June 21, 2016
For the past few months, it has been impossible for anyone living in the United Kingdom to escape coverage of the Referendum on the UK’s continued membership of the European Union. Whilst general coverage has been extensive and unrelenting, there has been considerably less focus on what might happen after a vote to "leave" (i.e. a vote in favour of "BREXIT", rather than a vote to "remain") compared to the dynamics of the vote itself. In this Client Alert, we seek to address some of the immediate and longer term potential legal consequences of a vote to leave.
What are the legal consequences of a vote to leave?
The legislation enabling the Referendum does not impose an obligation on the UK government to legislate one way or another following the outcome of the vote (unlike, for example, the legislation enabling the referendum on UK electoral reform in 2012). Whilst a vote to leave could be regarded as providing a like-minded government with a political mandate, it does not tie the UK government to any particular course of action – it has no binding legal effect and as a strict legal matter, its outcome is merely advisory. It is, therefore, a political judgement for the government of the day as to whether it acts upon or ignores the outcome of the vote on 23rd June. It is beyond the scope of this Client Alert to speculate as to the political consequences of the outcome of the vote, save to presume that whatever government is in power after the Referendum will be unlikely to ignore its outcome and, assuming a vote to leave, will seek to give effect to it.
In terms of practical steps, if the UK government decides to follow the outcome of a vote to leave, it must serve a notice on the European Council of its intention to leave pursuant to Article 50 of the Treaty of Lisbon (the Treaty of Lisbon, amongst other things, governs membership and operation of the European Union). Article 50 is silent as to the steps that lead up to the service of such a notice – it allows any member state to withdraw "in accordance with its own constitutional requirements". The manner is not prescribed; it can be a referendum, or a parliamentary vote, or some other means. In the UK, it would seem that some form of parliamentary approval would be required, although perhaps the lesser procedure of a motion or resolution, rather than an Act of Parliament, will be sufficient. The position, however, is not clear, and the UK government has not so far been specific about it. It is also apparent that not all constitutional experts agree as to what the relevant "constitutional requirements" are.
There is a hard deadline: exit negotiations under Article 50 must be completed within two years from the date of the notice. As a result, if notification is given, the UK will leave the EU in two years’ time (being "BREXIT"), unless this period is extended by unanimous agreement. It is possible that such unanimity may be forthcoming, but obtaining an extension would be outside of the power of the UK alone. This deadline gives real force to Article 50 – the alternative would be the prospect of interminable discussions and negotiations.
One would imagine that a well-advised government would seek to pre-negotiate as many aspects of a post-BREXIT world as possible, but what happens between a vote to leave and any Article 50 notification will be driven by politics and diplomacy, not by law. What is certain is that if there is an Article 50 notification, then there will be a significant amount of legal work to be done. Over 40 years of law-making, and tens of thousands of legal instruments, will have to be unpicked and either repealed, replaced or discarded, and this process will take years to complete, if it is ever completed. A number of experts speculate that this process will take ten years at least and will keep the UK civil service fully occupied for that period.
At the heart of the problem is the principle, enshrined in the European Communities Act 1972, that EU law is, to all intents and purposes, UK law. Extricating Britain from the EU’s legal embrace would require identifying which laws were no longer applicable or needed to be repealed, replaced or redrafted. This would of course be as much a political as a legal process – the degree of pruning would need to reflect the outcome of the Referendum vote, and could cause political unrest if it was seen as insufficiently (or excessively) decisive. An alternative to a case by case review of legislation would be to pass a single "BREXIT Act" which would enshrine in UK law all EU law as of the date of exit, but this would also be politically sensitive for the same reasons.
A complicating factor is the embedding of the principle of the European Communities Act in the legislation giving effect to Scottish, Welsh and Northern Irish devolution. Powers that were handed to the constituent UK nation states on devolution, in the belief that the nation states would ultimately be regulated by the EU, would still default to those nation states following BREXIT, with the result that, for example, Scottish agriculture and fisheries policy could be at odds with that of the rest of the UK. Any attempt by the UK government to force through legislation wresting control of these matters from the EU to the UK could set up intense political divisions between the UK and its constituent members and, in the case of Scotland, would simply add fuel to the likely campaign for a second independence referendum.
A post-BREXIT world?
