Whether you own a UK or non-UK business, whether you are an exporter or importer and whether the UK is the focus of the sale of the relevant goods or services or part of a broader sales territory, you should be taking into account the potential direct or indirect effects of Brexit on your existing commercial contracts and your business generally.
If Brexit is likely to have a negative effect on an existing commercial contract (for example, higher production, regulatory or administration costs leading to losses or insufficient profits), you may wish to try to renegotiate or even terminate the relevant commercial contract. If you believe that Brexit is likely to have a negative effect on a trading partner, you may wish to take steps to protect yourself from that trading partner terminating, seeking to terminate or renegotiate a contract or the risk of that trading partner ceasing to carry on business.
In this article, we consider the circumstances in which a party to a commercial contract may seek to terminate or renegotiate that contract as a consequence of Brexit and the ways in which Brexit may allow a party to terminate or renegotiate a commercial contract. It may be relevant to a broad range of long term commercial contracts (for example, agency agreements, distribution agreements, franchising agreements, licensing agreements, outsourcing agreements and supply agreements) but is less likely to be relevant to short-term or one-off contracts. Please read our article entitled “Brexit and your commercial contracts” for further information in this regard.
At the time of writing, it is uncertain as to whether the UK and EU will be able to conclude a withdrawal agreement in relation to Brexit. The existing draft withdrawal agreement was endorsed by the members of the EU on 25th November 2018. It was due to have been voted on by the UK parliament today (Tuesday, 11th December 2018) but the vote has been delayed. If no withdrawal agreement is concluded by 29th March 2019, then the UK will leave the EU without an agreement to govern the terms of withdrawal. This is commonly referred to as a "hard Brexit” or “no deal" scenario. Once again, please read our article entitled “Brexit and your commercial contracts” for further information. In this article, we focus on the implications of a “hard Brexit”, as this scenario is likely to cause the greatest problems for businesses.
Whether there is a “hard Brexit” or a “soft Brexit”, the UK will remain an attractive market for the majority of overseas goods and services. Whilst Brexit may raise a variety of new problems, it may also create new opportunities for your business (for example, the acquisition of a competitor or a convenient time to restructure).
The most important steps that businesses need to take in relation to Brexit are (a) to assess and monitor the legal, financial, operational and administrative implications of Brexit on their contracts, working practices and businesses generally; (b) create a plan (or amend their existing plan) including their Brexit strategy; and (c) ensure that they implement that plan.
What negative impact could Brexit have on your commercial contracts?
Brexit may affect your commercial contracts and your business generally in many ways depending on factors such as your business structure, business methods, the type of goods or services that you sell and the nature of the market for those goods or services. By way of example through fluctuations in exchange rates, increased trade tariffs, changes to the VAT treatment of payments under contracts, the costs and delays of greater customs checks, the risk of labour shortages (either generally or in specific sectors), the complexity of complying with parallel regulations and the potential need for relocation. These events could lead to businesses wishing to renegotiate or terminate contracts, which become loss-making or insufficiently profitable or because they become too onerous or difficult to perform. The result could be financial hardship for one of the parties.
Do you need to terminate (or seek to terminate or renegotiate) your contract on the grounds of Brexit?
In several cases, you may not need or wish to terminate (or renegotiate) your commercial contracts. By way of example:
1. Where you are confident that your (and your trading partner’s) ability to perform and the costs of performing the relevant contract will not be affected by Brexit or the relevant contract already provides for such a scenario.
2. Where the business or legal risks of terminating (or renegotiating) the relevant contract are higher than the risks of continuing with the existing contract.
3. Where you enter into short-term contracts and can revise your terms and conditions of trading as and when necessary in order to address the impact or potential effect of Brexit.
4. Where you have the right to terminate the relevant contract without penalty on short notice.
5. Where you have the right to suspend the relevant contract without penalty on short notice.
Does your contract contain a “Brexit clause”?
A "Brexit clause" is a contract clause which alters (or permits a party to require the alteration of) the parties' rights and obligations as a result of a defined event occurring. It is similar to a material adverse change clause (“MAC” clause), albeit specifically focussed on the occurrence of Brexit and/or specified events arising as a consequence of Brexit. As such, it attempts to govern what will happen should the legal and business environment change in the future in much the same way as any other "if/then" clause.
If you entered into a long term commercial contract prior to the outcome of the Brexit referendum (and quite possibly, if you did so prior to the UK formally triggering Article 50 of the Treaty on European Union (“TEU”) on 29th March 2017 by giving notice of the UK's intention to leave the EU), there is a significant probability that that commercial contract will not contain a Brexit clause.
