When it comes to Brexit, UK businesses are in the lull before the storm as the transition period in the Withdrawal Agreement expires in less than three months; on the 31 December 2020. In this article we look at Brexit and the impact on commercial contracts and how your business can best prepare for Brexit and the effect it may have.
- How does Brexit affect UK law?
- What type of commercial contracts will Brexit affect?
- What are the practical potential effects of Brexit on commercial contracts?
- How will UK de-regulation affect commercial contracts?
- Should I terminate my existing commercial contracts?
- If a contract will terminate before the 31 December is any action required?
- How will Brexit affect the enforcement of existing commercial contracts?
- Should the business not enter into new contracts until the transition period has ended and de-regulation occurred?
- Brexit audit checklist for commercial contracts
How does Brexit affect UK law?
Although the UK left the EU on 31st January 2020 the UK is in a transition period until the 31 December 2020. This was negotiated and included in the European Union (Withdrawal Agreement) Act 2020. The transition period means that EU law will continue to apply in relation to the UK until the 31st December 2020.
After the end of the transition period the following will cease to apply in the UK:
- EU Treaties
- EU free movement rights for people and goods
- The general principles of EU law (for example the single market and the customs union)
When the transition period comes to an end there is much uncertainty as to what will happen as no agreement has been reached and no one knows if a comprehensive agreement will be negotiated before the end of the transition period. Given the uncertainty it is essential that UK businesses ensure that their commercial contracts are flexible and protect their business interests.
What type of commercial contracts will Brexit affect?
Some UK business owners assume that if they aren’t in business with EU firms that Brexit won’t affect their existing or future commercial contracts but that isn’t correct. Although your business may not have existing commercial contracts with EU companies your business will nonetheless be affected by Brexit and the end of the transition period. Accordingly, commercial solicitors recommend that:
- Existing contracts are reviewed and audited
- Planned future commercial contracts are prepared with Brexit and the end of the transition period and de-regularisation in mind
Your Brexit audit should not just look at the legal implications of Brexit on your current and potential future commercial contracts but also the practical aspects of the end of the Brexit transitional provisions and how you can best protect your business through the review and auditing of your commercial contracts.
For a useful checklist of further information on preparing for the end of the transition period download our guide to Preparing Your Business For Brexit.
What are the practical potential effects of Brexit on commercial contracts?
Commercial solicitors know that businesses who wholly or primarily contract with other UK businesses won’t escape the impact of Brexit on their commercial relationships and contracts. Whilst no one has a crystal ball to know what 2021 will bring, here are a few of the potential practical implications of the end of the transition period on UK businesses:
- Increased labour costs and business immigration issues because of the end of free movement of EU citizens on the 31 December 2020 and the introduction of a new UK points based immigration system in January 2021. This means employers will have to apply for a Home Office issued sponsor licence in order to employ either non-EEA or EU nationals thus increasing their recruitment costs. In addition, there are no plans for a lower skilled visa in the government’s immigration proposals. As EU nationals, who aren’t eligible to apply for pre-settled status or settled status under the EU Settlement Scheme, will need a work visa after the 31 December 2020, there may be a reduction of available workers with the necessary skills and an increase in workforce training budgets to try and address the skills shortage and the reduced availability of EU workers. This may affect your overheads and the cost of production of goods or services or the price your business has to pay for goods or services.
For business immigration help read our article on how to prepare for the new UK points based immigration system.
- Increased supply costs because either your business or your supplier needs to purchase goods from the EU and there may be new taxes, duties, or other levies that EU countries introduce after the end of the transition period. In addition, if Brexit affects currency rates that may impact on the cost of supplies. The supply chain also needs to be considered if your business supplier is in the UK but is actually heavily reliant on source materials from the EU.
- Delay in supplies arriving in the UK from EU countries resulting in your business not being able to meet your contractual commitments and manufacture dates because of late arrival of supplies.
- Delay in transporting goods overseas with potential trade barriers and tariffs making your goods more expensive than those of your EU competitors as well as facing increased logistical and transport costs.