Significantly, the relevant treaties provide very little guidance about the legal consequences of withdrawing from the EU or what the post-BREXIT world would look like for the departing member state (and remaining members). Existing models for the EU’s relations with non-member states suggest that a range of arrangements that could be agreed if the UK decided to leave the EU, from the "EU-lite" precedent set by Norway, with its EFTA and EEA membership, through various levels of economic integration and cooperation with the EU implemented through a series of bilateral agreements (similar to the arrangement that pertains between Switzerland and the EU), to the UK "going it alone" at the other end of the spectrum.
What "going it alone" would look like is unclear, but a group of pro-BREXIT economists are advocating so-called unilateral free trade and reliance for market access on the rules of the World Trade Organisation (WTO). Whether this route would work is open to doubt on at least two grounds. First, no WTO member can unilaterally decide what its rights and obligations are. Thus, the UK’s trading partners would have to accept its new schedule of trade policies if it is to enjoy all the protections of membership. This could take a long time. Second, in the modern world, "unilateral free trade" is a complex notion. The UK might, for example, abolish all tariffs. But would it "bind" those tariffs at zero, losing its future freedom? Within the WTO, the treatment of tariffs makes a huge difference. Furthermore, the meaning of "unilateral free trade" for the regulatory barriers on which trade negotiations now focus is far from clear. Free trade in services might, for example, include movement of workers needed to provide them. That idea might not sit comfortably in a post-BREXIT UK that had explicitly voted against freedom of movement.
In reality, if the Referendum vote is in favour of BREXIT, there will be extensive and protracted negotiations between the EU and the UK, with a view to putting in place transitional arrangements aimed at minimising damage to business and trade between the UK and the remaining member states of the EU. Such a process may result in the agreement of a looser free trade area, the retention of a customs union, and the maintenance of certain rules relating to free movement of services, capital and workers and freedom to establish businesses. It must also be anticipated that the UK would itself, following a vote to leave, put in place transitional measures providing for the continuing practical effect of EU law for certain purposes. The true consequences of any BREXIT will fundamentally depend on the extent of the transitional arrangements.
We consider below some of the more obvious potential legal implications for UK/European companies and businesses as a result of a vote in favour of BREXIT. The summary is not exhaustive, and the situation for each company or business will be unique depending on its make-up, sector and circumstances, as well as the outcome of any transitional arrangements.
Legal implications of BREXIT for companies and businesses
Competition law and regulation: In the corporate mind, EU law is perhaps more closely associated with competition law and regulation than in any other area. Whilst there has been significant harmonisation and streamlining within the EU over the past 40 years, the UK retains its own independent competition regime and agencies, all of which will play a fuller role in the event of BREXIT. This could, in particular, be the case if, over time, the UK economy diverges from the European one such in more and more cases the UK market is seen as a separate from the EU one.
- Cartels and other anti-competitive agreements: Post-BREXIT, it would no longer be the case that where the European Commission initiates an investigation, the UK competition agencies could not also investigate the same alleged infringements. Businesses involved in a cross-border cartel covering EU countries and the UK could face separate investigations by both the European Commission and by a UK competition agency and could face fines under both regimes. In practice however, given limited resources, it is possible that some form of arrangement would be reached so as to avoid overlapping investigations.
- Merger Control: Currently, mergers falling under the EU Merger Regulation can be granted an EU-wide clearance. Following BREXIT, mergers meeting the UK thresholds would need to be separately reviewed by the UK CMA, unless an alternative arrangement (like that for Norway) was made to allow for such deals to continue to be reviewed by the EC.
- State Aid: Although unlikely, if BREXIT occurs without any special trade agreement in place between the UK and the EU, the UK would likely fall outside the state aid control system under EU law that prohibits the grant of state aid by member states. In theory the UK could perhaps grant previously prohibited state aid to UK entities, yet at the same time BREXIT could make it more difficult for the UK to complain about state aid granted by EU member states. In reality, it is likely that the UK would not leave the EU without a comprehensive trade agreement having first been negotiated, one feature of which is likely to be an EU requirement that the UK enact state aid legislation on broadly the same terms as under EU law.
Financial Services regulation:
Technically, free movement of capital would not be affected by BREXIT. However, it will be crucial for the UK to negotiate mechanisms for the on-going cross border provision of financial services, including various passporting schemes (which would otherwise terminate on BREXIT) and harmonised regulation. Crucially, effective provision of financial services will be enhanced if the UK remains within the EEA.
Imports and exports:
- Trade and single market access is a key element of the UK’s relationship with the EU. How this relationship is redefined following any vote to leave will be one of the main areas of focus, with future trading relationships dependent entirely on the nature of any agreements reached. In the medium term this would result in significant uncertainty for UK businesses.
