With the ongoing turmoil regarding the European financial debt crisis we noticed that investors, companies and other clients doing business in the Member States of the European Union are increasingly concerned about the consequences of the Euro collapsing and the European Member states that hold the Euro as currency (the “Euro States”) being potentially forced to return to their old currency. Various questions arise in respect of future scenarios for investors and companies that are party to contracts which require payment in Euro’s or are denominated in Euro’s. Although a complete “Euro fail” at this moment is still considered as a theoretical event, a drop-out by an individual Euro State may very well occur. In this newsletter we elaborate on possible points of attention in the event one or more Euro States return to their former currency and, in particular, on the issues arising in relation to contracts that contain multi-jurisdictional or cross border transactions which are either euro-denominated or have payment requirements in Euro. The re-establishment of a national currency may bring legal uncertainty regarding the re-denomination of existing contracts in the re-established currency.
As indicated, a full collapse of the Euro seems highly unlikely, but nevertheless not completely impossible. It is safe to state that (European) law and regulations as well as most contracts entered into with European parties do not address such a situation. The legal consequences are uncertain as no party has foreseen such a scenario or a reversion to the old currencies.
Taking into account that it is unclear if or how a Euro State can exit the Euro-zone, given that there is no legal structure to facilitate such an exit, the practical consequences of a collapse of the Euro are hard to predict. In addition, it is unclear which route the Netherlands (and the European Union) will take with regard to further actions. Therefore the following comments is rather speculative and there is no guarantee that one of the following scenarios will actually occur or will play out as described.
It should be noted that an exit of the Euro (the “Exit”) will most likely be dealt with on political level and not on a legal (European treaty) based exit. Article 50 of the Treaty of Lisbon allows a (complete) European Union withdrawal of a Member State. Such a withdrawal also includes an exit from the Euro-zone, although it may be argued that this is perhaps not necessary. In any event, no clear provisions exist relating to a Member State leaving the Euro-zone.
In respect of cross-boarder contracts, it is important that such contracts and any new contracts entered into should at least deal with:
- governing law and jurisdiction;
- currency of the contract and dispute settlement options;
- place of payment;
- currency fluctuation risks; and
- termination event and an event of default.
Each of these subjects are addressed below. Furthermore, we set out some basic example clauses that deal with these matters.
- Several scenarios
The first scenario is that the Euro-zone will collapse entirely and each Euro State would revert to its old currency. In this scenario, banks may face problems and may need to recapitalize if the new currencies (rapidly) devaluate. The banks’ debts will be converted into the new currency, but their claims will remain in Euro. Also, a further issue will arise regarding (commercial) contracts that stipulate the Euro as applicable currency.
The second scenario is for the North-European and South-European countries to divide the Euro-zone and will a new currency; possibly the NEURO and the SEURO. Although this scenario may seem unlikely, it is possible that in such scenario some form of exchange controls will be imposed, within the scope of European law, in order to limit any damage caused to the new (South-European) currency.
The third scenario is the departure of (a) weaker Euro State(s) from the Euro-zone. This could result in an increase of value of the Euro. This scenario will of course have no immediate effect on the outstanding (commercial) contracts in the Netherlands. However, there may be effects for (Dutch) companies doing business in such a existing Euro State. In the absence of a statutory intervention, contracts clearly denominated in Euro will remain denominated in Euro. This will, however, result in financial consequences for one of the contract parties, as the new currency would almost certainly be worth less than the Euro. The biggest issue the exiting Euro State would face is the possibility of a capital flight to more stabile economies.
Although other scenarios are probable and the above is not an exhaustive limitation of possible scenarios, these scenarios do serve to clarify some (legal) issues that may arise.
- A departure from the Euro-zone
As mentioned above, the withdrawal of a Euro State from of the Euro-zone, the break up of the Euro into domestic currencies or an entire collapse of the Euro itself will most likely first be dealt with on a political level. A Euro State leaving the Euro-zone will have to adopt legislation that enables the Euro State to do so. This newsletter does not describe how or if there can be a domestic or other legal basis for a withdrawal from the Euro-zone, but provides guidance on several issues arising from such withdrawal.
