On June 23 2016, the UK electorate voted to leave the European Union, a process commonly called 'Brexit'. The referendum was advisory rather than mandatory so it will have no immediate legal consequences. It will, however, have a profound long-term effect. As the next steps will be driven by UK and EU politics, it is difficult to predict the future of the United Kingdom's relationship with the European Union and their impact on M&A activity.
The treaties that govern the European Union expressly contemplate a member state leaving. Under Article 50 of the Treaty on the Functioning of the European Union, the United Kingdom must notify the European Council of its intention to withdraw from the European Union. Once notice has been given, the United Kingdom has two years to negotiate the terms of its withdrawal. Any extension of the negotiation period will require the consent of all 27 remaining member states.
Any negotiated agreement will require the support of at least 20 of the 27 remaining member states, representing at least 65% of the European Union's population, and the approval of the European Parliament. If no agreement is reached or no extension is agreed, the United Kingdom will automatically exit the European Union two years after the Article 50 notice is given, even if no alternative trading model or arrangement has been negotiated. The United Kingdom will continue to be a member of the European Union in the interim, subject to all EU legislation and rules.
It is not clear what relationship the United Kingdom will seek to negotiate with the European Union. In the run-up to the referendum, a number of options were suggested.
The United Kingdom might seek to join the European Economic Area, as Norway has. The United Kingdom would have considerable access to the internal market – that is, the association of European countries trading with each other without restrictions or tariffs – including in financial services. Conversely, the United Kingdom would have limited access to the internal market for agriculture and fisheries and would not benefit from or be bound by the European Union's external trade agreements. In addition, the United Kingdom would have to make significant financial contributions to the European Union and continue to allow the free movement of persons. It would have to apply EU law in a number of fields, but it would no longer participate in policy making at the EU level and would be excluded from participation in the European supervisory authorities, the key architects of secondary legislation in financial services. To adopt this model, the United Kingdom would require the agreement of all 27 remaining EU member states, plus Iceland, Liechtenstein and Norway.
Negotiated bilateral agreements
Like Switzerland, the United Kingdom might seek to enter into various bilateral agreements with the European Union to obtain access to the internal market in specific sectors rather than the market as a whole (which would be the case under the Norwegian model). This bilateral model would likely require the United Kingdom to accept some of the European Union's rules on free movement of persons and comply with particular EU laws. Again, the United Kingdom would not participate formally in the drafting of those laws. The United Kingdom would also have to make financial contributions to the European Union. Negotiating these bilateral agreements would be a difficult and time-consuming process. Switzerland, for instance, has negotiated more than 100 individual agreements with the European Union to cover market access in different sectors.
A customs union is in place between the European Union and Turkey in respect of trade in goods, but not in services. Under this model, Turkey can export goods to the European Union without having to comply with customs restrictions or tariffs. Its external tariffs are also aligned with EU tariffs. The United Kingdom might seek to negotiate a similar arrangement with the European Union. Under such an arrangement, and unless separately negotiated, UK financial institutions (including UK subsidiaries of US holding companies) would be unable to provide financial and professional services in the European Union on equal terms with EU member state firms. For example, the EU passporting regime would be generally unavailable to the United Kingdom, meaning that UK firms would have to seek separate licensing in each EU member state in order to provide certain financial services. It is possible that some limited passporting might be allowed under particular EU financial services laws. Furthermore, in areas where the United Kingdom would have access to the internal market, it would be required to enforce rules that are equivalent to those in the European Union. The United Kingdom would not be required to make any financial contributions to the European Union and would not be bound by the majority of EU law.
Free trade agreement
The United Kingdom might seek to negotiate a free trade agreement with the European Union, which would cover goods and services. To do so, it may look to the agreement that was recently agreed between the European Union and Canada after seven years of negotiations. This agreement removes tariffs in respect of trade in goods, as well as certain non-tariff barriers in respect of trade in goods and services. Although the United Kingdom would not be required to contribute to the EU budget, its exports to the European Union would have to comply with the applicable EU standards.