- Regulatory divergence through changes in the law and regulations affecting some aspects of commercial contracts. This is because the UK government will review legislation and gradually change some EU derived regulations and laws that are currently implemented in the UK. That’s because the UK considers some regulations overly restrictive and is committed to de-regulation. If you have entered commercial contracts with businesses based in the EU, your commercial contract could be subject to either UK or EU regulations depending on the specific provisions in the contract.
- Intellectual Property and the scope of any Intellectual Property licences and territorial issues with the UK no longer being part of the EU.
- Economic and financial considerations such as fluctuations in the value of sterling because of the end of the transition period and the specified currency payment terms in the commercial contract or the availability of corporate funding or insurance issues arising through the UK leaving the EU.
How will UK de-regulation affect commercial contracts?
It’s important to stress that deregulation won’t be immediate and won’t happen all at once in January 2021. However, in both existing contracts and contract negotiations you need to be aware of the likely changes in UK domestic law on matters, such as:
- Consumer protection laws and regulatory standards as there may be gradual changes in consumer protection law so the UK sets its own standards that differ to those of the EU. That may be an issue if your business is importing goods from EU countries as your commercial supply contracts will need to specify which standard and regulations the supplier needs to meet. Likewise, if you are exporting goods overseas you will need to review your contracts and make sure that you are meeting the required contractual standard and/or the overseas regulatory standards if your purchaser expects you to meet those as part of a contract variation. On a practical note, meeting new standards may affect the prices of goods depending on whether any new UK or EU regulations are more onerous or not.
- Competition law – the government may introduce changes to competition law rules. For example, to allow the inclusion of additional territorial restrictions.
- Data Protection – the UK will continue to apply the EU’s General Data Protection Regulation (EU GDPR) after the end of the transition period to some data that originates from the EU. However, at the end of the transition period the UK will no longer be treated as an EU member so data protection clauses in commercial contracts will need reviewing in addition to considering the need for data transfer agreements between UK and EU companies.
Whatever your views on deregulation and divergence from EU standards, from a contractual and business perspective, it means that both your existing and future contracts with UK and non-UK companies need to be reviewed and audited to ensure they remain fit for purpose. That’s because EU legislation will cease to be directly applicable in the UK at the end of the transition period and the government will convert existing EU law into domestic law wherever practical with the converted laws then being repealed at a later date as part of the de-regulation process. Frustratingly for business owners there is no timescale for the review of legislation and regulations or information about which ones will be reviewed first and those that will remain broadly unchanged from their EU content.
In the long term, commercial solicitors and UK businesses will need to monitor changes in legislation and regulations and the impact on commercial contracts and UK businesses generally, for example, in areas such as the recognition of professional qualifications, divergence of specified industry or food standards, data protection, VAT, and competition law.
If contracts have been prepared on the basis that obligations imposed by EU legislation will continue then this could result in contract problems, especially in business sectors where:
- Regulatory measures were imposed at EU level and are subject to UK criticism and likely change and/or
- Contractual parties have warranted that they will comply with EU regulations as specified in the contract or there is a broader clause saying that the business will comply with EU regulations from time to time in force.
Should I terminate my existing commercial contracts?
With talk of the need to review and audit contracts some business owners, and particularly those with EU supply chain contracts, are asking if they should terminate their existing contracts and then renegotiate a commercial contract that meets their post transition period business needs and takes into account Covid-19 and Brexit related market changes.
Whether you can terminate a contract will depend on the wording of the termination clauses. Legal advice should be taken as terminating a contract without valid grounds or failing to give valid notice could have serious financial implications for your business.
For more information on this read our article on termination of commercial contracts.
If your existing contract gives you the right to terminate your contract by giving notice then termination may be your best legal and financial option, but any professional advice must be bespoke to your business as the advice will depend on:
- The specific legal issues in the existing contract.
- Whether the legal issues or changes required to the contract can be made by an agreed variation to the contractual terms.
- Whether by terminating the contract (if you have the grounds to give notice) your business is then likely to be able to negotiate better terms with the existing party or a new third party.
