March 29, 2017
On 29 March 2017, the UK government delivered the formal notice to the other EU Member States that it is leaving the EU. The Brexit process is now formally under way. Companies of all sizes can and should be continuing their Brexit planning; there are risks and opportunities they need to know and contingency plans they may need to put in place.
Unless extended, two years are allowed for the negotiations of a withdrawal agreement (the “divorce” agreement), after which the UK will automatically exit the EU, with or without an agreement in place.
For now, the UK remains a part of the EU until exit. Since the UK government will not seek membership of the EU Single Market, we are looking at a “hard Brexit”.
The UK Government’s goal to negotiate both the withdrawal agreement and the future relationship between the UK and the EU within the two-year period is ambitious, to say the least. Additional challenges to meet the two-year deadline are being faced as a result of significant elections this year in France, the Netherlands and Germany. The Article 50 negotiators (from the EU side) will be governed by guidelines provided by their political masters, so this uncertainty as to the leadership of important countries will inevitably slow down the initial stages of the negotiation.
For more details, see Policy Thoughts.
According to the Treaty on the Functioning of the European Union, any agreement with the U.S. can come into force only after the “divorce” agreement with the EU has been finalised.
However, President Trump has moved the UK from the “back of the queue” for a post-Brexit free trade agreement (FTA) to the front of the queue. (The real impact of this statement remains to be seen.) The UK government is naturally keen for this to be the case and for discussions to start soon, not least to show that its Brexit strategy is working.
The UK Government is also very keen to “strike free trade agreements with countries around the world” and these would be separate from the EU’s current agreements, requiring difficult and no doubt lengthy negotiations.
Absent a trade agreement, the UK’s post-Brexit relationship with non-EU countries, including the U.S., will be governed by the World Trade Organisation (WTO) rules. Unfortunately, there is also legal uncertainty in this regard, since the UK does not have agreed schedules in place. Such schedules are a WTO member’s list of specific commitments on market access for goods and services (bound tariff rates, access to services markets).
Until exit from the EU is final, although the UK government may have informal discussions with non-EU countries such as the U.S., the UK cannot conclude bilateral trade agreements with non-EU countries. Regardless, two years is a very short period in which to finalise a trade agreement and thus it seems very unlikely that any non-EU trade agreement will be ready for conclusion at the point of the UK’s exit from the EU. Relations with non-EU countries, including the U.S., are likely to default to the WTO agreements, with or without specific schedules in place, at least for a period of time.
It is vital to understand the areas of a business and its operations and activities that might be impacted by Brexit. This is the case whether that business is a global multinational, a regional EU business, or a company that trades only in the UK. Not all areas will be impacted, but we’ve highlighted below some key areas to consider.
Financial institutions (including insurance companies, payment service providers and asset managers) will need to carefully review their businesses to determine which specific EU legislation governs their activities. They will also need to consider the impact that the potential loss of passporting rights could have. By way of background, the passporting system allows a firm authorised under one of the EU’s single market directives to carry on activities in another member state on the basis of its home state authorisation.
An important point to note is that while people generically talk about the “passporting regime,” the passport rights derive from the specific EU regulation governing a particular business activity. For example, the Capital Requirements Directive (CRD) governs deposit-taking and wholesale lending, Markets in Financial Instruments Directive (MiFID) and Markets in Financial Instruments Regulation (MiFIR) govern market operators of regulated markets, and Solvency II is relevant to direct insurance activities.
Some people take comfort from the fact that if the UK were to enact legislation that is “equivalent” to the relevant EU directive, then the EU would allow UK financial institutions to operate in the EU in the same manner as they would have done under the passporting regime. However, not every relevant piece of EU legislation has the concept of an “equivalence” regime, hence the importance of identifying the specific EU legislation governing the required activities. For example, the CRD has no equivalence regime for Third Country Credit Institutions to carry out deposit-taking, wholesale lending or other CRD activities within the EU. By contrast, MiFID and MiFIR do have equivalence regimes, but it may well become a political issue as to whether the EU accepts any future UK legislation that will be required to be enacted as being “equivalent.”