- BREXIT would also leave UK businesses without the benefit of more than 50 free trade deals that the EU has obtained. While some of these agreements may be replicated bilaterally by the UK, this process would undoubtedly take time and there would likely be a degree of renegotiation. Whether the UK could obtain deals as favourable as those granted to the EU also remains highly uncertain. In the short to medium term, fluctuations in exchange rates may also impact UK trade. An eventual EU/UK trade agreement may not overcome all tariff and non-tariff barriers, and other proposed models also have potential drawbacks. For example, a Norwegian model would require the UK to continue to observe many of the EU’s regulations, and a Swiss model would provide access to the single market for the UK’s goods, but not its services.
- In addition, if the UK were to leave the EU, it would probably cease to be a part of the EU customs union. Even though one would expect that the UK and the EU would enter into a free trade agreement with no or very low customs duties, exports and imports between the UK and the EU would then need to go through customs procedures. It is not clear what would happen to the land boundary with Ireland.
In a post-BREXIT world, businesses that currently benefit from EU grants or subsidies (e.g. research and development) may find it difficult to obtain funding for new projects following a vote to leave the EU. Transitional arrangements for on-going projects would have to be agreed, and the UK would need to decide what it would continue to fund post-BREXIT, at which point it may no longer be constrained by the EU state aid regime (see above).
- Depending on the post-BREXIT model, it may become more difficult to recruit, retain or move employees from the UK to the EU and vice versa, which could give rise to skills gaps, an inability to service customers in relevant countries and a loss of talent. In the worst case, UK nationals currently based in the EU, and EU nationals currently employed in the UK, may have to return to their home countries (potentially on short notice, although that is unlikely).
- There may also be an impact on EU-wide recognition of qualifications, which could present another barrier to staff mobility. This may extend beyond the EU if recognition of qualifications, or the ability to operate in particular countries, derives from free trade agreements entered into by the EU rather than the UK. BREXIT may also impact absolute staffing numbers if it affects customer demand for, or ability to provide, products or services. There is likely to be a need to look at existing agreements with works councils and other employee representative bodies if there is a significant change in the size of the workforce as a result of BREXIT.
- The implementation of equity incentive programmes for international groups may become more difficult post-BREXIT, as many such groups rely on EU-wide regimes to address local securities laws and other regulatory issues, and avoid the need to issue a prospectus.
- Currently virtually all UK indirect taxes are governed (or substantially impacted) by EU law, and EU law has a significant impact on direct taxes (particularly as they affect cross-border relationships).
- Currently, EU directives eliminate withholding taxes on intra-group interest, dividends and royalty payments made within the EU. Following BREXIT, unless the relevant EU directive is retained in UK law, such payments within a group between the UK and EU members would be subject to withholding taxes. Relief under bilateral double tax treaties may be an alternative, and in many cases would eliminate withholding taxes entirely. Alternatively (at least in the case of interest paid by a UK company) it may be possible to avoid withholding taxes by restructuring intra-group debt.
- Steps would have to be taken following BREXIT to legislate for automatic exchange of information under the Common Reporting Standard.
- Following BREXIT the UK would be able to introduce UK tax rules that would have been contrary to EU law (such as, for example, introducing reduced or zero rated rates of VAT). The UK would also have more scope to adopt tax regimes that would currently be contrary to state aid rules (for example, by providing tax incentives to certain industries or geographic areas without the need to obtain a state aid derogation from the EU).
- It is unclear what would happen in the case of tax regimes that have been held by the courts (or recognised by HMRC) either to conflict with EU law (such as, for example, the 1.5% stamp tax charge that applies on the issue of securities in ADR form), or not to have given effect to EU law in full. In many such cases, the underlying UK law has not been formally amended to reflect the overriding requirements of EU law, and taxpayers rely on the direct effect of EU law trumping the UK statute. It is unclear whether, following BREXIT, the underlying UK law would revive. On the flip-side of the same coin, will taxpayers be able to revive tax mitigation arrangements which have been challenged by HMRC on the basis of EU jurisprudential concepts (such as "abuse of rights") where there is no equivalent concept in UK common law?
- The taxation of internationally mobile employees is subject to EU law – particularly as regards the imposition of social security charges (national insurance contributions in the UK), and EU law ensures that such employees are liable to social security charges in only one jurisdiction at any one time. The UK’s network of social security agreements is extremely limited, and how national insurance contributions will be applied in the case of executives who split their time between the UK and EU countries remains uncertain.
