Effects of Departures of Countries from the Eurozone on Euro-Denominated Contracts
June 21, 2012
An exit by one or even more countries from the Eurozone1 is not an impossibility any more. Some go further and say it is only a question of time. If it happens, it is unclear at this point whether such departure will be voluntary or involuntary and if it is voluntary, whether it will be with or without consent of the other nations of the Eurozone. Whatever the details of such a departure are, there would be repercussions on existing Euro denominated legal arrangements between U.S. companies (or companies located in non-departing European countries) and companies located in the departing country. A decision will have to be made whether (i) such contracts should remain denominated in Euros or (ii) should be “converted” into contracts denominated in the new local currency (e.g. Greek Drachma or Spanish Peseta) of the departing country, and in the latter case at what exchange rate. As it is widely anticipated that the new currency of a departing country will weaken immediately following its departure, those decisions would have a major impact on the economics of a contractual arrangement. Litigations could ensue that could be avoided by addressing these issues now both in newly entered contracts or in modifications to existing contracts.
Effect of Departure on Validity of Contract
Under general principles of contract law, continuous contracts will not be invalidated by a currency denomination. Legal doctrines such as frustration of purpose or impossibility as well as force majeure or material adverse change clauses may be invoked by one of the contracting parties to invalidate a contract, but the success of such arguments is doubtful. It is safe to assume that the vast majority of contracts will remain enforceable.
The issue then is in which currency payments will need to be made by a contracting party which is located in a country departing the Eurozone. Consider for instance a U.S. supplier of goods to Greece or Spain who, as provided in the underlying supply agreement, expects payments in Euro and has entered into a currency hedging arrangement with its bank to protect against currency exchange rate fluctuations between the U.S. Dollar and the Euro. That supplier will prefer to continue to be paid in Euro. If it were forced to accept payment in Drachma or Peseta going forward, calculated based on the conversion rate between the Euro and such currency at the time of departure of Greece or Spain from the Eurozone, the supplier would run the risk of a devaluation of the new local currency going forward. Currency hedging may continue to be possible, but at a very different cost.
Which currency will apply following departure of a Eurozone country is unclear, absent specific provisions in the contract to address the issue. Under principles of “lex monetae”, irrespective of the choice of law in the contract, the law of the currency issuing country controls matters relating to currency. For example, when the members of the Eurozone converted their local currencies into Euros on January 1, 2002, the laws of the member countries provided for contractual payment obligations denominated in the local currency to be converted automatically into Euro obligations. However, the situation is not that clear in the event of a departure of a country from the Eurozone. After all, the Euro would continue to exist, and it is an open question at this point whether the legislature of the departing country would have the authority to convert Euro obligations into obligations expressed in the new local currency following departure. A local court in the departing country will potentially have a different view on this question than a court located elsewhere in Europe or in the United States. Having said this, specific contractual provisions addressing issues of payment currency would in all likelihood preempt any statutory default rules.
Contracts that may be affected by issues relating to currency conversions in countries departing the Eurozone include, but are not limited to:
- Long-term supply and customer agreements;
- Loan agreements and bonds;
- Joint ventures and other cooperations;
- Inter-company arrangements;
- Hedging and other derivative arrangements; and
- Acquisition and earn-out arrangements.
U.S. companies (or companies located in non-departing European countries) with contractual arrangements with companies in countries that may possibly leave the Eurozone should review their risk exposures related to a possible currency conversion. Elements that should be reviewed include, but are not limited to:
- Definition of payment currency;
- Governing law;
- Jurisdiction; and
- Location of payment.
Following such analysis, it may be necessary to (i) modify existing contracts or (ii) change provisions of forms of contracts for future use, to avoid any identified risks related to currency conversion.
Gibbons P.C., through its Cross-Border Transactions Group, has the necessary experience to help its clients in the United States or abroad to maneuver around any potential currency risk exposures in their cross-border contracts.
This alert was prepared by Peter Flägel, a Director in the Cross-Border Transactions group in the firm’s New York office. If you have any questions, please also contact Frank Cannone, or any member of our Cross-Border Transactions Group.
1 The Eurozone currently consists of consists of Austria, Belgium, Cyprus, Estonia, Finland, France, Germany, Greece, Ireland, Italy, Luxembourg, Malta, the Netherlands, Portugal, Slovakia, Slovenia, and Spain.