In relation to loans funded by UK-based banks, in the absence of any suitable replacement, there is a potential issue surrounding the loss of the CRD passport. Take, for example, a fully drawn loan legitimately entered into by a UK-based bank to an EU borrower under the CRD passport. Query whether that loan would continue to be enforceable if the CRD passport is no longer available? What about future drawings under a committed but undrawn or partially drawn facility or ongoing drawings under a revolving credit facility?
The consequences of breaching the licensing requirements under the relevant EU directive can be a criminal or a civil offence, leading to regulatory sanctions and possibly rendering the particular loan unenforceable.
The message, therefore, for financial institutions is to start analysing the regulatory regime applicable to their business and to prepare backup plans in the event of the loss of any required passport and the absence of equivalence. For example, a bank could consider setting up a facility office within the EU to whom loan participations can be transferred. However, the loan documentation would need to be checked to see whether such a transfer would require borrower consent.
1. Reinforce the message that competition law continues to apply in the UK. Competition law (whether based on EU or UK law) continues to apply in the UK in exactly the same way today as it did before the referendum vote. The corporate compliance programme, including all the training, is still relevant and businesses should disseminate this message to all relevant staff. The UK Competition and Markets Authority (CMA) recently stated publicly that its enforcement efforts will not waver in the period to Brexit and it is actively looking for cases.
2. Be careful with discussions on the impact of Brexit. Brexit raises significant commercial, legal and other issues for businesses, and therefore, there may be a desire to discuss it with competitors (either directly or in a trade association or elsewhere). However, if they involve confidential commercial information, these discussions are dangerous from a competition law point of view.
We recommend that no discussions with competitors take place in relation to Brexit without competition law guidance being provided in advance. Examples of potentially sensitive issues include a company’s particular contingency plans for Brexit and the likely commercial impact of Brexit-related changes on an individual business.
3. Consider the post-Brexit options, but take care with joint lobbying. It is highly likely that, post-Brexit, the UK will be outside the EU Single Market and the EU Customs Union, and this could be the case from as early as March 2019. The UK Government will be trying to negotiate a free trade agreement with the EU and there is significant scope for lobbying in relation to this. There is also scope for lobbying in relation to potential agreements with non-EU countries such as the U.S.
Joint lobbying which reflects the views of an industry sector will often be more effective than individual lobbying. This is, in principle, permissible under EU competition law, but again we recommend that competition law guidance be sought in advance so that information exchange or other concerns do not arise.
The general direction of EU and UK competition law, post-Brexit, is important here. There have already been calls for changes to EU competition law, particularly to allow “national champions” to be created in the EU (through more lenient application of the EU merger control rules post-Brexit) and to allow greater state intervention (through a relaxation of the EU State aid rules post-Brexit). It’s possible that these issues will form part of the EU/UK negotiations.
4. Review trading agreements. The form of many agreements (or at least certain clauses within them) is driven by competition law considerations. For many businesses, the most obvious example is distribution agreements, in particular, limitations on the ability to impose restrictions on distributors concerning pricing and cross-border sales in the EU and European Economic Area (EEA).
Given the uncertainty as to the shape of post-Brexit arrangements, it is not possible to make changes at this stage to ensure compliance with competition law going forward (or indeed to make sure that a business is not unnecessarily limited in its activities). We recommend that instead businesses review their existing agreements, precedents and new agreements to determine the impact of Brexit on relevant terms.
However, since the UK will likely be outside the EU Single Market following Brexit, it should be noted that it is possible the UK Government will take the opportunity to put in place UK rules which allow greater restrictions on cross-border trade from, or into, the EU than are currently allowed under EU and UK law. The UK CMA has expressly recognised that changes to the “block exemption” regime could follow Brexit. The EU block exemptions provide for automatic exemptions for certain types of agreement from EU and UK competition law, including distribution, licensing, and research and development (R&D) agreements.
5. Consider litigation strategy. Private competition law litigation (damages and other claims, particularly for injunctions) is expanding rapidly in the UK and the rest of the EU. This is now a genuine commercial weapon for businesses of all sizes and the amount of litigation will only increase as the EU Antitrust Damages Directive comes into force in all EU Member States.
