European Union: The Effect Of The Eurozone Crisis On Commercial Contracts

Introduction

Even six months ago, the possibility of the eurozone fracturing was said to be remote. Today, the prospect of a default by a eurozone country followed by its exit from the eurozone is openly discussed. As a result, businesses are taking seriously the need to assess the impact that such an exit and its potentially unquantifiable consequences may have on them.

This note sets out:

• Some of the consequences of a eurozone fracture on commercial contracts;
• Some thoughts as to what can be done now to improve the position of existing contracts; and
• Provisions that should be considered for inclusion in new contracts.

Eurozone Fracture

If the eurozone fractures, various scenarios can be envisaged, including the following:

• A eurozone member abandons the euro as its currency and adopts a new currency; or
• The eurozone itself disintegrates and the euro becomes obsolete as eurozone members revert to national currencies; or
• The eurozone restructures, such that one or more economically "weaker" members leave and the remaining members re-denominate the euro, replacing it with a "new euro".

Legally, it is not currently possible for a country in the eurozone to abandon the euro unilaterally (nor is it possible for a country to be expelled). If a eurozone country wishes to withdraw, it will have to do so:

• Unilaterally in breach of treaty (being the Treaty on the Functioning of the European Union); or
• On some agreed basis by way of an amendment to the Treaty; or
• By leaving the EU altogether (which is permitted under the Treaty on European Union).

For the purposes of this note, we will assume that any fracture will be by agreement and that the country leaving the eurozone will remain a member of the EU (and thus a party to the treaties that govern the relationship between EU countries). The euro will continue to exist as the lawful currency of those EU member states in the eurozone. If a country leaves the EU, the legal consequences are considerably harder to predict.

Effect of a eurozone fracture on currencies

If a new currency is created by a weaker country, the conversion rate set by the government of the country (with or without the agreement of the rest of the eurozone) is likely to leave the new currency weaker than the euro. If a stronger country were to leave the eurozone, its new currency would probably appreciate.

Any government deciding to leave the eurozone may decide at the same time to impose capital/exchange controls either to prevent a flight to stronger currencies or, for a stronger country and currency, to prevent inflows of capital making the new currency too strong.

Effect of a eurozone fracture on commercial contracts

The main effect on commercial contracts of a country leaving the eurozone will be on the payment obligations where the euro has been replaced with an alternate currency in the country of one of the parties.

We will take as an example a contract under which a UK company supplies euro-priced goods to a customer in a weaker eurozone country, such as Greece, that leaves the euro and adopts a new currency. It is assumed that, as part of the process, Greece will redenominate euro-denominated contracts, such that the amount payable by the customer becomes priced in the new Greek currency at a fixed rate. This rate is likely to be higher (i.e. stronger) than the rate which the markets would otherwise determine.

Exchange losses

Depreciation of the new Greek currency against the euro (and other currencies such as sterling) will have certain consequences:

One of the parties will incur an exchange loss

• If the euro amount payable under the contract becomes priced in the new Greek currency, the customer will pay what is due as far as it is concerned, but the amount received by the supplier in terms of euros (converted from the new Greek currency at the market rate on the date of payment) will be less than before. If the amount remains priced in euros, the customer will have to pay more in the new local currency for the supplier to receive the same amount in euros.
• Where the euro is specified as the currency of payment, whether the customer is bound to pay in euros or the new currency is not usually a question of the law governing the contract, but a question of the law governing the currency. Under the rule of law called "lex monetae", a payment obligation in the currency of a particular country is an obligation to pay that amount in the legal tender of that country at the time of payment. This gives rise to a problem where the euro is stated to be the currency of payment. Is the lex monetae that of the continuing eurozone countries (which would mean payment in euros) or that of the leaving country (which would mean payment in the new currency)?
• The answer will depend on whether the reference to the "euro" in the contract is intended to be (i) the international currency known as the euro or (ii) the national currency for the time being of the country of the customer. If the contract is not clear on the point (and few contracts will be), the answer will depend on the country with which the contract has the closest connection, the considerations for which will include the governing law of the contract, the place of payment and the courts with jurisdiction. For example, in an English law contract with the place of payment in England, "euros" will probably be interpreted to mean the international currency; in a Greek law contract with the place of payment in Greece, "euros" might well be taken to be the national currency of Greece from time to time; i.e. the "new" drachma.
• There may be differences in approach depending on whether English or Greek courts have jurisdiction. Even if both the Greek courts (which would be bound to apply Greek law and give effect to the re-denomination of its currency) and English courts agreed that Greek law was the lex monetae to be applied, the English courts might not give effect to it on public policy grounds if Greece had left the eurozone unilaterally in breach of its treaty obligations.

