The implications of the Euro crisis on contract drafting
The probability of an exit of certain members or even a breakup of the Eurozone has increased in recent months. Against this background, persons in charge of drafting contracts should consider the implications of such events. Furthermore, it is crucial to assess to what extent existing contracts should be amended. This article explains the legal framework and provides some practical advice.
Currently, there is great uncertainty as to whether the Eurozone will continue to exist in its present composition. Many believe that an exit of Greece from the Eurozone, and potentially also from the European Union (“Grexit”), is forthcoming. The president of the European Central Bank (ECB), Mario Draghi, emphasized in a recent speech that the ECB will undertake all necessary steps to preserve the Euro. He did not, however, comment on a possible exit of individual EU member states from the Euro. A complete breakup of the Eurozone, which would be accompanied by a return to 17 national currencies, is still seen as rather unlikely. However, the Euro Group Chairman, Jean-Claude Juncker, has already warned of a Eurozone collapse.
Taking the implications of an exit of member states and of a Eurozone breakup into consideration when drafting new contracts and evaluating existing contracts is not an easy task, especially given that references to this very relevant topic are scarce in the legal literature.
To simplify matters, we will deal primarily with the scenario in which a crisis state exits from the Eurozone, although our comments do largely apply mutatis mutandi to a Eurozone breakup as well. Furthermore, this article only deals with the constellation in which the debtor of a payment claim is located in a crisis state. In such a case, the creditor’s objectives will be to be paid in Euros following the exit, and to be able to actually enforce this claim. If, to the contrary, the creditor of a payment claim is located in the crisis state, it would be advantageous for the debtor to have the right to render payment in the crisis state’s new currency, as this new currency will likely rapidly devaluate against the Euro.
2. Drafting proposals
Elements that should be included in a contract with a debtor of a payment claim from a crisis state are (of course depending on the circumstances of the case at hand and the dynamics of the negotiations), among others:
- Rights of rescission or termination, for example in the event of an exit of a crisis state, or in a case where, following the exit, it is no longer legally or factually possible to render payment in Euros
- Definition of Euro as the currency in force in a non-crisis state from time to time, or (if a breakup scenario is seen as unlikely) as the common currency of the Eurozone countries in its composition from time to time
- Choice of applicable substantive laws of a non-crisis state
- Submission of disputes to an exclusive venue outside a crisis state
- Place of payment outside a crisis state
In the current economic environment, increased attention should be paid to other contractual terms as well. In particular, “force majeure”- and “material adverse change”-clauses, references to reference interest rates (in particular EURIBOR) and to financial ratios (like in financial covenants in loan agreements), as well as a number of other terms and conditions should be reassessed with a view to their appropriateness in the event of an abolition of the Euro in a crisis state.
In addition, it is important to verify, prior to the conclusion of a contract, whether substantial assets of the counterparty are located outside the crisis state. This will facilitate the enforcement of a claim since, following an exit of the crisis state, the enforcement of a payment claim denominated in Euros could be complicated if not impossible.
3. Regulatory Environement
We cannot say with absolute certainty which of the aforementioned measures might be successful in a particular case, as it is not fully predictable which rules the EU and the concerned state would enact in the event of an exit. Such rules could lead to a nullity or unenforceability of certain contractual terms. Therefore, while these proposals may decrease the risk of adverse consequences, they cannot serve as a safe harbor. We will explain in more detail below the circumstances under which the drafting proposals set out above could potentially have a protective effect.
The most relevant question in this respect will be whether the exit will be effected in a “regulated” or an “unregulated” fashion. In the event of a regulated exit, legislation dealing with the implications of the exit on existing contracts would be enacted at the EU level, accompanied by corresponding rules in the exiting state. In the event of an unregulated exit, rules would be enacted only by the national legislation of the exiting state and not at the EU level.
4. The "regulated" exit
It is not a given that creditors in non-exiting states would fare better in the event of a regulated exit. By way of a political compromise, certain protective measures for the benefit of the local economy and general public could be conceded to the crisis state within the framework of a regulated exit.