One of the issues that is momentarily unclear and is of great concern to investors, companies and other parties involved in a country (possibly) leaving the Euro-zone, is whether a creditor can claim for payment in Euro from debtors or whether creditors are under an obligation to accept payment in the new (revived) currency.
- Contracts and currency
In addition to the practical issues arising from re-establishing a national currency, a significant issue concerns the enforceability of contracts between debtors an creditors in the exiting Euro State. As indicated, no current laws or legislation cover the abolishment of the Euro and a subsequent establishment of a new national currency.
At the time of implementation of the Euro, the question was raised whether courts would enforce contracts that were issued in the (old) national currencies of a Member State. These currencies would be converted to the Euro. In Council Regulation (EC) 1103/97, recital 7, it was decided that:
“it is a generally accepted principle of law that the continuity of contracts and other legal instruments is not affected by the introduction of a new currency.”
Instead of relying on the principles of law, the European Union issued Regulation 235. Article 3 of this regulation states that:
“The introduction of the Euro shall not have the effect of altering any term of a legal instrument or of discharging or excusing performance under any legal instrument, nor give a party the right unilaterally to alter or terminate such an instrument. This provision is subject to anything which parties may have agreed.”
This provision, which has effect in the entire European Union (and not just the Euro-zone), ensures that contracts are enforceable in Euro if there is no agreement stipulating otherwise. Accordingly, this provision, at least within the European Union, ensured that contracts issued under national currencies could be re-denominated in Euro.
It is not unrealistic or improbable to imagine that the exit of a Euro State is likely to be discussed on a political level prior to a possible inclusion of a similar provision as Regulation 235 in order to return to the old currency. If the European Union will not do so, the Member State that departs from the Euro-zone would probably itself issue a decree by which all domestic (commercial) contracts, including all deposits, government bonds, loans, prices and pay, are transferred into a new currency. This creates a new issue for contracts and parties concerned. Contracts between companies which both reside in the same (exiting) Euro State should, in principle, not be affected by an exit. The contract would be redenominated in the new (revived) currency of the particular country and the parties to the contract would most likely continue business as usual.
In the EU, the general law applicable to a contract and the manner of performance are governed by the Rome I regulation (the “Regulation”).
The Regulation prescribes that the law governing the relationship between the rights of creditors against debtors determines which courts have jurisdiction. In the event that a contract is governed by the law of the exiting Euro State, the courts of that Member State will in principle apply its own national law and recognise a change of currency.
On the other side, if a contract contains a foreign jurisdiction clause, the courts of the exiting Euro State will not have jurisdiction. Therefore a foreign jurisdiction will regulate of a change of currency. A problem arises for parties in the event the Euro is abandoned all together. Even when parties have agreed that payment will continue in Euro after a change of currency in a departing Euro State, a contract will most likely not contain any arrangement in the event the Euro ceases to exist. As a result thereof, presumably the currency of the country of the governing law of the contract will be upheld, until parties agree otherwise.
A (foreign) court would in principle apply its (own) laws in order to decide which law governs the contract. The Regulation does, however, provide for the absence of a choice of law in a contract. It should be noted however that parties to a contract may (and should) negotiate a solution for the switch in currency. Firstly parties should be concerned whether they can fulfil their (payment) obligations and secondly the currency in which payment is due.
A problem arises if a claim is converted to the desired currency and, due to exchange rates, the amount of the claim/obligation increases on the side of the debtor who can therefore not fulfil his obligations. An exiting Euro State returning to its former currency would probably have a (rapid) devaluation of its currency, and the debtor, in order to fulfil its obligations under the contract, will have to pay in its own currency an amount equal to the Euro amount agreed. The costs for the debtor may become unbearable.
