"No Deal" Brexit Risk Grows

January 16, 2019

The UK House of Commons has rejected the government’s proposed Withdrawal Agreement. Unless the Agreement (or an amended version of it) is approved by the House of Commons, or the Brexit date of 29 March 2019 is postponed or revoked, the UK will leave the EU without a transition period or arrangements governing the terms of its exit.

Although many MPs oppose this outcome, it remains unclear what alternative can command a majority. Contingency planning by the EU and by governments on both sides of the Channel is being stepped up – and businesses are advised to ensure that they are also fully prepared.

The Brexit Process

The EU and the UK government have negotiated a Withdrawal Agreement that would establish legally binding arrangements for the UK’s departure from the EU, including a transition period broadly maintaining the status quo until at least end-2020. They have also agreed on a non-binding Political Declaration on the shape of the future trade, political and security relationships to form the basis of agreements to be negotiated after Brexit.

The Withdrawal Agreement can only come into force following ratification by both the UK and the European Parliaments. While the latter would be expected to support the Agreement, the UK House of Commons voted on 15 January not to ratify it, doing so by a very substantial majority of 230 (432 to 202).

There will now be a vote of confidence in the government, which could trigger a general election. But assuming it survives that vote today, the UK government must set out its plans by 21 January for taking Brexit forward. The government may continue to work for approval of the Withdrawal Agreement, possibly in an amended form if changes or legally binding assurances can be agreed with the EU.

But given the scale of the parliamentary opposition to the Withdrawal Agreement, it is uncertain whether it can be adopted without substantial amendments which the EU would not be prepared to agree. It is also unclear what alternative way forward could command a majority in the House of Commons. The main options being canvassed are a second referendum, a closer future relationship between the UK and the EU, or leaving the EU with no agreement (a "No Deal" Brexit).

The UK could request to postpone the date of Brexit: this requires the agreement of all EU Member States, only likely to be given for a short period and for a specific purpose (e.g. finalising a negotiation, a UK general election or second referendum). The imminence of new elections to the European Parliament (on 23-26 May) represents a complication here. And the postponement would also require changes to the UK legislation which embedded the 29 March exit date.

Alternatively, the UK has the right (confirmed by the Court of Justice of the EU) unilaterally to revoke its notification to withdraw from the EU, at any time before withdrawal takes effect. But doing so would be politically controversial if it were done without a second referendum that favoured remaining in the EU. And again this would require changes to UK domestic legislation.

A "No Deal" Brexit is the default option: unless the date is postponed, the UK is committed by law to leaving the EU on 29 March 2019. This will happen automatically, with or without a Withdrawal Agreement.

Future UK Trade Relations Post-Brexit

As a member of the EU, the UK has until now been precluded from even starting trade negotiations with third countries. After Brexit, the UK government has indicated that starting such negotiations will be a high priority, particularly with the U.S. Importantly, the Withdrawal Agreement (if adopted) would allow such negotiations to begin, with entry into force possible from the end of the transition period.

In the meantime, questions arise regarding the immediately applicable trade regime. With or without a Withdrawal Agreement, it remains to be seen whether all existing EU trade deals with third countries will continue to be applied to the UK. If these are not rolled over, the UK’s relations with the third countries concerned will default to WTO principles. This represents, however, a much more rudimentary system. Notably the rules for trade in services are minimal, while full customs tariffs will apply.

UK Government and EU "No Deal" Measures

The UK has set out the steps that it would take in the event of a "No Deal" Brexit in a series of Technical Notices.1 To a more limited extent, the European Commission has taken similar measures set out in "Brexit Preparedness Communications".Previous Dechert briefs and advice on Brexit can be found in our Resource Centre.

