"Money speaks sense in a language all nations understand." Aphra Behn, The Rover
As the beating heart of the Economic and Monetary Union (EMU) created by the 1992 Maastricht Treaty, the EU has "irrevocably" fixed at least according to the EU treaties the rate at which the euro has been substituted for seventeen qualifying national currencies. However, the upcoming tenth anniversary celebrations for the introduction of the actual euro banknotes and coins on January 1, 2002, have now turned gloomy. The lingering effects of the global financial crisis, plus slow economic growth in comparison to major competitor nations and blocs, have led the EU into what resembles a dead end road. Now, on top of all this economic gloom, comes the mother of all economic crises: the insolvency of certain eurozone nations. In strict legal terms, this sovereign debt crisis should not be happening in the eurozone, but it is happening, and its increasing whirlwind may just lead to the unthinkable the withdrawal from the eurozone of certain debt-impaired members. The question then becomes whether such actions legally possible. If possible, what would be the major legal effects upon the repayment of euro-denominated obligations by the departing eurozone member governments and by private parties?
A Legal as Well as Political Failure
The current eurozone sovereign debt crisis stems from a legal as well as political failure, namely, the lack of enforcement of the EU's famous 1997 Stability and Growth Pact. This legally binding agreement between eurozone members imposed strict limits on national deficits at no more than 3 percent of gross domestic product (GDP), and debt at no more than 60 percent of GDP, in addition to European Commission supervision and possible sanctions against violating nations. Unfortunately for Europe's new currency, these legal constraints turned out not to be very strict after all. Not only was the pact not enforced against Greece for repeated and serious violations, but the sanctity of the pact was brought into question by the refusal of both Germany and France to adhere to the agreed limits. In a surprising decision, the European Court of Justice (ECJ) ruled against the EU Council for its refusal to pursue the pact's enforcement against these two "EU Pillars" when they exceeded the agreed limits on deficits. Thus, the rule of law within the EU pertaining to national finances was seriously undermined by the very nations now called upon to straighten out the eurozone mess. One must mention that recent EU legislation provides for stricter enforcement of the pact's fiscal constraints, but only time will tell whether EU institutions have the will to implement these rules in a consistent and effective manner. Accordingly, with the crisis upon them, EU nations are now reaping the harvest that they themselves have sown.
Consequences of this Legal Failure
Confronted with the escalating European sovereign debt crisis, the governments of Germany and France now find themselves between a rock and a hard place. Bailing out Greece, Ireland and Portugal from their sovereign debt morass is one thing, but the prospect of an EU rescue of Italy and Spain respectively the third and fourth largest eurozone economies is another. If the experts are to be believed, it must be assumed that these major economies will require staggering amounts of financial support from other eurozone members, other EU members and, most likely, the International Monetary Fund (IMF). The so-called "Franco-German Axis" is clearly up against the wall in this extraordinary situation as lenders of last resort. Whether done through the current European Financial Stability Facility (EFSF) with a proposed lending capacity of €440 billion plus maximum guarantee commitments of €780 billion or the successor entity called the European Stability Mechanism, the amount of eurozone member state support required to even begin to resolve this sovereign debt debacle is truly staggering and may well exceed the trillion euro mark. Of course, the bulk of this lending is to be guaranteed by Germany (27 percent) and France (20 percent). However, recent reports suggest that France itself is under threat of a credit rating downgrade in light of its ballooning debt an action which could seriously jeopardize the "AAA" rating currently enjoyed by the EFSF when floating its bonds.
This leads to some interesting options for EU leaders. They can either allow the eurozone's debt-impaired nations to work out a structured default (as with Greece) and suffer the consequences for the euro exchange rate and economic stability, or they can suffer the exit of one or more eurozone members. While the first option can be assumed to be more palatable for eurozone members, as evidenced by the recent structured default in Greece, these leaders are realistic enough to understand that the affected nations will require at least a decade to extricate themselves from the enormous debt overhang and its debilitating effects upon their national economies. Therefore, one must ask whether the other eurozone members really prepared to remain bogged down by such an economic ball and chain for such an extended period of time. Will the other eurozone members have the patience to await a rebound in productivity and competitiveness in the "laggards" something not so easily accomplished without the ability to devalue a national currency? Accordingly, the other option the withdrawal or temporary suspension of debt-impaired members from the euro currency system may well be attractive under such dire straits. This possibility is routinely referred to by EU scholars as "thinking the unthinkable," but is it really? Further, if it is thinkable under the current extreme circumstances, is it legally possible?
