1. What is the main risk in relation to contracts?
The main risk in relation to contracts is the risk of payment obligations being redenominated from euros into the new local currency adopted by a member state following its exit from the Eurozone. Any new currency is likely to fall in value against the euro resulting in potential losses to creditors and counterparties to whom payment obligations are owed. For further detail, see the section on Redenomination risk.
2. What contracts might be at risk?
Redenomination risk should only be an issue in practice in relation to euro payment obligations under contracts with a sufficient connection or nexus to the exiting member state (e.g. contracts governed by the laws of the exiting member state, where the counter-party is resident in the departing member state or where the place of payment is in the exiting member state).
3. What due diligence might be undertaken in relation to existing contracts?
A business should have a team in place to undertake due diligence and identify which of its contracts might be considered “risk” contracts. A business may want to consider and consult external advisers on the potential to amend payment and other terms of existing contracts to try to protect against potential exposure and losses. See Risk Management section for further details.
4. What protections can a business build into new euro denominated contracts?
In the case of new transactions, the extent to which a business can draft around issues such asRedenomination risk will depend on the facts of the transaction (e.g. which court has jurisdiction in any dispute). For further details see the section on Redenomination risk. There are however some simple drafting protections that a business entering into new euro denominated contracts may want to consider depending on the facts of the transactions. These may not be conclusive for all purposes, but they will certainly help. However it is also important to remember that certain contractual provisions agreed by the parties may be overridden by legislation implemented at the time of any exit by an exiting member state. We would encourage all our clients to talk to us about what they want to achieve in particular types of transaction, so that we can advise accordingly.
Definition of euro
If you want the payer to continue to have to pay in euro, you should ensure that there is a definition of “euro” which makes that clear that the governing law is a law other than that of a member of the Eurozone.
Governing law and jurisdiction
The governing law and jurisdiction clause should not be that of a member state considered to be an “exit” risk.
Place of performance/payment
The place of payment should be outside the Eurozone. If possible, this should also be the case for the place where the contract is being performed though of course this may not be possible in practice because of the facts of the transaction.
Where are parties incorporated?
Counter-parties should if possible be incorporated outside of an exiting member state although this may not be possible (for example with supply and services contracts). For more detail see the Counter-party risksection.
Restrictions on assignment/transfer
Restrictions on assignment or transfer could be built into relevant contracts to protect against exposure to counter-parties considered to be a risk.
MAC clauses/right to terminate
A member state exit is unlikely to give rise automatically to a right to terminate in existing contracts. In most contracts, the parties will not have expressly contemplated the possibility of a member state exit and therefore are unlikely to have drafted any provisions dealing with the consequences of such an exit. However, even if a member state exit is not itself a termination event, related events may be sufficient to trigger other termination or default events. For example, if exchange controls are imposed by the departing state following its withdrawal from the Eurozone1, it may become difficult if not impossible for a party to meet its payment obligations in euro under the contract. This may trigger non-payment “illegality” termination events or events of default, if any, in the contract.
However a business can and should consider building in the exit of a member state from the Eurozone as an event which will trigger the material adverse change (MAC) or force majeure clauses in their new euro denominated contracts. When drafting the relevant MAC or force majeure clause, care should be taken to ensure that a member state exit falls within the scope of events covered by the relevant clause as the provisions will be strictly construed.
A typical material adverse change clause provides that a change having a material adverse effect on a company's financial condition or business prospects, or the ability of a contractual party to perform its obligations under the contract, will trigger a default under the contract, enabling the other party to terminate the contract. Either or both limbs of such a clause could be triggered in the event of a redenomination and/or accompanying change in law which has the effects contemplated in the clause. However, this would be unlikely except in the most extreme circumstances as the clause requires that it is the company that will need to have suffered a significant deterioration in its financial condition or be unable to perform its payment or other material obligations. To ensure that a Eurozone exit is caught by a MAC clause, it would be necessary for the parties to stipulate expressly in the clause that such an event constitutes a material adverse change.
