Finance Briefing. May 2012

Transcription

1 Finance Briefing May 2012 Contents Introduction Possible Outcomes of the 02 Eurozone Crisis 2. What are the Options for a 02 Withdrawal and How Might it Happen? 3. Existing Loan Agreements The 03 Potential Consequences 4. Mitigation Action Contingency Planning 10 Contacts 11 The Eurozone Crisis and Loan Documentation The financial crisis in the eurozone continues unresolved with, as yet, no definitive solution in sight and market participants are increasingly focusing attention on the possibility of, and the potential consequences of, some form of break up. Against this backdrop, this briefing considers the issues that may arise from a break up of the eurozone in the context of loan financings and, in particular, the risks of redenomination. The consequences of a break up may vary significantly depending on a number of factors, including those of general application and the specific features of each individual financing. Factors of general application include the manner in which any break up occurs, whether it is effected on a lawful or an unlawful basis and whether it involves exchange controls. For the reasons discussed below, there is a significant chance that any break up would be effected on an unlawful basis and that it would involve exchange controls. The financial crisis in the eurozone con tinues unresolved with, as yet, no definitive solution in sight and market part icipants are increasingly fo cussing attention on the possibility of some form of break up. Specific features of loan financings affecting the consequences of any breakup would include the governing law, the lex monetae (explained below), the jurisdiction of the parties and the terms of the relevant documentation. Provisions such as those dealing with the place specified for payments and currency definitions are likely to have a significant bearing on the impact of a break up on any particular financing. Although it is not possible to predict how any break up might occur it is possible, by analysing the issues which would affect the consequences of a break up, to identify the scenarios (both factual and contractual) likely to afford the greatest protection against the risks of redenomination. wfw.com

2 02 FINANCE BRIEFING 1. Possible Outcomes of the Eurozone Crisis There are a number of possible outcomes to the eurozone crisis, each of which may have different implications. These include: Dissolution of the eurozone involving dissolution of the eurozone, abandonment of the euro by all eurozone member states (EMS) and the introduction of new national currencies in the former eurozone member states. There are a number of possible outcomes to the eurozone crisis, each of which may have different implications. Break up of the eurozone involving one or more EMS withdrawing (a withdrawal) from the eurozone and the departing member state(s) (DMS) introducing, among other things, a new national currency. A dual or multiple euro instead of one or more EMS departing from the eurozone, they would adopt a secondary ʺnationalʺ euro which would have a lower value than the euro, allowing them to stay in the eurozone but also to devalue their currency. Default without exit involving an EMS defaulting but not leaving the eurozone. Orderly resolution without default or exit. The remainder of this briefing focuses on the withdrawal scenario. Different or additional considerations would apply in other scenarios. 2. What are the Options for a Withdrawal and How Might it Happen? A withdrawal may occur in a number of ways and the analysis of its potential consequences would depend significantly on the legal basis of the withdrawal. The EU treaties do not provide for an EMS to leave the eurozone without also leaving the EU. Under Article 50 of the Treaty on European Union, an EMS may voluntarily leave the EU (which would also involve leaving the eurozone). However, significant issues would arise if an EMS wished to leave the EU because it would be necessary for it to consider, and deal with, the effect on its legal relationships with the other members of the European Union (MS) and the effect on that part of its domestic law constituted by existing EU law. Moreover, the use of Article 50 involves numerous steps and a lengthy process. An agreement must be negotiated between the EU and the MS wishing to withdraw and the agreement must be approved by the European Parliament. The EU treaties cease to apply to the relevant MS on the withdrawal agreement becoming effective or, failing that, two years after the original notification from the MS of its intention to withdraw. As there is no clear legal basis for an EMS to leave the eurozone (without also leaving the EU), it is not possible to predict the basis upon which this may occur. However, the potential scenarios might be broadly as follows: Withdrawal from the EU under Article 50 For the reasons set out above, this is unlikely to be a practical option. Consensual withdrawal from the eurozone on the basis of amendments to the EU treaties This would require the unanimous agreement of the remaining MS and specific amendments to the EU treaties to permit the withdrawal. Any such amendments are likely to cover the issue of redenomination to some extent, but they may well leave this issue to be determined in many cases by application of the principles described below.