We recommend that, as with other types of litigation, the impact of Brexit on private competition litigation be considered when planning strategy. There are various issues specific to competition law claims, but general litigation issues such as recognition and enforcement of judgments post-Brexit also apply.
6. Use legal advisers to ensure privilege protection. Post-Brexit, EU competition law will continue to apply to any company active in the EU (including UK or U.S. businesses which have no physical or legal presence there but do trade in the EU). The European Commission will continue to be the lead competition law regulator for the EU.
For the purposes of EU competition law and investigations by the EU institutions, including the European Commission, only advice from external EU/EEA-qualified lawyers is privileged. This means only that advice is protected from disclosure in EU antitrust, merger control, cartel or State aid investigations. Post-Brexit, advice from UK-qualified lawyers would have to be disclosed to the European Commission in an investigation.
Companies need to consider how (even now) they obtain external legal advice on EU competition law matters and, in particular, whether to continue to use lawyers who are qualified only in the UK. McGuireWoods has undertaken its own contingency planning and its EU and UK competition law partner Matthew Hall (an English lawyer) is now also qualified in the Republic of Ireland (an EU Member State).
7. Consider EU State aid, EU funding and UK aid. EU State aid law bans aid in all forms from EU member state governments and public bodies to companies, unless a market investor would have done the same thing or the aid is exempted. It seems likely that these rules will not apply in the UK post-Brexit, which means the UK Government will then, in principle, be able to assist companies and industries in ways that it cannot do at the moment.
We recommend that businesses consider whether they have received aid in the past in the UK, whether they might be able to receive it in the future under a looser post-Brexit regime (and indeed, in the run up to Brexit, if the UK government already starts to provide aid), and also whether competitors might similarly benefit. This can impact investment and other decisions. UK businesses should also consider whether they wish to make a complaint to the European Commission about a competitor receiving aid from other EU member states, since post-Brexit UK entities may not have the right to do so.
In relation to EU-level funding, the UK Government has indicated that post-Brexit it will stand behind grants obtained under programmes such as Horizon 2020. However, this remains uncertain and companies should plan for the possibility that such funds will not continue post-Brexit (or take an alternative route, such as seeking funds from entities which will still be in an EU Member State post-Brexit).
8. Consider leniency. This is really a point for external advisers, but a company which applies for leniency at EU level (protection against competition law fines imposed by the European Commission in return for whistleblowing about a competition law infringement) should consider very carefully whether to do so in the UK at the same time. This is often done anyway, but could become a crucial issue post-Brexit, when the UK CMA is likely to run parallel investigations with the European Commission concerning the same behaviour. If a leniency application has not been made in the UK in relation to pre-Brexit conduct, then a company may not gain protection in relation to its activities in the UK and may be exposed to significant (avoidable) fines as a result.
Existing Contracts
With respect to existing contracts, particularly those with entities within the EU, businesses should undertake a due diligence exercise to, firstly, identify their key contracts and, secondly, consider the terms of such contracts. When performing this due diligence exercise, it is important to consider the following factors.
1. Territorial scope. Identify if any agreements have the EU as their territorial scope. Once the UK leaves the EU, it will no longer be covered by any such territorial descriptions. Consideration will need to be given to whether an amendment to the contract is required or if instead a business can invoke a force majeure or material adverse change clause to terminate the contract.
2. Reference to EU legislation. Many existing contracts will refer to a raft of EU legislation. Whilst a laborious task, an analysis of the clauses dealing with the applicable laws, compliance with such laws and changes to such laws will be critical. Many contracts referring to EU legislation, particularly where it was assumed that the UK was included within the EU or that EU legislation applied, may need to be amended to deal with such references that will no longer work.
3. Force majeure provisions. Where a force majeure provision is drafted sufficiently widely (for example, drafted to include reference to acts of government or a regulatory body), it can potentially be relied on to trigger termination of such contract. In deciding whether a party is entitled to terminate as a result of Brexit, the court likely will look at the circumstances in which the contract was made, and ask questions such as whether Brexit was foreseeable or whether membership of the EU is essential to performance of the contract. The court is unlikely to terminate on the basis of Brexit where a contract was initiated after the possibility of an EU referendum became public knowledge.
