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Brexit: Implications for Commercial Contracts

The UK left the European Union (EU) at 11 PM on 31st January 2020. At this point, the UK  entered a transition period which is scheduled to be in place until the end of 2020. It may be extended, but the UK government has indicated that no extension will be sought. 

The transition period generally means business as usual for the time being. Even though the UK has left the EU, during the transition period the UK is generally treated as a member of the EU with EU law being applicable. Whilst certain existing contracts may have been impacted due to the UK’s exit from the EU, the key question is what will happen when the transition period comes to an end. The Withdrawal Agreement addresses some relevant areas, but at this point in time there remains considerable uncertainty as to the result of the planned negotiations and a real possibility that no agreement (or only partial agreement in certain areas) will be reached before the transition period ends.

There are relevant concerns for contracts already in place (as at the exit from the EU and particularly at the end of the transition period) as well as for upcoming contracts – what are the provisions a contracting party should be looking for, and how can they best safeguard their position? The first section below looks at the most serious concerns where the impact is expected to be most significant. The next section looks at concerns that are noteworthy but not necessarily as pressing, and the final section suggests some lower risk issues.

Significant Impact post Brexit

Generally, when looking at major commercial contracts to gauge how Brexit may affect them, the top priority should be the contracts already in place which fall within both of these two categories (the Key Categories):

  1. the contractual term will run beyond the date of the end of the transition period which is likely to be 31st December 2020, unless extended; and
  2. the nature of the contract means that it crosses the UK-EU border in some way.

The second Key Category is very broad and can come in many forms. For instance, there may be a supplier situated in Germany and a buyer situated in England, or an English company offering its products to English customers but doing so in reliance on EU regimes and laws. It is worth remembering that for some contracts which superficially appear not to cross the UK-EU border, perhaps on account of all elements of the contract falling within the UK, or no elements falling within the UK, there may still be underlying ramifications which will be relevant.

The broad possibilities of the second Key Category are further explored under the following subheadings.

References to the EU as a territory and EU legislation

If a contract refers to the EU (for example, by establishing the EU as an area of exclusivity), the UK’s exit could lead to unintended treatment of the UK under that contract – that area of exclusivity may be cut down so that it no longer covers the UK. It is possible that contractual references to the EU, meant references to the EU as at the date of the agreement. Alternatively it may mean the EU as constituted from time to time. There may be some uncertainty in relation to contracts existing at the time of exit. New contracts should obviously be very clear about references that are meant to include the UK.

References to legislation could also be problematic, and not necessarily addressed by a simple check for mentions of EU Directives or Regulations. EU legislation will cease to be directly applicable in the UK at the end of the transition period, although the UK's approach is to preserve and maintain UK legislation originally introduced to harmonise with EU legislation and to import EU legislation into UK law. However, the effect could be particularly pronounced for sectors where significant regulatory measures have been imposed at the EU level, and more generally for parties which have warranted that they will comply with EU rules.

The UK government has enacted the European Union (Withdrawal Agreement) Act 2020 as part of the Brexit process. At the end of the transition period, the Act will repeal the European Communities Act of 1972 (the Act which originally made EU law part of the UK legal system), and convert existing EU law into domestic law “wherever practical”. Those converted laws can then be repealed or reworked at a later point.

This approach means a more gradual process of detachment, with EU-derived legislation not necessarily being dis-applied en masse at the end of the transition period (although amendment will obviously be required  in the implementing legislation to replace EU institutions or references to EEA nationals with appropriate UK substitutes)  There is also little indication of which converted laws would be the prime targets for being rewritten to a significant degree in the near future, as opposed to those which would most likely remain virtually unchanged from their pre-Brexit form. For these reasons, if a contract is drafted on the assumption that obligations and restrictions currently imposed by EU-derived legislation will continue to be in effect in much the same way for years to come, this could prove to be problematic.

