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The Law and Practice of International Banking, 2nd Edition by Proctor, Charles (1st March 2015)

Part F Cross-Border Issues, 40 Banks and the Eurozone Crisis

From: The Law and Practice of International Banking (2nd Edition)

Charles Proctor

From: Oxford Legal Research Library (http://olrl.ouplaw.com). (c) Oxford University Press, 2015. All Rights Reserved. Subscriber: null; date: 21 November 2019

Regulation of banks — Debt — Security interest — Eurozone

(p. 685) 40  Banks and the Eurozone Crisis


40.01  The financial crisis that has gripped the eurozone since the extent of Greece’s sovereign debt problems became public in 2009 requires no introduction or explanation from the present writer. Some of the regulatory consequences of that crisis for banks have already been considered in other contexts.1

40.02  The present chapter does not seek to examine the crisis in a broader context. Rather, it seeks to examine the consequences that would have ensued had a Member State found itself compelled to withdraw from the eurozone as a result of its difficulties. It will be recalled that speculation to this effect swirled around Greece for a number of months, and that country will therefore be used to illustrate the discussion. The general commentary would, however, apply equally to any eurozone Member State that found itself in a similar position. The crisis that erupted in Cyprus is also instructive in various ways, and will be referred to as appropriate.

40.03  It should be said that the possibility of a eurozone withdrawal has been considered by a number of writers in a variety of different contexts.2 The present chapter will, however, focus primarily on the implications of a eurozone withdrawal for financial obligations and the assets/liabilities of a banking institution.

40.04  At the outset, it will be necessary to make a few general remarks about the applicable treaty provisions and the framework for a eurozone withdrawal since, as will be seen, the (p. 686) mode of departure may have some incidental consequences for private and contractual obligations.

Eurozone Withdrawal—The Treaty Framework

40.05  It is necessary at the outset to consider the legality of a withdrawal from the eurozone. Thereafter, it will become possible, to consider the alternative means by which this may occur.

40.06  It should be made clear that neither the Treaty on the European Union (TEU) nor the Treaty on the Functioning of the European Union (TFEU) contains any express or implied right to withdraw from the eurozone. In particular, (i) the substitution of the euro for the former national currencies is stated to be ‘irrevocable’3 and (ii) unilateral withdrawal from the treaty is only permitted in conformity with its express or implied terms.4 Under these circumstances, a Member State could only withdraw from the eurozone if it consulted with the other Member States and obtained their consent for these purposes.5

40.07  This view of the treaties is perhaps reinforced by Article 50 TEU which, admittedly, was introduced in the TEU after the euro had been created. That article provides that ‘A Member State may decide to withdraw from the Union in accordance with its own constitutional requirements’, and then makes provision for the associated negotiation processes. If a eurozone Member State elected to withdraw from the Union as a whole, then this would necessarily imply its withdrawal from the single currency as well.6 Whilst the Article 50 procedure may be useful to a Member State seeking to withdraw from the Union in more benign circumstances, it will be of no assistance to a Member State which is in the midst of a financial crisis and which, in any event, will almost certainly wish to preserve its status as an EU Member State—even if outside the eurozone.

40.08  It follows that a Member State that wishes to withdraw from the Eurozone may only achieve that end in a lawful manner with the consent of all other EU Members. A consensual withdrawal may be contrasted with unilateral withdrawal, which would plainly constitute a breach of the EU Treaties. Unilateral withdrawal could provide proceedings for breach of the Treaties and other sanctions. Measures of this kind would no doubt be dealt with at an official level, but the distinction between a (lawful) consensual withdrawal and (p. 687) an (unlawful) unilateral withdrawal are noted at this stage because—as will be seen—the distinction may have relevance to contractual rights in a banking context.7

40.09  Experience thus far suggests that there are two particular forms of eurozone crisis measures that might have an impact on contractual rights in a banking or financial context, namely:

  1. (1)  a withdrawal from the eurozone and the creation of a new national currency by the affected Member State; and

  2. (2)  the imposition of exchange controls in order to avert a ‘run’ on the domestic banking system.

These two issues will be considered in turn.

Eurozone Withdrawal

40.10  A Greek withdrawal from the eurozone—whether consensual or unilateral—will involve the creation of a new currency which, for convenience, we will label the ‘new drachma’ or ‘NDR’. Since the creation of a monetary system is the prerogative of a State and its legal system,8 it would be necessary for Greece to introduce new legislation that would, as a minimum:

  1. (1)  create the new drachma as the lawful currency of Greece;9 and

  2. (2)  prescribe the rate at which obligations formerly expressed in euro would be converted into, and performed in, the new drachma.10

40.11  In practice, such a move would no doubt have to be planned in the greatest secrecy and would have to be executed during a period in which the banks were closed, so as to prevent a ‘run’ on the banking system to withdraw euro deposits prior to their conversion into new drachma. In addition, it would almost certainly be necessary to impose exchange controls for a period.11

Consequences of a Eurozone Withdrawal

40.12  If Greece were to withdraw from the eurozone on a consensual basis, then the following issues would arise:12

  1. (1)  would a contract affected by the currency changeover remain valid and effective; and

  2. (2)  if so, would the new drachma substitution be valid and effective in relation to it, given that the euro would itself continue to exist as a lawful currency?