A Legal Path for Exiting the Euro
While there exists no specific EU law providing for the orderly withdrawal from the EMU and euro, EU law does provide, by by Article 50 of the Treaty on European Union [PDF], for the withdrawal of a member state from the EU itself. This provision, added by the Lisbon Treaty, which was adopted in December 2009, provides the right of EU member states to notify the EU Council of their desire to withdraw from the union without any preconditions. The withdrawal shall be effective two years from the date of notification or from the date of agreement with the council concerning continuing relations between the exiting member state and remaining union. Surprisingly, this provision does not specifically mention the necessary accord of the European Central Bank (ECB) for eurozone members wishing to withdraw. Thus, a departing member state could legally withdraw in two years and one day without any specific agreement concerning ECB-governed currency issues. Practically speaking, however, a concerned member state would most likely pay very close attention to details pertaining to the return of capital contributions and reimbursement of foreign reserve holdings by the ECB. Therefore, complex and perhaps contentious withdrawal negotiations with EU institutions and in particular, the ECB seem to be a given for any exiting member state.
While this option may seem somewhat far-fetched, it should be noted that the ECB has itself undertaken preliminary studies of the modalities and, most importantly, legality of EMU and euro withdrawal. In a 2009 study entitled "Withdrawal and Expulsion from the EU and EMU: Some Reflections," the ECB legal staff stated its well considered opinion (although not binding as official policy), that while EU withdrawal would be legal under the explicit terms provided by the Lisbon Treaty, the unilateral withdrawal from the EMU and euro (i.e., without a negotiated agreement with the EU institutions) without simultaneous EU membership withdrawal would be illegal. Thus, a stand-alone withdrawal from the EMU and euro would be legally impossible, as it would be in direct defiance of the "irreversibility" of European EMU. Concerning a much more contentious issue, the ECB staff opined that EU law does not provide for the expulsion of EU members from the union itself.
The Legal Effects of Euro Withdrawal
Clearly, the process of withdrawal from the EMU and the euro currency by a eurozone member is fraught with legal difficulties. These difficulties, however, pale in comparison to the legal quagmire which will ensue concerning the currency of payment for obligations involving both the government and private parties located within the withdrawn state. Will these payments be made in the new currency of the withdrawn nation at some statutorily fixed conversion rate, or will they be required to be made in the former currency? This problem becomes all the more important due to the fact that the euro would still exist after the withdrawal of a current eurozone member state. While the withdrawal from a supranational entity such as the EU and its currency union presents unprecedented legal issues, especially in a world of public international law focused upon the actions of "nation-states," several basic principles contained in the body of the "law of money" can provide some navigational aids for these rather uncharted waters.
Our first legal principle, referred to as lex monetae, or "state theory of money," provides that the law of the nation of the currency in which the debt is expressed shall decide what constitutes the currency. Although the euro is, legally speaking, the currency of the EU, it is also the legal tender of each individual eurozone member. Accordingly, pursuant to the lex monetae principle, an EU nation is free to exercise its sovereign powers to substitute a new national currency for the euro currency and to then, by national law, establish a conversion rate for the exchange of former euro obligations into the new national currency.
While the exercise of this sovereign right may be considered as perfectly legal under the withdrawing state's constitutional structure, such action may very well breach EU treaty provisions, and thus be considered by other member states as a violation of EU law and international obligations if carried out unilaterally.
Second, the "continuity of contracts principle" which is widely followed throughout the world's major legal systems would ensure that both domestic and international contracts expressed in the euro would remain valid and enforceable even though the euro may no longer be the legal tender of the obligor under the contract. Assuming that the new currency unit is considered as a "reasonable substitute performance" for the original euro payment provision, this legal principle would, in effect, thwart the classic defenses to contract enforcement such as "impossibility of performance," "frustration of contract" and "commercial impracticability," which might be posited by disgruntled parties. This continuity of contracts principle was in fact imposed upon all EU member states as a matter of law during the introduction of the euro currency. Most nations (and US states) applied this provision within their own legal systems in order to provide stability during the euro transition.
