Brexit: Impact on debt finance transactions

Regulatory change for lenders

You will find a series of reports that look at the impact of a Brexit on the regulatory position of lenders and other Financial Institutions here.

Increased costs

Brexit is likely to require changes in law that will engage the increased costs clauses in facilities agreements. We anticipate that increased costs clauses will become a focus of negotiation as the date for Brexit approaches following a “leave” result in the referendum, in the same way that they did in the lead up to the implementation of the Basel II and Basel III capital adequacy regimes. However, a claim under an increased costs clause will only arise if the legislative acts constituting Brexit result in a lender facing additional costs in providing its funding, which is not a certainty. Even if increased costs can be reclaimed from borrowers, lenders have been reluctant to utilise increased costs clauses in the past.

Bank Resolution and Recovery Directive (BRRD)

If Brexit results in the UK ceasing to be member of the European Economic Area (the EEA), then English law governed contracts that EEA lenders are party to will need to include a bail-in clause in order for EEA lenders to comply with the requirements of Article 55 of the BRRD as implemented by individual states. While bail-in clauses have been the subject of much debate recently, resulting in the publication of a Loan Market Association form of bail-in clause and guidance note, the market view has been that lenders becoming party to non-EEA law governed multi-party contracts such as syndicated facilities agreements cannot expect existing parties to modify those contracts at the time of accession to include a bail-in clause if there is no other basis for amending the contract at that time. However, given the prevalence of English law governed facilities agreements and intercreditor agreements in cross-border European financing, it may be that pressure from EEA lenders will lead to English law governed contracts being amended to include bail-in clauses prior to Brexit even if there is no other cause for amendment.

Material Adverse Effect

The Loan Market Association’s form of “material adverse effect” definition would only be engaged if Brexit resulted in a detrimental effect on a borrower group “as a whole”, its members’ ability to perform their obligations under the relevant finance documents or the effectiveness or enforceability of the finance documents (including security) and that effect was “material”. We believe it is unlikely that most borrower groups would be sufficiently impacted by Brexit for a material adverse effect event of default to be triggered since businesses will seek to mitigate the impact of Brexit by e.g. moving operations to within the EU if necessary. In addition, material adverse effect is seldom relied upon as the sole trigger for calling an event of default and lenders will tend to wait for a clearer event of default to arise (e.g. financial deterioration triggering financial covenant breaches).

Sanctions

It is common for loan documentation to require compliance with sanctions laws. Many sanctions enforced by the UK result from the UK’s implementation of EU Council Decisions relating to the EU’s Common Foreign and Security Policy, or from directly applicable EU Regulations. While Brexit may result in the current legal mechanism for implementing those sanctions ceasing to apply, we would expect the UK to legislate in order to replicate those sanctions in order to meet its international commitments. Current drafting of sanctions-related provisions in loan documentation should be wide enough to capture this change in legislation, but should be checked with other drafting that has assumed the UK’s continued membership of the EU.

Choice of law

EU Regulations known as “Rome I” and “Rome II” generally require EU courts to recognise parties’ express choice of law in contracts, including the laws of UK jurisdictions. While Brexit would result in those Regulations ceasing to apply to the UK, it is unlikely that the UK courts would deviate from their willingness pre-Rome I and II to accept parties’ contractual choices. In addition, Rome I and II as in force currently will require EU states to continue to give effect to a choice of UK jurisdictions’ laws in contracts.

Choice of jurisdiction

The EU Regulation known as the Brussels Regulation generally requires EU courts to recognise and give effect to the selection of an EU state’s courts to hear contractual disputes, and for other EU courts to recognise the chosen courts’ judgments. If those regulations cease to apply due to Brexit and are not replaced with similar laws, parties to loan agreements will face uncertainty as to whether their contractual choices will be upheld by EU courts and whether judgments obtained by them in UK courts will be recognised and enforced within the EU. There are other conventions that the UK could accede to that would give similar benefits. For example, the Lugano Convention (which currently applies between EU states and those within the European Free Trade Association) is very similar to the Brussels Regulation and the Hague Convention offers similar recognition of judgments provisions if the relevant agreement includes an exclusive jurisdiction clause.

Security

We would not expect Brexit to have a significant impact on secured lending to businesses that do not rely on the UK’s Financial Collateral Arrangements (No 2) Regulations 2003 (the Financial Collateral Regulations), which implement the EU directive on financial collateral arrangements. The Financial Collateral Regulations provide a simplified method for taking security over financial instruments, cash or credit claims, which exempts qualifying arrangements from certain insolvency, security registration and security enforcement laws. The Financial Collateral Arrangements on their own are seldom relied upon outside of lending between financial institutions where perfecting alternative forms of security is difficult. In any event, it may be that the UK government enacts legislation that replicates the effect of the Financial Collateral Regulations.

Lenders that rely on security over trade marks as a significant part of their security package will need to consider whether further registrations and/or filings are necessary to properly protect borrower’s intellectual property if it has registered European trade marks and Brexit results in those trademarks no longer being protected in the UK.

The information contained in this report is intended for firms planning for the consequences of a potential withdrawal of the United Kingdom from the European Union. It is not intended, and should not be taken, as expressing any view or recommendation (i) as to how anyone should vote at the forthcoming referendum, (ii) as to the anticipated result of that referendum or (iii) otherwise as to whether the United Kingdom should remain within or leave the European Union. It is provided for information only and general interest, and is not to be relied upon by any reader as constituting legal, tax or professional advice.