Under English contract law, a contract is “frustrated” if an event occurs which the parties could not have foreseen when contemplating the contract that radically alters the parties' performance of the contract such that it would be unjust for the parties to continue. Since the effect of frustration is to release the parties from further contractual performance, the bar for a finding of frustration is set high by the courts.
Unfortunately for the EMA, the High Court held that, in this case, the lease had not been frustrated by Brexit. Consequently, the EMA remains liable not only to pay rent but also to perform its other contractual obligations for the remainder of the term. The EMA has been given permission to appeal to the Court of Appeal.
What does this ruling mean for businesses’ Brexit plans?
The EMA case affirms that the common law doctrine of frustration is unlikely to save contracting parties from contracts entered into that have since turned out to be a bad deal because of Brexit.
However, there are contractual means by which businesses may seek to deal with any future Brexit uncertainties. Contracting parties often try to “expect the unexpected” and many agreements include express termination rights to deal with unexpected adverse events. For example:
- Force Majeure clauses - this standard boilerplate clause is included in a significant number of contracts. It generally operates to allow a party to suspend or terminate its performance of particular contractual obligations in the event of specified events beyond the reasonable control of that party, such as a natural disaster or the outbreak of hostilities.
- Material Adverse Change (MAC) clause - this clause typically appears in lending and corporate acquisition agreements. It can be drafted in any number of ways but generally operates to allow a party to suspend, terminate or vary its obligations (dependent on the drafting of the clause) on the occurrence of an unforeseen event that is detrimental to the party.
It is debatable whether or not either clause in its standard form would allow a party any respite from its obligations because of Brexit. In any event, for contracts entered into since the referendum vote in June 2016, it will be difficult to argue that the adverse effects of Brexit were unforeseen. Consequently, in response to the turmoil surrounding Brexit – and, in particular, a no deal scenario - parties are increasingly seeking to include bespoke provisions to deal specifically with Brexit.
Brexit clauses
Similar to a Force Majeure or a MAC clause, a Brexit clause is one that triggers some change in the parties’ rights and obligations because of a defined Brexit event, in order to provide some protection against Brexit-related risks.
Brexit clauses can take various forms and may not be appropriate in all circumstances. For example, a Brexit clause may not be needed where the parties can terminate without penalty on short notice or in short-term contracts.
Some options that could be considered for a Brexit clause include:
- Requirement to renegotiate
This type of Brexit clause requires parties to renegotiate if Brexit has a material adverse effect on the contract. The party affected by Brexit may request renegotiation of the contract and, if no agreement can be reached, the party affected by Brexit can terminate. This provides a degree of flexibility for the party invoking the clause that may be advantageous given the unpredictability of Brexit.
The other side, however, faces the prospect of early termination unless it accepts the less favourable terms proposed in the renegotiation. Consequently, they may insist that the triggering adverse event includes metrics and is defined by reference to costs and market prices. But if the trigger is narrowed too much it runs the risk of not capturing the particular event affecting the party wishing to invoke the clause.
- Termination for convenience
This clause could be drafted to give a right to terminate for convenience if performing the contractual obligations would result in an adverse effect for a contracting party because of Brexit. Any such clause will need to be carefully considered and negotiated.
The party wishing to invoke the clause will need to ensure that the right to terminate is sufficiently broadly drafted to capture the events (eg imposition of tariffs or change in regulatory requirements) likely to arise as a result of Brexit.
Alternatively, the clause could provide that the agreement will continue unless there is an urgent need to terminate for licensing or another regulatory reason following Brexit. This approach may be appropriate if the parties not only wish to include a Brexit clause but also want to limit as far as possible the circumstances in which it can be invoked.
- Variation as a result of a specific event
Essentially a variation on a MAC/price adjustment clause, the parties could opt for a Brexit clause providing that a specific event, such as where Brexit causes a major currency fluctuation or a significant disruption in the supply chain, triggers a specified consequence such as adjusting the price by a set amount.