Contracts

  • Applicable Law: significant changes are not likely but for new contracts it would be advisable to state explicitly which law is to govern the contract.
  • Material Adverse Change (MAC): a No Deal Brexit could constitute an Event of Default/MAC/Force Majeure Event depending on the formulation of existing clauses; in future contracts these should anticipate possible Brexit risks.
  • Availability of free movement within the EU: consideration should be given to how the loss of this may affect the ability to perform, or the profitability of, the contract.
  • Trading UK-EU and UK-third countries: new contracts should anticipate the risk that the UK may trade on WTO terms with the EU and third countries with which it currently has a trade agreement.
  • References to the EU: amendments may be needed to improve contractual certainty where the post-Brexit position is not clear and needs to be agreed.
  • Intellectual Property: it is advisable to review how far contracts assume the continuation of current EU-wide IP protections.
  • Data Protection: it is advisable to consider whether contracts need to provide for an alternative transfer mechanism for transfer of personal data between the UK and EU.
  • Flexibility: given the Brexit risks, it is advisable to consider whether, depending on the circumstances, to keep contracts flexible or to tie counter-parties down to clear commitments that will survive in all cases.
  • Counterparties “redomiciling” or novating may give rise to termination.

Corporate Transactions

  • Pricing: it is advisable to check whether Brexit will impact the pricing of your transaction e.g. if it is subject to a post-closing purchase price adjustment.
  • Financing: consider the potential impact of Brexit on transaction financing; for example, in the event of an economic downturn, would financial covenants be tripped in loan agreements? 
  • Warranties/Indemnities: could Brexit result in a breach of warranty / indemnity under a sale and purchase agreement? 
  • Closing conditions: issues to consider include whether the transaction qualifies for merger control review in the EU, but may also require separate UK review; and, how this may impact time-sensitive provisions in the agreement.

Asset Management

  • Portfolio Management: UK firms will no longer be eligible for the MiFID management passport. In the absence of an agreement, the ability to provide portfolio management services on a cross-border basis directly to EU clients will depend on local law. The ability of EU MiFID managers, AIFMs and UCITS Mancos to delegate to a UK manager will depend on whether certain cooperation arrangements (required under MiFID, AIFMD and the UCITS Directive) have been entered into between the FCA and the relevant EU regulator.
  • Mancos for EU-based funds: EU UCITS will need to be managed by an EU UCITS Manco. EU AIFs will need to be managed by an EU AIFM if it is necessary or desirable for marketing to continue under the AIFMD marketing passport. Clients have been putting new management structures in place, whether through the engagement of third party service providers or the establishment of EU27 regulated entities. Subject to local law, UK AIFMs should be able to continue to manage EU AIFs, albeit the pan-European marketing passport will not be available.
  • Acting as AIFM for non-EU AIFs: a UK AIFM managing non-EU AIFs should not be affected. A UK AIFM that currently markets a non-EU AIF in an EU27 member state under a national private placement regime (NPPR) under AIFMD Article 36, would need to change to marketing under a different NPPR under AIFMD Article 42, if available. Marketing by a UK AIFM of a non-EU AIF in the UK will not be affected.
  • Marketing, distribution and sales by UK firms in the EU: investment services provided in the course of marketing by UK MiFID firms, or by UK UCITS and Mancos marketing under “extended” MiFID permissions, will no longer be eligible for EU passports and their ability to continue providing those services on a cross-border basis into the EU will depend on local law.
  • Marketing, distributing and selling EU funds into the UK: the FCA’s temporary permissions regime, which will enable funds that are currently passported into the UK to continue be marketed in the UK. There is also a temporary permissions regime permitting EU firms that currently provide services in the UK under a passport, either on a cross border basis or from a branch, to continue to do so. There are no changes to application of existing marketing passports for EU27 managers marketing into the EU27. 