- Back to the drawing board
The difficulties that arise in contracts are likely to be in respect of businesses in countries that exit the Euro-zone. Unfortunately it is impossible to draft or suggest clauses that can effectively cover all the scenarios that might occur, given the political uncertainty and uncertainty regarding the course of a Euro-zone break-up or exit of a Euro State and the variety ways in which investors, companies or other parties do business. However, we will note some points of attention below.
Monetary (payment) obligations are governed by the principle of nominalism. This means that inflation and currency depreciation are to be considered irrelevant. In principle, the rule is that a creditor cannot require a debtor to pay an amount if the (new issued)currency is depreciated by inflation or otherwise. This means creditors can claim only the nominal amount of debt and cannot insist on a revaluation after the change of currency. However, parties that wish to avoid an exchange-rate risk might agree to allocate the risk to a particular party. Additionally, these risks might be hedged with derivatives.
Furthermore, the principle of the lex monetae could apply to a contract. Under this principle, the European Union establishing the legal status of the Euro is universally recognised and that the provisions governing the conversion from national currency to the Euro and the continuity of contracts are respected (in other jurisdictions). To clarify by example, if a contract governed by Dutch law requires payment (in Euro) to the bank account of a company in a departing Euro State, it is possible that the law of the departing Euro State will be applicable to matters relating to the currency of payment (to the relevant bank account). If the currency of this Euro State were to change from Euro to its old currency, the old currency could be considered as the currency of payment under a contract governed by Dutch law. Parties should include in contracts that contain multi-jurisdictional or cross-border transactions (which are either Euro-denominated or have payment requirements in Euro) clear wording that the currency of the contract will remain in Euro regardless whether or not the (counter)party remains in the Euro-zone. For example , for a Dutch company doing business with a company in a(n) (imminent) departing Euro State, it might be prudent to include a clause with wording which stipulates:
“This agreement is denominated in Euro and all payments under this agreement shall be in Euro. If the Euro ceases to be the currency in the country of residence and/or principle place of business of a party to this agreement, all payments under this agreement shall continue to be in Euro. Any conversion necessary from a new currency to the Euro shall be at the official rate of exchange as recognised by the central bank of [•].”
If the Euro is abandoned as a whole and the Euro States return to their former currencies, parties to a contract should include a clause in the contract identifying a substitute currency:
“If the Euro ceases to be a currency in the Euro-zone and any other country, parties shall determine that all payments under this contract shall continue [under the currency recognised by the government as lawful new currency of [•]] or [in United States Dollar].”
Presumably, existing contracts do not contain such a clause and, therefore, if parties cannot agree otherwise, the appointed courts will have to decide which currency applies
When a change of currency takes place, there will presumable be a period in which both currencies, the old and the new, will be an effective payment currency. Another provision can be inserted to deal with this problem.
“if more than one currency or currency unit are at the same time recognised by the central bank of any country as the lawful currency of that country, then (i) any reference in the contract to, and any obligations arising under the contract in, the currency of that country shall be translated into, or paid in, the currency or currency unit of that country designated by [Party X] (after consultation with [Party Y]); and (ii) any conversion from one currency or currency unit to another shall be at the official rate of exchange recognised by the central bank for the conversion of that currency or currency unit into the other, rounded up or down by [Party X] (acting reasonably).”
In addition to the above, the place of payment can determine the currency of payment, even if the currency of payment is clearly specified. Therefore, even if a bank account is denominated in Euro or a contract specifies Euro payments, if the place for payment is in a Euro State that exits the Euro-zone, such Euro State could pass legislation to the effect that payments are to be made in the new currency. Such a clause could contain wording as follows:
“Parties to this agreement agree to establish and maintain a Dutch designated account with a Dutch designated account bank (as would be defined in the agreement) for the purpose of receiving the payments due [resulting under this agreement] made by [Party X] to [Party Y].”
Further, parties should check or include that the (possible) exit of a Euro State from the Euro-zone may be included in the force majeure clause, in such a way that this includes currency exchange controls or that such an event falls in the scope of an event of default as defined in a contract. The same applies to material adverse change clauses.
