Brexit – A United Kingdom lost and disruption guaranteed
Since the last blog entry on Brexit, many new headlines and developments have been produced. By way of example, Theresa May was forced to quit and Boris Johnson took over in Downing Street No 10. More recently, he was on Tour d' Europe talking to other European leaders about the UK's withdrawal from the European Union. At this very moment, it is hardly possible to predict the cost of Brexit or the impact it might have on the economy, not speaking of the society. The withdrawal of the United Kingdom might not happen after all. The United Kingdom was due to leave the European Union two years after Article 50 of the Treaty of the European Union (TFEU) was invoked and thus triggered the exit process. Three rejections of a Withdrawal Agreement have led to the UK remaining in the EU for now. Depending on how you take which event into account, three is the magic number in this drama. There have been three Prime Ministers since the Brexit vote and three constitutional crises. Three is also the reported number of times a senior Brexit official had to change desks in the beginning of Brexit negotiations (https://www.bbc.com/news/uk-politics-49008826). As pointed out before, Brexit will a have lasting impact on the economy, population and politics in the UK and beyond. The economy will shrink and the population will become less diverse. The EU and UK's influence on the world stage will decrease both economically and politically and at an accelerated rate.
Introduction – Risks and Challenges ahead
The UK was expected to leave the European Union on March 29, 2019. It still is a Member State today and has been granted a second extension of six months until October 31, 2019. One could wonder if the date of Halloween was chosen on purpose.
The only possibility of preventing a No-Deal-Brexit would be for British MPs to approve the Withdrawal Agreement. Even if that happens and a no-deal scenario is avoided, the crucial issue of the future trading framework between the EU and the UK remains unresolved. The Withdrawal Agreement does not resolve uncertainties but leaves them, and the Brexit risks and challenges, waiting for a future negotiated solution.
At this time, it is not possible to anticipate what precisely will be agreed. It is even possible that nothing will be agreed. Every now and then, the idea of a second Brexit referendum is discussed. This entails serious risks and challenges for the companies.
General remarks on key risks and challenges
The range of risks resulting from the UK's withdrawal from the EU is broad and the impact depends on the activities concerned, be it sale of goods, cross-border manufacturing operations, providing services or maintaining a commercial or manufacturing presence in the UK or the EU27. Irrespective of the outcome of future negotiations, it is certain that Brexit will generate additional costs and challenges for all economic operators, both in the UK and in the EU27. As the outcome of the negotiations on the future framework remains unclear, businesses need to prepare themselves by identifying and addressing risks in advance.
Even though the risks depend on the particular activities of a company, we can group them into several broad categories that every business (and its subsidiaries) should evaluate:
- The entire manufacturing and supply chain should be reviewed and (re-)considered in light of Brexit.
- All contracts related to the UK, which will still be valid or have effects after October 31 2019 or, should the Withdrawal Agreement be signed at the end of the proposed transition period, in December 2020 should be reviewed and eventually modified or terminated.
- All cross-border shareholdings between the UK and EU27 countries that will continue or have effects in October 2019 or after December 2020 should be reviewed and eventually modified.
- All future movement and postings of persons and goods must be Brexit-proofed. Boris Johnson has yet again declared that he wanted free-movement to end on October 31, 2019.
Manufacturing and supply chains
Brexit poses the greatest risks and challenges for manufacturing and supply chains, irrespective of whether any Withdrawal Agreement enters into effect or a subsequent free trade agreement, if any, is concluded and what such an agreement may provide. From the outset, it should be emphasised that all known EU rules concerning free movement of goods, services, capital and people between EU countries and the UK will no longer apply. The UK has signed an order to scrap the 1972 Brussels act. In consequence, EU regulations will be hindered from becoming British law after a Brexit on October 31. Disruption is guaranteed.
In such a no-deal situation the UK must be treated like any other third country when evaluating the consequences of Brexit and the possible need for action. This means the movement of goods between the UK and any EU27 country will be subject to customs control and the payment of duties. The UK has indicated that it plans to keep tariffs at similar levels as the current EU28 tariffs for industrial products, which will result in additional costs in manufacturing and supply chains. The burden for companies that carry out production steps in different countries will increase significantly, as will the costs of doing business. For example: if a gas heating system made in Germany is installed in a motor vehicle manufactured in the UK, which is then sold in France, duties will have to be paid on the gas heating system in the UK and duties on the vehicle in France. Duties on the imported parts may possibly be refunded, but this will require further efforts and possibly delays.