(p. 688) 40.13  The first question is relatively straightforward. A contract governed by English law will generally remain valid and enforceable notwithstanding the occurrence of supervening events, unless these are sufficient to trigger the application of a doctrine of frustration.

40.14  The possible application of the doctrine of frustration to contracts affected by the original introduction of the euro in 1999 generated a great deal of ill-informed debate in the run-up to that event. In truth, there was no prospect that the doctrine of frustration could apply as a result of the currency substitution.13 The debate was, in any event, put to an end by Article 3 of Council Regulation (EC) 1103/97,14 which provided that the substitution of the euro for national currencies ‘shall not have the effect of altering any term of a legal instrument or of discharging or excusing performance under any legal instrument, nor give a party the right unilaterally to alter or terminate such an instrument’.

40.15  As has been noted, however, the EU Treaties do not contemplate the possibility of a withdrawal from the eurozone and, as a result, there is no specific legal framework to cover the contractual aspects of such a departure. The issue must therefore be looked at afresh.

40.16  On the basis that (i) the borrower or debtor is established in Greece and (ii) immediately following its introduction the new drachma depreciates substantially against the euro, then two possible scenarios arise, as follows:

  1. (1)  the new Greek monetary law is effective to convert the euro obligation into new drachma, in which event the creditor will suffer loss because he will have to accept payment in new drachma at the legally prescribed substitution rate; or

  2. (2)  the new Greek monetary law does not apply and the debt owing by the Greek debtor remains outstanding in euro. In that event, the debtor will suffer loss because its cash and other assets in Greece will be converted into a depreciating new drachma but its debts will remain euro-denominated.

40.17  In either eventuality, one of the parties will suffer significant losses on the transaction. Will that fact give rise to the frustration of the contract? Under English law, it is generally accepted that there are five tests for the application of the doctrine of frustration, and all of these tests must be satisfied if the doctrine is to apply in a given case:15

  1. (a)  there must have been a change of circumstances since the contract was made;

  2. (b)  that change must have been beyond the control of the parties;

  3. (c)  the contract does not provide for the changed circumstances;

  4. (d)  the change was not anticipated or foreseen by the parties; and

  5. (e)  as a result of the change, and performance of the contract in accordance with its stated terms would be unlawful or impossible or would otherwise be radically different from that contemplated by the parties when the contract was made.

40.18  In the normal course and for the purposes of the present discussion, it may be assumed that tests (a)–(d) above would be met, at least in the context of an agreement entered (p. 689) into before Greece’s eurozone membership came under threat. It therefore becomes necessary to consider whether test (e)—the ‘radically different’ test—would be met in this situation.

40.19  If the contract remains payable in euro, then there is no change to the substance of the debtor’s obligations. However, compliance with these obligations will become more difficult and expensive since its domestic assets will have been converted into a depreciating new drachma. In such a situation, the debtor’s sole complaint is that compliance with the obligation has become more expensive. The English courts are reluctant to apply the doctrine of frustration solely on this ground.16 It has also been stated in the context of a real estate transaction that ‘the doctrine of frustration cannot be brought into play merely because the purchaser finds, for whatever reason, he has not got the money to complete the contract’.17 In the United States, the corresponding doctrine of ‘commercial impracticability’18 has been held to be inapplicable where the debtor’s costs increased as a result of changes in exchange control regulations19 or as a consequence of currency fluctuations.20 It would therefore appear that the Greek debtor or borrower could not invoke the doctrine of frustration, even though the cost of meeting his obligations is significantly increased by the changed circumstances.

40.20  If the debtor’s obligations under the contract are validly converted into new drachma at the substitution rate provided by the new Greek monetary law then, as noted above, it will be the creditor who suffers loss. Could the creditor invoke the doctrine of frustration in that situation? It is submitted that he could not, for the following reasons:

  1. (a)  an obligation to pay an amount in a given currency implies an obligation to make the payment in lawful currency as at the due date—and not as at the date on which the contract was made;21

  2. (b)  as a matter of public international law, a State is entitled to create and regulate its own currency and—in the event of a replacement of its monetary system—to prescribe the substitution rates applicable to debts affected by the transition;22

  3. (c)  the United Kingdom and its courts have an obligation to recognize both the currency substitution and the prescribed rate;23

  4. (d)  the debtor’s payment of the substituted amount in new drachma at the prescribed substitution rate would thus constitute a valid discharge of the (previously euro-denominated) debt; and

  5. (e)  it would not be open to an English court to apply the doctrine of frustration in this situation because (i) as has been shown above, changes in the currency and financial dynamics of a contract will not normally suffice for the purposes of this doctrine and (ii) the application of the doctrine would also be inconsistent with the United (p. 690) Kingdom’s international obligation to recognize Greece’s sovereignty over its own monetary system.

