The Eurozone debt crisis continues to impact the financial markets, the structured finance market included. Sovereign downgrades have resulted in corporate and
bank credits suffering downgrades as well. This in turn has made it harder to price and bring new transactions to market. Whilst it is impossible to predict how the
Eurozone crisis will ultimately play out, the ability to assess and anticipate potential market risks is crucial. One critical issue for commercial parties considering the
implications of the exit of a country in the Eurozone (a Member State) from the Euro (or indeed, the break-up of the Eurozone) is the extent to which their contracts will be insulated from changes in local law imposed by the withdrawing State.

The legal effect of redenomination on existing debts The impact for holders of Euro denominated bonds issued by an entity incorporated in a Eurozone country, which may leave the Eurozone and establish its own currency, would depend on essentially the following four main areas in the terms and conditions of the bonds, which would determine the currency in which the debt is to be paid:

• the submission to jurisdiction provision;
• the governing law of the bonds;
• the way in which the obligations to pay in a particular currency are drafted; and
• the place of payment stipulated in the terms and conditions.

If we consider a typical Euro denominated bond which will usually include (i) an English governing law provision, (ii) submission to the exclusive jurisdiction of the
English courts, (iii) a payment obligation in the single currency of the Eurozone and (iv) provision for payment outside the departing state, then the English courts
should hold that payments are to be made in Euro and that if they are not made in Euro there will be a resulting event of default.

However, when any of the above factors are missing then the analysis would become more complicated and depend on the above four points namely, jurisdiction, governing law, currency of payment and place of payment under the relevant documents as:

• if the governing law of the debt is that of the departing state, the debt is effectively at the disposal of the departing state. If the departing state wants to
  change currency of payment, it may do so;
• if the currency of payment is the currency of the departing state, it can redefine the currency as it sees fit;
• if the place of payment is in the departing state, and the state makes it illegal to pay in Euros, then even foreign courts have discretion to give effect to the
  departing state’s law; and
• if the place of litigation is in the departing state’s courts, the assumption must be that those courts will give effect to the departing states redenomination laws.

 
Would an exit by a Member state constitute an automatic default under the bond documentation? Usually, terms and conditions of notes do not envisage a Eurozone exit as a specific event of default. It is therefore unlikely that any existing bond documentation would do so, but you should check under the relevant
documentation nevertheless. However, depending on the terms of the underlying documentation, there may be other events of default, such as non-payment or
illegality, that may be triggered.

Cross default and impact on swaps Even if obligations under the bond issue remain denominated in Euro and no events of default would be triggered by a
departing state leaving the Eurozone or redenominating its currency or imposing exchange controls, the issuer could be a party to other agreements or underlying
credit support or swap agreements which may be defaulted by these events.

Steps to try and achieve insulation There has been much debate as to how best to insulate oneself from a redenomination by an exiting Eurozone country.
There is concern that, following a Eurozone exit by one or more States, there may be a pan-European legislation which would seek to allocate the risks of that
exit across Europe. Such legislation may seek to require Member State courts to recognise the existing country’s redenomination and/or any exchange controls.
This action could be particularly onerous where certain legs of currency or interest rate products were redenominated, leaving institutions in non-exiting States (and
potentially those outside Europe) exposed to future devaluations of the exiting country’s new currency. Theoretically, this could occur notwithstanding the fact that
the exposure on the previous Euro trades was fully collateralised with Euro cash or Euro debt securities. The likelihood of any such legislation, the timing and terms
are all uncertain. Even in the absence of pan-European legislation, there is concern that in certain circumstances Member State courts would give effect to local
redenomination or exchange controls.

Nevertheless there are certain measures that should be considered (although there are no guarantees to their efficacy) including:

• a definition of the currency in which payment is due that makes it clear that the obligation is in Euro (and not the currency from time to time of the issuer’s jurisdiction of incorporation);
• avoiding any mandatory place of performance in the exiting State;
• introducing prospective termination rights around any steps to redenominate;
• consideration of the suitable governing law and jurisdiction clause and their potential insulation benefits; and
• conversion of currencies at spot rate and indemnities.

The above is a broad overview of some of the issues generated by the Eurozone crisis as there are likely to be a number of questions and concerns regarding its impact on bond documentation. However, in view of the foregoing you would be prudent to establish your exposure to bonds that may be potentially affected and analyse the extent to which they deal with the issues discussed above.

About the Financial Industry Group at Reed Smith Our Financial Industry Group (“FIG”) is comprised of more than 210 lawyers organized on a cross-border, cross-discipline basis, and dedicated to representing clients involved in the financial sector, advising most of the top financial institutions in the world. Lawyers in our global group advise on transactional finance covering the full spectrum of financial products, litigation, commercial restructuring, bankruptcy, investment management, M&A, consumer compliance, and bank regulation, including all aspects of regulatory issues, such as examinations, enforcement and expansion proposals.

Executive Summary
Key points to consider when
analysing bond documentation
for the potential effects of a
Eurozone member’s departure
are:
• Jurisdiction
• Governing law
• Currency definitions
• Place of payment
• Events of default and other documentary provisions

Client Alert -12-130