Trade and Supply Chains

  • Customs declarations: will be required on UK-EU trade. Goods need to be classified and valued.
  • Duties: will be payable on UK-EU trade; both sides will apply the current EU "Most Favoured Nation" tariffs. It is advisable to review the potential for using Customs Special Procedures to minimise duty and VAT payments.
  • VAT: the UK government will introduce postponed accounting for import VAT on goods from the EU and non-EU countries, but the EU has not given a reciprocal commitment.
  • Border Delays: may be caused by the introduction of customs and regulatory checks. Businesses should consider the contractual implications of delays and the scope for increasing stockpiles, re-routing goods or identifying UK suppliers.
  • Product certification: the UK will continue to recognise EU-certified goods but unless the EU gives a reciprocal undertaking, UK goods requiring certification will need to acquire it in the EU before they can be placed on the EU market.
  • Export Licences: will be required for UK-EU trade in dual-use items. Both sides intend to issue open general licences: businesses trading in any such items will need to register for these licences and meet their conditions.
  • Trade between UK and third countries: UK trade with third countries will also be affected if existing free trade agreements with the EU are not rolled-over for the UK (which appears to be a distinct possibility) or, even if the agreements are rolled-over, UK goods incorporating parts from the EU do not fulfil the UK Rules of Origin test.

Workforce

  • Short stays: (up to 90 days in a 180 day-period) UK travellers to the Schengen area will need passports with at least 6 months validity.
  • Longer stays: should Parliament not legislate to bring the proposed "settled status" regime into effect before 29 March 2019, the UK government has indicated that it is not the government’s intention to remove existing statuses from any EU nationals currently resident under EU law. The Commission has called upon Member States to take similar measures for UK nationals.
  • Professional Qualifications: qualifications recognised before Brexit would not be affected but there would be no system of reciprocal recognition for new applicants and recognition will depend on host state national policies.

Data Processing

  • Adequacy: the Commission has ruled out adopting an “Adequacy Decision” for the UK before Brexit. As a result, where EU businesses transfer personal data from the EU to UK recipients, they must ensure they have put “appropriate safeguards” (e.g. standard data protection clauses, binding corporate rules, approved codes of conduct and/or approved certification mechanisms) in place before the transfers may take place. For its part, the UK will continue to recognise EU data protection standards as adequate after Brexit; therefore, personal data transfers from the UK to the EU will be able to continue as now.

Intellectual Property

  • Trade Marks and Community Designs: the UK government will almost certainly put in place measures to ensure that any registered trade marks, registered Community designs and unregistered Community designs will continue to be protected in a No Deal Brexit.
  • Copyright: copyright laws in the UK will remain largely unchanged, in part owing to the UK being a party to the main relevant international treaties. However, the reciprocal element of cross-border mechanisms will cease to apply to the UK (unless the EU passes new legislation) and consequently UK businesses should consider whether new agreements (e.g. for broadcasting) need to be negotiated.
  • Patents: the UK has ratified the agreement on a Unified Patent Court (“UPC”), which will have jurisdiction over European patent disputes. If the UPC does not come into force before Brexit, there will be no changes to UK law at that time. However, if the UPC has been launched, the UK will need to consider whether it is possible to remain within the UPC system. See our Brief.

Tax

  • UK Holding Companies/EU groups: EU tax directives will no longer apply to UK businesses. Reliance will need to be placed on UK double tax treaties (DTTs) to avoid withholding taxes on interest and dividend payments between international EU groups involving a UK member. Not all DTTs eliminate withholding tax so a review of relevant DTTs is essential. 
  • Group Royalties: the loss of EU tax directives could also result in withholding tax applying to royalty payments for the use of intellectual property between related companies involving a UK member.
  • U.S. Double Tax Treaties: U.S. DTT benefits for U.S. businesses/those dealing with U.S. businesses could be lost due to the UK no longer being in the EU and the impact on the “derivative benefits” provisions. This could result in withholding tax arising on dividend, interest and royalty payments between U.S. entities with UK owners and entities based in the EU or EEA member states.
  • Jurisdictions: businesses should consider the tax implications of relocating operations and employees – some jurisdictions have amended their tax laws to anticipate tax restructurings following Brexit.

How Dechert Can Help

While a “no deal” scenario continues to be unlikely, businesses should plan on the basis that it remains a possible outcome. If they have not done so already, businesses are advised to consider implementing contingency measures. Members of Dechert’s cross-practice Brexit Task Force have extensive experience in these and related issues  – please refer to our extensive advice on “no deal” planning available in the Dechert Brexit Resource Center.

Footnotes

1) How to prepare if the UK leaves the EU with no deal

2) European Commission Communications of 19 July 2018