To understand what kind of rules could be implemented at the EU level, it is helpful to consider the contents of the regulation enacted in connection with the Euro’s introduction in 1997 (“Euro Regulation I”). In particular, the Euro Regulation I determined that the principle of continuity of contracts was to apply. Due to the applicability of this principle, the introduction of the Euro warranted neither a release from contractual duties nor a non-fulfillment of contractual obligations, nor did any party have a right to unilaterally amend or terminate an agreement. However, the principle of continuity of contracts was subject to deviating arrangements agreed upon by the parties to the contract at hand.
It is more likely than not that comparable continuity rules would be enacted in the event of a regulated exit. In addition, a similar EU regulation could, for example, stipulate that the debtor of a payment claim located in the exiting state would have the right to render payment in the new local currency instead of Euros. In such a case, the creditor of the payment claim would not have the right to rely on the German principle of “Wegfall der Geschäftsgrundlage” or the (comparable) common law principle of frustration of contact based on the argument that due to the expected devaluation of the new local currency, either an extraordinary termination of the contract would be justified or a higher nominal amount of the new currency would be owed.
The freedom of contract with respect to deviating arrangements between the parties (which would potentially be granted as was the case in the framework of the Euro Regulation I) would allow for problem-solving measures. For example, the parties could agree on a right of extraordinary termination in the event of an exit or in the event that the debtor of the payment claim is no longer obliged to pay in Euros (see drafting proposal 1. above). Furthermore, a contractual provision could potentially be upheld, whereby in all cases, including an exit, a claim would have to be fulfilled in Euros and not in any new local currency (see drafting proposal 2. above). Given that the respective EU Regulation would be enacted on the basis of consultations with the legislature of the exiting state, judgments rendered on the grounds of respective contractual provisions should be enforceable in the exiting state under normal circumstances.
5. The "unregulated" exit
In the scenario of an unregulated exit without legislation at the EU level, in addition to the creation of a new currency, the exiting state would most likely enact rules that contain mandatory conversion rates, capital transaction controls, and prohibitions of payment and of legal enforcement with respect to claims denominated in Euros. It seems conceivable that the drafting proposals 1. and 2. set out above would not be upheld by the courts of the exiting state. In such cases, the focus of the creditor’s efforts should be to obtain a judgment of a court with its seat outside the crisis state in order to pursue enforcement actions with respect to assets located outside the crisis state. To achieve this objective, the applicable substantive laws of a non-crisis state (see drafting proposal 3. above), an exclusive venue outside the crisis state for submission of disputes (see drafting proposal 4. above), as well as a place of payment outside the crisis state (see drafting proposal 5. above) should be agreed upon. An alternative instead of an exclusive venue outside the crisis state would not be sufficient as jurisdiction would be given to a court within the crisis state if proceedings were first brought before a court in the crisis state.
For a variety of reasons that cannot be explained in detail here, these drafting proposals should be implemented cumulatively. If, for example, the agreed upon venue was located outside the crisis state, but the substantive laws of the crisis state applied, a newly enacted law of the crisis state whereby payment claims have to be fulfilled in the new currency (instead of Euros) could be upheld by the court of the non-crisis state. If, conversely, a venue with its seat in a crisis state was agreed upon, but the substantive laws of the non-crisis state applied, it would be uncertain whether the court of competent jurisdiction would give effect to a contractual provision if these provisions were contrary to mandatory laws or public policy of the crisis state. Finally, the choice of a place of payment outside a crisis state would ensure that laws enacted in the exiting state, which apply to cases in which the place of payment is located within the exiting state, will not be relevant. It is, however, not certain whether such a provision would be enforceable if the substantive laws of the exiting state applied or if a venue in the exiting state was chosen.
It is conceivable that a number of the national laws that would be enacted in an exiting state would not be compliant with European laws. However, it is possible that the exit from the Eurozone would be accompanied by an exit from the European Union. In any event, it would be a very time-consuming exercise, fraught with uncertainty, to invoke the invalidity of the national legislation of an exiting state on the basis of European laws.
The remarks contained in this article only begin to shed light on the many complex issues connected with the abolition of the Euro in a member state or of a Eurozone breakup. Against the background of the existing uncertainties, and in particular with respect to potential future activities of the national and the EU legislatures, comprehensive protection is probably difficult to achieve. Rather, the focus should be to minimize the risks to the extent feasible. We highly recommend clients consider the protective measures we have outlined when drafting new or revisiting existing contracts.