World Trade Organisation membership
Under this model, the United Kingdom would have no preferential access to the internal market or to the 53 markets with which the European Union has negotiated free trade agreements. Tariffs and other barriers would be imposed on goods and services traded between the United Kingdom and the European Union. However, under World Trade Organisation rules, certain caps would apply on tariffs applicable to goods and limits would be imposed on particular non-tariff barriers applicable to goods and services. The United Kingdom would no longer be required to make financial contributions to the European Union and would not be bound by EU laws (although it would have to comply with certain rules in order to trade with the European Union).
Regardless of which model it adopts, the United Kingdom will no longer be required to apply certain EU legislation. The United Kingdom has implemented certain EU laws (generally, EU directives) via primary legislation that will continue to be part of UK law, unless these are amended or repealed. Other EU laws (generally, EU regulations) have direct applicability in the United Kingdom without the need for implementation, which means that these laws will fall away once the United Kingdom withdraws from the European Union, unless they are transposed into UK law. Finally, thousands of statutory instruments have been made pursuant to the European Communities Act 1972. If this act is repealed upon the United Kingdom's withdrawal from the European Union, then these statutory instruments will also cease to apply, unless they are transposed into UK law. Therefore, the United Kingdom will have to determine which EU laws and EU-derived laws it wishes to retain, amend or repeal. These decisions will be driven, in part, by the nature of any agreement reached with the European Union during Brexit negotiations.
The United Kingdom's withdrawal from the European Union will affect countless areas of the economy. The extent to which these areas will be affected by the United Kingdom's withdrawal from the European Union will depend on the model of relationship that the United Kingdom and the European Union adopt following Brexit negotiations.
For private and public M&A transactions, the potential impact may include the following:
- As a result of ongoing uncertainty around the future of the UK's relationship with the European Union, a number of M&A transactions with a UK nexus may be affected pending Brexit negotiations. However, with significant fluctuations in exchange rates and share prices, the dislocation in the markets may encourage both opportunistic and defensive M&A transactions.
- Private share sale transactions are not generally subject to much EU law or regulation. Private asset and business sales, however, may be more affected by Brexit. For example, the regulations that protect the rights of employees on a business transfer stem from an EU directive. When the United Kingdom withdraws from the European Union, it may no longer be bound by this directive and so the United Kingdom may wish to amend or repeal the related regulations.
- Public takeovers are regulated by the EU Takeovers Directive, among others. While the directive did not really change UK practice when implemented in 2006, it does provide a shared jurisdiction framework for the regulation of a transaction involving a takeover of a company incorporated in one member state, but listed in another. When the United Kingdom withdraws from the European Union, it may no longer be bound by this directive. The United Kingdom may wish to agree on a protocol with EU regulators to avoid takeovers becoming subject to dual regulation.
- Pursuant to the EU Cross-Border Merger Regulation, a company incorporated in one member state may effect a legal merger with a company incorporated in another member state. The procedure has been used to carry out cross-border internal group reorganisations and has also been used to effect the mergers of public companies. When the United Kingdom withdraws from the European Union, it may no longer be bound by this directive and so may wish to amend or repeal the related regulations.
- The financial markets will likely remain volatile, particularly during Brexit negotiations. This may affect the timing of M&A transactions or their ability to be consummated, particularly where the transaction is to be financed with the proceeds of a capital raising or where the consideration for the acquisition includes stock.
- Mergers that fall within the scope of the EU Merger Regulation can receive EU-wide clearance, which means that they need not also be cleared by individual member states. Following Brexit, however, mergers with a UK nexus may need to be reviewed separately by the United Kingdom's Competition and Markets Authority. More generally, UK antitrust legislation is currently based on, and interpreted in line with, EU law, including decisions of the European Commission and the European Court of Justice. Given that UK courts may no longer be required to interpret national law consistently with EU law once the United Kingdom withdraws from the European Union, businesses face the prospect of having to comply with divergent systems.
- During Brexit negotiations, corporate transaction documents may need to include specific Brexit provisions – for example, addressing the uncertainty around the model of relationship to be adopted and allocating the commercial risk of any uncertainty between the parties.
For further information on this topic please contact Will Pearce or Michael Sholem at Davis Polk & Wardwell London LLP by telephone (+44 20 7418 1300) or email (email@example.com or firstname.lastname@example.org). The Davis Polk & Wardwell website can be accessed at www.davispolk.com.
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