As businesses conduct their Brexit planning, one of the most important tasks will be to understand how their commercial contracts will be affected. This will depend on a number of legal and commercial considerations, but there are some important factors that businesses should be taking into account now.
Impact on English contract law
Brexit is likely to have a limited direct impact on English contract law. This is because the general principles of English contract law (being the rules that govern the conclusion of contracts, contract terms, the rights and obligations which contracts create, and the remedies which arise on breach of contract) are predominately found in our judge-made common law. That common law, such as it stands on “exit day” and including any judgments of the Court of Justice of the European Union (CJEU) which have been interpreted and implemented into our common law, will be unaffected by Brexit.
Legislation does play a part in shaping contract law, commonly by supplementing or qualifying the common law. Some of that legislation is national in origin and therefore will not be directly affected by Brexit. Examples are the Contracts (Rights of Third Parties) Act 1998 which introduced a new, and significant, exception to the common law doctrine of privity of contract, and the Misrepresentation Act 1967 which removed the need to establish a duty of care between the representor and the representee.
Other legislation which impacts on contracts is European in origin, particularly that which governs certain specific types of contracts (rather than contract law itself), such as contracts with commercial agents and consumers. The current draft of the European Union (Withdrawal) Bill states that “EU-derived domestic legislation”, such as the Commercial Agents (Council Directive) Regulations 1993, will continue to have the same effect after exit day as on exit day, and that “direct EU legislation”, such as EU regulations, will form a part of domestic law after exit day. It is these areas of law which, while initially preserved, may be most vulnerable to repeal or amendment after exit day.
But while the law may not change a great deal, at least at first, the operation of contracts may be affected in other ways.
Changes in meaning of contract terms
Territorial restrictions, which are commonly included in licence and distribution agreements, may be defined by reference to “the EU” or perhaps “the member states of the European Union from time to time“. Will these expressions continue to include the UK post-Brexit? Most likely, the latter phrase would not include the UK, which may well impinge on a company’s rights as anticipated when the contract was entered into, and need to be reviewed. It will be a matter of construction of each agreement how the relevant term is interpreted post-Brexit, but the uncertainty could be avoided by businesses reviewing contracts now, and seeking to clarify the position by written agreement.
References to specific EU legislation
Some commercial contracts make express reference to specific EU legislation, usually by way of an obligation on one party to comply with that legislation. As noted above, there should be no immediate impact on exit day because EU-derived implementing legislation will continue to have the same effect, and direct EU legislation will form a part of domestic law after exit day. However, such laws are more likely to change post-Brexit than legislation which is national in origin.
Other EU references
Agreements may also contain references to EU regulatory bodies, or EU standards. It is important that businesses are aware that such references may no longer be relevant to their agreement, or may impose an unnecessary level of regulation, post-Brexit. Businesses are advised to perform an audit of key contracts to determine which provisions might be affected, and seek clarificatory changes to those contracts where necessary.
Where laws are amended post-Brexit, will a party be contractually required to comply with the new laws?
First, we should consider a standard interpretation clause which is found in many commercial contracts. Commonly, such a clause states that “any reference to a statute or statutory provision includes any statute or statutory provision which modifies, consolidates, re-enacts or supersedes it“. Such a provision is likely to mean that the contract continues to operate post-Brexit, but may have a huge commercial impact. We recommend that parties give greater attention to interpretation clauses in contracts being negotiated currently, and consider their impact given the more significant changes which can be expected post-Brexit.
The Courts’ approach to construction
When considering the issues outlined above, it is important to note the current approach that English courts are taking to the construction of contracts. In Arnold v Britton and subsequent cases, the courts have set limits on the “commercial common sense” approach which had previously been followed. As a general rule, a court should now be very slow to reject the natural meaning of a provision simply because that natural meaning appears to be a very imprudent term for one of the parties to have agreed. Thus, where the wording of the contract is clear, the fact that the result makes little commercial sense is unlikely to assist a party which is adversely affected by Brexit.
Commercial consequences of Brexit
It is likely that Brexit will have a number of commercial consequences for your trading relationships. Businesses should therefore be conducting an audit of their key commercial contracts to assess which of those contracts will be affected. Possible effects include the following:
- Import and export duties may be imposed, making goods and services more expensive to supply into the UK or the EU.
- Non-tariff barriers such as documentation requirements or customs checks may be imposed or increased, adding complexity, causing delays and increasing transaction costs.
- There may be restrictions on the free movement of people, which may make it more expensive to use labour in the UK and could make a contract uneconomic.
- There may be further fluctuations or shifts in the Sterling exchange rate.
- Tax changes may be introduced; for example, tax rates or the tax treatment of goods or services may be altered.
What relief may be available without making changes to the current terms of your contracts?
It is unlikely that a standard force majeure clause will be of assistance in the event of Brexit. The term has no general recognised meaning in English law, so whether a force majeure clause is triggered will depend on the exact words that the parties have used – particularly the non-exhaustive list of events that the clause is intended to cover. Looking at the list of non-exhaustive events that are included in a standard force majeure clause, we would not expect there to be any event that could provide a basis for construing the clause as including Brexit or the commercial consequences of Brexit.
Further, a change in economic circumstances which affects the profitability of a contract, or the ease with which the parties’ obligations can be performed, has been held not to be a force majeure event. In 2005, and again in 2010, it was held that the fact that a contract has become more expensive to perform, even drastically more expensive, is not a ground to relieve a party on the grounds of force majeure (or frustration).
If a business wishes to include a force majeure clause that can be invoked as a result of Brexit, they should refer expressly to the commercial consequences of Brexit in their force majeure clause.