40.21  It follows from this analysis that the doctrine of frustration should not be applied to a contract that is affected by the Greek withdrawal from the eurozone. The contract thus remains valid and enforceable. It will nevertheless remain necessary to determine whether the debt remains payable in euro, or whether it has now become payable in the new drachma?

Currency of Denomination

40.22  The currency denomination question raises an issue of particular difficulty, in the sense that:

  1. (a)  Greece has introduced a new domestic currency and provided a euro/new drachma substitution rate for those purposes; but

  2. (b)  the replacement currency—the euro—continues to be the valid currency of the remaining eurozone Member States—what principles are to be applied in determining whether the debtor may now discharge his obligations in new drachma, or whether he must continue to pay in euro?

40.23  As noted above, the lex monetae principle normally applies to determine the currency in which the debt is to be paid when the maturity date arrives. In the present situation, however, the difficulty is that there are two separate systems of law that compete to provide the lex monetae—that of the euro and that of the new drachma. Which system is to prevail?

40.24  It must not be forgotten that any contractual reference to a currency must reflect the intentions of the parties. It is thus necessary to ask—did the parties intend to contract by reference to the lex monetae of Greece, or by reference to the lex monetae of the eurozone as a whole? The obvious difficulty with this formulation is that parties who entered into their contract in happier times will not have turned their minds to the matter, and certainly will not have addressed it in the terms of their contract. Nevertheless, it is by no means uncommon for the court to have to determine contractual issues by reference to the presumed intention of the parties. Inevitably, the process of reasoning will depend on the circumstances surrounding the contract and the extent of the factors that connect it with Greece. Extreme cases will of course be straightforward. A euro-denominated loan agreement made between a London bank and an Italian borrower has no nexus with Greece, and there is no reason at all to suppose that the contract was made with reference to the lex monetae of Greece. Equally, where a Greek bank has made a euro-denominated mortgage loan to a Greek national and resident to enable him to purchase a flat in Athens, the parties would clearly have contracted by reference to the lex monetae of Greece because, plainly, the transaction has no nexus with any other jurisdiction. But cases involving Greece and one or more other countries will inevitably pose more difficulty. Some of the problem areas can be illustrated by reference to certain types of international transactions.24

Loan Agreements

40.25  A group of London banks has entered into a euro-denominated syndicated loan agreement with a Greek borrower to finance a project within Greece itself. The loan agreement is expressed to be governed by English law and repayments are to be made by credit to an (p. 691) account in London. It is suggested that such a loan would continue to be denominated in euro, notwithstanding the introduction of the new drachma. Under the circumstances, it would be clear that the Greek borrower intended to access the euro from an international financial market. In addition, there is a weak presumption that the law of the place of payment supplies the currency of payment. Although this presumption cannot apply in a positive sense in this instance,25 it may assist in a negative sense, in that the parties selected a place of payment outside Greece. Considerations of this kind would make it clear that the parties did not intend to contract by reference to the lex monetae of Greece.26


40.26  A London bank has entered into a euro-denominated fixed/floating rate swap with a Greek counterparty. The Greek counterparty entered into the transaction to hedge its interest rate obligations to the bank under a separate, floating rate loan euro facility agreement. Consequently, the bank pays interest at a floating rate by reference to EURIBOR,27 whilst the Greek counterparty pays interest at a predetermined fixed rate. The contract is expressed to be governed by English law, and part of it remains to be performed when the new drachma is introduced in Greece. Given that (i) the purpose of the swap is to hedge the facility agreement and (ii) the facility agreement itself would remain denominated in euro for the reasons given above, it is fair to work on the basis that the linked swap arrangements should follow the same position. Again, this would reflect the presumed intention of the parties.