4. Material adverse change provisions. In a similar fashion to force majeure provisions, if a contract has the benefit of a “material adverse change” provision, this could potentially allow a contract to be terminated. Whether this is to be the case, will heavily depend on the specific wording of the provision in the contract. However, it is important to bear in mind that a court is unlikely to allow a party to rely on a material adverse change provision to terminate a contract where the party entered into such contract while aware of the possibility of a vote to leave the EU.
5. Currency. Where payments under a contract are made or received in a foreign currency or fixed to a particular exchange rate, consideration should be given as to whether the currency used is amended to reflect the recent drop in the GBP or other activities in the marketplace as a consequence.
New Contracts
1. Potential impact. Consider including specific provisions relating to the potential impact of prolonged negotiations to implement the exit and/or the impact of the new trade agreements once negotiated.
2. Termination rights. Consider whether to include termination rights in case the new trade agreements will result in an increased burden or negative effects on the intended business transaction.
3. Force majeure provisions. Consider whether to expressly include or exclude Brexit from force majeure provisions. Such provisions should include suitable notice terms and detailed explanation of the consequences of the right to terminate. More importantly, ensure that the Brexit definition and when it can be triggered is sufficiently wide to cover relevant concerns.
4. Material adverse change provisions. In a similar fashion to force majeure provisions, consider whether to carve out Brexit from the material adverse change definition depending on the preferred outcome. Similar considerations will need to be given to how the Brexit definition is drafted and when it can be triggered.
How can McGuireWoods help?
The firm’s corporate and commercial lawyers can advise companies on the implications of Brexit by offering:
It is impossible to determine the precise impact of Brexit on UK tax laws.
The main reason is that most of the EU tax legislation has been incorporated into UK legislation through directives and local laws (mainly Finance Acts).
It is arguable that where the legislation is already entrenched in UK law, and benefits UK businesses, the Government of the day may wish to leave the laws as they are. However, this will not be of benefit to businesses with a more pan-European focus, unless the UK is able to join or negotiate a reasonable trade agreement.
The main tax implications which businesses should consider are as follows:
1. Parent subsidiary directive
This is not an issue for UK subsidiaries as the UK has limited dividend withholding restrictions. However, most European countries do. Leaving the EU may mean the removal of the benefit that UK holding companies currently profit from under the directive. This will mean that UK businesses will need to consider applicable double tax agreements with countries in which subsidiaries are present, or rely on the Government to negotiate new terms.
2. Interest and royalties directive
This will be highly divisive for businesses relying on favourable interest and royalties tax treatments. Again, while the UK Government may wish to assist UK businesses, by leaving the favourable tax treatment for interest and royalties received from other EU countries, the EU may look to withhold tax on payments of interest and royalties to UK companies. This could be a major blow to businesses which set up in the UK relying on the favourable patent box regime and the advantages received by royalties laws to export across the EU.
3. Capital duties directive
This may no longer apply, giving the UK freedom to impose stamp duty on new share issues, should the Government so wish.
4. Corporate tax
As corporate tax is decided by individual member states, Brexit is unlikely to affect the corporate tax rate, although the government may wish to reduce the corporate tax rate to stimulate investment in the UK.
5. Value-added tax (VAT)
Once the UK leaves the EU, the UK will no longer need to give effect to the VAT directive and so it could be repealed. However, with a large amount of revenue coming from VAT, the Government is likely to leave it unchanged, with only small modifications being made, such as excluding certain products.
UK importers’ and exporters’ cash flow would be at a disadvantage because of the delay between payment of custom charges and the recovery of VAT.
6. Customs union
The EU is a customs union so there are no barriers to trade. With Brexit, the UK will no longer be part of the customs union and new customs duties will have to be put in place. This results in UK businesses being at a competitive disadvantage, both due to potential custom fees and clearance issues. New trade agreements will need to be negotiated, both with the EU and with other countries signed to 34 EU free-trade agreements.