Suggested actions are as follows:

  • For contractual provisions dealing with the EU as a territory, confirm whether the relevant definition covers the member states from time to time, or specifically names each country. The “from time to time” wording will not include the UK, but if there is a full list of countries and the UK is named, then the UK should still be covered by the contract. If there is no express wording to indicate which interpretation prevails, various contextual factors will determine whether the UK is suddenly excluded, so the outcome could vary from one case to the next.
  • If there is any legislation key to the operation of the contract which may be affected, check for a clause which says that references are to provisions as modified or re‑enacted. In the absence of express wording to say otherwise, the default position (as established by the Interpretation Act 1978) is that references to repealed laws are construed as referring to the new law where that new law repeats and re-enacts the older law being cited in the document unless the contrary intention appears. The combination of the Interpretation Act with the EU (Withdrawal Agreement) Act 2020 could deliver an outcome of minimal effect on references to legislation, with a contract’s citation of an EU law being effectively rewritten as a citation of a newly-converted UK law. Having said that, it would be risky to place significant reliance on the conversion always producing a straightforward result and for new contracts it would certainly be advisable to deal with references to EU laws and statutory provisions to make sure that there is clarity going forward, for example when incorporated laws are further amended.

Force majeure, frustration and material adverse change

It may be that the UK’s withdrawal, or more likely the end of the transition period,  will have a particularly serious effect on the operation of the contract, and the parties may feel that being tied to commitments based on a different framework will lead to undesirable outcomes. On that basis, it is advisable to check whether these events could fit into the ambit of any force majeure clause, or whether there are any other ways to establish them as grounds for ending or renegotiating the contract.

Suggested actions are as follows:

  • Review the definition of force majeure and consider whether the UK’s exit or the end of the transition period could fit within this definition. If it is feasible that it could, consider the impact on the other contracting party’s duty to perform its obligations, and the potential for it to rely on this to avoid liability for non-performance.
  • Look for a “material adverse change” clause, or any wording which may permit renegotiation of terms should the contract become unprofitable or subject to a change in the law.
  • Consider whether it will be possible for either party to argue that following the UK’s withdrawal or the end of the transition period, frustration will apply. This would only apply to a contract which creates obligations that have become impossible to observe, with neither party being responsible for the change. Further a contract cannot be frustrated if the alleged frustrating event should have been foreseen by the parties. Mere inconvenience or the incurring of additional costs would be unlikely to qualify. Conceivably there may be a stronger case for frustration post transition phase where a contract heavily depends on EU regimes such as passporting.

New burdens when operating the contract

Any cost-benefit analysis of a contract may be completely altered in the new commercial and legislative landscape that develops after the end of the transition period. New burdens of cost, risk and compliance will most likely appear and they will have to be borne by one or both of the parties. If responsibility for them is not addressed explicitly, these burdens could sour the relationship, and could even lead to fines or other penalties if neither party addresses what is needed under the new rules.

Suggested actions are as follows:

  • Review mechanisms for pricing, given the potential for new import tariffs, VAT changes and other costs of trading. If the currency of the contract is sterling, look for any wording addressing serious fluctuations in its value. There may also be provisions for both parties conducting reviews and renegotiation of prices, especially in contracts with a particularly lengthy term.
  • Look for arrangements which depend on regimes that may cease to apply, such as free movement of goods / services / people or EU trade deals. If new compliance procedures are introduced, is there any indication of which party will have to discharge that duty?
Potential Significant Impact post Brexit

There may be less risk for contracts which are not yet executed than for current contracts, because the parties can plan around the effect of the UK’s exit and the end of the transition period and redraft accordingly (although the uncertainty regarding the position we will be in at the end of the transition period does not make this simple). Nevertheless, once the review of current contracts is complete, businesses should take care when drawing up new contracts which will fall into both Key Categories.

This section revisits topics covered in the previous section, but here the focus is on how to draft new contracts so as to anticipate and accommodate the impact. There is also a new topic to consider for both current and future contracts – jurisdiction and enforcement.

References the EU as a territory and to EU legislation

Suggested actions are as follows:

  • Consider the circumstances and decide whether the contract should cover the EU as its membership changes or from time to time (there may be further changes to members of the EU). If the UK is to be included in addition to the EU member states, this now needs to be expressly stated.
  • As an additional precaution to address the possibility of a future change in membership of the UK (e.g. Scotland proceeding with independence), when the UK is mentioned as a territory in a long-term contract, it may be sensible to plan ahead and draft appropriately. Should the territory be the UK as it stands now, or the UK as it changes from time to time? Make the preferred position clear.
  • Decide whether it will be best to incorporate legislation as it evolves or to have references remain fixed at the time of signing the contract. As a precaution where legislation is incorporated ‘as amended’, consider whether the contract should state that changes that have a materially adverse effect on the standing of either party under the agreement are disregarded where possible. Also deal with the effect of subsequent amendments to statutes and/or the enactment of subordinate legislation. 

