce a judgment in Euro since it would be obligated to give effect to a departing member state’s currency redenomination law.
Continuity of contracts
The exit of a departing member state from the Eurozone may raise issues as to the continuing validity of an agreement or may trigger termination events. The generally applicable principle of “continuity of contracts” provides inter alia that the validity of contracts is not affected by the introduction of a new currency. This principle is likely to be incorporated into the law of a departing member state, notwithstanding any currency redenomination. Under this general principle, contracts governed by a departing member state law therefore would remain valid.
Doctrines such as frustration of purpose, impossibility, commercial impracticability or force majeure might also be invoked to attempt to justify termination of the agreement. The success of any such argument will depend on the availability of that doctrine under the relevant governing law and whether the criteria for its application are satisfied, which will depend heavily on the particular facts of the case. The imposition of capital, exchange or other currency controls will also have a significant impact on these arguments.
Unless an agreement includes as a specific termination event one of the parties being located in a departing member state, which would be rare, a party seeking to terminate an agreement with a counterparty in a departing member state may be compelled to look to standard provisions such as events of default and material adverse change and force majeure clauses. Their applicability will depend on the specific drafting of the provisions. Cross-defaults and breach of representation defaults may apply as well. The material adverse change clause may be of particular relevance to M&A transactions with parties from a departing member state.
As noted above, interpretation and performance of agreements are generally determined by the law applicable to such agreements. In the case of monetary obligations, however, these general principles are subject to a significant exception. Where agreements refer to a specified national currency, there is an implicit choice of the law of that member state to determine the identification of that state’s currency. This rule is generally referred to as the lex monetae principle, and it generally applies regardless of the system of law which governs the agreement as a whole, or any other term of the agreement. In other words, even where the governing law of the agreement is other than that of a departing member state, under the principle of lex monetae the law of the currency issuing country would control matters relating to the currency. For example, following hyperinflation in the 1920s, Germany elected to replace the Mark with successor currency regimes, and eventually the Reichsmark. Non-German courts generally enforced this redenomination as the appropriate outcome under German law, the law of the currency-issuing country.
In the case of forced or voluntary departure from a currency union, however, various commentators have noted that there is no clearly-indicated lex monetae. For example, if Greece departed from the Euro and legislated that Euro contracts be redenominated in “new drachma” Greece would be the issuer of the replacement currency, but the Member States of the Eurozone would remain the joint issuers of the replaced currency. The precise outlines of “Eurozone law” for lex monetae purposes is not entirely clear, but is apparently some subset of existing EU law. This law says nothing about redenomination. Thus, while Greek law would permit or indeed require redenomination, EU law (another plausible law of the currency) would not, unless specific measures were adopted in connection with any such departure.
Special issues to certain types of contracts
There is a debate in the market concerning the definition of the currency of payment in facility agreements. The standard form facility agreements of the Loan Market Association (LMA) do not include a definition of any currency. In practice, such definition is added by the parties and the Euro is usually defined as the single currency unit of the participating member states of the EU. This being said, in a recent trend, borrowers are asking for the Euro definition to include any changes to the currency of their country from time to time. While this approach makes perfect sense for a borrower whose domestic business requires it to settle payment obligations in the new currency as well, it raises a number of questions for lenders engaged in cross border transactions (refinancing, exposure etc.).
Equity linked instruments
According to the principle of “continuity of contracts”, a redenomination of equity linked instruments such as convertible bonds, bonds with options and exchangeable bonds will most likely not affect their enforceability. In particular, the redenomination of the payment currency will most likely not trigger a termination right as a consequence of an event of default. Events of default clauses as used in the terms and conditions of equity linked instruments mostly deal with certain events occurring at the level of the issuer only so that macroeconomic issues such as redenomination of currencies usually are not the subject matter of termination rights. A subsequent significant devaluation in a departing member state’s new national currency which renders the performance of the contract uneconomic may result, however, in a termination right according to general principles of law, provided that the redenomination of a departing member state’s new currency effectively results in a redenomination of the payment currency under the respective equity linked instrument which will depend on the following considerations.
If the terms and conditions of the respective equity linked instrument define the payment currency as the single currency introduced pursuant to EU treaties (and not as Euro as the official currency of a departing member state), the risk of redenomination would be expected to be lower. According to the principle of lex monetae, however, the reference to a certain currency is only one indication of the parties’ choice of payment currency. To determine whether a redenomination of payment currency has to take place it is important to consider whether the equity linked instrument has an international context or rather a national context which, inter alia, depends on the following circumstances:
- international or local offering only
- international listings or local listing only
- type of equity linked instrument and relation to national corporate law
If the equity linked instruments (i) are offered via an international offering, (ii) are traded on international exchanges and (iii) are cleared via international clearing systems, the risk of redenomination could be expected to be lower. However, the type of equity linked instrument may also have a particular impact on the risk of redenomination. For example, in the case of convertible bonds the holders of the bonds have a conversion right according to which they can exchange a certain number of bonds into a certain number of shares of the issuer. The conversion ratio between bonds and shares is fixed or may vary as a result of changes in the share price. However, as a matter of corporate law, the currency of the bonds and the shares is in any case identical. As the shares of the issuer will be denominated in a departing member state’s new currency there is an inherent risk that the bonds will need to be redenominated into the same currency.
The same risk of redenomination exists in the case of bonds with options, provided that the options cannot be separated from the bonds; in this case the payment obligation under the options (payment of strike price) will be netted with the repayment obligation of the nominal amount of the bonds by the issuer. One could argue, therefore, that the options and the bonds need to be denominated in the same currency as the shares, which is a departing member state’s new currency. This argument will be of less importance in case of options which can be (and have been) separated from the bonds; in such case a netting between the payment obligations under the options and the repayment obligation of the nominal amount of the bonds by the issuer will not occur.
In addition, the redenomination of a departing member state’s currency may also result in a restructuring of equity linked instruments and such restructuring may lead to completely different results as described above.
Like the LMA-based documentation and many other contracts, ISDA Master Agreements do not typically contain provisions dealing with the departure of a member state from the Eurozone, and change of currency is not typically an event of default or a termination event. Ensuing exchange or capital controls may, however, result in a termination event such as illegality or force majeure, or in a disruption event depending on which ISDA definitions apply.
The situation for derivatives is complicated by a number of specific factors, the first of which being the number and variety of assets that they refer to, and the fact that they usually involve two-way payment obligations. Unlike loans, the Euro may itself be the subject matter of the derivative, the obvious example being that of a currency swap, which increases the possibility that frustration of purpose will be invoked. In other instances, the derivatives may be hedging cashflows redenominated into the new currency against the Euro surviving among the non-departing member states, and vice versa. And if some Euro-denominated obligations are redenominated into a new currency but others not, the parties would lose the benefit of the payment netting which the ISDA Master Agreements enable for same day settlements within a trade, or worse, across transactions, depending on the options selected in the relevant derivative.
Even if it is difficult at this stage to anticipate precisely the legal consequences and scope of a Eurozone exit or breakup, steps may be taken to mitigate the risks. We have mentioned above the importance for anyone with contractual exposure to the Eurozone or the Euro to identify and analyze their exposure and catalogue certain key contractual terms. The next step may be to consider whether any modifications to such contractual relationships are necessary or desirable depending on the extent of perceived risks. In all cases, it is probably unwise to “wait and see”.