Brexit will affect business across the board, from businesses trading with Europe, to businesses structured across Europe (either due to holding/subsidiary arrangements or businesses relying on passporting rights), to businesses relying on debts or royalties arrangements and businesses with internationally mobile employees.
1. Prepare for the GDPR and changes to UK data protection laws. The EU’s new General Data Protection Regulation (GDPR) is coming into force on 25 May 2018 and will overhaul the EU and UK’s data protection regime. Whilst the UK remains a member of the EU, the GDPR will be directly applicable to the UK and replace the UK’s Data Protection Act. It’s not clear, following the UK’s departure from the EU, whether and how the UK’s data protection regime will change and much will depend on the post-Brexit UK-EU relationship going forward. However, the UK was heavily involved with the GDPR negotiations and the Information Commissioner's Office (ICO), the UK’s data protection authority, has already advised that UK data protection standards will need to be equivalent to those in the GDPR if it wants to trade with the European single market.
UK companies will therefore need to comply with the new regime from May next year. Following that, the UK very likely will need to adopt legislation similar to the GDPR to continue trading with other EU Member States. With this in mind, businesses should continue with their GDPR compliance preparations.
2. Determine whether the business targets EU citizens. The GDPR has a wide scope and will apply not only to businesses established in the EU, but also to non-EU organisations processing personal data of EU citizens, either by offering services or goods or from monitoring behavior. Therefore, following Brexit, the GDPR will still apply to UK-based businesses trading with the EU or targeting EU citizens and such companies should, therefore, continue to prepare for the GDPR.
3. Consider where personal data is processed and transferred. EU data protection laws prohibit transfers of personal data to countries outside the EEA, unless they have been recognised as providing "adequate protection" to personal data. Companies need to consider whether they receive data in the UK from global regions which are currently compliant based on the UK being within the EU or EEA. Following Brexit, the UK could apply to the EU Commission to secure a decision of adequacy to continue to receive personal data from EU Member States. However, if the UK is not classified as adequate post-Brexit, UK companies receiving data from the EEA will need to rethink their data protection compliance strategy and put in place adequate safeguards, such as Model Clauses or Binding Corporate Rules.
In addition, the converse (transfers outside the UK) may also be an issue, so companies should consider whether they send personal data from the UK (e.g., to third-party services providers) and what compliance measures they may need to put in place. Following Brexit, the new EU-U.S. Privacy Shield will not cover transfers of personal data from the UK to the U.S. However, the ICO could approve the Privacy Shield as an adequate means of data transfer from the UK to the U.S., or it could establish a similar framework (e.g., like the U.S.-Swiss Privacy Shield).
4. Determine where the organisation’s main EU establishment will be. Some GDPR provisions are dependent on the “main establishment” of a business being in the EU. Once the UK leaves the EU, a company with UK-based headquarters will no longer count as the main establishment under the GDPR following Brexit. This will affect a company’s lead data protection supervisory authority under GDPR for the purpose of enforcement and other reasons such as approval of Binding Corporate Rules. Companies will therefore need to determine where their second establishment in the EU is based, which will likely be where the lead data protection supervisory authority will be located under GDPR.
1. Prepare for possible changes to free movement of workers. We do not yet know what, if any, changes will be made to the free movement of workers following Brexit. However, it now seems inevitable that changes will be made following the UK leaving the EU. Employers should begin preparing for these possible changes by establishing the number and roles of affected employees so that as and when new rules are introduced, the nature and scale of the issue is already identified and can be monitored during the period until the UK actually leaves the EU, and solutions can be found once details of the new rules become known.
An important point to reiterate is that the UK has not yet left the EU and no changes to the law have yet been made that materially change the employment laws to which employers remain subject. Therefore, employers who try to anticipate or pre-empt potential changes to UK or EU immigration rules risk breaching UK anti-discrimination law. Nationality is a “protected characteristic” under the Equality Act 2010, and decisions regarding an individual’s recruitment, promotion or dismissal should not be made on grounds of nationality. Therefore, an employer who rejects a job candidate or selects someone for redundancy because the employee is not a UK national will likely be liable for an act of race discrimination under the Equality Act.