- It is clear that if group structures have been created for specific reasons (e.g. for tax purposes or to take advantage of EU-wide arrangements) they would, in due course, need to be reviewed to ensure they would continue to have their desired effect following BREXIT. Where issues are identified, corporate relocations might form part of the solution.
Finance and derivatives:
- For some borrowers or issuers, uncertainty around BREXIT and resulting financial market volatility may impact the availability or cost of some types of finance. However, the impact on the loan market will probably be limited, at least in the short to medium term, and relationship-driven lending is unlikely to be significantly affected. The impact may be greater in the bond market. It is also inevitable that the volume of refinancings and restructurings will increase, as borrowers and issuers look to more creative solutions to overcome the uncertainty of a looming BREXIT environment.
- Those with businesses that will be adversely affected by the threat of BREXIT may find their access to finance is reduced or their borrowing costs rise (through increased margins or coupons on new transactions or step-up provisions on existing ones). In the longer term, the availability or cost of finance could be affected by the regulatory landscape post-BREXIT (e.g. through loss of the ability to ‘passport’ prospectuses, or changes in regulatory capital rules or their application). However, much will depend on the UK’s post-BREXIT relationship with the EU.
- Whether immediately following a vote to leave, or eventual as part of a post-BREXIT world, it is almost certain that there will be volatility in the financial/currency markets. Whilst consideration could be given to the possibility and desirability of hedging against or otherwise mitigating any perceived risks, in reality, it is difficult to assess the precise impact of BREXIT on the value of such assets ahead of time. However, either way, the changing environment will lead to exposures in existing derivatives positions. To the extent that counterparties are required to provide collateral to support their obligations under derivatives contracts in the form of UK-linked assets (e.g. UK gilts), a deterioration in the value of those assets could lead to increased margin calls under the relevant collateral arrangements. Adverse hedging positions – where borrowers may find themselves significantly ‘out of the money’ – could also increase the likelihood of lenders/hedge counterparties invoking a ‘material adverse change’ clause (see below).
- It is unclear what will happen in circumstances where the borrower is relying on cash flow from a related party to service the debt and the relevant directives no longer apply to exempt the payment from withholding tax. This is potentially a significant issue for acquisition finance, where the borrower will be relying on the cash flow from the underlying target entity.
Any pensions impact will vary depending on the structure of the scheme and the degree to which a particular company is detrimentally affected by changes to trading conditions post-BREXIT. Trustees of defined benefit schemes may seek increased contingent security to mitigate funding risk where there is a strong perceived threat to the underlying company. More generally, corporates will need to consider whether detrimental changes will trigger any reporting or funding requirements under existing pension scheme contingent security arrangements. Trustees will also need to review investment and hedging arrangements in relation to scheme assets; for defined benefit schemes BREXIT could increase funding requirements.
- In a contract award subject to EU procurement rules, the party awarding the contract may not usually discriminate against a tenderer just because it is from outside the EU, although EU utilities do have a limited ability to discriminate against a tenderer supplying from outside the EU. However it is quite likely that these rules will soon be replaced. If so, this could be significantly detrimental to the UK in a post-BREXIT world.
- In practice, application of procurement rules is likely to form a large part of the negotiations around internal market access following a vote for BREXIT. Assuming the UK wanted to maintain full access to procurement in the EU internal market for UK businesses, it is likely to need to agree to reciprocal access for EU businesses to UK processes.
- The most immediate impact of BREXIT would be on unitary, pan-European, intellectual property rights such as Community Trade Marks and Community Registered Designs. These would not cover the UK post-BREXIT, although they would continue to cover the rest of the EU as before. It is widely expected that the UK government would provide for right-holders who lose protection in the UK in this way to be granted an equivalent UK national registered trade mark or design right preserving their priority rights, so they should not lose out in the long run.
- The position for unregistered Community Design Rights is less clear, therefore companies operating in fields where designs are important, including consumer goods and mobile devices, will need to consider registering design rights wherever possible. In the patents field, post-BREXIT, the UK would not (unless agreed otherwise as part of transitional arrangements) automatically be able to participate in the new European Unitary Patent or Unified Patent Court. However, traditional European patents protecting inventions in the UK would continue to be available through the European Patent Office as before.
