"Brexit": what might it mean for contracts and disputes?

This article was produced by Olswang LLP, which joined with CMS on 1 May 2017.

A vote to leave the European Union on 23 June could have significant implications for businesses' compliance and contractual obligations and disputes. As the referendum draws closer, we consider the potential impact of a Brexit and how this might be determined by the exit model adopted by the UK Government.

Possible models for future UK/EU relationship

The consequences of a Brexit will partly turn on the model chosen for the future relationship between the UK and the EU. This is the biggest unanswered question in the Brexit debate. The UK Government has identified a range of possible models, but neither it nor the Brexit campaign have made any commitment to specify in advance of the referendum which model would be adopted. The options are as follows:

• joining the European Economic Area ("EEA") (the EEA Agreement incorporates substantial parts of EU legislation);
• joining the European Free Trade Association ("EFTA"), known as the "Swiss model";
• entering into other bilateral trade agreements with the EU and other territories;
• reliance on rights and obligations established by the World Trade Organisation; or
• having no formal relationship with the EU at all.

Contracts

A Brexit would raise three main issues for contracting parties: (1) Which rules will govern the parties' choice of applicable law for their contracts? (2) How will existing contracts be interpreted? (3) Can existing contracts be terminated as a result of Brexit? In addition, there is the question of providing for the possibility of Brexit in contracts which are still under negotiation.

Contractual choice of law

At present, the EU rules governing the choice of applicable law are set out in the Rome I and Rome II Regulations (which deal, respectively, with contractual and non-contractual obligations). As these are EU Regulations, they will cease to have effect in the UK following a Brexit. They will, however, continue to apply within the EU, so the courts of EU Member States will still respect the parties' choice of law (even if it is a law which is outside the EU).

The UK will need to draft its own legislation to fill the gap. It may choose to reproduce the provisions of Rome I and II within domestic legislation, of course with the English courts as the final arbiter on interpretation, rather than the Court of Justice of the EU. This may lead to a divergence in interpretation over time.

The Government could instead revert to applying the legislation in force in the UK prior to the introduction of Rome I and II: the Contracts (Applicable Law) Act 1990 (which implemented the Rome Convention) for contractual obligations, and the Private International Law (Miscellaneous Provisions) Act 1995 ("PILA 1995") for non-contractual obligations. This is unlikely to have any significant impact relation to contractual obligations, as the provisions of the Rome Convention and Rome I are substantially similar, and both respect the parties' express choice of law.

The position is more complicated for non-contractual obligations because, unlike under Rome II, PILA 1995 does not permit the parties to specify in a contract the law governing their non-contractual obligations (and of course in situations where there is no contract, there will be no means for the parties to agree). In addition, the legislation contains different tests for determining the applicable law: under PILA 1995, the applicable law is the law of the country in which the events constituting the tort occurred; under Rome II it is determined on the basis of where the damage occurs, or is likely to occur, regardless of the country or countries in which the act giving rise to the damage occurs. This could lead to uncertainty over which law would apply to claim for, for example, misrepresentation.

Finally, the Government could decide to draft something entirely new.

Interpretation of existing contracts

Issues of interpretation which could arise as a result of a Brexit include the following:

• How will an obligation to comply with a specific piece of EU legislation be interpreted?
• How will a choice of "English" governing law be interpreted where the UK was in the EU at time of contracting, but not at the time of performance? Should it include EU legislation to which the UK is no longer subject?
• What will be the interpretation of "EU" if the UK subsequently leaves? For example, if the territory in a distribution or licensing agreement is defined by reference to the EU, will the distributor's or licensee's rights extend to the UK following a Brexit?

Can contracts be terminated as a result of Brexit?

A vote in favour of Brexit is going to lead to a changed economic and commercial landscape within both the UK and the EU, and no doubt parties will reassess their contractual arrangements and try to exit any that are no longer profitable. Whether a Brexit will give parties a right of termination will, unsurprisingly, depend on the terms of the individual contract. Where a contract does not give parties the right to terminate on notice, they will need to consider provisions dealing with force majeure or material adverse change, or it may be possible to argue that the contract has become frustrated or illegal (for example where its performance is dependent on the continuing operation of EU legislation).

In deciding whether a party is entitled to terminate as a result of Brexit, the court is likely 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.

Provision for Brexit in new contracts

Similar issues arise in relation to contracts which are still under negotiation, including the interpretation of obligations which are defined by reference to EU legislation, and the territorial scope of contracts which refer to the "EU". Parties should also consider whether to include express rights of termination in the event of a Brexit, or to provide that a vote to leave the EU will amount to a force majeure event.

Disputes

In relation to disputes, a Brexit would raise four main issues: (1) How will we determine which court has jurisdiction over a dispute? (2) Will judgments from the English courts be enforceable in the EU (and vice versa)? (3) Will it affect the service of proceedings out of the jurisdiction? (4) What will be the impact on arbitration?

Jurisdiction agreements

The question of which EU Member State court should have jurisdiction over a dispute is currently governed by the Recast Brussels Regulation (1215/2012) for proceedings issued on or after 10 January 2015, and the old Brussels Regulation (44/2001) for proceedings issued before that date.

