On 23 June 2016, the UK voters indicated their wish to leave the EU. Although the process of leaving will not legally start until the UK formally serves its notice to leave under Article 50 of the Lisbon Treaty, the uncertainty caused by the result of the public referendum has already had far-reaching political and economic consequences. Following the service of its intention to leave in accordance with the Article 50, the UK will have two years to agree the terms of its exit. The UK will not only have to establish a trade relationship with the EU but also look into arrangements with other non-EU countries with whom the UK has previously traded by virtue of its EU membership. The resultant economic volatility and legal uncertainty is likely to continue until the UK leaves the EU and a negotiated co-operative framework is put in place.

In this article we consider the potential impact that the UK’s exit may have on disputes and, given the almost inevitable exit scenario, what contractual issues may be of immediate consideration for parties with current or future litigation exposure in the UK and the EU.

Contractual profitability

Following the leave vote, the British Pound collapsed to a 31 year low against the US dollar. In the context of global trade, the scale of the fluctuations could significantly affect contractual profitability. Unhedged traders with exposure to the British Pound may seek to renegotiate the contracts or look for reasons to terminate. The risk of volatile markets will be magnified for commodity traders as the already oversupplied markets face continuing political instability.

Companies’ profit margins may also be negatively affected by trade tariffs. Under EU regulations, goods wholly obtained or produced within the EU, when sold to a country with preferential arrangement in place, are subject to lower or nil rates of duty. The UK’s decision to leave the EU may increase the underlying duty that will be added to the cost base. In addition, companies will need to consider the tax implications. For instance, currently most UK businesses do not need to be VAT registered in other member states and do not need to pay withholding taxes. This may be subject to change depending on terms of the deal agreed between the UK and the remainder of the EU.

Scope

Many companies will have entered into contracts on the assumption that the goods or services would be provided within a free market. Depending on the trade agreement entered into between the UK and the EU a company’s ability to perform its contractual obligations may be significantly affected.

Currently, certain authorised companies such as insurers and banks are able to provide their services across the EU from the UK without the need to establish any local presence. Unless the UK is able to negotiate a substantially similar framework, these so-called passporting rights will be no longer available to UK-based institutions. As a result, there could be a period of time when UK companies are unable to operate in the EU without establishing local subsidiaries and obtaining relevant licences.

Contractual provisions

There are a number of contractual provisions and legal concepts upon which parties seeking to terminate may wish to rely.

Force majeure and Material Adverse Change clauses (MAC clauses) allow parties to avoid liability for non-performance when an extraordinary event beyond their control prevents them from performing their contractual obligations. There is no common law definition of force majeure so it is up to parties to agree contractually what events are to be considered a force majeure event for the purposes of the contract. The concept is similar to the common law doctrine of frustration, albeit the purpose of the force majeure clause is to avoid the higher threshold for establishing “impossibility” under the common law.

MAC clauses are particularly common in the context of acquisitions and lending transactions where they are designed to protect one party against any deterioration in the other party’s condition or circumstances. The breadth of the clause will vary from contract to contract.

Contracts may also include express representations as to territory, creditworthiness, and compliance with local laws. Dependent on how important these clauses are to the purpose of the contract they could be regarded as sufficiently serious to allow the non-defaulting party to repudiate the contract.

In the absence of special contractual provisions dealing with Brexit, we do not consider it likely that most of the standard wordings could be triggered by the sole act of the UK leaving the EU. The topic of referendum had been first announced around 2013 and as such it would be difficult to argue that it was a sudden or unforeseeable event. Nonetheless, some of its potential consequences discussed above may lead to circumstances falling within the scope of the abovementioned provisions.

This will be of particular reference to contracts dependent on free market access discussed above. Certain industry standard forms such as documentation prepared by the Loan Market Association include representations as to the contracting parties’ ability to conduct business and their creditworthiness. If the UK-based institutions cease to benefit from the passporting rights, there will likely be arguments that the contracts have been breached or that early termination rights have crystallised for the benefit of the non-defaulting party. Alternatively, a party may wish to argue that the contract has been frustrated as a matter of law based on the counterparty being unable to perform.

In recent days we have also seen the UK’s credit rating being downgraded by Moody’s. If the same were to slowly filter through to the corporate sector, companies could find themselves in breach of financial covenants triggering events of default or raising arguments under force majeure or MAC clauses. We note that similar arguments have been raised before in the aftermath of the 2008 financial crisis. Please see our previous article on this1.

We have previously advised the specific issues that will impact on disputes; these are summarised below and covered in greater detail in our publication Brexit Considerations: Dispute Resolution2. We anticipate disputes with an EU counterparty being affected as follows:

  • Choice of governing law is unlikely to be affected.
  • Choice of jurisdiction is likely to be affected as Recast Brussels will cease to apply, unless the UK/EU agree otherwise, or adopt other conventions such as the Lugano Convention or the Hague Convention on Choice of Court Agreements 2005.
  • Service of litigation proceedings is likely to be affected as the EU Service Regulations will cease to apply. Inserting an agent for service of process clause (namely, a party nominated to accept service of proceedings in this jurisdiction) will circumnavigate the issues, otherwise it is likely that we will revert to the service provisions under the 1965 Hague Convention which will be time-consuming and costly.
  • Enforcement of UK court judgments will be affected. There will be a major impact here – if parties facing an EU counter-party are close to judgment, or have obtained judgment already, they would be well advised to enforce under the current Recast Brussels regime whilst still in place. Unless similar regimes are adopted, UK and EU courts will look at the substantive nature of the claim leading to the judgment - there will be a mini-trial, in the same way as between the US/UK.