In an effort to resolve the current debt crisis, the leaders of the 17 Eurozone member countries met in Brussels and have agreed a compromise deal involving a set of short-term and long-term measures to shore up the Euro, including :
- The establishment of a new supervisory body within the European Central Bank with powers to oversee banks within the Euro bloc
- The utilisation of European rescue funds to recapitalise banks directly, rather than through their national governments
- The approval of a €120 billion stimulus package for jobs and growth
The agreement exceeded expectations, but required a U-turn by the German Chancellor, who had vigorously opposed the use of European funds to bail out banks directly. This will help to reduce rising borrowing costs for Spain and Italy. Germany may still push for national governments to bear responsibility for any shortfall if the borrowing banks fail to repay.
It remains to be seen whether this latest firewall will stabilize the markets. However, the crisis is unlikely to be resolved until European leaders agree to further integration, a full Eurozone banking union, a European Treasury with powers to control national budgets and, the issue of Eurobonds to share debt liability. The decision to establish a new banking regulator is no more than a statement of intent at the moment, pending draft legislation from the European Commission which will need to define:
- What powers will this new supervisory body have
- Whether it will be able to restrict or control reckless banking practices
- Whether it will be able to hold offending banks responsible; or
- Whether it can be protected from falling victim to the national political factors that have until now prevented the effective supervision of banks on a European-wide basis?
Until these questions are answered, the prospect of an EU Member State exiting the Eurozone (a "Eurozone exit") remains a real threat. In particular, the compromise is not considered to be sufficient to prevent a Greek exit, which will lead to yet further uncertainty in the market. In the meantime, Cyprus became the latest victim of the debt crisis to request bail-out funding. It is the fifth Eurozone country to do so.
The EU legal framework1 only permits a Eurozone exit by agreement2. There is no provision which allows a unilateral exit; it is a one-way street. The exact implications of a Eurozone exit or Eurozone break-up are economicall, politically and legally uncertain; and therein lies the ‘Eurozone Crisis’.
A complete collapse of the Euro, although a possibility, is considered the least likely outcome. Indeed, most commentators consider that the Eurozone Crisis will be resolved without any Member State withdrawing from the Euro, in the short to medium term at least. However, a unilateral exit by one or more Member States may be inevitable and may indeed be permitted if such a sacrifice would restore confidence in the Euro as a currency. Even with its recent pledges of austerity, the prospect of an exit by Greece remains a distinct possibility.
For the purposes of this briefing, it has been assumed that there may be one or more unilateral exits, but that the Euro, as a single currency, will continue to exist even if in the longer term the Eurozone may comprise a more limited membership.
In the meantime, those continuing to trade with customers in Europe need to put in place suitable contingency planning to negate or minimise the effects of a Eurozone exit. This applies both in relation to (i) existing contracts with customers in the Eurozone and (ii) any new contracts currently being negotiated.
- Existing Contracts
You should be undertaking a review of your existing contracts where one of the commercial parties is within the Eurozone, with particular attention to the following:
Depending upon the strength of your relationship and bargaining position, you should consider whether you can renegotiate the terms of your deal with your trading partner. This will be particularly important for any long-term or critical contracts you may have in the Eurozone, where exchange rate fluctuations could have adverse economic effects, and where you may prefer to contract in a currency other than the Euro. In short, you will wish to ensure that any currency risk is born by your counterparty and to consider whether to take additional security or collateral.
Currency of the Payment Obligation
Where the “Euro” is clearly defined as the currency of the contract, the obligation to make payment in Euros will remain, regardless of whether one of the Member States of a contracting party has exited the Euro (an “Exiting Member State”) and its Government has redenominated and revalued its currency into “New Local Currency”.
If the Euro is not the identifiable currency of the contract, because it has been imprecisely defined or the payment obligation is by reference to the currency of the Exiting Member State, then; pursuant to the lex monetae principle3, the payment obligation under the contract would be in the New Local Currency if the place of payment is that of the Exiting Member State.