Third, the law applicable to the contract transaction involving withdrawn country obligations (whether private or public) will be key in determining the currency of payment thereunder. The currency of payment and conversion rules for so-called "domestic contracts" within the exiting euro member state involving local parties and clearly subject to the withdrawing nation's law would, in application of the lex monetae principle, be submitted to that nation's new currency laws. Most government debt issues are made subject to the debtor nation's laws; thus, it may be assumed that the currency payment situation is clear for such contracts. This is especially true where the parties are located in the withdrawn state and payment is to be effectuated in that nation. However, the situation becomes much less clear for contracts with an international dimension, whether concerning sovereign or private obligations. For contracts involving foreign parties and foreign law clauses entered into outside of the withdrawn nation and calling for payment outside of that nation, it is most likely that foreign courts would strictly apply the euro payment called for in such contracts. This is the case since the euro will still legally exist and, as expressed by several legal scholars, EU law concerning the euro may itself constitute the lex monetae of such "international contracts" denominated in euros. In all events, choice of law clauses and/or conflict of law determinations as to the applicable law will be central to outcomes concerning currency of payment in such situations.
A Negotiated Legal Framework for Withdrawal from the Euro
Assuming the EU authorities stick within a strict interpretation of treaty law provisions prohibiting EMU and euro withdrawal without simultaneously exiting the EU it appears absolutely necessary, for obvious political, economic and legal reasons, to provide all concerned with a solid and negotiated exit plan. Thus, this circles back to the provisions of the Lisbon Treaty which added the right of withdrawal from the EU subject to negotiations with the EU Council concerning post-withdrawal relations. Although, as previously mentioned, the withdrawing member may quit the EU without reaching any negotiated agreement with the council, it seems more realistic to assume that the withdrawing nation itself will be highly interested in establishing the most stable economic and monetary environment possible under such destabilizing circumstances. Therefore, the EU and withdrawing member state would have the opportunity to jointly fix as a matter of EU and national law the modalities of withdrawal. Though not mentioned in the Lisbon Treaty's withdrawal clause, the ECB would, by necessity, play the leading role in these negotiations. Accordingly, the EU, ECB and departing member state may well be able to fix a negotiated euro conversion rate for the new national currency and impose it within all remaining member states. The more contentious issue (assuming that such could even be considered by the EU authorities) would be the decision concerning the currency of payment for what might be defined as "international contracts" compared to purely "domestic contracts" at least within the remaining EU. The question remains as to which contracts will be payable in the still existing euro currency, and which will be payable in the new national currency of the departing member state.
Another possibility discussed within would be for the EU to amend existing law to legally permit debt-impaired eurozone nations, so-called "peripheral zone nations," to remain within the union following a very radical adjustment of the EMU system. This plan would create a two currency system, allowing the peripheral eurozone members facing insolvency and unable to regain economic competitiveness to adopt a weaker currency for their respective economies with the exchange rate for the euro and the weaker currency fixed by EU authorities. A similar arrangement was used during the transition period for the euro currency. These two currencies would then be managed by the ECB, with the weaker euro nation subject to tight oversight of economic and fiscal fundamentals to allow the return to a single currency as soon as economically and fiscally possible.
Regardless of which negotiated option is chosen, this dual legal approach would help to avoid substantial conflict in the event foreign courts should rule that the lex monetae of any particular obligation remained EU law and not that of the re-denominating nation. Such a coordinated approach would go a long way in providing some degree of legal certainty during what would necessarily be a terribly uncertain economic situation.
Finally, none of this euro exit planning will be necessary should European leaders somehow find a way to quickly harmonize economic and fiscal policies to regain eurozone stability. However, if these leaders fail to do so within the near future, there remains the distinct possibility that the "unthinkable" could happen. If so, better to have a well-conceived euro exit plan in place to help smooth over what will be very choppy waters.
Larry Eaker is an associate professor at the American University of Paris. In France, Eaker has served as a legal consultant to the OECD on international environmental law matters and worked with various French law firms on international law cases. His teaching areas include public international law and international business law subjects.
Suggested citation: Larry Eaker, The Debt Crisis and the Legality of Leaving the Eurozone, JURIST - Forum, Sept. 22, 2011, http://jurist.org/forum/2011/09/larry-eaker-eurozone-exit.php.
This article was prepared for publication by Nathan Marinkovich, an associate editor for JURIST's academic commentary service. Please direct any questions or comments to him at firstname.lastname@example.org