If you don’t have the grounds to terminate your existing contract but Brexit and the end of the transition period means changes are needed (for example, as otherwise the contract isn’t economic) you could look at:
- Frustration of the contract because of Brexit and the end of the transition period.Frustration only applies to a contract which creates a contractual obligation that has become impossible to observe, without either party being responsible for the change in circumstances or the frustrating event being foreseeable by the parties. However, keep in mind that additional costs in meeting the contract aren’t normally viewed as a frustration of the contract.
- Material adverse change clause depending on how precisely the clause was drafted.
- Force majeure clause depending on if Brexit and the end of the transition period is a force majeure, and if so, the impact on you and the other party’s duty to perform your contractual obligations, and the potential for either one of you to rely on the clause to avoid liability for non-performance of a contractual term.
However, commercial solicitors caution that the above three options need careful assessment and are interpreted given the particular facts. Historically, changes in a party’s economic circumstances generally haven’t qualified as force majeure events under English law.
If a contract will terminate before the 31 December is any action required?
If a commercial contract will end before the 31st December 2020 then the contract isn’t a major concern provided that:
- Any surviving clauses won’t be affected by Brexit and by jurisdiction conflicts if there is a dispute.
- Any such contracts aren’t automatically renewed on the same terms without first checking the terms to see what Brexit related legal or market changes should be made.
How will Brexit affect the enforcement of existing commercial contracts?
Commercial solicitors are being asked whether existing contracts will be enforceable after the end of the Brexit transition period. Prior to Brexit, English courts determined:
- The governing law of a contractual agreement in accordance with the EU Rome I Regulation and
- The governing law in respect of non-contractual obligations in accordance with the EU Rome II Regulation.
The UK has said that it will incorporate both Rome I and Rome II into UK law. This means an express choice of law clause in favour of English governing law will still be followed by the UK courts and the remaining EU member states. In addition, parties entering new commercial contracts can continue to choose English law to govern their agreements.
The rules which determine the choice of court to hear a contract dispute and to enforce a judgment are the EU Recast Brussels Regulation. These won’t apply at the end of the transition period and the UK has said that instead it will sign the Hague Convention onChoice of Court Agreements 2005. This should result in contract clauses that choose the exclusive jurisdiction of the English courts being recognised by the EU member state courts if the contract is entered into after the transition period. However, non-exclusive jurisdiction clauses may be more problematic as they won’t receive the same reciprocal protection. That is why it is important to take legal advice on jurisdiction and enforcement issues to ensure that jurisdiction clauses provide straight forward redress.
If you are entering into a commercial contract with an EU company, you could consider commercial arbitration for the resolution of disputes to avoid potential court jurisdiction issues. In relation to existing contracts, they should be audited to assess the likelihood of disputes based on existing jurisdiction clauses. The other party to the contract may be willing to agree to a variation of the jurisdiction clause to avoid ambiguity or the added expense of jurisdiction disputes before the resolution of the contractual issue in dispute by either the use of binding arbitration or the rewording of the jurisdiction clause.
Should the business not enter into new contracts until the transition period has ended and de-regulation occurred?
It simply isn’t feasible for most businesses to wait and do nothing until either the end of December 2020 or some date in the future when de-regulation has occurred. That is because any changes in UK law and regulations are likely to be gradual. Furthermore, the timescale for change may be affected by Covid-19 or economic or political forces. No business can stay in limbo and not enter into new contracts. However, if you are entering into new contracts you need to look at your Brexit checklist. Your commercial solicitor also needs to consider the impact of Brexit and the end of the transition period on your contracts and assess if they should include Brexit specific material, adverse change or force majeure clauses that are linked to de-regulation or other Brexit related events.
Brexit audit checklist for commercial contracts
We wish that there was a simple Brexit audit checklist for commercial contracts, but it just isn’t that simple. Not only does the legal advice depend on the specialist nature of the contract (for example, a supply chain contract or a contract for the provision of professional services or IT) but also the market conditions specific to the business sector, de-regularisation issues, compliance with relevant EU or UK standards, as well as the economic considerations post Brexit and the end of the transition period.