As the shipping conditions change to those applicable to businesses in a third country, additional regulatory burdens for customs documents, taxes and import turnover tax will arise and pose challenges. Delays in crossing the UK/EU border are a likely result of additional export/import controls. This needs to be taken into account upfront.
If the Withdrawal Agreement is signed, these additional burdens will be imposed at the end of the transition period; a free trade agreement, should one be concluded, will only reduce these additional burdens to some extent. Indeed, such an agreement can avoid the levying of customs duties on goods originating within the area, but can lead to additional controls. Currently, once goods have cleared customs in one EU country, they can circulate freely within the EU. Moreover, physical movement between countries for goods and persons will be subject to agreements on (air, road, rail and sea) transport.
At the latest after the transition period and the time necessary for the British legislature to enact changes, product requirements will diverge (assuming that the UK will in fact (de-) regulate). Issues of certification (within the British, EU and other markets), recognition of certifying bodies and costs for meeting standards will pose additional challenges for manufacturers. Today, there is a one-stop-shop for chemicals, medicine, medical apparatus, pharmaceuticals, etc. On Brexit day, decades of progress towards frictionless trade will become history, with the irony that it was the UK that pushed for the completion of the single or internal market in the 1980s!
Additionally, tax-related issues have to be taken into account; for further details please see below.
For all of these reasons, manufacturing and supply chains must be analysed in terms of economic viability and cost-effectiveness, and adapted if necessary. Irrespective of the Withdrawal Agreement and the envisaged free trade agreement, companies should evaluate their costs and exposure. They should review manufacturing and supply chains with their most important customers and suppliers:
- Identify the most important suppliers for each manufacturing site or operation. While economic importance will be key to identifying the importance in the manufacturing and supply chain, attention must be given to smaller, but strategic supply chain relationships which could have a big impact on both production and supply as well.
- Analyse supplies to and from the UK:
- How should supply chain relationships be configured, in particular will they be maintained or replaced, and how will contracts be adapted? For details see below “Contracts related to the UK”.
- How will the company react to a foreseeable delay? Do you need to build-up stocks, look for alternative suppliers, etc.?
- How will the company react to increasing costs and who will bear them? Increased costs through customs duties, import turnover taxes, logistics, certifications for products, etc. need to be assessed and taken into account in business planning. Future contracts should include terms to apportion responsibilities for costs and risks; for details see below under “Contracts related to the UK”.
- If movement of people is restricted, which location should be used to provide services (installation, repair, maintenance)?
- If applications for industrial property rights (especially EU trademarks and community designs) were filed, which ones will need to be filed or renewed in the UK or the EU27 after Brexit?
- If there are products with CE certification, which ones might have to meet new UK safety Standards?
- Are IT systems prepared to handle new requirements for customs and statistical declarations, or can they be adapted? Possible diverging data protection requirements in the processing of data should be taken into account.
- Identify the most important customers that are supplied from different factories.
- Analyse customers located in or supplied by the UK:
- How should supply chain relationships be configured post-Brexit, in particular should they be maintained or replaced, and how should contracts be adapted? (For details see below under “Contracts related to the UK”);
- How should the company manage increased costs and who should bear responsibility for these costs and risks?
Contracts related to the UK
Irrespective of the Withdrawal Agreement being concluded and a free trade agreement being reached, Brexit will cause additional costs and challenges. Contracts that will remain in effect beyond Brexit need to be examined closely. Some long-term contracts may no longer be adequate and need to be adapted or terminated. For new contracts that will still be valid after Brexit, the distribution of costs and responsibilities for risks should be taken into consideration when negotiating the contract and be spelled out in clear terms.
A key aspect that needs to be reviewed and (re-)considered in contracts is the apportionment of additional risks and costs as a result of Brexit. These can be caused by border delays, shortage of supplies, additional export/import controls and newly arranged documentation requirements. Modifications regarding the modalities for the submission of documents and licenses, customs, VAT and import-turnover tax will give rise to long-term costs.