Force majeure, frustration and material adverse change

Suggested actions are as follows:

  • If the UK’s departure from the EU and / or the end of the transition period is likely to seriously interfere with the contract, include an express right to suspend, terminate or renegotiate terms which will arise upon the particular change that is anticipated (such as, in the case of a contract dealing with goods being exported from the UK to an EU member state, the new imposition of a quota or tariffs on such exporting).
  • The definition of force majeure could also encompass certain Brexit-related events relevant to the subject matter of the contract – for example, the EU procurement regime becoming inapplicable.
  • If looking to ensure that the contract continues and the other party will not try to claim Brexit as grounds for any change in position, include an express statement to confirm that the force and effect of the contract (or select clauses of the contract) shall not be prejudiced or diminished by the UK’s departure from the EU or the end of the transition period.

New burdens when operating the contract

Suggested actions are as follows:

  • Add express wording to address pricing mechanisms, pricing reviews, fluctuations in value of currency and how newly-arising compliance duties will be fulfilled by the parties.
  • If one party is weighing up the option of either moving their business out of the UK or undertaking some other reorganisation, consider whether assignment to a group company should be permitted, and whether there should be automatic termination following such restructuring.

Governing law, jurisdiction and dispute resolution

Unlike the previous topics, this could prove to be an area of lower impact for current contracts, but equally there could be significant shifts whose effects are widely felt, and so it belongs in this section where the impact is particularly uncertain.

The end of the transition period could introduce further complications to any disputes between parties where one remains in the EU and the other does not. Currently the UK is subject to the Brussels / Lugano Regimes’ rules on determining jurisdiction for disputes which bridge more than one country from the EU Member States and/or the European Free Trade Association states of Iceland, Norway and Switzerland. These regimes will continue to apply to proceedings commenced before the end of the transition period, but there is some uncertainty relating to disputes arising following the end of the transition period.

In the absence of agreement as to the UK’s continuing participation in a scheme such as Lugano, English courts should still continue to respect foreign judgments and jurisdiction clauses, but it could cast doubt on whether a clause claiming English jurisdiction will be followed in the courts of every remaining member state, and on whether English court judgments would be fully enforceable in every remaining member state – some member states will be more of a risk than others. On a more positive note, a choice of governing law should continue to be respected by both the UK and EU member states

The effect of Brexit could be effectively minimised in respect of jurisdiction, because it is foreseeable that the UK and EU could enter into an agreement that mimics the approach under the Lugano Regime. Further the UK has indicated its intention to enter into the Hague Choice of Court Convention which should mean that exclusive jurisdiction clauses are generally respected (to the extent that they are entered into after the UK accedes to Hague or are reaffirmed in some way at this point).

If planning around the outcome of not having the Lugano Regime or anything similar in place for the UK, suggested actions are as follows:

  • If you have a potential dispute which relates to the UK and another part of the EU look to commencing  proceedings prior to the end of the transition period (even if these are subsequently stayed with a view to settlement)
  • For any upcoming contract which crosses the UK-EU border in some way, ensure that the contract is explicit on its governing law and jurisdiction (exclusive or non-exclusive) which has been chosen.
  • If existing contracts have an exclusive jurisdiction clause consider reaffirming this once the UK joins Hague (there is significant doubt about the effect of clauses which have been entered into prior to the UK joining in its own right).
  • A further option is to consider including a binding arbitration clause or other alternative dispute resolution mechanism.
  • If you have a contract where jurisdiction and enforcement in a particular EU country might be an issue, consider getting local law advice on respect for choice of jurisdiction clauses and enforcement under national law.
Lower Impact post Brexit

Beyond this, the “lower risk” label applies to any minor contracts and contracts that are not within the Key Categories. If a contract will end before 31st December 2020, then it should not be a concern, although a prudent approach would still be to consider the likelihood of some such contracts being renewed on the same terms without full scrutiny or some form of litigation being pursued. If a contract will last beyond that date but does not appear to fall into the second Key Category, insofar as none of the topics listed in the previous sections are applicable, the safest approach will still be to exercise caution, and to be on the lookout for new Brexit-related issues coming to light.