Eurozone: eight redenomination principles for banks

Author: Gemma Varriale | Published: 6 Dec 2011
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With Europe’s leaders locked in debate over what to do next, IFLR takes a look at the complex rules of redenomination that are set to determine the future of the world’s second biggest currency in the coming weeks.

Here are the eight principles that, according to Philip Wood of Allen & Overy, are the main points clients should address when examining the risks of a country leaving the eurozone.

1. The first rule applies if the only available courts are local. In this case, regardless of governing law, these courts will have jurisdiction. They will apply the local redenomination and exchange controls.

2. Second on the list is where there are foreign courts, but local law – a local law bond for example (most Greek bonds are local law). In this case, the national government can change the law and this will be recognised by most countries.

3. According to Wood, the third rule is that a Greek law (for example) cannot change a foreign law: so Greece has no jurisdiction over settled UK law. But there are exceptions to this and this is where the rules begin to get complicated and cause more concern.

4. The main carve-out applies if there are local insolvency proceedings. Enforcement prospects will be weak as local courts will have jurisdiction.

“A paper claim gives parties a negotiating advantage but it’s hard to enforce,” said Wood. “But in practice, it’s much better to have a paper claim, even though it creates practical problems of enforcement, than not to have a claim at all.”

In 1998, when a moratorium was imposed during the Russian crisis, any Russian law obligations were subject to this moratorium. But anyone with an English or New York law obligation was not subject to this moratorium. This made a material difference to people’s position.

5. Rule 5 is the lex monetae principle. Under this law, if Japan, for instance, changed its currency from the yen to the ducat, all contracts would be changed and wherever the word yen appeared it would read ducat. “Courts in most countries have said it’s a universal rule that if the country changes its currency you follow the currency,” said Wood.

The result of this is that a country can change its currency regardless of the foreign law, so foreign law offers no protection here.

It follows that if the eurozone went through a complete break-up and was left with no currency, the region would instead have 17 new currencies and wherever a contract stated euro, contracting parties would be required to read deutsche mark, drachma, or whatever the local currency turned out to be. A system of weighting the currencies would also need to be introduced.

6. Another situation lawyers have mentioned is where a euro obligation as a Eurobond exists, denominated in Europe. But it’s clear that the intention of the contracting parties was that if the currency changes then Greece could change it.

Even if investors had a foreign law obligation they would be subject to Greek law in this situation and so the rule constitutes another exception to the insulating effect of the governing law. It means that parties could be forced into a money change.

But according to Wood this is a tiny [carve out] and people have made much of the risk. When contracting parties talk about the euro, they generally mean the euro.

7. The next rule which is also relatively minor but has gained a lot of attention occurs if, according to the contract, the only place payment can be made is Athens for example and exchange controls make it illegal to pay in foreign currency in Athens. In this case, the English courts would not force payment in foreign currency because it’s illegal in the place of performance.

But most agreements provide for an alternative place of payment: there are already terms in the major standard documents such as the Loan Market Agreement standard forms, most international bonds and the Isda master agreement.

8. The final major rule to be considered addresses the IMF agreement, and the provision stating that exchange contracts contrary to the exchange controls of a member state that are consistent with the IMF agreement are unenforceable in member states.

“Some countries have treated this as applying to loans and sale contracts, but other countries like England and New York don’t apply it to anything except foreign exchange contracts,” said Wood.

If this applies it would mean that if Greece introduced exchange controls and obtained IMF approval for the type of exchange controls it had, this would override the foreign law insulation and give Greece a one way option to change the deal, lawyers have told IFLR.

“This won’t happen in England and New York, but it could happen in France and possibly Luxembourg. But even there, most commentators say it doesn’t apply retrospectively. There’s a lot of doubt about it,” said Wood.

These are the significant rules which will be on the minds of many of Europe’s governments this week, but many believe that the eurozone is still in the very early stages of deciding what it should do.

“Some people might be changing some things but on the whole I don’t think there is a mass movement to reformulate documents,” said Wood. “A lot depends on how the situation unfolds.”

Click here to read about the litigation worries around exchange controls.

Click here for the key concerns of a partial break-up.