3 FINANCE BRIEFING 03 Non consensual withdrawal In the event of an EMS withdrawing from the eurozone but not the EU without amendments to the EU treaties and the consent of the remaining MS, the withdrawal would be in breach of the EU treaties and unlawful. This may well have consequences in relation to the redenomination issue see further below. New monetary laws In the event of a withdrawal, the DMS would require a new currency and it would be likely that the DMS would pass legislation (new currency legislation) establishing a new national currency (new currency) and establishing a fixed exchange rate for the conversion of euro to the new currency. It is also likely that the DMS would pass legislation providing for foreign exchange controls (exchange controls) to seek to prevent a rapid withdrawal of funds and the collapse of its financial system. 3. Existing Loan Agreements The Potential Consequences As noted above, the potential consequences under existing loan agreements would depend on a number of factors in addition to the legal basis of the withdrawal including the general degree of connection with the DMS and, more specifically, the applicable forum for disputes, the governing law of the agreement, the lex monetae, the specified currency and the jurisdiction of the borrower. In this section, we consider the following: Would the loan obligations be redenominated? Would the loan agreement be terminated or its validity disrupted? Could the borrowerʹs ability to perform be jeopardised and which events of default might be triggered? Which commercial and operational terms may cause problems? Would the lenders be protected against exchange rate risk and other costs? A. Would the loan obligations be redenominated? The question of whether loan obligations might be redenominated is important because in the event of a withdrawal and the DMS creating a new currency, it is highly likely that the new currency would depreciate rapidly. Assuming that no overriding EU legislation is implemented specifically covering the issue of redenomination and addressing all relevant circumstances, one of the key elements in the analysis will be the application of the principle of nominalism and the determination of the lex monetae: i. Nominalism and lex monetae What is the principle of nominalism, what is the lex monetae and how do they apply? Nominalism The principle of nominalism can be summarised as follows. A debt expressed in the currency of another country involves an obligation to pay the nominal amount of the debt: (a) in whatever is the legal tender at the time of payment according to the law of that country (lex monetae);...in the event of a withdrawal and the DMS creating a new currency, it is highly likely that the new currency would depreciate rapidly. (b) irrespective of any fluctuations which may have occurred in the value of that currency between the time when the debt was incurred and the time of payment. Watson, Farley & Williams May 2012

4 04 FINANCE BRIEFING Lex monetae The ʺlex monetaeʺ principle generally applies to the determination of the applicable currency of monetary obligations under a contract. The lex monetae principle provides, broadly, that where a contract specifies a monetary obligation in a national currency, there is an implicit choice of the law of that country to determine questions relating to the identification of that currency, regardless of the governing law of the contract. For example, if a Greek borrower entered into a single currency loan agreement denominated in pounds sterling governed by German law, questions regarding the currency of account would be determined under English law, not German law. So, if under English law, the currency of the UK were changed from pounds sterling to US dollars, US dollars would be the currency applicable to the loan agreement. Where a state does elect to change its national currency, it is necessary for the relevant legislation to prescribe the exchange rate, or recurrent link between the old currency and the new currency. The ʺlex monetaeʺ principle generally applies to the determination of the applicable currency of monetary obligations under a contract. It should be noted that a distinction needs to be drawn between the money of account which is the currency in which the nominal amount of an obligation is to be calculated and the money of payment, which is the currency in which the obligation is payable. They may be different. If the currency in which the nominal amount of the obligation is to be calculated, i.e. the currency of account, is pounds sterling but the loan agreement provides that payment may be made in New York, the obligation may be discharged in New York by payment of the US dollar amount equivalent to the pounds sterling obligation. The lex monetae deals with the currency in which the nominal amount of an obligation is to be calculated. The application of the lex monetae principle is relatively simple for currencies used by only one country. Taking the above example, the reference in the above loan agreement to pounds sterling results in the application of English law as the lex monetae. However, the euro is not the currency of a single country but of all 17 EMS and the lex monetae of the 17 EMS is the EU law applicable to the euro. Accordingly, in the case of certain obligations denominated in euro, the question is likely to arise as to whether the lex monetae is the relevant law of the EU or the law of the DMS. This question has not been addressed before and no definitive answer can be given in response to it. As will be clear from the above, the answer to the question in any particular case may be very significant in the determination of the quantum of an obligation. For example, if (1) a Greek company borrowed 1,000,000 euros in 2010 with an obligation to repay in 2015, (2) the applicable lex monetae is Greek law (see below) and (3) in 2012 Greece withdraws from the eurozone and enacts legislation replacing the euro with new drachma as its new currency at an exchange rate of 1 new drachma for 10 euros, the borrower s obligation will be to pay 100,000 new drachma in 2015.

