Market uncertainty

The outcome of the EU Referendum is already causing turmoil in the markets. The uncertainty over trade is likely to continue for some time, not least because of the scale of the task facing Government. The UK has to juggle the EU withdrawal negotiations, negotiating a new trade agreement with the EU, replacing the 36 trade treaties which we have with the rest of the world by virtue of our EU membership, potentially negotiating with the World Trade Organisation (WTO) and reviewing which legislation derived from the EU we wish to keep and which we do not.

Formal withdrawal negotiations start when notice is served under Article 50 of the Lisbon Treaty. Once notice is served, the EU Treaties cease to apply from two years after the notification or earlier, if the withdrawal agreement is concluded in advance. The two year period can be extended if the European Council and UK unanimously decide to extend it.

A new trade agreement?

Provided UK goods comply with EU Regulations, the UK can currently export goods and services to the EU free of tariffs or quotas. Exporters and importers might well be trying to assess how the outcome could affect the operation of their contracts, or any other contracts in the supply chain (especially if they depend on the EU freedoms of goods, persons, services or capital). Of course, much depends on the trading model we are able to adopt and how quickly. At the moment, that is unclear. However, trade negotiations seem likely to take much longer than the withdrawal negotiations. A new trading agreement with the EU would require the unanimous consent of all 27 remaining EU member states.

One option might be to seek to join the European Free Trade Association (EFTA) whose members such as Norway and Iceland have tariff free access to EU markets. However, the UK would have no automatic right to join the EFTA or European Economic Area (EEA). If the EU were to offer this to us, we would have to make a financial contribution towards the operation of the EU via an EEA grant. We would also accept most of the other free market rules (although we would not be able to vote on them) including free movement of people. Given that much of the Leave campaign was focused on taking back border control, it remains to be seen where the negotiation will end up.

If we have not completed trade agreements pre EU withdrawal, there appears to be an assumption that the UK would be forced back onto the WTO's General Agreement on Tariffs and Trade. However, the director-general of the WTO has said that this is not automatic and that:

"Britain would have to strike a deal on everything from the thousands of tariff lines covering its entire trade portfolio to quotas on agricultural exports, subsidies to British farmers and the access to other markets that banks and other UK services companies now enjoy. Pretty much all of the UK’s trade [with the world] would somehow have to be negotiated,” and "An exit from the EU, for example, would cause the UK to lose the preferential access to other markets covered by 36 trade agreements with 58 countries negotiated by the EU. As a result, to remain compliant with WTO rules the UK would have to impose higher “most favoured nation” tariffs on imports from those 58 countries, while they would have to levy their own surcharges on British exports."

The WTO rules follow the principle of non-discrimination. Countries must not treat any trading partner less advantageously than any other, unless governed by separate free trade agreement. EU member states would have to apply the same tariffs to the UK as others who aren't part of the customs union. Each WTO member operates a schedule of agreed tariffs. If we adopt the WTO model, we would need to negotiate a new set of tariffs. That might mean they are less competitive than EU member states that are able to export tariff free within the EU, or other non EU countries that have successfully negotiated a free trade deal. Page 75 of this WTO publication shows the estimated average tariff rates the EU charged in 2015 for those countries. They are charged as a percentage of weight or value. For instance, animal products are 20.4%, dairy 45.3%, fruit and vegetables 10.4%, coffee and tea 6.1%, cereals 19.4%, beverages and tobacco 20.8%, sugars and confectionery 25.6%, petroleum 2%, clothing 11.5%, electrical machinery 2.4% and transport equipment is 4.1%.

For more information, take a look at the WTO's World Tariff Profiles 2015.

Flexibility and options

In uncertain times, businesses tend to value flexibility and agility. They want to know what their options might be. If a business is concerned that a certain contract might no longer be profitable (for example, because of exchange rate volatility or import or export duties which may be imposed in due course), or is incapable of being performed, might the UK's withdrawal from the EU enable the parties to get out of the contract? Specifically, could the contract be frustrated? If a contract is frustrated, it will discharge the parties from further liability.

What is the doctrine of frustration?