If your contract does contain a Brexit clause, then you will need to assess whether that clause permits you to terminate the relevant contract, change the way in which certain parts of the contract operate or force the other party to renegotiate the contract. Each business, each contract and each set of circumstances are likely to be different. By way of example:
1. Specified consequence, specific event – In these types of case, the contract will specify the consequences (for example, the price of the products or services is adjusted) which follow upon the occurrence of a specific event (for example, fluctuation in currency exchange rates).
2. Trigger, renegotiation, termination - In these types of case, the contract specifies an event or range of events which act as a triggering event (for example the imposition of tariffs, a change in regulatory requirements, a party's costs increasing). If and when a triggering event occurs, the party affected by Brexit may request renegotiation of the contract. If no deal can be reached, the affected party may terminate the contract. The party not affected by Brexit faces the choice of accepting less favourable terms or early termination. The more broadly drafted the trigger, the greater the risk. The affected party may find the trigger too narrow to capture what has actually happened. In addition it has no certainty that it can reach a new deal.
If your contract has no effective Brexit clause, on what other grounds may Brexit enable you to terminate your commercial contracts under English law?
The right to terminate a contract is likely to depend on the interpretation of the express terms of the relevant contract, but may also arise from implied terms of contract or English common law.
There are a number of clauses, which are sometimes included in commercial contracts (particularly long-term contracts), that may enable a party to terminate the relevant contract or provide the opportunity for a party to reduce its risk in relation to the relevant contract by bringing about changes to the contract by negotiation or otherwise. Alternatively, implied terms of contract or English common law may provide similar opportunities. These may include the following:
1. Force majeure clause - Force majeure clauses are frequently included in commercial contracts. They are often considered as being of possible assistance with Brexit-type scenario.
The term “force majeure” has no general recognised meaning in English law. However, the underlying principle is that on the occurrence of certain events, which are usually wholly or partly outside a party's control, that party is excused from, or entitled to suspend performance of all or part of its obligations. In such circumstances, that party will not be liable for its failure to perform the obligations, in accordance with the clause. It is used in contracts because of the limited remedies available to parties under English common law when a contract becomes impossible to perform. The possibility of using it as a means of terminating a contract will depend on the exact words that the parties have used and how they are to be interpreted. Typically such a clause contains a non-exhaustive list of events that the clause is intended to cover.
In the absence of an express reference to Brexit, it seems unlikely that a force majeure clause will assist on Brexit, particularly in relation to a contract entered into after the outcome of the referendum (and, potentially, once it became known that a referendum may take place). This is because (a) an event is only usually considered to be outside the control of a party if the party has taken all reasonable steps to avoid its operation or mitigate its results. If Brexit was a possibility when the contract was entered into, it could be argued that the parties could and should have planned for its effects. (b) A change in economic or market circumstances affecting the profitability of a contract or the ease with which the parties' obligations can be performed is not generally accepted as being a force majeure event. (c) Force majeure clauses are most often intended to deal with temporary situations. Accordingly, they often offer the option of terminating the contract if a force majeure event continues for more than a specified length of time.
2. Material adverse change (MAC) clause - MAC clauses are less common than force majeure clauses. They are more commonly included in financial, lending or acquisition agreements.
They usually permit a party to terminate an agreement if an event occurs that is detrimental to that party (for example, the financial status of a borrower (or its subsidiary) in connection with a loan agreement).
Once again, the extent to which a party may be able to rely on a MAC clause when seeking to terminate an agreement due to the effects of Brexit will depend upon the interpretation of the relevant clause. A contracting party is not normally able to rely on a MAC clause in relation to circumstances of which it was aware (or ought to have been aware). Accordingly, any attempt to utilise a MAC clause contained in a contract entered into after the outcome of the referendum (and, potentially, once it became known that a referendum may take place) in order to terminate an unwanted contract may be considered unlikely to succeed.
3. Frustration - A contract may be discharged on the ground of frustration when something occurs after the formation of the contract which renders it physically or commercially impossible to fulfil the contract, or transforms the obligation to perform into a radically different obligation from that undertaken at the moment of entry into the contract.
A claim that a Brexit-related event frustrates a contract could be challenged on the following grounds that: (a) The event was within the contemplation of the parties at contract formation. Whether this is the case will depend on when the contract was entered into and the nature of the event. It is not enough that the event was merely unexpected. (b) The event does not make further performance impossible, illegal or radically different. The bar is set high by the courts. For example, it is not enough that the contract is merely more expensive to perform.
In the circumstances, it seems unlikely that a business will be able to terminate a contract because of Brexit where the contract was entered into after the outcome of the referendum (and, potentially, once it became known that a referendum may take place). Where a contract was entered into prior to that time, there may be more scope for ending contracts on the grounds of frustration.
4. Compliance with law clauses – It is common for contracts to contain an express clause stating that the parties must comply with applicable law. In particular, a contract often defines the law as being “the law at the date of the agreement” or “the law as it may be amended from time to time”. If the contract is silent on this point, it will generally be a matter of interpretation.