Event of Default, Material Adverse Change and Force Majeure Clauses
To ensure that its withdrawal is effective and in order to support its New Local Currency, any Exiting Member State is likely to introduce emergency legislation imposing exchange control restrictions on payments made in Euro. Depending upon the terms of the specific contract, those circumstances could comprise a material adverse change, trigger a force majeure or satisfy the criteria of an event in default, allowing the customer to terminate where the obligation to pay in Euros is not met.
The introduction by an Exiting Member State of local legislation to prohibit trading in Euros may trigger an illegality clause in the contract, thereby rendering payment obligations unenforceable.
Whether the Exiting Member State’s exchange controls would be recognised as effective (and so an illegality clause triggered) would depend on the circumstances of the Member State’s exit from the Eurozone. In the absence of a consensual Eurozone exit, the Member State’s exchange controls would be regarded as ineffective in all but the Exiting Member State’s courts. If the Member State’s exit was consensual, including the introduction of domestic exchange controls, an illegality clause could become effective.
Governing Law and Jurisdiction Clauses
Contracts expressed to be governed by the laws of, and subject to the jurisdiction of the Existing Member State’s courts can be expected to be interpreted in favour of any new monetary policy the Exiting Member State implements following its Eurozone exit. If the Member State’s Eurozone exit is non-consensual, such clauses will be particularly onerous.
Note however, that where an Exiting Member State’s new monetary policy conflicts with EU law and amounts to an abrogation of its EU law obligations, this may provide grounds for an arbitration claim against the Exiting Member State under applicable investment treaties.
- New Contracts
When negotiating any new contracts, it would be advisable to consider the following:
- Aim to contract with a counterparty outside a potential Exiting Member State (or, if no such counterparty is available, prefer an Exiting Member State counterparty with assets outside the Eurozone to minimise the risk of being unable to bring enforcement proceedings);
- Review and amend standard boilerplate clauses (in particular, those dealing with events in default, material adverse change and force majeure) to ensure their drafting is not so wide that, if unintended, a Eurozone exit or break-up triggers them;
- Choose governing law clauses and jurisdiction clauses by reference to countries outside the Eurozone (or, at least, outside potential Exiting Member States);
- Nominate a place of payment outside the Eurozone, or alternatively outside a potential Exiting Member State, to reduce exchange control risks;
- Specify payment obligations in a non-Euro currency;
- Where it is considered necessary to nominate the Euro as the currency of the contract, ensure that the term “Euro” is clearly defined and is not defined simply by reference to the currency of the counterparty’s jurisdiction;
- Ensure that you have incorporated a right of termination at your option (alternatively, rights of variation) in the event of a currency re-denomination, the unilateral creation of a New Local Currency, and/or the introduction of legislation to restrict the movement of currency;
- Link any currency conversion to or from Euro to a series of spot rates in another currency (rather than a single fixed rate);
- Ensure the contract incorporates stringent insolvency provisions (as counterparties within potential Exiting Member States with strict currency controls are more likely to default on payment obligations);
- Where appropriate, consider new insurance products to minimize the loss of any unintended currency conversion or loss of earning from a defaulting counterparty;
- Consider short(er) term supply contracts to reduce the effects of any default by your counterparty;
- Take security for payment by entering into escrow arrangements or requesting payment in advance/in instalments;
- Generally, place all the currency risk on your customer, for example, by including currency indemnities and obtaining payment guarantees from parties outside the Eurozone (or at least, outside potential Exiting Member States);
- Include warranties (for example, in a business sale contract) to ensure a party’s exposure to a Eurozone exit or break-up has been adequately disclosed; and/or
- Include restrictions on novation and assignment to prevent unintentional contracting with counterparties within the Eurozone/potential Exiting Member States.
In considering and implementing any or all of the above suggestions, parties will avoid (or at least limit) the legal risks associated with the Eurozone Crisis.