40.27  A slight change to the factual matrix may, however, lead to a different conclusion. Suppose that the Greek party had raised a euro denominated, floating rate loan from a bank in Athens, so that the primary transaction is essentially ‘domestic’ to Greece. The borrower chooses to hedge its floating rate obligations with the London bank, which enters into an English law swap agreement on terms identical to those described in the last paragraph. Payments by the Greek counterparty are to be made to an account of the bank in London. However, payments by the bank are to be made to the Greek counterparty’s account in Athens, to coincide with the interest payments to be made to the Athens bank on its loan.28 The London bank will be dealing in the international markets and the Greek counterparty will have been seeking access to those markets in contracting the swap. Accordingly, the lex monetae of the Greek counterparty’s obligations remains that of the eurozone, and payments to it must be made in euro. On the other hand, the Greek counterparty is seeking to hedge an entirely domestic transaction, and Athens is the place of payment of amounts due to it.29 The bank was aware of the purpose of the swap and intended to assist its customer in hedging a domestic obligation. Under these circumstances, it is reasonable to conclude (p. 692) that the lex monetae of the bank’s obligations to the Greek counterparty is that of Greece, with the result that future payments to be made by the bank would be due in new drachma, rather than the euro.

40.28  The conclusion that the bank must make future payments in new drachma is not, however, the end of the matter. The further question is, how much does the bank have to pay? Its payment obligations were formerly calculated by reference to EURIBOR, but that particular benchmark would no longer be appropriate to obligations that have been redenominated into new drachma. In this situation, it is submitted that a term should be implied into the contract to the effect that the floating rate obligations should thenceforth be calculated by reference to the most nearly equivalent interest rate source for the new currency. This would be required to give business efficacy to the contract since, otherwise, floating rate interest would be computed by reference to a price source that was no longer relevant to the currency at issue.

Letters of Credit/Guarantees

40.29  By way of further illustration of some of the difficulties that may arise as a result of a eurozone withdrawal, it is now proposed to consider the consequences of that event for letters of credit and bank guarantees. How would amounts owing under a letter of credit or bank guarantee be payable (i) where the instrument is issued by a London bank to a Greek beneficiary or (ii) by a Greek bank to a beneficiary outside that country?

40.30  As a starting point, it is tempting to suggest that the currency of payment under an instrument of this kind should ‘follow’ the currency of payment in respect of the commercial contract that forms its subject matter, because the intention of the parties will have been to ‘cover’ that underlying obligation. However, that proposition could not be accepted. As is shown elsewhere,30 documentary credits are independent from the related commercial contract, and issues affecting that contract cannot result in a change in the obligations of the issuing bank’s obligations under the credit. In each case, therefore, the question will be identical to that applied in earlier situations—namely, what is the lex monetae of the issuing bank’s payment obligation?

40.31  Where a documentary credit is issued by a London bank to a Greek beneficiary, it will usually be the case that the parties will have contracted by reference to the monetary law of Greece, with the result that the bank would usually be obliged and entitled to discharge its payment obligation by payment in new drachma at the substitution rate prescribed by the new Greek monetary law.31 It is true that the issuing bank’s obligations under the credit will be governed by English law,32 but that is an issue separate from the lex monetae. In addition, the objective of the instrument is to assure payment to a business within Greece itself, thus providing a pointer to the currency of that country.

40.32  Where a Greek bank issues a euro-denominated letter of credit to a foreign beneficiary, that credit would be governed by Greek law.33 Applying the reasoning in the last paragraph, the (p. 693) lex monetae of the credit would be that of the beneficiary’s country or, at least, it would not be that of Greece. In the present instance, however, that would not be the end of the analysis. The credit is governed by Greek law and, under the terms of the new monetary law, an obligation expressed in euro can now be discharged by the corresponding amount in new drachma at the prescribed substitution rate. Since the monetary law forms a part of the law applicable to the contract, an English court would be bound to give effect to it in formulating a judgment against the Greek issuing bank.34


40.33  As shown elsewhere,35 the law applicable to a bank account will be the law of the country in which the account-holding bank is located; that country will also provide the lex situs of the deposit. In the absence of any other indicators, that country will also provide the lex monetae of the bank’s repayment obligation.

40.34  The consequences of a Greek departure from the Eurozone for deposits and other bank accounts are therefore relatively straightforward. A euro deposit held outside Greece will not be governed by Greek law, nor will Greece supply the lex monetae. Under these circumstances, such a deposit will remain denominated in euro, even though (i) the deposit is maintained at a foreign branch of a Greek bank and/or (ii) the depositor is a national or resident of Greece.

40.35  Conversely, a euro deposit held at a branch within Greece will be subject to Greek law, which will also supply the lex monetae of the bank’s obligation. As a result, the bank’s obligation to repay the deposit will be validly converted into new drachma pursuant to the Greek monetary law. This result will apply regardless of the nationality or residence of the depositor, or any other consideration affecting his status. The bank will therefore be able to discharge its obligations by paying the new drachma equivalent of the deposit at the substitution rate prescribed by the Greek monetary law.

Unilateral Withdrawal

40.36  The above discussion has worked on the assumption that Greece withdraws from the eurozone with the consent of the other Member States of the EU. Would this position change if, instead, Greece withdrew from the zone on a unilateral basis? This would involve a contravention of Greece’s obligations under the EU Treaties and may lead to infringement proceedings brought by the Commission or by other Member States. Whilst such matters are plainly beyond the scope of a work of this kind, it is pertinent to ask whether this revised factual background would have any impact on the reasoning and approach set out above.

