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Brexit and Contracts - A Practical Guide
For businesses trying to navigate the current Brexit landscape, one key consideration is the impact of events on their contractual relationships. This is a very real issue with potentially significant consequences.
On 21 February 2019, the English Courts tackled the issue of a Brexit argument in the context of a lease related contractual dispute. Canary Wharf Group (as landlords) succeeded in obtaining a declaration that a withdrawal by the UK from the EU and / or the relocation of the European Medicines Agency (“EMA”) (as tenant) did not absolve EMA from its obligations under the lease, as a consequence of which EMA remains liable for lease obligations worth about £500 million. EMA had argued Brexit would frustrate the lease, as it drastically changes the original reason for signing it. Although it remains to be seen whether this decision will be appealed, it is indicative of the narrow approach of common law courts to the doctrine of frustration.
Can a party avoid contractual obligations which become more onerous or impossible to perform as a result of Brexit?
With Brexit day fast approaching, many businesses are wondering whether the fact and / or form of Brexit will – of itself – constitute an event which operates to discharge parties from their obligations under commercial contracts.
Unforeseen events which occur after a contract has been entered into may be used by a disadvantaged party to argue that performance of the contract has become impossible, illegal or radically different from that originally contemplated, such that the contract has been discharged by the operation of the doctrine of frustration or by reason of force majeure or material adverse change (“MAC”) clauses.
Ultimately, the question of whether these types of clauses can be triggered as a result of Brexit will depend on the wording of the relevant clause. It is unlikely that the very fact of Brexit in and of itself would trigger such clauses, absent specific wording to that effect. It is, however, possible that legal changes that come about as a consequence of Brexit, and the impact of such changes, might trigger those clauses.
What is frustration?
A frustrating event would generally be an event which could not have been foreseen by the parties at the time of entering the contract.
A contract will not be frustrated merely because performance has become more expensive or changes to economic conditions. Rather, for a frustration argument to succeed, it would need to be established that an event has occurred of sufficient seriousness that it renders performance impossible or the obligation fundamentally or radically different from what was agreed to when the contract was entered into. For example, currency fluctuations are less likely to be a frustrating event than an inability to source products that meet revised regulatory standards.
The doctrine of frustration is a narrow one and the burden of proving it is onerous. There is very little case law on the doctrine of frustration. One reason for this is that commercial parties have, for many years, sought greater contractual certainty by including express termination rights in agreements, through force majeure or MAC clauses, where an adverse event arises.
What are force majeure and MAC clauses?
Force majeure clauses generally operate so as to excuse performance of particular contractual obligations on the happening of certain specified events beyond a party’s control. However, there is case law to the effect that a change in economic circumstances which affects the profitability of a contract or the ease with which the parties’ obligations can be performed, does not constitute a force majeure event in the absence of express wording to the contrary.
Similarly, MAC clauses are designed to relieve a party of its obligations on the occurrence of an unforeseen adverse event. These are very common in finance documents. For example, where the prospects of a business have been materially adversely affected by Brexit, a lender might wish to rely on a MAC clause to limit its ongoing exposure to that business.
Is there anything that can be done to Brexit-proof new contracts?
In the event of a no-deal Brexit, one can see how it might be argued that this constitutes an unforeseen adverse event in contracts that were entered into prior to the original Brexit vote in the UK.
However, for more recent contracts, it will be more difficult to argue that this possibility could not have been foreseen and, for this reason, “Brexit clauses” have been included in commercial contracts more frequently in recent months.
Irrespective of whether we see a no-deal or negotiated withdrawal, Brexit has the capacity to affect almost every aspect of doing business (although of course some sectors and industries are more susceptible to impact than others).
Parties often have in their contracts a term by which a party (or both parties) may be excused from performance of the contract, in whole or in part, or be entitled to suspend performance or to claim an extension of time, upon the happening of certain events. Since the vote on 23 June 2016, Brexit has featured in the list of such events in many commercial contracts.
Alternatively, some commercial contracts have incorporated bespoke Brexit clauses to trigger automatic changes to a contract. A Brexit clause might simply provide for a requirement that the parties will seek to renegotiate certain relevant aspects of the contract, failing agreement on which the contract may be terminated.
For such clauses to be effective and enforceable it is essential to define the “trigger event” clearly. Some commonly used trigger events we have seen as a result of Brexit contingency planning include the following:
- the contract becomes unprofitable for one party (by reference to specific margins and / or thresholds);
- a change in law, regulation, or illegality;
- changes in regulatory regimes which give rise to additional costs over certain agreed thresholds;
- prices change substantially (eg, costs relating to tariffs or taxes); and
- the exchange rate fluctuates (up and / or down) more than a specified percentage over a specified period.
Other contractual quagmires
- Standard interpretation clauses commonly provide that “any reference to a statute or statutory provision includes any statute or statutory provision which modifies, consolidates, re-enacts or supersedes it”. One likely interpretation of this is that relevant UK legislation will continue to apply post-Brexit, but the consequent legislative changes may have a significant commercial impact.
- Is a provision allocating costs arising from a change in law required? 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 inevitable as a result of Brexit.
- Is a clause which protects against changes in currency value required?
- Is a clause that seeks to allocate the burden of increased costs in providing the goods or services on agreed terms required? Current tariffs that are in place, applicable corporation tax rates, applicable VAT rates and treatment, the level of complexity of current customs checks and / or paperwork requirements are all issues to be considered in this regard.
- Consider the governing law and jurisdiction clause. This will be very important for contracts with cross border implications. Such clauses will be particularly important where the contract relates to regulated industries or data processing, where EU law may need to be expressly stated as continuing to apply.
Is there anything that can be done to Brexit-proof existing contracts?
Unprecedented events are unfolding and outcomes are far from clear. What is clear, however, is that, Brexit will directly or indirectly affect most if not all transactions between Irish and UK businesses or Irish businesses doing business in the UK (including Northern Ireland).
Suppliers need to consider not just events which may directly impact them, but also their supply chain. Customers need to consider not only possible impacts on their own ability to use goods or services purchased under an agreement (and whether the price they are paying will remain competitive), but also how the market for their own products may be affected.
An audit of contracts, both in the pipeline and already in place, as well as a high awareness within businesses as to any contractual relationships which are already under pressure due to Brexit related events, is advisable. This should be stress tested in the context of both no-deal and negotiated Brexit outcomes.
At a minimum, businesses should:
- consider how Brexit could affect their business generally and their commercial arrangements with third parties;
- identify the key contracts governing those arrangements and assess if they provide sufficient protection against Brexit or are at least clear about the implications of Brexit;
- consider whether it will be necessary from a legal or regulatory perspective, or desirable from a commercial perspective, to renegotiate or amend those contracts to deal more clearly with the implications of Brexit; and
- keep contracts under ongoing review.
Ultimately, there is no one single solution and each contract and solution needs to be tailored for each individual business. Bespoke legal advice and input should be sought.