Brexit - planning for uncertainty - "What if?" has become "what now?"

Providing you with tools for a post Brexit future

It goes without saying that yesterday’s leave vote marks the start of a period of uncertainty for all of us in business. The UK is still a member of the EU until the process for exiting is completed and that process is likely to take some time before new trade arrangements with the EU are finalised. What we also don’t know at this stage is how this will play out politically within the UK and the terms of any deal the UK may be able to strike with the EU. We don’t yet know what proposals will be put forward by those who have won the vote. All we know is that there is only one established way to leave the EU (contained in Article 50 of the Treaty on European Union) and that once the UK government gives notice to trigger this procedure, there is no turning back. But this is not the only way to leave, only the most likely route. This leaves all of us in business with some interesting contingency planning to do. We cannot say that we are guaranteed seamless and tariff-free access to EU markets and we cannot say what the terms of access will be. We need to start thinking about how this will impact on the contractual relationships we have in place and those we will have in the future. Today we are focussing on the general implications for trading agreements rather than looking at specific sectors or industries or even specific law and giving you some idea of techniques we can use now to help us through this initial phase of uncertainty, before the future look of our relationship with the EU takes shape. Can I stress that this is very much an initial phase of risk review. Over the future months and years, the picture should become clearer and more detailed analysis possible

Scenarios for exit

There has been much talk about the model that the UK would adopt in a Brexit world and you may remember talk of whether our relationship would be similar to that which Norway or Switzerland or Turkey has and there were various other models that the UK could use. But I think for the purpose of contingency planning for general trading arrangements it is easier to start an assessment by looking at a worst case scenario and a best case scenario. There is no shortage of viewpoints on what will happen but I think I good starting point is to use the 2 scenarios used by PwC in their report to the CBI in March 2016 as a basis for some of the assumptions we can make when we start to think how we can contingency plan.

So, what were these two scenarios?

If we look first at the PwC best case scenario, it is that the UK negotiates a free trade agreement with the EU, based on tariff-free trade in goods. This still means that the UK will have to implement EU standards on goods supplied to the EU, the UK would be in a position to negotiate a separate free trade agreement with the US and other countries and it would gain greater control over regulatory policy which could result in the cutting of some red tape and cost savings. However, there would be a regulatory divergence between the UK and the EU over time which would have to be managed by businesses, leading to potential other costs. The worst case scenario means that the UK, having failed to agree a free trade deal, trades with the EU on the World Trade Organisation’s rules, so that tariff-free trade in goods with the EU would stop. Again, the UK government would gain greater control over regulatory policy and again there would be regulatory divergence between the UK and the EU over time. This scenario also means that current free trade agreements between the EU and third party countries may well no longer apply to the UK so that tariffs and other barriers should be assumed in all cases, at least initially. Whichever scenario applies, there are certain constants: regulatory divergence and short term uncertainty over the UK’s future relationship with the EU which in turn is likely to lead to financial market and exchange rate volatility, higher risk premia in credit and equity markets and consequential impacts on investor confidence – at least in the short term

Understanding the framework of risks

So, just to summarise these assumptions we think we can use to process map Brexit risk best case and worst case. However, we have of course the sheer uncertainty of the next few years and how that will play out in the financial and currency markets. UK businesses may find themselves subject to higher risk premiums and weakening investor confidence. We simply don’t know, although we can all take a view. We don’t know how to factor in what happens within the rest of the EU in the next few years as well.

A starting point – high level review

So, having attempted to set out some basic assumptions, we can start looking at contingency planning for Brexit. A starting point is an initial high level risk assessment to identify priorities, for example by focussing on strategic contracts or those relationships where:   - there is dependence on EU trade on or EU funding or grants - EU registration, authorisation or passporting is assumed pricing mechanisms assume no tariffs, quotas or other barriers (non tariff barriers such as regulatory requirements, legal barriers and transaction costs) or are tailored to take account of particular savings or levels based on EU free movement of goods and people or EU funding or grants currency volatility is a particular risk or cost - performance assumes compliance with EU law that is potentially assessable as an over-regulatory burden or where regulatory divergence is likely in the future.

Determining the risk criteria

Following on from this high level review, the arrangements you have identified should then be assessed to the extent to which they could be affected by market turmoil, by currency movements in a particular direction or by the potential application of tariffs, quotas or non-tariff barriers or by regulatory divergence. A review of categories such as location of production or service, industry sector, value of the contract can be used to score arrangements to establish a priority of review. Remember that this process should also be embedded into any tender or evaluation processes for new arrangements.

Contract review using a range of contractual tools

The next stage would be to assess the risks you have identified against the possible contractual mechanisms you can use in mitigation. These include:   compliance with law obligations. providing that changes in particular laws or new barriers give rise to rights to renegotiate or price adjust – but with significant changes or those which result in material adverse consequences allowing for exit or suspension rights agreeing renegotiation rights or costs allocation if Brexit or any associated market volatility or credit risk results in increased or reduced costs or reduced rate of return considering transitional arrangements if exit rights are triggered ensuring territorial restrictions or definitions continue to work in a post Brexit world   But it is vital that each of these tools will need to be assessed against the desirability of triggering them. And remember that these tools can cut both ways. For example, if you are reviewing a clause in a contract that requires you or your counterparty comply with all applicable law, Brexit might mean that your obligations become less onerous but equally it could mean that the standards of performance of your supplier could be reduced. You need to ask yourself, are these tools the best way to deal with Brexit uncertainty? For example, if the result of Brexit is increased transaction costs, force majeure provisions suspending performance does not seem to be the appropriate tool for dealing with the risk. And when should they come into play –only if the cost of performing a contract increased beyond a certain level? Should they be conditional on a quite specific event occurring rather than general worsening of economic factors?

Potential problems

As a member of the EU, the UK benefits from EU wide harmonisation of rules on jurisdiction and enforcement of judgments. It is a moot point whether we would be able to continue to benefit from these in the future. And so considerations will begin to come into play as to the jurisdictions we choose for our contracts and how we will be able to enforce judgments. This is an area which our litigation colleagues will be keeping a close eye on.

France

• Need to check contractual references to EU regulations/passports
• Brexit is not a force majeure case for termination
• But French courts could potentially order revision or termination of the contract if Brexit makes it too onerous

Germany

• No force majeure case, unless you define Brexit as a force majeure event
• German concept of “frustration of contract” (Wegfall der Geschaeftsgrundlage) may be used by courts to allow adjustment or termination
• Data protection: no free transfer of personal data unless UK considered a “safe third country”

Final comments

We hope you have found this short podcast useful. At Eversheds our specialist teams are already advising businesses on the implications of Brexit. We can provide health checks for your arrangements, provide process mapping tools, provide strategic advice for mitigation and advise you on future arrangements with a close eye on developments during the exit process. After all, we are all in it together.

Thank you for listening.

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