Other Brexit-ready amendments
In addition to considering whether to include a specific Brexit clause in a contract, consider what amendments might be needed to existing contracts or included in future contracts. For example:
- Territorial scope - Ensure that future contracts clearly address territorial scope. If the territory is defined in existing contracts by reference to the EU or EEA, this needs to be reviewed. To avoid the UK being carved out of the agreement after Brexit, you could define territorial scope by reference to membership of the EU at the date the agreement was signed or by expressly including the UK.
- References to EU legislation - Contracts that refer to EU legislation may also require amendment to reflect English law counterparts. Existing contracts that include a standard interpretation clause that provides for references to legislation to include such legislation as it may be amended from time to time are likely to be interpreted so that equivalent UK legislation will continue to apply post Brexit.
The commercial effect of such legislative change should, however, also be considered. Contracts originally drafted on the basis that EU legislation applied may also need to be reviewed once the terms of the UK's exit from the EU are clearer. An example of this could be licences of IP rights and distribution agreements drafted on the basis of compliance with existing block exemption regulations.
- Payment provisions - Consider how costs associated with Brexit should be allocated between the parties. For example, if import tariffs are imposed, customs checks make trade more costly or raw material costs are an issue.
- Insolvency provisions - If Brexit is likely to adversely affect the solvency of a party, consider whether intercompany guarantees could be sought, payment terms restructured to require advance payments, and/or whether robust financial reporting provisions ought to be included. Check that sale of goods contracts include robust retention of title clauses and ensure that contracts give the business the right to terminate for insolvency events.
- Jurisdiction clause - In the event that the withdrawal agreement is entered into between the UK and the EU, English jurisdiction clauses will continue to be upheld and the resulting judgements enforced across the EU until, at least, the end of the transition period (currently 31 December 2020). This will give businesses some degree of comfort.
However, during the transition period, the UK and the EU will need to agree the framework for their ongoing future co-operation following the expiry of the transition period. The UK has outlined its proposals for this in a position paper which includes seeking a bespoke agreement that closely reflects the current reciprocal EU rules on jurisdiction agreements as found in the Recast Brussels Regulation.
It remains to be seen whether such an arrangement could be agreed. It may, for example, be scuppered by the UK’s desire to bring an end to the direct jurisdiction of the European Court of Justice. In any case, this scenario only comes into play if a deal is agreed and the withdrawal agreement signed which, at the time of writing, may not happen.
In the event of a no deal scenario (or if a deal is reached but no further agreement is reached following a transition period) the existing EU rules on jurisdiction agreements will cease to apply. You may therefore need to take local advice from lawyers in the relevant member state as to what the approach to English jurisdiction clauses and judgements would be under local laws.
The UK has also taken steps to enter into the Hague Convention on Choice of Court Agreements in its own right on 13 April 2019 or 23 May 2019 (depending on the date of the UK’s exit from the EU). This would require contracting states to recognise exclusive jurisdiction clauses in favour of the English courts and enforce any judgements arising out of them.
If there is a gap between the UK leaving the EU and re-joining the Convention, the UK Parliament has put forward legislation to require courts within the UK to treat exclusive jurisdiction agreements concluded before the re-entry into force of the Hague Convention as if the Hague Convention continued to apply without that gap. However, as the exit day has been extended, these provisions may not be required.
In addition, the Convention only applies where there is an exclusive jurisdiction clause in favour of a contracting state's court and only where the clause was entered into after 1 October 2015. The Convention also does not apply to consumer or employment contracts or to certain other matters such as those relating to land or certain intellectual property rights.
If enforcement in a particular EU member state is important to a party because, for example, key assets are located there, as mentioned above check with local lawyers in that member state whether its courts are likely to enforce an English judgement under their local law.
Conclusion
In summary, it is clear that there is no “one size fits all solution” when it comes to contracts and Brexit. Businesses should review their key contracts and consider how these and future contracts are likely to be affected by Brexit. Businesses will need to consider if any existing contracts need to be amended or renegotiated in light of Brexit.
For further information on the Canary Wharf case see: Canary Wharf v European Medicines Agency lease dispute High Court decides that Brexit is not extraordinary, an article by Andrea Nicholls, senior associate in our property litigation team.