5 FINANCE BRIEFING 05 Determination of lex monetae The determination of the lex monetae question will depend in part on the court to which the question is submitted and the issue of jurisdiction is discussed further below. The lex monetae should be determined by interpreting the relevant contract in accordance with the law applicable to that contract. Where that law is English law, that means that the lex monetae is to be determined by reference to the intention of the parties at the time they entered into the contract. The intention of the parties may well need to be inferred. As is obvious from the above, there is a difference between the governing law of an agreement and the lex monetae applicable to monetary obligations under that agreement. The governing law is likely to be specified. The lex monetae will almost certainly not be specified. Where English law is the law applicable to a contract, the parties are presumed to have referred to the currency of the country with which the contract is most closely connected. There are a number of issues which the English courts would look at as being indicative of a close connection and as indicating the setting of the transaction as a whole. These are considered below. Place of payment In the absence of an indication to the contrary, parties are presumed to have selected the law of the place of payment as the lex monetae of their contract. However, this is a rebuttable presumption and an evidentiary consideration only which might be outweighed by other circumstances in the case. Where several places of payment are specified, the place of payment may be treated as comparatively unimportant. Status of the obligor There is a strong but rebuttable presumption that a government or public authority intends to contract in its own currency. The governing law is likely to be specified. The lex monetae will almost certainly not be specified. Currency definition and currency related terms If there is a definition of euro in the loan agreement, this is likely to be significant. If it defines the euro as, broadly, ʺthe lawful currency from time to time of the DMSʺ there is likely to be a higher risk of redenomination than if it is defined as ʺthe currency of the participating member statesʺ. If the agreement contains currency related provisions which indicate that the creditor is not intended to bear any exchange rate risk arising from payment in a currency other than the currency of payment, this will be an indication that the currency of account was intended to be the same as the currency of payment. Financial environment of contract If the agreement was entered into before the DMS joined the euro and was originally performed in the former national currency of that DMS, there is likely to be a higher risk of redenomination than if the agreement was entered into after the EMS adopted the euro. Governing Law The governing law is also likely to be relevant. If the governing law of the agreement is the law of the DMS, there is likely to be a higher risk of redenomination than if the governing law is that of another EMS or is another foreign law. Watson, Farley & Williams May 2012

6 06 FINANCE BRIEFING ii. Jurisdiction the court to which the question is submitted The issue of which court has jurisdiction is likely to be significant. The court having jurisdiction will depend upon applicable law and the terms of the contract. Assuming the Brussels Regulation (Council Regulation (EC) No 44/2001 on jurisdiction and the recognition and enforcement of judgements in civil and commercial matters) applies, the position would be as set out below. The issue of which court has jurisdiction is likely to be significant. The Brussels Regulation applies, broadly, to civil and commercial matters where the defendant is domiciled in a MS (Article 2). It does not extend to revenue, customs and administrative matters (Article 1(1)) and it does not apply in matters of insolvency, in which case the EC Insolvency Regulation (Council Regulation (EC) No. 1346/2000 on insolvency proceedings) applies, except in relation to credit institutions, to which the EU Directive on the Reorganisation and Winding Up of Credit Institutions applies. If there is an exclusive jurisdiction provision in the loan agreement, the court chosen will have jurisdiction (Article 23) (unless the exclusive jurisdiction provisions of Article 22 or one of the exceptions in Articles 5 to 21 applies). However, it should be noted that if the defendant initiated proceedings in another MS, for example in the DMS in which it was domiciled, in breach of the express provisions of the agreement, the English courts would be required to stay proceedings in the English courts until the court in which the proceedings were first commenced had determined whether it had jurisdiction (Article 27). If the loan agreement is silent on the question of jurisdiction, the position would be broadly as follows. A person domiciled in a MS must be sued in the courts of that MS unless one of the other jurisdiction rules under the Brussels Regulation applies. iii. Courts of DMS As has been noted above, in the event of a withdrawal, the DMS would require a new currency and it is likely that it would pass new currency legislation. If the courts of the DMS have jurisdiction, it is likely that they would give effect to the new currency legislation on the basis that the new currency legislation formed part of the mandatory rules of the forum. However, it is unlikely that either the new currency legislation could be expressed to apply to all euro denominated obligations or that even the courts of the DMS would seek to apply the new currency legislation to all euro denominated obligations. For example, if the DMS was Italy, it would seem unlikely that the new currency legislation would apply to a euro denominated loan between a Dutch lender and a German borrower with no connection with Italy. The application of the new currency legislation would depend upon a consideration of the facts of each case and whether there was a sufficient nexus with the DMS. This is likely to depend upon a consideration of such factors as whether the obligor or other parties are domiciled in the DMS, whether the place of payment is in the DMS (and whether there are other places of payment specified outside the DMS), whether the governing law of the relevant agreement is the law of the DMS and the other issues which might be considered in determining the lex monetae.

