Ireland has been a beneficiary of eurozone membership and it is clearly in the interests of only the very few to “talk down” the euro.  However, as the days pass, there is growing conjecture that at least some parts of the eurozone problem may be irreconcilable.  Analysis of the implications of a change in the eurozone, and giving thought to contingency planning, has become a discussion item at the board table. 

What is the backdrop?

2012 brings with it a number of key sovereign debt funding dates for European countries. To the extent a country cannot raise funds, and domestic and capital market pressures continue to build, it raises the prospect that a eurozone member may consider departing from the currency block.  This might be a managed exit, however, there is a lesser possibility that a country could “leave” unilaterally.

On a managed basis, a country could leave the eurozone but remain in the EU. However, if a country unilaterally chooses to withdraw from the EU, it must also leave the block. A unilateral withdrawal from the EU would require two years notice.

While predictions can be made, there are a number of variations in any form of fragmentation.  For example, an outright movement by the 17 members back to individual currencies cannot be fully ruled-out.  Equally, one might have a “northern” and a “southern” block, or just one or two break-aways with the eurozone otherwise broadly intact.  In contingency planning for extreme scenarios, thought may need to be given as to where Ireland might find itself in each of these eventualities (and, in turn, the impact for an Irish counterparty to a contract).

Legally speaking, how might this affect me?

The impact from an Irish point of view can only really be considered at the broadest levels until there is more clarity.  The area of key concern will be contracts where a party is located in, or closely linked to, an “exiting” jurisdiction.  To a greater or lesser degree this could therefore affect any type of contract which involves cross-border euro money flows, e.g.:

• Contracts for goods or services
• Hedging & other derivatives contracts
• Debt issues (sovereign & corporate)
• Loan agreements, leases, cash pooling
• Share and asset purchase deals

Although the parties will have a contract contemplating payment in euro, (the relevant currency at that time) if a debtor is no longer in the eurozone it may intend to make payment in its local currency instead.  Is it lawful to settle in this way? Can a creditor demand euro payment?

Given an exiting member is likely to be in economic stress; its currency may devalue relative to the rest of the block.  There may therefore be a desire that payment obligations are met in the harder currency – otherwise, the creditor suffers.  Ironically, the elimination of this currency risk was a central reason for the creation of the euro. 

What are the ground rules?

While the issues giving rise to the current crisis are unique, there have been currency break-ups, and related disputes, in the past.  There are therefore some existing legal principles which can partially inform the analysis.

What form would a departure take?

The nature of the financial markets and the eurozone means systems are closely interwoven.  Given the “Lehman moment” that a unilateral withdrawal would bring, the probability is that, if it ever happened, an exit would be a managed gradual process.  It would involve domestic and EU legislation, as well as broader international support, and have features including:

• New currency law – the country “leaves” the eurozone through domestic legislation creating a new national currency.  This is exchangeable into euro at an initial specified rate.  The currency becomes effective at a given time, after which it may be traded (subject to controls) and probably moves immediately to its own “floor”.  The currency law will have other aspects, such as new payment systems and clearing arrangements as the euro “pipework” can no longer be accessed. 
• Exchange controls – moving currency in and out of the country is restricted through the implementation of exchange controls.  To the extent foreign exchange in the new domestic currency is transacted, permits are needed.  Exchange controls would probably require IMF agreement.
• Tariffs – on the basis the new currency may be worth less than that of other currencies, it creates an immediate competitive advantage.  Depending on how the exit occurs, states may wish to impose duties and tariffs on the exiting country to redress this, though such restrictions are generally prohibited within the EEA.

How does this affect legal agreements?

An area which the eurozone crisis brings into focus is the “boilerplate” in contracts.  These are the provisions that top and tail a contract but do not set out the specific commercial agreement. These technical pieces will be a key part of the analysis.  Broadly, this analysis will include as follows:

• Is “euro” defined? – longer-form agreements will define what a euro “is” but a lot of contracts may have no definition.  Where the definition includes, for example, that it is the currency for the time being of the Member States which have adopted the common currency, there is a clear expression that it is the common euro that is the reference currency.  However, if the document is silent (or perhaps something like “the euro being the currency of Ireland”) there is scope for dispute.
• “Lex monetae” – is a legal principle in most jurisdictions that if a document references a currency of a country, the rebuttable presumption is that if the country changes its currency the contract is treated as if made with reference to its successor currency.  This principle might prove difficult to operate where, for example, one country leaves the currency block but the euro remains in existence (i.e. which is the “successor” currency?)  One may then start looking to other connections, such as the place of payment under the contract.
• Jurisdiction – as part of the analysis of the “boilerplate” the place where the parties have agreed litigation will occur will be central.  The crisis brings into focus conflicts between national self interest and the broader interests of the eurozone as a whole.  If a contract is litigated, in the courts of the exiting state, national public policy may (legitimately) be preferred. The local court, before which an order for recovery of a debt might be sought, may therefore be required to follow its new domestic currency legislation.  This may therefore mean an award in the local currency, not euro.
• Governing law – an element which sits side-by-side with the courts that have jurisdiction will be what the contract says about which law is used in interpreting the contract in dispute.  To the extent that both governing law and submission to jurisdiction refer to the local jurisdiction, it further heightens the likelihood of an award in the new domestic currency.
• Others – there will be a range of other influencing factors, in part dependent on the subject matter of the contract involved and connection with a given jurisdiction, or location of a party.

How will agreements be enforced?

A euro-denominated award by a court outside the country in which the debtor is based (which has left the zone) may still have to be enforced in the local country’s courts.  This would involve application before local courts, which may not be minded to enforce in the euro amount.  There is also every chance the litigation process may become drawn-out.

Creditors in these situations will also typically begin to focus on other areas of recovery – e.g. set-off provisions or recourse to guarantees and other secured assets sitting outside the jurisdiction of the debtor.  The potentially multi-jurisdictional aspects would therefore need to be carefully analysed.

Experience from previous crises, for example when Russia suffered its oil crisis, suggests that attention quickly moves from a desire to collect the debt to analysis of relevant insolvency laws. An example of the financial stress debtors may come under would be the application of cross-default provisions, where a default under one payment obligation (e.g. payment in non-euro) means a default under all finance documents.  There is therefore an acceleration of all creditor claims.

A “sting in the tail” which is also mentioned with regard to insolvency proceedings is that, under international conventions, typically even where an award is granted in euro the debt must automatically convert to the local currency at the time a liquidator is appointed.  To the extent a currency is devaluing rapidly, this can therefore have the effect of further undermining the amount recovered.

What can I do now?

Although the picture remains unclear, there are a number of steps which can be taken or factored into business dealings pending final resolution of the crisis:

• Contingency planning – although the chances of any exit remain remote, there is no real down-side to planning.  It pays to be aware of the possibilities, particularly in new negotiations.
• New contracts – there should be renewed focus on “the boilerplate” provisions in all cross-border contracts with a payment obligation in euro. Is the definition of “euro” appropriate?  If there were a eurozone exit, which court and governing law jurisdiction is best to apply in the contract?  Similarly, is there a preferred approach to payment arrangements – e.g. either in amount, or indeed in place and manner of payment?
• “Material adverse change” provisions – negotiations and contracts may need to factor-in some type of “walk away” provision should there be a euro exit or other relevant change. 
• Due diligence – parties need to be aware which countries may be exposed to a devaluation event.  In takeover deals, this may mean greater focus on income streams and location of assets.

Contributed by Eoin Caulfield.