What we can say, with complete certainty, is that when it comes to Brexit there are no certainties. To put your business in the best position it can be, all your existing and future commercial contracts need to be audited considering the following:
The cost-benefit analysis of the contract and a Brexit impact clause: This applies to both existing and future commercial contracts as assumptions can’t be made about the profitability of a contract in the economic and legal landscape after the end of the Brexit transition period. Increased costs, new risks and taxes, and different compliance standards are likely. If your contract isn’t flexible, one party may be bound by uneconomic terms either because of price rises in supplies or the additional costs incurred in transport costs or duties. That may be OK, from your perspective, if they affect the other party but the full burden could fall on your business if you don’t audit and review your contracts.
Price mechanisms in the contract: These clauses can be reviewed and you could agree a review mechanism for pricing goods and/or services to take into account the impact of new duties and tariffs, VAT changes, additional supply chain, transport and compliance costs of trading.
Currency payment in the contract: If an existing or future contract says payment is in sterling or euro think about how potential fluctuations in currency value could affect profitability. Could this be addressed through a price mechanism review if there is a significant currency fluctuation?
Data protection: If your relationship with the other party involves the transfer of data between the UK and the EU or IP rights then the contract needs to be reviewed to ensure that you and the other party don’t breach regulations.
Compliance and regulatory matters: Does the contract say that goods will be provided that comply with current EU regulations? That may no longer be appropriate if you are supplying within the UK where de-regulation may change UK standards. Likewise, if your contract says that you will supply goods compliant with EU regulations from time to time in force that may commit you to changing the compliance standard of your goods without a corresponding price review.
Review and termination clauses: You could include an express right to suspend, re-negotiate or even terminate the contract if a Brexit related event makes the contract unworkable (for example, a contract to supply fresh produce from the UK to the EU that is thwarted by border controls and transport delays or made uneconomic through the imposition of tariffs on exporting). This could be through a force majeure clause that includes defined Brexit-related events that are specific to your commercial contract. Alternatively, you may want a more general termination clause that gives the right to terminate without fault on the part of the other party. That way, the business can use the notice to cancel the contract if Brexit related issues result in significant problems requiring a new contract with the third party or with a new third party. However, this no-fault termination clause may not be in your business interests if the Brexit related changes work in your favour and you therefore would not want the other party to be able to serve notice of termination on you.
Brexit cover: Do you still will want your contract to continue without threat of reviews or termination because of Brexit related matters? But you think that the other party may want to renegotiate as they haven’t protected themselves or audited their contracts? You could include a clause or statement that both parties agree that the whole or parts of the contract are not to be affected by the end of the transition period or any change in regulations specific to the subject matter of the contract.
Breach of contract: Is your business at risk of being in breach of contract as a result of supply chain issues outside its control or new border controls affecting transport times? Do clauses need to be reviewed to minimise penalties for breach of contract for Brexit related issues?
Definitions and jurisdiction: The definitions section of your contract may seem straightforward but needs auditing and reviewing. For example, the contract may refer to the EU. At the time the contract was prepared, the EU may have included the UK but as that is no longer the case the contract needs to be refined. Alternatively, the contract may define the EU specification that you will meet in your supply of goods to a UK party. You or they may want to amend the specification of the goods (potentially linked to a review in the pricing mechanism) if the UK changes the minimum specification for the goods in the UK. If there is a dispute over the terms of the contract you may want the English court to have jurisdiction and for the dispute to be determined in accordance with English law. In future, English law may significantly diverge from EU law depending on the extent of any changes in UK law and de-regularisation.
When it comes to Brexit preparation and the negotiation and drafting of commercial contracts, businesses need to be alive to the potential practical and financial consequences as well as the legal implications of Brexit and the end of the transition period. Your specialist commercial solicitor should attempt to address potential Brexit related issues in both existing contracts, through an audit and review process, and ensure new commercial contracts are prepared with Brexit related issues at the forefront of negotiations and drafting.