The same applies to force majeure clauses. Without express reference, it is unlikely that a member state exit would constitute a force majeure event and trigger the default provisions of that clause. Force majeure events typically cover situations where a party's performance of its obligations is frustrated or made impossible by events outside its control. Even if a Eurozone exit were to render the performance of the contract more expensive, it would not be a force majeure event as performance would still be possible. The complete dissolution of the single currency may constitute such an event (depending upon the wording of the force majeure clause). However, again, depending upon the wording of the force majeure clause and the contractual payment obligations, the dissolution would not be a force majeure event if the difficulties can be overcome, such as paying in new national currencies according to new treaties between the exiting Eurozone members. To ensure that a Eurozone exit is caught by a force majeure clause, it would be necessary for such event to be defined as a force majeure event in the clause.
Alternatively, the parties can include illegality as a termination event, which will allow either party to terminate a contract if it becomes illegal for a party to perform its payment obligations under the contract. As with the MAC and force majeure clauses, care should be taken to ensure that the illegality clause is wide enough to cover the unlawfulness of payment obligations pursuant to a country's exit from the Eurozone and subsequent exchange controls. If a party can pay from a different jurisdiction then they will not be able to rely on illegality. Again, such clauses are strictly construed under English law.
The parties may also wish to include in new contracts an express termination right or automatic termination in the event of a designated country or any country leaving the Eurozone. This has the advantage of maximum certainty and flexibility compared with termination under the MAC or force majeure clause and can be drafted to cover the different eventualities and circumstances of Eurozone exits.
Finally whilst contractual provisions giving parties a right to terminate may assist, it is also important to remember as above, that contractual provisions agreed by the parties may be overridden by legislation implemented at the time of any exit by an exiting member state. Termination provisions for example may not prevent payment obligations under euro-denominated contract being redenominated into a local currency or assist with problems in enforcing payment, especially where a debtor's assets are located in an exiting member state.
5. Will recent events in Cyprus give rise to any contractual “exits” (e.g events of default or force majeure events)?
Recent events in Cyprus are unlikely to give rise to an automatic right to terminate in existing contracts. This is because in most contracts, the parties will not have expressly contemplated the current issues in Cyprus and so will not have drafted any provisions addressing for example the consequences of capital and exchange controls coming into effect.
Without express reference, it is also unlikely that the imposition of capital and exchange controls would constitute a force majeure2 event. Force majeure events typically cover situations where a party's performance of its obligations is frustrated or made impossible by events outside its control. Even if capital and exchange controls were to render the performance of the contract more difficult or expensive, it would not be a force majeure event if performance of the contract is still possible. To ensure that capital and exchange controls are caught by a force majeure clause, it would be necessary for such event to be expressly contemplated as a force majeure event. MAC3 clauses (which contemplate in generic terms events, conditions or changes which may impact on the financial condition of one party and it’s ability to perform the contract, giving right to a rise to terminate) are also difficult to rely on as a means of termination as MAC clauses tend to be drafted broadly and so will be difficult to trigger in the absence of express provisions for capital and exchange controls. In both cases, it will of course ultimately be a matter of construction, looking at the specific terms of the contract in question.
However, even if the imposition of capital and exchange controls would not give rise to a clear termination right, related events may be sufficient to trigger other termination or default events. For example, the effect of the controls may make it difficult if not impossible for a party to meet its payment obligations under a contract. This may trigger non-payment termination events, if any, in a contract.
For any new contract with a connection with Cyprus, a business could consider incorporating specific events which will trigger the force majeure or MAC clauses in such contracts. The parties might also include illegality as a termination event, which will allow either party to terminate a contract if it becomes illegal for a party to perform its payment obligations under the contract. As with the MAC and force majeure clauses, care should be taken to ensure that the illegality clause is wide enough to cover the unlawfulness of payment obligations pursuant to capital and exchange controls in place. If however a party can pay from a different jurisdiction then they will not be able to rely on illegality. Again, such clauses are strictly construed under English law.