40.37  Whilst the point is again by no means free from doubt, it is suggested that a unilateral withdrawal would have a fundamental impact on an English court’s approach to the issues and instruments that have been discussed above. Under these circumstances, the Greek monetary law will have been passed in plain contravention of a treaty obligation owed by that country to other EU Member States, including the United Kingdom.36 Under these (p. 694) circumstances, the English courts would be obliged to disregard the new Greek monetary law on the basis that its application in the United Kingdom would be manifestly contrary to public policy.37 Although an English court would naturally be reluctant to hold that another Member State was in breach of its treaty obligations, the matter would be clear and there is authority for the proposition that an English Court should disregard foreign laws that contravene the treaty obligations of that country to the United Kingdom.38

Consequences and remedies

40.38  It is now proposed briefly to consider certain general and wider consequences of a eurozone withdrawal.

40.39  Where, under the analysis set out above, an obligation to pay in euro remains outstanding in euro, there would be no direct contractual consequences for the payment obligations at issue; they would remain to be performed and enforced in accordance with their terms. There may well be practical difficulties, in the sense that the assets of a Greek borrower within the country will be converted into new drachma. On the expected basis that the new drachma would depreciate against the legal substitution rate prescribed by the monetary law, the borrower or obligor is likely to encounter difficulty in meeting its euro-denominated obligations, and may even be rendered insolvent as a consequence.39

40.40  Where, however, an obligation is validly converted into new drachma, then the counterparty can discharge his obligation by payment in new drachma at the legally prescribed exchange rate. On the ‘depreciation’ basis noted above, a lender who has funded his loan in euro will suffer loss because the new drachma repayments will be insufficient to cover the euro funding obligations. Yet the borrower will have fully discharged its own debt. There can therefore be no recourse to the borrower in respect of those losses, because there is no breach of contract that could found such a claim.

40.41  It would therefore be natural for the bank or creditor to look elsewhere for compensation in respect of its losses. Given that the euro is an EU creation, the obvious targets for an attempted compensation claim are (i) the European Union and (ii) Greece itself.

40.42  The European Union itself may be required to pay compensation for any damage caused in the performance of its functions, and the extent of its contractual liability is to be determined in accordance with legal principles common to the Member States.40 However, a consensual Greek withdrawal will be an act of all of the Member States (and not the EU), and a unilateral withdrawal will be an act of Greece alone. The Union itself is not responsible for the acts or omissions of the Member States.41 Furthermore, any assistance given by the Commission to Greece in connection with a eurozone departure would be designed to (p. 695) secure a policy objective in preserving the currency in a wider sense, and it could not normally incur any liability for action of that kind.42

40.43  Equally, it is very difficult to identify a basis or cause of action against Greece itself. The action of Greece in leaving the eurozone and creating its own new currency are plainly sovereign (as opposed to commercial) acts and any claim against Greece would therefore fail on the basis that Greece is entitled to immunity before the English courts.43

40.44  It may be that the currency devaluation could be viewed as a de facto expropriation of creditors’ claims and, in consequence, it may be possible to establish a claim under bilateral investment treaties entered into by Greece with other States for the protection of foreign investments into that country. However, a detailed discussion of that subject goes beyond the scope of this work.

Exchange Controls

40.45  As noted above, a Greek withdrawal from the eurozone will involve, as a minimum (i) the creation of a new Greek currency and (ii) the establishment of a legally enforceable substitution rate between the euro and the new drachma.

40.46  In practice, however, a number of other measures are likely to be necessary to protect the national economy and the banking system. This would almost certainly include the imposition of exchange controls. It is proposed now to consider the implications of such a measure and their consequences for agreements of a banking or financial nature. In the context of its financial crisis in 2013, Cyprus had occasion to impose exchange controls to regulate the flow of funds out of its domestic economy. Although Cyprus remains a eurozone country and the measures were not imposed in the context of a prospective withdrawal, the episode provides a useful basis for the review of this particular part of a likely package of measures in the event of withdrawal.

40.47  It is not necessary to go into the details of the system of exchange controls imposed by Cyprus. It may suffice to say that, as the Cypriot banking crisis began to develop in March 2013, the legislature passed an Emergency Law, which in turn authorized the Ministry of Finance to introduce decrees to protect the economy. In the course of 2013, a series of Decrees on ‘The Enforcement of Temporary Restrictive Measures on Transactions’ were made under the terms of that law. Those decrees restricted withdrawals from local bank accounts and, subject to various exemptions and limitations, also prohibited payments to foreign creditors. The imposition of exchange controls by a single country within a monetary union is an especially unhappy event, because a single currency should have a uniform value throughout the zone; these measures clearly detracted from the value of the euro in Cyprus.