Those looking to include or rely on a force majeure clause should also consider the effect of invoking that particular clause. Some force majeure clauses are suspensory in nature, whereas some result in termination rights.
Frustration is a common law concept, which is applied narrowly by the courts. Where a contract is frustrated, it will be discharged, and the parties are no longer bound to perform their obligations. But the frustrating event must render further performance impossible, illegal, or make it radically different from that contemplated by the parties at the time they entered into the contract.
If that isn’t a high enough hurdle, it has been established that a contract is not frustrated where the contract is merely more expensive to perform, or more onerous to perform, or where an alternative method of performance is possible. Contracts will be frustrated by Brexit only in a small number of cases.
Existing termination rights
It seems unlikely that a party which itself suffers adverse consequences as a result of Brexit will be able to terminate its agreements on the basis of the sort of termination rights which are most commonly included in commercial agreements, with the exception of any express termination for convenience rights.
What express changes to an agreement should be included in agreements?
Clauses to protect against changes in currency value
Clauses which protect against changes in currency value are increasingly common in commercial agreements. An agreement may not set out a fixed price, but include provisions to cater for where there has been an exchange rate shift between the order date and the payment date which exceeds an agreed “exchange rate tolerance”.
Alternatively, a distribution agreement, for example, may provide for the price to be based on a specified exchange rate, that the price will be reviewed quarterly, and that if the value of Sterling to the foreign currency has fallen by a certain percentage during that quarter, the price will be increased by, say, 50% of the percentage change. Short-term, isolated changes may need to be excluded. The appropriate solution will depend on the agreement in question, but as a general rule, such clauses will often make commercial sense.
Clauses to protect against the imposition of tariffs, customs checks, non-tariff barriers or other increases in costs
A supplier should consider including clauses that seek to share the burden of increased costs in providing the goods or services in accordance with the agreement. Agreements could include a number of Brexit-related assumptions on which the charges, or the price, are based. Those assumptions may include the current tariffs that are in place, applicable corporation tax rates, applicable VAT rates and treatment, the level of complexity of current customs checks, or paperwork requirements. Where those assumptions change, a mechanism could be included for how the agreement will be impacted. This will require some proper thought by the parties (see “Change in law” and “Broader Brexit clauses” below).
Indexation clauses – and the index used – may become more important and deserve greater scrutiny. An index commonly referenced in commercial agreements is the RPI (despite it no longer being a national statistic) and the CPIH. But there are other indices which parties should consider. For example, in any contract where labour is a key cost, using the Index of Labour Costs per Hour (ILCH) may provide better protection in the event of a labour shortage and an increase in labour costs.
Change in law clauses
Many contracts contain change in law clauses. These clauses provide certainty by setting out which party will be responsible for the costs incurred in complying with certain change in law. Changes in law are more likely, as well as more likely to be significant, as a result of Brexit.
Often, costs associated with changes in law which affect all of a supplier’s customers (as opposed to a change which is specific to one industry) are borne by the supplier. But this default position may not deal with Brexit-related changes appropriately and the supplier may seek to negotiate a better position. Businesses are likely to agree that changes in law that may be introduced as a result of Brexit are, at this stage, unforeseeable – which may help a supplier in its negotiations.
Some issues for businesses to consider are as follows:
- A supplier may seek to negotiate that it will be reimbursed by its customer for the costs incurred with complying with a Brexit-related change in law up to a specific amount, or a certain percentage of the value of the contract, or that the costs will be borne equally by the parties.
- Customers are likely to require that the change in law is “Brexit-related” in order to narrow the scope of the clause. However, proving this causal link may be difficult for a supplier and suppliers are likely to prefer to refer to the adverse consequence itself rather than the causing event.
- The parties should consider what stage in the Brexit process is the most appropriate trigger. Some of the consequences of the referendum decision (such as a movement in exchange rates) have occurred, and may occur again, prior to exit day. Others may be triggered either at the beginning or the end of any transition period.
- Where any change in law clause is defined by reference to Brexit-related changes to “Applicable Law”, the parties should take care that such definition is broad enough to cover all of the potential impacts on the agreement such as changes to import duties, taxes, tariffs, quotas, required licences, consents, and indeed changes to laws in other countries which may impact on the agreement etc. Not all of these may fall within the current of the definition of “Applicable Law”.
- The parties should consider whether there should be a limit to the number of times, or frequency with which, a supplier can seek to invoke a Brexit-related change in law clause.
Express Brexit clauses?
The parties may also consider including an express Brexit clause. A Brexit clause triggers certain changes in the parties’ rights and obligations as a result of a defined event occurring, which will be broader than a change in law (although many of the considerations mentioned above in relation to change in law are likely to be relevant). The parties will need to consider:
- Whether the clause will specifically refer to Brexit and, if so, what degree of causal connection between Brexit and the adverse consequence is required.
- How narrowly the adverse consequence should be drafted. The adverse consequences may be as broad as an increase in the costs and expenses of the supplier, or as narrow as a material change in the requirement for a specified licence or permission which is required for the performance of the agreement. The parties may consider whether it is appropriate to have a time period after the triggering event in which the clause must be invoked.
- What the consequence will be. The parties may be able to agree any of the following consequences:
- A change to any defined term used in the agreement, such as a territorial restriction.
- An express termination right (bearing in mind how any such termination would be categorised and whether any early termination fees would apply).
- That where the costs of performing the contract increase by more than a certain percentage (or at all), those additional costs will be borne equally by the parties, or that one party will reimburse the other up to a specified sum (or up to a specified percentage of the value of the contract).
- To categorise any Brexit-related change to the agreement which is sought as either a “dispute” or a “change” and to use an agreed dispute resolution / change procedure to resolve the issue.