Under the Recast Brussels Regulation, where a contract contains an exclusive jurisdiction clause in favour of an EU Member State court, it is for that court to determine whether it has jurisdiction to hear a dispute arising out of the contract. Any proceedings issued in other Member States must be stayed until the question of jurisdiction is determined. Where there is no exclusive jurisdiction clause, the court first seised of a dispute will determine whether it has jurisdiction, and proceedings in other Member States must be stayed.

The Brussels Regulations will cease to have effect in the UK following a Brexit. The new regime will depend on the model chosen for our future relationship with the EU. If the Government elects for EEA or EFTA membership, the UK is likely to accede to the 2007 Lugano Convention. This is substantially similar to the regime under the Recast Brussels Regulation, but there are two main differences. First, a jurisdiction agreement will only be effective under the Lugano Convention if one of the parties is domiciled in a Lugano Contracting State (there is such requirement in the Recast Brussels Regulation). Secondly, unlike the Recast Brussels Regulation, it does not give precedence to an exclusive jurisdiction clause, so the question of jurisdiction is always determined by the court first seised of a dispute. If proceedings are subsequently commenced before the court given exclusive jurisdiction, these will have to be stayed. This gives rise to the possibility of an "Italian torpedo", i.e. a party issuing proceedings in a jurisdiction known to be slow, even if they believe jurisdiction will ultimately be refused, in order to delay proceedings before the court named in a jurisdiction clause.

If the UK adopts some other free trade agreement, or opts for WTO regulation, there are a number of options. It could still seek to accede to the Lugano Convention, or look to negotiate individual treaties (which might perhaps be based on the Brussels/Lugano regime). Alternatively, the UK could accede to the Hague Convention on Choice of Court Agreements, which came into force between EU Member States and Mexico in October 2015. This gives effect to exclusive jurisdiction agreements.

Finally, the UK could decide not to enter into any international agreements and rely on international principles of comity. This is likely to create considerable uncertainty over how other Member States will treat jurisdiction clauses in favour of the English courts.

Recognition and enforcement of judgments

As with jurisdiction agreements, the recognition and enforcement of judgments will depend on the exit model chosen by the UK Government. The options here are the same as for jurisdiction agreements (i.e. accession to the Lugano or Hague Conventions, negotiating individual treaties or no international agreements). The first three options should provide a clear framework for the recognition and enforcement of judgments across the UK and EU.

As before, the most troubling scenario is if the UK decides not to enter into any international agreements, as it will mean the enforceability of English judgments within the EU will depend on the law of the Member State in which enforcement is being sought. This is likely to lead to significant uncertainty and additional expense. For example, an English company which is contracting with a Spanish counterparty would need to take Spanish law advice as to the enforceability of an English judgment in Spain. Another question is whether other forms of relief granted by the English courts (such as injunctions and declarations) will be recognised by other Member State courts. The flip side is that the English courts will no longer automatically recognise judgments from EU Member State courts. Enforcement of such judgments will instead be governed by common law rules and become a slower, more expensive and uncertain process.

Service out

Where the English court has jurisdiction under the Recast Brussels Regulation, permission to serve proceedings out of the jurisdiction is not usually required where service is to be effected in an EU Member State. A similar exemption exists for Lugano Convention states. However, if the UK leaves the EU and does not accede to the Lugano Convention, parties will have to apply for permission to serve in EU Member States. In addition, the EU Service Regulation will no longer apply, which will make service out a slower and more expensive procedure. It will therefore be essential to ensure that a EU-based counterparty appoints an agent for service in England if there is an English jurisdiction clause.

Arbitration

A Brexit will not affect the conduct of arbitrations with their seat in London, as these are governed by the Arbitration Act 1996. Neither will it affect the international enforcement of arbitration awards, as all current EU members (including the UK) are members of the New York Convention on the Recognition and Enforcement of Foreign Arbitral Awards. In addition, English courts will be able to grant an anti-suit injunction to restrain proceedings brought in an EU Member State court in breach of a London arbitration clause, something which is currently precluded by EU case law.

Comment

It is clear that the model chosen for our new relationship with the EU will have an impact on the consequences of a Brexit. The further the UK moves away from its ties with the EU, the more uncertainty (and consequent delay and expense) is likely to result.

Perhaps the most fundamental question is whether the potential difficulties of enforcing judgments - particularly if the Government decides against joining the established regimes, such as the Lugano Convention - will impact on the desirability of London as a forum for litigation and discourage parties from agreeing to confer jurisdiction on the English courts. There will likely be some impact, but a Brexit is unlikely to detract significantly from the main reasons why many parties choose to issue proceedings in the English courts - their reputation for fairness, impartiality and clearly-reasoned decisions from judges with considerable experience in their fields. Where, however, parties are looking for a greater degree of certainty in relation to enforcement, we may see more contracts providing for arbitrations seated in London, as these will not be so subject to the vagaries of the post-Brexit world.