40.48  In the present context, it is only necessary to ask (i) whether those exchange controls were lawfully imposed and (ii) to what extent those controls may affect the enforcement of obligations owing by a Cypriot borrower or counterparty to a UK bank?

(p. 696) Legality of Exchange Controls

40.49  As a very general rule, States are free to impose such exchange controls as they think appropriate. That right forms a part of a State’s accepted sovereignty over its monetary system and resources.44 But the right to impose such controls is subject to various constraints. Most immediately, the right to restrict the free movement of capital and payments within the eurozone is circumscribed by the EU Treaties. More broadly, the Articles of Agreement of the International Monetary Fund also deal with various exchange control matters.

40.50  Article 63 of the TFEU provides that, subject to certain exceptions noted below, ‘all restrictions on the movement of capital [and payments] between Member States and between Member States and third countries shall be prohibited’. This provision existed even prior to the creation of the single currency, but it assumes a particular importance in that context. A monetary union necessarily connotes an area in which capital and payments can flow freely and without restriction. This provision is expressed in clear and unambiguous language, and has been held to have direct effect in Member States. As a result, Article 63 can be relied upon by individuals in national proceedings.45 However, by way of derogation from that provision, Article 65(1) states that ‘[t]he provisions of Article 63 shall be without prejudice to the right of Member States…to prevent infringements of national law and regulation, in particular in the fields of taxation and the prudential supervision of financial institutions…or to take measures which are justified on grounds of public policy or public security.’ Article 68(3) then requires that any measures imposed by a Member State in reliance on the Article ‘must not constitute a means of arbitrary discrimination or a disguised restriction on the free movement of capital and payments’.

40.51  On 28 March 2013, the EU Commission issued a press statement to the effect that Cyprus was justified in relying on the ‘public policy/public security’ exceptions to address the prevailing crisis. However, the controls had to be restricted to the shortest possible period, and the Commission would remain in contact with Cyprus over the issue. It may be possible to take issue with this point, for example (i) on the basis that the imposition of exchange controls necessarily involves a form of ‘arbitrary discrimination’ which is forbidden by Article 65(3) or (ii) on the basis that the exception should be restrictively construed and should not be employed to secure purely economic ends.46 Nevertheless, reading the provisions as a whole and bearing in mind the situation that confronted Cyprus, the Commission’s approach to the subject seems to be a reasonable one.47

40.52  The question is, to what extent are these provisions relevant in English proceedings? Suppose, for the sake of illustration, that a UK bank has made a euro-denominated loan to a company incorporated in Cyprus to acquire a property in London.48 The documentation (p. 697) is governed by English law and the loan is secured by a mortgage over the property itself. Repayment instalments have fallen due and are payable to an account in London but, because of the Cypriot exchange controls, the borrower is unable to remit sufficient monies out of Cyprus to meet its obligations. The bank accordingly wishes to accelerate the loan and to exercise its power of sale over the property. Can the borrower resist these steps in reliance on the impediments imposed by the exchange control regime?

40.53  This question must be answered in the negative. The terms of the documentation are governed by English law and must be performed in accordance with that law.49 The fact that exchange controls have been imposed in the debtor’s jurisdiction of incorporation or residence is an entirely irrelevant consideration, since Cypriot law does not govern the contract, nor does it supply the law of the place of payment.50 The unexpected imposition of exchange controls and the resultant difficulties in making payment do not excuse the debtor’s performance, nor does it result in the frustration of the contract.51

40.54  As a result, the bank may accelerate its loan in accordance with the terms of its agreement and enforce its mortgage, in each case without reference to the Cypriot exchange control regulations,52 or the EU law discussion that may serve to justify their imposition. This conclusion is, however, subject to the discussion in the ensuing paragraphs.

IMF Agreement

40.55  Both the United Kingdom and Cyprus are members of the International Monetary Fund (IMF) and are thus bound by its Articles of Agreement. It contains a number of provisions dealing with the imposition of exchange controls and which the writer has discussed in another context.53 For the most part, the provisions of the Articles of Agreement are binding only as between the member countries and would therefore not have any impact on private litigation of the type described above. It is, however, necessary to discuss one exception to this general rule.

40.56  Article VIII(2)(b) reads as follows:

…Exchange contracts which involve the currency of any member and which are contrary to the exchange control regulations of that member maintained or imposed consistently with this Agreement shall be unenforceable in the territory of any member…

In order to give effect to this provision, the United Kingdom requires its national courts to apply Article VIII(2)(b). This was achieved by means of an Order in Council.54

40.57  There is some debate about the characterization of Article VIII(2)(b), especially in the private international law context. For example, it may form a part of substantive English (p. 698) contract law; or it may be a rule of procedural law; or it may form a mandatory rule that has to be applied by the English court in any event. However, that debate is not especially relevant in the present context, because the English court would have to apply this rule in the factual situation now under consideration, regardless of the precise classification of the provision.