For example, if a material adverse change clause stipulates that a material effect on a company’s financial condition or business prospects triggers the clause, it is unclear if an exit from the Euro-zone has material effect. Depending on the contract, parties may include:
“an exit from the Euro-zone of a country in which a party to this agreement has its country of residence and/or principle place of business, constitutes a material adverse change.”
Parties should also consider a contract clause which prohibits transferring the agreement to (counter)parties in a Member State which is exiting the Euro-zone.
It is advisable for Dutch companies doing business with other Euro States, especially those countries on the brink of departing from the Euro-zone, to include in the contract, Dutch governing law, Dutch jurisdiction or dispute settlement mechanism, clear wording that Euro will be the currency and specify the Netherlands as place of payment. The above mentioned is of course applicable if the Dutch company wishes to maintain the Euro as currency, only there may be commercial reasons for a Dutch company to change the applicable currency.
Further, most basic contracts do provide against currency fluctuation risks. The possible financial loss from conversion of the new currency to the Euro will have to be borne by either party. It is of course possible that for example a Dutch company wishes for the risk to be carried by the company residing in an exiting Euro State. A clause might contain wording such as:
“In the event [party X] suffers loss due to payment after conversion of the [new currency] to the Euro, [Party Y] shall as an independent obligation make a compensated payment within  business days after the original payment. The compensated payment covers any cost, loss or liability arising out of or as a result of the conversion, including, but not limited to, the rate of exchange used to covert the [new currency] to the Euro.”
One should bear in mind that if the parties allocate the risk of such currency fluctuation to solely one of the parties, this may cause financial troubles to such party. E.g. if the new currency unit of an departed Euro State rapidly devaluates to one to three to the Euro, a company doing business and earning money in such country (and presumably being paid in the new currency), may not be able to fulfil its payments under a contract. Such a company must pay three new currency units for every Euro due.
As mentioned above, a contract will not end because a change of currency. Parties may however, wish to include in (new) contracts a clause that stipulates that the contract terminates automatically if a designated country exits the Euro-zone. The parties could negotiate a new contract stipulating the new currency (rates) and prices. For example:
“In the event that a country [specified in the agreement] either voluntary or forcibly to exits the Euro-zone, and as such issues a new lawful currency, this agreement is automatically terminated.”
However, parties may wish to continue business, so an additional clause may be included:
“After the automatic termination of the contract under clause [•], parties to this agreement shall undertake to negotiate a new agreement using their best efforts to do so.”
Alternatively, in case parties do not wish that such an event automatically terminates the contract, but do wish to alter or amend the contract to include new provisions, the following wording may be used:
“In the event a change in the currency of a country occurs, this contract will, to the extent [Party X] (acting reasonably and after consultation with [Party Y]) specifies to be necessary, be amended to reflect the change in currency and any other obligations relating thereto, including, but not limited to, [place of payment and/or currency of the contract].”
New contracts should at least deal with governing law and jurisdiction, the currency of the contract and dispute settlement options. Furthermore, parties should consider including in the standard documentation a clause which stipulates a place of payment.
The consequences of a break up of the Euro-zone cannot be easily foreseen. Even if the break up is properly supervised, banks (and companies) in the Euro-zone would face several difficulties. Due to the (re)introduction of new currencies domestic and foreign assets and liabilities will no longer match.
Speculation about the potential impacts of the possible break-up of Euro-zone is rife. It is of course only speculation and the only aspect most economists really agree on is that a break-up will trigger a recession in the European Union at least in the short term. This scenario is becoming increasingly certain as the Euro-zone crisis continuous and seemingly intensifies, particularly given the current weak or absent growth figures.
The draft wording above gives parties and counterparties an idea of the possible adverse issues they could face and hopefully will give some guidance on how to deal with those issues. Should you have any questions or would like to discuss any of the above mentioned, please do not hesitate to contact Matthijs Bolkenstein or Michiel Jaeger.
Note: Any reference to a law or a regulation is limited to those laws and regulations effective in the Netherlands, unless specifically mentioned otherwise.