7 FINANCE BRIEFING 07 Subject to the above, the court which has jurisdiction will apply its own conflict of law rules to determine the law applicable to the determination of the redenomination issue. iv. English Courts If the matter falls to be determined by the English courts, it is expected that the following would apply: (a) In the event that the withdrawal was non consensual, that is, it is effected without the consent of all other MS and therefore in breach of the EU treaties and unlawful, it is quite possible that the English courts would not give effect to the new currency legislation on the basis that it was manifestly incompatible with English public policy. (b) Where the agreement is governed by English law, the court would seek to determine the lex monetae in accordance with the principles described above. Subject to the above, where the lex monetae was determined to be that of the DMS, the courts would be required to apply the new currency legislation and redenomination would occur to the extent provided for in the new currency legislation. Where the lex monetae was determined to be the law of a jurisdiction other than the DMS, the new currency legislation would not apply and redenomination would not be required. However, the English courts would not order specific performance of an act which is unlawful under the law in the place where it has to be performed. Accordingly, if a DMS passed new currency legislation establishing a new currency and implemented exchange controls prohibiting payment in euro, the English courts would not order payment by the debtor in euro in the DMS. In these circumstances, there may be grounds upon which an English court would order payment in the new currency applying an exchange rate determined by it. The court which has jurisdiction will apply its own conflict of law rules to determine the law applicable to the determination of the redenomination issue. v. Best scenario for avoiding redenomination Taking the above considerations into account, it seems likely that the best scenario for avoiding redenomination of a euro denominated loan would be if all the following were to apply to the loan agreement: It includes a contractual submission to the exclusive jurisdiction of the English courts (or to the courts of a jurisdiction other than the DMS) It provides for English law (or the law of a jurisdiction other than that of the DMS) as the governing law The term ʺeuroʺ is defined by reference to the currency of the participating member states of the eurozone It provides for payments outside the DMS Watson, Farley & Williams May 2012

8 08 FINANCE BRIEFING The withdrawal and the new currency legislation are unlikely, in themselves, to result in an automatic termination of... the loan agreement. B. Would the loan agreement be terminated or its validity disrupted? The withdrawal and the new currency legislation are unlikely, in themselves, to result in an automatic termination of, or affect the validity of, the loan agreement. Standard loan terms common in the market do not specify exit from the eurozone or redenomination as an event of default or termination event. Where English law is the law applicable to the contract, it is also unlikely that the withdrawal and the new currency legislation would, in themselves, result in the contract being frustrated although, as noted above, an English court would not order specific performance of an act which is illegal in the place of performance. However, it is likely that the withdrawal and the new currency legislation and, in particular, exchange controls, would lead to uncertainties in the interpretation of the contract, operational difficulties and events of default and therefore give rise to acceleration rights and possibly trigger illegality provisions see further below. C. Could the borrowerʹs ability to perform be jeopardised and which events of default may be triggered? In the event of the DMS passing new currency legislation and imposing exchange controls, it seems highly likely that the obligorʹs ability to perform would be jeopardised and that a number of events of default might be triggered under loan terms common in the market. Relevant provisions would include the following: Non payment in the event that the loan is not redenominated, unavailability of euro to the obligor and exchange controls would be likely to lead to payment default. Breach of representation loan terms commonly include a representation by the obligor that performance of the loan agreement will not conflict with any law applicable to it. This may well be breached. Unlawfulness it is generally an event of default if it becomes unlawful for the obligor to perform its obligations, and this may well be the case. Material adverse change these provisions typically include tests by reference to the obligor s ability to perform and the validity of the finance documents, both of which are likely to be questionable. Accounts and financial covenants multiple issues may arise in connection with accounts and financial covenants. If accounts are required to be produced in the new currency, there may be a breach of the obligation to deliver accounts complying with the loan requirements and covenants may be difficult to monitor and may be breached. D. Which commercial and operational terms may cause problems? In the event of the DMS passing new currency legislation and imposing exchange controls and the loan obligations being redenominated, a number of commercial and operational terms may require review and adjustment if the loan agreement is to continue. The types of commercial provision which would be relevant include: Facility and utilisation limits Repayment provisions Thresholds in covenants and events of default Provisions relating to the production of accounts

