European Union: Eurozone Contracts: Considerations For GCC Entities

The economic crisis in Europe could have unforeseen consequences for GCC entities that are party to Euro-denominated contracts. Unless specifically provided for under those contracts, uncertainty will arise as to how Euro-denominated contracts should respond where a European party's member state exits the Eurozone. Engaging with counterparties in advance will avoid this uncertainty.

For the purposes of this guidance it is assumed that if a country exits the Eurozone it is likely to be one of the weaker economies and to re-denominate contracts from Euros to the new currency on a 1:1 basis. There are, however, other scenarios which could transpire, including that the Euro could cease to exist altogether.

Impact on contracts

If a Eurozone country were to switch from the Euro to a new currency this would be achieved through legislation (New Currency Legislation) which would set out a number of details including the exchange rate at which Euros would initially be converted into the new currency, also providing for the automatic re-denomination of Euro denominated contracts in that country. The latter of these is of important consideration to contractual arrangements.

General contract considerations

There are a number of general principles and considerations which apply to all contracts when considering what impact a Eurozone exit would have on a contract - particularly the question of whether or not the contract will automatically re-denominate.

Some of the key general considerations are as follows:

• What is the governing law and jurisdiction of the contract? Where the governing law and jurisdiction are those of the member state which exits the Eurozone the contract is more likely to re-denominate.
• What is the contract currency? If the contract is denominated in Euros and Euro is not defined as the single currency of the monetary union, then the contract will be more likely to re-denominate.
• Where are the parties? If a GCC entity contracts with or through counterparties based in the Eurozone exiting member state, this will increase the probability of the contract re-denominating.
• Where is the place of payment? If the place of payment is in the exiting member state then this will increase the probability of the contract re-denominating.

Where there are inter-connecting contracts how each of these contracts will react in the event of a re-denomination will need to be considered fully to understand the potential impact on a managing agent.

In general, for any contract, there will be two stages to a managing agent's analysis:

• What is likely to happen to the contract in the event of a Eurozone exit?
• What steps need to be taken to achieve the desired outcome/assist in providing contractual certainty?

Obtaining contractual certainty

Whilst there is no guarantee that a contract will react in a particular way in the event of a Eurozone country re-denominating to a new currency, there are clauses which can spell out the parties' intentions and make it more likely that the contract will react in a particular way. It is also possible to use these clauses to improve the chances that interacting contracts (such as policies, distribution agreements, reinsurance etc) all react in a way which does not distort the economic effect of the overall arrangements.

Euro denominated

If a contract is denominated in Euros and the parties wish to determine how it will be treated in the event of a Eurozone exit by one of the parties, they can insert clauses to help achieve this. If they intend that it should remain in Euros they can include a definition of Euro and a re-denomination prevention clause. If instead they intend that the contract should re-denominate to the new local currency, a re-denomination clause can be included.

As an alternative, the parties could include a clause which converts a Euro-denominated contract into, for example, AED or USD. However there are some enforceability issues with such a clause. Whilst it is likely that this would succeed if the contract were subject to English law and it was examined by an English court, the same cannot be said for other governing laws and jurisdictions. In particular this clause could be viewed negatively by courts in a jurisdiction which exits the Eurozone and they may also seek to seize jurisdiction over the contract. However, such clauses are likely to be desirable in the outwards reinsurance agreements of UK-based managing agents where multiple currencies may already be in use within the contractual framework and the contract is governed by English law. It is not possible to provide a template clause for these purposes as the drafting will need to take account of the overall contractual arrangements and will be very specific to the particular contract. In the context of such a clause one will need to consider what happens to any payments which have been made under the contract before the redenomination. One possible solution would be to address this through an appropriate exchange rate in the contract which would put the parties in the same position as if the contract had been denominated in the new contract currency from inception.

Exiting state governing law and jurisdiction

Avoiding Eurozone governing law and jurisdiction (particularly those jurisdictions considered at higher risk of an exit) makes sense if the parties do not want the contract to redenominate to the new currency in the event of a Eurozone exit. Conversely, if it is the intention of the parties that the contract would redenominate in these circumstances then it would be better if the governing law and jurisdiction were those of the exiting member state.

Contract continuity

To mitigate the risk of the contract terminating in the event of a Eurozone exit the Euro contract continuity clause published jointly by the LMA, IUA and LIIBA on 7 August 2012 (LSW1820 (08/12)) should be used.

Issues to consider

Where GCC entities are party to Euro-denominated contracts, they should engage with their counterparties to consider in each particular case how those contracts should respond where a currency redenomination is required following the exit of a European counterparty's member state from the Eurozone. Set out below are some key issues which GCC insurance entities may wish to consider in preparation of reviewing their Euro-denominated contracts:

• What is the number and value of your Euro/Eurozone policies?
• What is the domicile/residence of the insured or the location of the insured property?
• Is there a high risk of the European counterparty's territory exiting the Eurozone?
• Do you have facultative reinsurance for a policy and, if so, is it important that this remains back-to-back with the underlying policy?
• Is the policy protected under your reinsurance treaty arrangements and, if so, is it important for relevant programmes to react in the same way as the underlying book of business in terms of currency, or is it more important that the reinsurance arrangements remain unchanged?
• If a policy will redenominate, will any connected distribution agreements and services contracts (and vice versa)?
• Do you have a local coverholder in a high risk territory? If so:
• • What are its banking arrangements and how much does it typically hold?
  • Does it issue certificates on the basis of an agreed pro forma and, if so, what law and jurisdiction does the certificate stipulate?
  • What is the impact on multi-country arrangements?

Other publications

The LMA published a guidance note on 8 June 2012, which discussed a number of points relevant to premium and claims settlement and terms of business agreements (TOBAs):

Clyde & Co has published a number of materials relating to the Eurozone crisis and in particular considering the impact of the Eurozone crisis on insurers: