The effects of Brexit on Commercial Contracts

With less than one month to go until the end of the transitional period within which EU law continues to apply to the UK, Brexit trade negotiations continue to determine its future relationship with the EU. Despite this ongoing period of uncertainty amidst the backdrop of global economic strain caused by the Coronavirus outbreak, businesses must think ahead to assess the impact of Brexit on their current and future commercial contracts.

This blog will consider what Brexit means for existing commercial contracts and how Brexit will affect their interpretation, whether a contract can be terminated as a result of Brexit, and considerations when auditing current or negotiating new contracts.

What does Brexit mean for commercial contracts?

EU legislation with direct effect will remain in force in the UK, but on a different constitutional basis. At some point after the end of the transition period, each EU-inspired measure remaining in force as UK law will be reviewed as appropriate, and a decision taken as to whether to retain, modify or withdraw it.

Therefore, Brexit will have very limited impact on English contract law (which is largely derived from English common law), but it will likely have significant commercial ramifications which may affect the profitability of individual contracts, such as the imposition of tariffs, restrictions on the free movement of people or further changes in exchange rates. The wider impact may result in businesses suffering from financial difficulty and hardship. However, in the absence of express contract provisions, parties are unlikely to have any legal entitlement to relief.

How will Brexit affect contract interpretation?

Parties will largely be bound by the words of their contract, with very limited relief under common law for those who made a bad deal or are adversely affected by Brexit, as addressed below.

As discussed in our recent blog on Brexit and contracts, questions may be raised over the interpretation of contract provisions, for example whether references to “the EU” will continue to include the UK: it will depend whether the EU is defined as its member states “from time to time”. If so, this strongly indicates that the definition does not include the UK after Brexit. If the definition instead specifically names each country including the UK, then the UK should be covered, even post-Brexit. If the definition is not clear and simply refers to “the EU” – then the wider commercial background and commercial common sense becomes more relevant and will vary case by case.

Enforcing an English judgment in an EU Member State could also become more difficult as current arrangements fall away or the status of the UK thereunder changes.

Is Brexit a sufficient ground to terminate an existing contract?

It will depend on provisions of your existing contract and the facts of the specific case as to whether Brexit is a sufficient ground to terminate.

• Force majeure: it is unlikely that a business will be able to rely on a standard force majeure clause to seek relief from its obligations under a contract. These clauses are usually limited to obligations that are rendered impossible to perform as a result of the force majeure event; the fact that economic hardship will be suffered is not normally sufficient to claim relief. This will, however, depend on the exact wording of the clause. It is possible that some types of clauses, for example, material adverse change clauses, could be wider than a standard force majeure clause and could potentially be triggered by financial hardship suffered in the lead up to, or following, the end of the transition period. The counter argument is that force majeure events do not normally encompass events which one party reasonably foresees will inevitably come into operation, so the date of the contract and the timing of Brexit may be relevant to the application of force majeure to contracts.
• Frustration: frustration arises when something without the fault of either party occurs after the date of the contract which means either the contract obligations are transformed into something different, or it is physically or commercially impossible to fulfil the contract. It may be possible for a business to argue that a contract has become frustrated due to Brexit but such argument will depend on the facts of the specific case and typically the English courts construe the law of frustration narrowly.

Looking ahead: what to consider when auditing current or negotiating new commercial contracts

Businesses need to consider how their contracts will be affected by the commercial and economic implications of Brexit. Although there is no one-size-fits-all approach while negotiations go on, each business should consider various factors such as location, regulatory environment, location of its customers and suppliers and composition of its workforce.

The options to manage contractual risk are likely to be unique to each contract. Some contracts contain a significant amount of flexibility, for example, they are terminable at short notice, or are purchase contracts with no volume commitments. Other contracts might contain long term commitments. Flexibility can be good or bad depending on your position but is an important factor when determining whether the contract should be left as is, amended or terminated.

It would be prudent to consider the following points when auditing current or negotiating new commercial contracts:

• Definitions: it is important for businesses to consider whether or not a definition of the EU includes the UK, or whether to list each jurisdiction separately. It may also be sensible to deal expressly with other possible changes in the membership of the EU and indeed in the membership of the UK.
• Termination and force majeure: it is important for businesses to consider whether their existing force majeure clauses expressly include Brexit and its implications (or should do, going forward) as a termination trigger-event.
• Inclusion of a Brexit Clause: the expression “Brexit clause” refers to a clause in a contract that triggers some change in the parties’ rights and obligations as a result of a defined event occurring. The trigger events might not be Brexit as such, but the occurrence of events which the parties predict might occur as a result of Brexit, for example, changes to tariffs, exchange rates or customs procedures.
• Tariffs: businesses should assess the commercial impact of any potential increase to tariffs which may be applied to goods and services provided to and sourced from the EU, and countries outside the EU. In particular, businesses should consider the extent to which prices should include or exclude taxes, duties, or other levies that the UK or EU member states introduce after the end of the transition period.
• Customs checks: businesses should consider the impact of additional customs checks for goods leaving and entering into the EU which may result in additional delays and costs in connection with supply contracts, and how to allow for some flexibility as a result of such delays and costs.
• Exchange rates: it is important for businesses to consider how fluctuations to the exchange rates may impact existing commercial agreements, and how to allocate the risk of future variation to the pound’s value.
• Movement of persons: businesses should consider how restrictions on the free movement of people may lead to labour shortages in the UK – particularly for those businesses which rely on workers from the rest of the EU (e.g. franchising, care services, construction, hospitality). Businesses should consider how restrictions may create difficulties to provide services across Europe where the free movement of people is essential.
• Data protection: whilst even at the end of the transition period the data protection framework in the UK will be largely unchanged, multi-national organisations that transfer personal data between the UK and EEA states will need to consider whether new or updated arrangements will be required at the end of the transition period.
• Territory scope: businesses should consider whether existing contracts have the EU as its territorial scope and whether the UK is carved in or out of agreements.
• Parallel regulatory regimes: UK businesses selling to the EU may need to comply with different regulatory regimes and conformity assessments and vice versa; businesses should therefore consider which party is responsible for achieving compliance and which is responsibility for the consequences of non-compliance.
• Changes to the law: it is important for businesses to ensure that the contract – existing or future – is clear on whether they wish to incorporate legislation as it evolves, or to have legislative references fixed at the time of signing.
• Dispute settlement options: assessing if Brexit could make enforcement of an English judgment more difficult and, if so, whether arbitration is a suitable alternative.

Summing up

In practical terms, we recommend most businesses should review their current contracts with third parties to assess the impact of Brexit on these commercial arrangements and should continue to “future-proof” their contracts against Brexit if that has not been done already.

If you would like to discuss this blog or any other commercial contract query, please contact a member of the Commercial team and we will be delighted to assist you.

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This update was co-authored by Lucy Andrews, Trainee Solicitor and Emily Sadler, Associate.