9 FINANCE BRIEFING 09 Financial covenants LTV provisions Indemnities Operational provisions which may require adjustment would include: Payment provisions Reference rates Market disruption provisions Mandatory costs provisions Increased costs provisions E. Would the lenders be protected against exchange rate risk and other costs? Loan terms common in the market generally include specific currency indemnities, general indemnities to apply upon the occurrence of an event of default and increased costs provisions. However, none of these have been drafted to cater for the losses that may arise on redenomination and while it would be necessary to review these on a case by case basis, it is unlikely that they would afford any protection. 4. Mitigation Action It will be clear from the above that many of the areas of exposure under existing arrangements arise from the fact that agreements have not been drafted to cater for the possibility of withdrawal. This is not surprising. Joining the eurozone was intended to be irreversible and the EU treaties do not provide for withdrawal from the eurozone without withdrawal from the EU. Loan terms common in the market... have [not] been drafted to cater for... redenomination... it is unlikely that they would afford any protection. However, that does not mean that parties cannot or should not take steps to seek to mitigate their exposure under euro denominated arrangements. Set out below is a summary list of provisions which might be amended in existing agreements, and which will require particular attention in any new agreements, with a view to mitigating risk: Governing law it is likely to be helpful to provide for English law as the governing law. The laws of any EMS which are perceived to be at risk of becoming DMS should be avoided. If total disintegration of the eurozone is considered a possibility, the law of a country outside the eurozone should be chosen. Jurisdiction the same comments as above apply and the agreement should include a submission by the obligor to the exclusive jurisdiction of the courts of a country which is not considered to be at risk of becoming a DMS. Currency express provisions should be included dealing with the currency of account and the currency of payment. i.e. provisions should be included specifying euros as the currency of account and payment and defining euro in terms that avoid the risk of the defined term being construed as a reference to the currency of a DMS from time to time. Payment provisions these should provide for payments outside any EMS which is perceived to be at risk of becoming a DMS or should give the agent the right to change the place of payment. Watson, Farley & Williams May 2012

10 10 FINANCE BRIEFING Tailored events of default / termination rights (if required) these should be included to cover withdrawal, the passing of new currency legislation and exchange controls and related consequences. Variation rights these may be required for operational provisions and commercial provisions. Express indemnities these may be required to cover costs and losses arising from a withdrawal. DMS related restrictions provisions might be included prohibiting transfers of obligations or assets from entities in EMS which are perceived to be low risk to entities in EMS perceived to be at risk of becoming a DMS. Collateral provisions might be included requiring collateral to be in, or where possible, moved to, or replaced by, collateral in low risk EMS. The FSA has publicly suggested that the prospect of the disorderly departure of some countries from the eurozone should be within the realm of contingency planning. 5. Contingency Planning A. The merits of contingency planning In the UK, the Financial Services Authority (FSA) has publicly suggested that the prospect of the disorderly departure of some countries from the eurozone should be within the realm of contingency planning. Many banks and corporates have no doubt already commenced the process of contingency planning. In considering the merits of contingency planning, it is worth bearing in mind the following: No definitive solution to the eurozone crisis is in sight Governments of the MS have moved slowly in tackling the eurozone crisis The EU treaties do not cater for withdrawal and the implementation of any necessary legislation is likely to be a lengthy process A withdrawal would lead to uncharted territory If a withdrawal does occur, it may well be announced overnight without prior warning to prevent a flight of funds from the DMS There are steps which might be taken to seek to mitigate risk. B. The process In the context of loan agreements, a simple risk mitigation plan could include the following elements: Identification of existing risk exposures As will be clear from the above, certain exposures are likely to be at greater risk of redenomination than others, depending in general terms on their nexus to a DMS. Relevant factors will include the domicile of the parties, the currency of account/payment, if specified, the governing law and the selected jurisdiction for disputes. Loan transactions which are perceived to be at risk should be identified. Termination Consideration should be given as to whether it would be desirable to terminate the relevant transactions and whether this would be possible in accordance with their terms.

11 FINANCE BRIEFING 11 Amendment Consideration should be given as to whether it would be possible to amend relevant agreements to seek to mitigate risk. The relevant provisions likely to require attention are those referred to in sections 3 and 4 above. New Agreements Particular attention should be given to the provisions identified in sections 3 and 4 above with a view to ensure that new agreements do not have a sufficient nexus to perceived high risk EMS as would give rise to a redenomination risk. Attention should also focus on seeking to ensure that, in the event of redenomination, there are provisions for dealing with, and allocating, the resulting risks and costs. The effectiveness of any such measures may be affected by any overriding legislation introduced to deal with a withdrawal. However, parties may consider it prudent to seek to obtain contractual protection against the consequences which may follow from a withdrawal. If you have any questions regarding loan documentation in the context of the eurozone crisis, or any other financing matter, please get in touch with a member of our team listed below or your regular contact at Watson, Farley & Williams. Contacts Simon Kavanagh Partner London skavanagh@wfw.com David Osborne Partner London dosborne@wfw.com Andrew Savage Partner London asavage@wfw.com Watson, Farley & Williams May 2012

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