Equally, employers should be wary of over-committing to employees who may be very concerned about their future following Brexit. It may be tempting to offer advice or comfort to individuals who may be EU nationals living and working in the UK. However, employers should be careful not to make commitments which may be difficult or impossible to achieve and which may be construed as contractual promises or, at the very least, inducements for employees to stay that may prove to have been misleading. Similarly, it should generally be for individuals to establish their immigration rights and status following Brexit, and employers should be careful not to offer advice themselves which may prove inaccurate and give rise to liability.
2. Review contracts of employment, human resources policies, and practices for EU-specific or -driven terms. Many contractual terms and employment policies and practices are currently driven by the need to comply with EU-originated law. There may be changes in these areas, and employers should prepare so they are ready to respond to any changes to ensure their contracts are best suited to their businesses. As a first step, it may be worthwhile to ensure that the business is aware of its terms and conditions and policy provisions that are EU-originated and potentially vulnerable to change.
Agency worker protections emanate from the EU Agency Workers Directive and may be a candidate for repeal or reform in the interests of maintaining flexibility in the workforce. Employers should prepare for changes and be ready to respond or take advantage of those changes, if in the interests of their businesses.
Works councils, transnational works councils, consultation obligations on redundancy and TUPE transfers are all EU-originated laws, so change to these laws is a possibility. Employers should consider what mechanisms are currently in place, as regards UK employees, and the extent to which those mechanisms are desirable in the context of the employer’s business.
3. Protection of business assets. As in the case of any commercial disputes, employers will need to keep under review whether there are any changes to jurisdiction and choice of law rules, currently harmonized across the EU. If, as a consequence, there are changes to the applicability of these rules, this may impact the ability of employers to protect business assets through, for example, the enforcement of post-termination restrictive covenants. Further thought may therefore need to be given about whether existing post-termination protections are adequately drafted.
Brexit may have a profound impact on the structure of the Court system of the UK. The Court of Justice of the European Union (CJEU) is responsible for the rule of law within the EU. Current indications are that the UK government will seek to negotiate Brexit terms that do not include the jurisdiction of the CJEU, in order to re-establish the sovereignty of domestic UK Courts.
The UK’s right to appear in all cases and to appoint judges to the CJEU would therefore no longer exist when Brexit is concluded. Accordingly, it appears that from the date Brexit takes effect, litigants will no longer be able to appeal cases to the CJEU and UK judges will no longer be required to follow CJEU decisions (although they may decide to do so). Litigants would no longer be able to challenge UK legislation on the basis of incompatibility with EU law, although they would retain the ability to mount such challenges based on human rights issues.
In other respects, the court system in the UK is likely to remain unchanged, with the UK Supreme Court as the final Court of Appeal. Likewise, Brexit will not have any impact on the UK’s position insofar as the European Convention on Human Rights (ECHR), its council and its court are concerned. The UK’s membership of the Council of Europe will not be altered by Brexit and the convention has been incorporated into UK law through the Human Rights Act.
Initially, the UK government suggested that existing EU Regulations and Directives would remain part of English law after Brexit, until repealed or replaced. If that is the case, the effects are likely to be gradual, with the process of UK law diverging from its EU neighbours taking a number of years after the conclusion of the Brexit negotiations.
Lack of certainty as to the terms of the Brexit deal ultimately negotiated remains problematic in assessing how Brexit will affect international commercial litigation. There are, however, some key areas in which Brexit is likely to have a significant impact.
McGuireWoods will continue to recommend that commercial parties select the English courts and English law for the jurisdiction and choice of law clauses in their agreements, for a variety of reasons, notwithstanding the ultimate terms of Brexit.
Where commercial parties prefer an arbitration clause with a London seat, McGuireWoods will recommend no change as a result of any Brexit, as the UK will continue to be a party to the New York Convention on the enforcement of arbitral awards.
1. Scenarios beyond the withdrawal agreement. As can be seen, even now, nearly nine months after the UK referendum and with the negotiating period formally under way, there are doubts as to the process and timing. Leaving aside these issues, there are also doubts as to what might be agreed.