Personal data is permitted to flow around the EEA without specific restriction on cross-border transfers. Following BREXIT, the UK may put in place a solution for the cross-border transfer of data from the EU to the UK, which the European Commission recognises as adequate. In the meantime, companies that move personal data from the EU to the UK would need to implement their own compliance mechanisms (e.g. standard contractual clauses approved by the European Commission).
- From a purely legal perspective, neither a vote in favour of BREXIT, nor BREXIT itself, is likely to have a significant impact on existing or new contracts, save in any exceptional situations where a counterparty’s business is severely affected or where specific definitions or clauses are tied to EU concepts. The vast majority of contracts will remain in force, the parties’ rights and obligations will be largely unaffected, and specific BREXIT-related provisions in new contracts are unlikely to be needed.
- Further, BREXIT should not affect the approach that parties take to including English governing law clauses in their contracts or, in most cases, to including English jurisdiction clauses (save in the limited category of cases where enforcement of English judgments becomes more difficult post-BREXIT). That said, clauses dealing with choice of law and jurisdiction and which assume a common EU law-based regime will cease to apply to English courts post-BREXIT and therefore the impact of these clauses will be uncertain and will likely require some modification. Some contracts also contain territorial restrictions that refer to the EU. These would likely need to be amended following BREXIT, as would references to EU legislation to the extent it is no longer applicable.
- More interestingly, it will be necessary to consider the practical implications of certain boilerplate clauses such as market disruption, illegality and material adverse change clauses. It is expected that BREXIT will increase the likelihood of these clauses being invoked. In the context of a loan agreement, whilst it is thought unlikely that BREXIT itself will lead to a lender calling a material adverse change provision, there may be certain consequential effects of BREXIT, e.g., prejudicial hedging exposure, negative trading positions, and disruption to pensions and employee arrangements, which collectively make it more likely that a lender will formulate a case for invoking the clause.
It will be apparent from this discussion that the UK’s departure from the EU would be complicated and protracted, and would in the long run give rise to a vast number of legal issues that would need to be thought through and resolved. Many of those issues themselves give rise to larger questions of policy that will also need to be addressed both by the UK government and by the various institutions of the EU. There are unlikely to be many immediate "day one" legal consequences following a vote for BREXIT on 23rd June, save to the extent caused by market fluctuations or even disruptions in the light of that vote. However, the necessary transitional arrangements, and the likely terms of the exit itself, will give rise to a number of significant legal changes and challenges which will have far-reaching implications for anyone doing business in or with the UK for many years to come.
 To be held on Thursday 23rd June 2016, with the result expected early on 24th June 2016.
 In this Client Alert, "BREXIT" means the final act of the UK leaving the EU, it does not mean the referendum on 23rd June, 2016.
 Gibson, Dunn & Crutcher LLP neither holds nor expresses a political view for or against BREXIT. This Client Alert is agnostic as to the political outcome and seeks to focus solely on the potential legal consequences of a vote in favour of BREXIT.
 The European Referendum Act 2015: http://www.legislation.gov.uk/ukpga/2015/36/contents/enacted
 The Parliamentary Voting System and Constituencies Act 2011: http://www.legislation.gov.uk/ukpga/2011/1/contents
 Note that some pro-BREXIT constitutional experts have proposed that instead of relying on the Article 50 mechanisms, the UK could leave the EU simply by repealing the European Communities Act 1972. This would seem to be tantamount to taking a sledgehammer to crack a nut, as repeal would have a myriad of other consequences which would need to be considered carefully and could potentially take many years to address and rectify.
 In the UK context, devolution refers to the UK government having granted certain statutory powers to the Scottish Parliament, the National Assembly for Wales and the Northern Ireland Assembly respectively.
 Tariff barriers are barriers resulting in certain levies/duties being imposed on imports. Non-tariff barriers are things such as noise limits imposed on lawnmowers, specific requirements regarding the chemical content of toiletries, etc.
This Client Alert was prepared by London partner Stephen Gillespie, with specific input from fellow London partners Ali Nikpay and Nicholas Aleksander and Senior Associate Amy Kennedy. Please feel free to contact Stephen, Ali, Nicholas or Amy, or your usual Gibson Dunn contact, for any further information or clarification you may require.
Stephen Gillespie (+44 (0)20 7071 4230, [email protected])
Ali Nikpay (+44 (0)20 7071 4273, [email protected])
Nicholas Aleksander (+44 (0)20 7071 4232, [email protected])
Amy Kennedy (+44 (0)20 7071 4283, [email protected])
© 2016 Gibson, Dunn & Crutcher LLP
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