40.58  The question therefore is: do the terms of Article VIII(2)(b) apply to the English law loan agreement and the mortgage executed by the Cypriot company? It is suggested that they do not, for the following reasons:

  1. (a)  in their interpretation of this provision, the English courts have taken a narrow view of the meaning of ‘exchange contracts’, holding that the expression applies only to contracts for the exchange of one currency for another.55 A mortgage loan to assist in the purchase of a property in the United Kingdom would not fall into this category;

  2. (b)  the loan agreement is not ‘contrary’ to the exchange control regulations of Cyprus because it was entered into before the regulations were enacted. In other words, Article VIII(2)(b) should not be applied on a retrospective basis; and

  3. (c)  the use of the expression ‘shall not be enforceable’ suggests that offending contracts cannot be enforced by a court or tribunal. This would not prevent the bank from declaring the loan to be immediately payable and appointing a receiver, since those steps do not involve the initiation of court proceedings.

40.59  It should therefore be possible to conclude that, in general terms, a bank that has entered into a transaction with a Cypriot borrower under documents governed by English law and involving property in England would still be able to enforce those arrangements notwithstanding the supervening imposition of Cypriot exchange controls. Of course, the position may be different if the bank finds it necessary to take enforcement proceedings within Cyprus itself, because the exchange control regulations will be of mandatory application before the local courts.


See, in particular, the discussion on capital adequacy reforms in Chapter 6 above.

For other work by the present writer, see Mann, ch 32; ‘The Euro—Fragmentation and the Financial Markets’ (January 2011) 6(1) Capital Markets Law Journal 5; ‘The Failure of the Euro—What happens if a Member State leaves?’ (2006) 17 EBLR 909.

Article 140(3) TFEU.

On this point, see Arts 54(a) and 56, Vienna Convention on the law of Treaties. Article 56 of this Convention is perhaps unlikely to apply in any event because the TEU does contain certain termination rights—see the discussion (below) on Art 50 TEU.

Article 54(b), Vienna Convention on the Law of Treaties. It may be noted at this point that all EU Member States are parties to the TFEU and that the consent of all of them—including Member States outside the eurozone—would be required to permit a lawful withdrawal from the zone.

This inference may be drawn from a number of provisions of the Treaties themselves. For example, the right of withdrawal created by Art 50 applies to eurozone and non-eurozone Member States alike. Article 128 TFEU states that banknotes issued by the eurosystem central banks ‘shall be the only such notes to have the status of legal tender within the Union’ (ie within the eurozone Member States). Finally, Art 282(1) TFEU and Art 1 of the Statute of the European System of Central Banks each confirm that only the central banks of participating Member States can be members of the eurosystem.

It has on occasion been suggested that the eurozone should have power to expel a Member State that is unable to comply with associated limits on borrowings and deficits. Whatever the merits of such a proposal, it is clear that the current EU Treaties contain no such right of withdrawal.

On this subject and the State theory of money, see Mann, paras 1.17–1.28.

This would include banknotes and coins, security features and similar detailed matters.

10  The rate so prescribed is referred to as the ‘recurrent link’ between the outgoing and the new currencies: see Mann, para 2.41.

11  That aspect is discussed at para 40.45 below.

12  The text is, of course, written on the assumption that the contract and monetary obligations at issue are governed by English law. Where the contract is governed by Greek law, then the new drachma substitution will change the currency of the contract since the relevant legislation will form a part of the law applicable to the contract as a whole: see Art 12 Rome I and National Bank of Greece and Athens SA v Metliss [1957] 3 All ER 608.

13  The reasons for this conclusion are discussed in Mann, paras 30.08–30.35.

14  Council Regulation (EC) 1103/97 on certain provisions relating to the introduction of the euro, OJ L 162, 19.6.1997, p 1.

15  The tests are drawn from the House of Lords decision in Davis Contractors Ltd v Fareham UDC [1956] AC 696.

16  See Davis Contractors, n 15 above.

17  Universal Corporation v Five Ways Properties Ltd [1978] 3 All ER 1131, 1135. This observation was approved by the Court of Appeal [1979] All ER 552, 554.

18  See Uniform Commercial Code, para 2, 615. The two doctrines are similar (although not identical) and serve an essentially similar purpose.