2. The ultimate ambition — free trade agreement with the EU. As noted, the UK government wants to negotiate a “new strategic partnership with the EU” (including an “ambitious and comprehensive” FTA and a new customs agreement with the EU), as well as interim arrangements to take effect from the date of exit.
The most comprehensive FTA agreed to date by the EU is that with Canada (CETA). CETA provides for the phasing out of all tariffs on industrial and most agricultural goods entering the EU. It also addresses a number of other directly discriminatory measures such as quotas and subsidies for industrial goods. It does not include “passporting” for financial services firms and provides for only limited liberalisation of other services markets. It does not allow free movement of people.
The UK government has said it does not seek to adopt a model enjoyed by other countries, but nevertheless, CETA is a relevant precedent due to its scope and the fact that it was finalised recently. The EU/UK FTA may include specific arrangements for certain sectors. Clearly, heavy lobbying is occurring in relation to this, but at this stage, the UK government proposes seeking special arrangements only for particular, limited sectors.
3. Customs issues. An FTA generally does not cover external trade policies and the UK government has said the UK will be outside the EU customs union (which provides for the EU common external tariff and the removal of tariffs between EU member states). The government has said it will seek a bespoke arrangement, but being outside the EU customs union is likely to mean customs checks at the border and the application of the EU’s rules of origin. In practice, customs checks could be a very significant issue for businesses trading cross-border with the EU.
4. WTO — the worst-case scenario? The worst-case scenario is that the UK exits the EU without an agreement and, absent any agreement, the default option is assumed to be trading with the EU solely on the basis of WTO rules. The UK government has, in fact, already raised the possibility of an exit without an agreement, saying that “no deal for the UK is better than a bad deal for the UK.”
The WTO governs trade between its members in goods, services and IP under various agreements. The agreements include two basic principles: the obligation not to discriminate against goods or services based on their origin, and the obligation to afford the same treatment to foreign goods or services as the member accords to its own. However, the option of relying on WTO principles does present various difficulties.
Absent an FTA or customs union, because of the basic WTO principles, each WTO member must impose its schedules uniformly, without discrimination. The UK’s exports to the EU would therefore be governed by the EU’s common external tariff, and EU exports to the UK would be governed by the UK’s WTO schedules.
The UK government has said work is underway on establishing the UK’s schedules at the WTO. It may, however, be the case that the UK is unable to regularise its position at the WTO by establishing valid goods and services schedules at the point of EU exit. That raises the issue of whether (in the absence of an FTA) WTO rules would not apply to EU trade at the point of exit and the EU could selectively discriminate against the UK (i.e., an even more unfavourable scenario than trading solely on the basis of WTO rules).
Nevertheless, on balance, the better view is that the UK is likely to be protected under the general WTO rules even in the absence of agreed schedules (even if only following a political fix). The worst-case scenario would therefore result in the UK having at least the basic protections provided for WTO members.
5. Interim arrangements — great practical importance. In practice, businesses are probably most concerned about a sudden change at the point of exit, from EU membership to an FTA or solely WTO-based trading (or, indeed, even non-WTO trading). The UK government has said it wishes to avoid a “disruptive cliff-edge” and will, therefore, seek to phase in the new arrangement (as an interim arrangement). This could be either a phased implementation of the future agreed relationship or transitional arrangements to apply pending the start of any agreed long-term relationship.
WTO rules could also bite here. If a transitional arrangement provides for a gradual introduction of tariffs and other barriers to goods and services trade between the UK and EU, there will likely come a point at which the WTO exception allowing for special treatment of other countries under a preferential trading agreement (an FTA) will no longer apply, since that requires substantially all trade to be unrestricted (as it is under the current UK relationship with the EU). The result is that the WTO members would, as things stand and subject to any political fix, have to approve certain forms of transitional arrangement.
In any event, companies need to be very vigilant as to the form of the interim arrangements and make concerns known to both sides in the negotiations as soon as possible. They also need to prepare for the legal ramifications. This may commercially be the most important area of the whole Brexit process.