The contract will continue as is, in the absence of any express provision

Unless there is a specific provision to the contrary, an exchange loss will not, under English law, usually be:

• A frustrating event (which would otherwise put an end to the contract);
• A force majeure event (which would otherwise, initially at least, suspend the obligation to pay); or
• A breach of contract or other event giving rise to a right of termination. The English courts have long held that changes in economic circumstances are simply risk factors for the parties and do not entitle the parties to be excused from contractual performance. However, termination might be available to a party if it were the beneficiary of a "material adverse change" representation or continuing representations by the other party - for instance, that performance by it would be lawful.
• The exchange rate differential may make it difficult for the customer to afford the revised payments. The customer then becomes a credit risk.

Capital controls, new laws and other consequences

Even if the currency of payment is held to be the international currency of euros, there may be a number of further problems for the supplier:

• The leaving country may impose capital/exchange controls or may re-denominate all debts owed by its nationals into the new local currency, making it impossible for the customer to meet its obligation to pay in euros.
  Failure by the customer could amount to a breach of contract, entitling the supplier to terminate and to claim as damages any exchange losses. An English court might well award damages, especially if the Greek government had acted in breach of treaty. A Greek court would probably not do so, being likely to give effect to the acts of the Greek government in such circumstances.
• Any legislation that prevented (as opposed to hindered) payment may amount to:
• • Frustration, in which case the contract would be at an end; or
  • A force majeure event, in which case the customer's obligation to pay would at least be suspended. Increased difficulty in performance will only be a force majeure event if the contract says that it is.

• The leaving country or the remaining eurozone countries may make other changes to the law that prevent or hinder performance (e.g. export controls). These again might frustrate or suspend the contract.
• Even if the withdrawal etc does not give rise directly to termination of the contract, cross default clauses could apply to terminate it if connected contracts are terminated.
• The enforcement of guarantees and security will require consideration.

Practical steps to be taken

What to do about existing contracts?

There are some steps that a supplier can take to help protect its position should its customer be based in a country that may leave the eurozone:

• Review all relevant contracts now in light of the possible risks and outcomes, so that the contractual position is at least known to the best possible extent.
• Determine the preferred commercial position.
• Discuss the issues with the other party so that commercial life under the contract can continue.
• Tighten credit terms, e.g. require deposits, shorten payment and debt collection times, increase interest for late payment, impose stricter retention of title.
• Increase credit security, e.g. letters of credit, bank and other guarantees, asset security.
• Ship in smaller quantities.
• Consider using local costs as a hedge, so that counter-balancing costs are also incurred in the leaving country.
• Try to agree amendments to the contract along the lines of those advised for new contracts below.

What to do about new contracts?

When negotiating a new contract with a customer who is in one of the more at risk eurozone countries, a supplier should consider one or more of the following steps:

• Try to contract instead with another group company based in a stronger eurozone country or outside the eurozone (commercial considerations may make that impracticable).
• Be specific about the currency of payment. It may be better to have payment in a currency other than euros, but if it has to be euros, define "euro" as the international currency known as the euro, not the domestic currency of the weaker eurozone country from time to time. Make payment in any other currency a breach of contract. If it is intended that payment should be made in the currency of the weaker eurozone country, the exchange rate for any new currency will be unknown unless and until withdrawal occurs, so, whatever assumptions are made, both parties will be taking some degree of exchange rate risk.
• Make the place of payment outside a weaker eurozone country.
• Do not have the law of the weaker country as governing law and do not give its courts jurisdiction to hear disputes.
• Include a right of termination specifically covering the introduction of a new currency of payment or other consequences of the withdrawal of the weaker eurozone country from the euro.
• Include a material adverse change clause covering the consequences of withdrawal.
• Include non-performance resulting from withdrawal from the eurozone in the list of force majeure events (this may alternatively or also be desired by the customer).
• Adjust the contract price or obtain an indemnity for any exchange losses resulting from withdrawal. Currency losses could be shared between the parties.
• Restrict the right to assign (and possibly to subcontract), if assignment (or subcontracting) may be to a company in a weaker eurozone country.
• Obtain a parent company or other guarantee, preferably from a person not based in a weaker eurozone country. Or seek to obtain security situated in a county that is not a weaker eurozone country.
• Include an obligation to consult in good faith. This may not be legally binding, but it will show an intention that the parties want to work together to solve problems.

If the supplier is based in the weaker eurozone country, many of the above arguments will be reversed. For instance, if goods or services are being bought from a supplier based in a weaker eurozone country, the customer will want to pay in the new currency following conversion – if it is not able to, the prices paid by the customer will be undercut by other customers of the supplier who are able to pay in the new currency.

Even then there will be risks associated with

• Overarching legislation passed by the EU, eurozone or relevant government;
• Enforcement;
• Capital and export controls; and
• The customer's ability to pay.

The analysis will be similar, but the issues are likely to be far more complex (and may be the subject of specific legislation) if the eurozone as a whole fractures into separate national currencies.

We suggest that you carefully monitor developments and publications over the coming weeks and months. Should you have any questions regarding how you could be impacted, please contact us directly.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.