The doctrine of frustration is when something happens after a contract has been entered into which renders it physically or commercially impossible to fulfil, or transforms the obligation into something radically different from that agreed at the start. The doctrine has a narrow scope. Courts do not want parties to use it to get out of a bad bargain. One requirement is that the event has to be not due to the fault of either party. Another is that the event has to be so fundamental as to affect the root of the contract, and go entirely beyond what was contemplated by the parties when they entered into the contract.

Usually if performance of a contract just becomes more difficult, the party who fails to perform is liable in damages.

The potentially frustrating event

In this instance, what might be the potentially frustrating event is arguable. For example:

  • Was it the outcome of the vote on 23 June 2016 ie the EU Referendum (since that is only advisory);
  • Might it be the serving of notice under Article 50, assuming that happens?
  • Might it be the coming into effect (or not as the case may be) of a new trade agreement at which time it should be clearer about whether the UK will need to comply with EU Regulations and whether tariffs will apply?
  • There was a commitment to a referendum in the Conservative Party manifesto. The UK General Election was on 7 May 2015. Therefore, it might be argued that the possibility of leaving the EU should not have been entirely beyond parties' contemplation for contracts entered into from 8 May 2015 onwards.

The answer to the above question may partly depend on the nature of the contractual obligation in question.

Examples of frustrating events include:

  • Where parties agreed to let one of them use a music hall for concerts on four specified nights. After the contract was made, but before the first night, a fire destroyed the hall. The defendants were found not to be liable for failing to provide the use of the hall – the contract was subject to an implied condition that the parties must have known from the beginning that its fulfilment depended on the continuing existence of the hall. The fire rendered performance impossible. The contract was frustrated;[1]
  • Performing the contract would impose a burden on one party which is radically different from that contemplated at the time of contracting;[2]
  • An employee was unavailable to perform an employment contract.[3] In the event that the UK in due course applies the same visa rules as non-EU nationals and an employee does not successfully obtain a visa, there are probably better arguments employers can rely on rather than frustration of contract, to terminate eg misconduct or "some other substantial reason" (SOSR);
  • Where there is a change in the law or circumstances which can make performance illegal. (eg if war breaks out).[4]

Expense is not enough

Contracting parties should take into consideration that English courts have consistently been unwilling to accept that a contract is frustrated simply because they are more expensive to fulfil than originally anticipated. Therefore to rely on frustration, the contract must be affected by Brexit in a more fundamental way than mere additional expense.

When may 'frustration' be applicable?

Given the narrow scope of the doctrine, generally speaking a contracting party is very unlikely to be successful in seeking to rely upon the doctrine of frustration to relieve them of their contractual obligations. One exception might be where it is unlawful to continue obligations without EU authorisation (eg obtaining a licence), that authorisation can no longer be obtained and this was completely beyond the parties contemplation when the contract was entered into.

Much depends on the particular terms of individual contracts and legal advice should be sought on a case by case basis. In each contract which relies fundamentally on free movement of goods, harmonised regulations and/or EU legislation, parties will need to consider their contractual obligations, allocation of risk, profitability and whether they can still be performed. They will obviously need to monitor those as the UK's negotiations continue with the EU.

Better options

There may well be better ways of avoiding unprofitable contracts rather than seeking to rely on the doctrine of frustration. For instance:

  • Are there grounds for termination eg if one party has breached the contract?
  • Is there a force majeure clause? This typically excludes one or both parties from performing the contract in a certain way following the occurrence of certain events. This might be a better peg to hang your coat on if seeking a way to avoid your contractual obligations, or when ascertaining whether your contracting party may have an "out." The other party may of course disagree on whether Brexit constitutes a force majeure event. Check whether there is any contractual requirement for you to work around the force majeure clause
  • Is there a material adverse change clause that will trigger on Brexit (and if so, what is the precise trigger)?

It should of course be noted that all of the above points about frustration and better alternatives to avoiding contracts cuts both ways. Businesses based in the EU may well also consider these options in appropriate circumstances.

To pre-empt disputes, parties should review each of their contractual arrangements and assess whether Brexit is likely to have unplanned (and/or undesired) consequences.