The British Department for Business, Energy and Industrial Strategy advises the registration for the transitional simplified procedure after requesting an EORI-number while indicating that the CE marking will stay valid for some time. In a hard-Brexit scenario, a new symbol, the UKCA (UK Conformity Assessed) sign is foreseen.
In addition, in the case of territorial limitations or industrial property rights, it should be considered whether the contract still includes the UK after Brexit. If this is not the case, an evaluation should be performed as to whether it is appropriate to adapt the contract in question.
In most cases, the risks associated with Brexit will not have been calculated and taken into account, nor will the attribution or sharing of responsibilities for new risks have been agreed and set out in the contract. Rarely will it be possible to terminate a contract because the implicit basis of the contract no longer exists (which can lead to an adaptation of the contract under German law) or for "frustration" (which can lead to termination of a contract under British law).
Irrespective of the conclusion of the Withdrawal Agreement and a free trade agreement, a company should:
- Identify the most important contracts (as deemed necessary for manufacturing and supply chains).
- Review the distribution of costs and the attribution of responsibilities for risks, taking into account the applicable law.
- In particular, review the distribution of additional costs and the allocation of responsibilities for risks arising from delays, additional services, additional approvals required (safety and certification standards) and for impossibility to fulfil a contract.
- If these elements are not yet defined, will it be possible to terminate or adapt the contract?
- Which applicable law and jurisdiction were agreed upon?
- Adapt or terminate contracts with greater risks, if possible.
- Consider hedging for currency fluctuations.
- Conclude new contracts with an appropriate distribution of costs and attribution of risks, taking into account the choice of law and jurisdiction, and possibly arbitration rather than court proceedings in the case of dispute.
Post-Brexit and the transition period, companies established and operating in the UK will no longer have to abide by EU rules and will no longer benefit from EU rules with respect to their subsidiaries in EU countries, unless UK law or international or bilateral agreements apply rules that are similar or identical to EU law. EU regulations regarding disclosure, incorporation, transparency, capital maintenance and alteration, cross-border restructurings and mergers will no longer apply to the UK. The same is true for rules on the common system of taxation applicable to interest and royalty payments made between associated companies of different Member States, and on the elimination of double taxation within corporate groups from profit distribution between related EU companies. Whether or not this will have consequences for the company has to be examined in detail and solutions for any negative developments must be sought.
Over time, UK corporate law may start to deviate from the current EU law requirements, since it will no longer have to comply with EU regulations. UK companies hoping to establish a branch in the EU will, in principle, be subject to the more extensive disclosure formalities applicable to branches of non-EU companies. They will be treated as “third country companies”.
Companies that use the English legal form of limited company but are located in EU Member States will no longer be able to rely on the right of establishment granted by the European treaties. After Brexit, limited companies resident in Germany, for example, will no longer be regarded as corporations, but they will be subject to the rules for partnerships and might lose their limited liability status. As a consequence, shareholders of such limited companies may be personally liable without limitation.
An EU Member State may in the future require companies resident in the UK to appoint a fiscal representative when they register for VAT within the EU. The representative usually takes on joint and several liability for the VAT debts and accounts of the company.
Finally, Brexit will have consequences for European works councils, since the EWC agreements under UK law will not automatically endure. If the agreements are not renegotiated, EWCs will lose their UK members.
- Identify agreements concerning dividend and royalty payments, supplies as well as the supply of goods and services within the corporate Group.
- Review which tax regulations apply if EU regulations are no longer applicable (see as a fall back double taxation agreements).
- Calculate the financial consequences of the upcoming changes and consider optimisation measures.
- If changes to the group structure are already being considered, review whether it is appropriate to implement them before or (if still useful) after Brexit.
- Determine cash flows within the company group and whether they need to be adapted.
- Determine whether there are accumulated profits and losses and whether they may be claimed or offset post-Brexit.
- If you have a limited company established in an EU27 country, prepare the appropriate adaptations under corporate law.
In our view, the above-mentioned points are the most important issues that you need to consider. However, every business is different and will face different risks and challenges as a result of Brexit. Tailored legal advice is therefore strongly recommended.
In sum, irrespective of whether Brexit happens or not, it provides companies with an incentive to review, modify and reconfigure their manufacturing and sales chains, in order to future proof them.
Dr Rainer Bierwagen will be happy to answer any questions you may have about this article.