19  Bank of America NT&SA v Envases Venezolanos SA 740 F Supp 260 (SDNY 1990).

20  Bernina Distribution Inc v Bernina Sewing Machine Co 646 F2d 434 (1981).

21  This is the so-called lex monetae principle, on which see Mann, ch 9,

22  This is the principle of monetary sovereignty, on which see Mann, ch 19.

23  The obligation of recognition is subject to a reservation considered at para 40.37 below.

24  It must be accepted that the various points about to be made are by no means beyond debate or dispute.

25  ie because the euro is not the currency of the United Kingdom, with the result that the presumption cannot apply. On the presumption stated in the text, see Adelaide Electrical Supply Co v Prudential Assurance Co Ltd [1934] AC 122 (HL); Auckland Corporation v Alliance Assurance Co [1937] AC 587 (PC); and National Mutual Life Assurance of Australia Ltd v A-G for New Zealand [1936] AC 369 (PC).

26  Where the borrower is Greece or one of its governmental entities, then there may be a presumption to the effect that the borrower intended to contract by reference to its own, national monetary system: see Bonython v Commonwealth of Australia [1950] AC 201 (PC). But that case was not decided in the context of a monetary union and, even if the borrower were a Greek entity, it is suggested that the analysis in the main text would continue to apply.

27  The interbank offered rate for euro deposits.

28  It is acknowledged that the scenario is slightly artificial, in that the relevant obligations would normally be settled on a net basis, but the example helps to explain the monetary law analysis.

29  See the ‘place of payment’ presumption noted at para 40.25 above.

30  See the discussion on the independence of letters of credit (autonomy principle) at paras 26.24–26.25 above.

31  This tentative conclusion may be reinforced if the credit requires payment to a bank account maintained by the beneficiary with a bank within Greece.

32  See the discussion of the governing law of letters of credit at paras 24.75–24.92 above.

33  See the discussion at para 24.82 above.

34  See Rome I, Art 12.

35  See paras 41.06–41.10 below.

36  Although the United Kingdom is not a member of the eurozone, it has the right to join that zone, subject to meeting the so-called Maastricht criteria: see Protocol 15 of the TFEU, which sets out the UK’s position in relation to the single currency.

37  The court may refuse to give effect to a rule of foreign law if its application would be manifestly contrary to public policy. This principle has always been well-established and it is now enshrined in Art 21 of Rome I.

38  Royal Hellenic Government v Vergottis Ltd (1945) 78 Ll L Rep 292.

39  The issues just noted may, however, lead to other contractual consequences for a borrower. If the conversion of the borrower’s assets into new drachma renders it insolvent, then this may constitute an ‘insolvency’ event of default under the agreement. Equally the change of economic and financial circumstances in the borrower’s home country may constitute a ‘material adverse change’ default. On these default provisions, see para 20.46 above.

40  Article 340 TFEU. The European Court of Justice has exclusive jurisdiction in relation to this type of claim: Art 268 TFEU.

41  Case T-113/96, Edouard Dubois et Fils SA v Council and Commission [1998] 1 CMLR 1335.

42  Case 54/76, Compagnie Industrielle et Agricole du Comte Laheac v Council and Commission [1977] ECR 645.

43  Section 1 of the State Immunity Act 1976.

44  On monetary sovereignty and public international law, see Mann, ch 9. On the implications of the euro for the monetary sovereignty of the participating Member States, see Mann, paras 31.19–31.23. Mann, paras 31.51–31.53 discuss the extent to which the EU Treaties allow for the imposition of such controls. As will be apparent, those paragraphs were written prior to the development of the crisis in Cyprus.

45  There is a certain amount of case law to this effect: see for example, Case C-163/94, Criminal Proceedings against Sanz de Lera [1995] ECR-I 4821.

46  See, for example, Case C-367/98, Commission v Portugal [2002] ECR-I 4757.

47  The principal difficulty lies in the justifiable duration of Cypriot exchange controls. At the time of writing, they have been in effect for an extended period, and no date has been set for their final repeal.

48  For present purposes, it is assumed that the loan was made before the Cypriot exchange controls were introduced.

49  Rome I, Art 12.

50  On the potential relevance of the law of the place of payment, see para 40.25 above.

51  See Universal Corporation v Five Ways Properties Ltd [1978] 3 All ER 1135, where the buyer’s financial difficulties resulted from an unexpected delay in obtaining a Nigerian exchange control approval. The case has already been noted at para 40.19 above.

52  For a comparable case which neatly illustrates this issue in the context of exchange controls adopted in Germany, see Kleinwort Sons & Co v Ungarische Baumwolle Industrie AG [1939] 2 KB 678 (CA).

53  See Mann, ch 15.

54  Bretton Woods Agreement Order 1946 (SR & O, 1946/36).

55  The leading case on this subject is United City Merchants (Investments) Ltd v Royal Bank of Canada [1983] 1 AC 168 (HL). It should be noted that this narrow approach to the Article is not accepted by the case law of civil law jurisdictions, and has been much criticized. Nevertheless, the point would now only be amenable to review by the Supreme Court itself.