Where a contracting party is obliged to comply with “the law as it may be amended from time to time”, Brexit may make a party’s obligations substantially different to what they were originally or make it difficult or impossible for a party to comply with a contract. However, it is still likely to be a matter of interpretation as to whether such a clause could oblige a party to absorb the costs associated with a Brexit-related change in law. Long-term agreements often expressly address what will happen if the law changes, for example by specifying that charges cannot be increased and requiring the supplier to consult with the customer before making any necessary changes to the services.
5. Change control clause - Long-term agreements often contain a clause setting out a procedure to follow when either party wishes to amend the contract. Typically, they allow either party to raise issues (often of an operational nature), and set out a process and timetable for discussing such issues and implementing any agreed changes. However, it is unusual for a party to be able to demand that any amendments it suggests take place and it is uncommon for there to be a right to terminate if a change (particularly a non-essential change) is not agreed.
It is unlikely that a change control clause could be used in order to terminate an unwanted contract. However, it may be of assistance if, for example, the way the contract is performed needs changing to reflect a Brexit-related change in law.
6. Hardship clause - A long-term agreement may contain clauses which deal with which party should bear the burden of increases in costs of supply, fluctuations in interest rates or exchange rates, and other changes to factors that the parties took into account when they made the deal. Whether such a clause can be invoked when a Brexit-related event occurs depends entirely on how the clause is drafted (for example, if it includes a mechanism for making price adjustments in specified circumstances)
It is unlikely that a hardship clause could be used in order to terminate an unwanted contract. However, it may be of assistance in connection with renegotiating a contract if, for example, the way the contract is performed needs changing to reflect a Brexit-related changes.
7. Interpretation and implied terms - The courts may be reluctant to interpret a contract or imply a term into a contract to assist a party who is adversely affected by Brexit. While interpretation should have regard to business common sense, this does not mean the courts will relieve a party from the consequences of their imprudence or poor advice, if that involves departing from the natural meaning of the contract. Similarly, the fairness of a proposed implied term or the fact that the parties would agree to it is (by itself) insufficient grounds for implying it. Both interpretation and implication of terms have regard to the background knowledge reasonably available to the parties at the time they entered the contract.
In the circumstances, it seems unlikely that a term which would assist a contracting party in connection with Brexit could be implied into a contract where a contract was entered into prior to the outcome of the referendum (and, potentially, once it became known that a referendum may take place) as it is unlikely that any such term would have been in the contemplation of the parties. Where the parties fail to specifically provide for Brexit after that date, they may be taken to have accepted that any additional costs and risks should lie where they fall.
8. Other contractual terms – Various other contractual terms (for example, assignment clauses or the existence of minimum purchase or sales targets or requirements) may enable a party to reduce its commercial risks. The ability to do so is likely to depend on the wording and interpretation of the relevant clause (for example, can a party assign the benefit and burden of a contract).
9. Business structure and restructuring – It is possible that the existing business structure of a party may enable that party to avoid some or all risks in relation to unprofitable or unwanted contracts (for example, where it has used special purpose vehicles) or to restructure its business in order to achieve the same outcome.
In the absence of an express reference to Brexit in your commercial contract, it seems unlikely that you will be able to terminate your contract because of Brexit, particularly in relation to a contract entered into after the outcome of the referendum (and, potentially, once it became known that a referendum may take place). In general terms, this is because a court is likely to take the view that the parties could and should have planned for its effects and would have done so if they had intended it to affect the contract. However, it may be that certain express or implied contractual provisions or English common law enable a party to require changes to contracts (typically, financial or operational changes) or that commercial inducements (for example, a longer contract or improved terms in other areas of a contract) may enable parties to resolve problems created by Brexit. It may also be in the commercial interests of both parties to find solutions to any problems created by Brexit.
Ultimately, the earlier you create your Brexit strategy and more thoroughly you prepare and carry out your due diligence, the better your chances are of making your Brexit strategy work. In order to maximise any benefits and minimise any risks of Brexit, you need to be in control of the process from start to finish, which requires detailed thought, preparation and planning. Determining your objectives and setting your goals early on, creating a viable plan and reviewing and revising it regularly means that you will maximise your chances of being ready to take advantage of any good opportunity to develop your business or minimise any risks to your business as a consequence of Brexit.
Need to talk?
Whatever stage of the contractual process you have reached, we can help you to understand the different legal and related commercial issues relating to Brexit, to choose the option that is right for you and to help you develop or minimise risks for your business.
If you would like more information about the contractual effects of Brexit or would like to discuss a potential or existing contract, please contact us by telephone on +44 (0)20 3126 4520 or +45 38 88 16 00 or by email at firstname.lastname@example.org