The impact of Brexit on risk allocation in contracts

This article was published prior to the publication of the post-Brexit agreement between the UK and EU which covers the relationship between the UK and EU following the end of the implementation period (commonly referred to as the “transition period”) created by the European Union (Withdrawal Agreement) Act 2020, and should be read in that context.

We are increasingly becoming involved in negotiating Brexit clauses between contract parties, for a range of different reasons. They all revolve around one key point – unexpected or unascertained hardship caused by the Brexit process. Hardship clauses themselves are not new. They have historically been used most often in international contracts – for example, obliging the parties to re-negotiate their agreement in the event of hardship of any one of the parties resulting from an event that occurred after the signature of the agreement, but before the relevant party's obligations have been fulfilled, and which makes the contract materially less beneficial or more onerous, but where performance is still possible. Some of the risk areas where we are seeing these clauses include:

Currency fluctuations

Concerns surround the impact of Brexit on the foreign exchange rate between Sterling and other currencies (for example, the currency of a country where there is a need to source raw materials). Clauses addressing these risks could take on several forms including:

• recording the parties' intentions to renegotiate (for a period) before triggering any termination right.
• agreeing a specific action resulting from the Brexit related trigger event: for example, adjust the pricing mechanism to take account of specific increased raw materials costs.  This approach has the advantage over a more general hardship clause as the disadvantaged party is not in a position where it simply has to continue to perform the contract pending further agreement and  negotiation. 
• a freezing clause which essentially freezes the exchange rate and so the price paid would always be based on that exchange rate irrespective of fluctuations in the two base currencies.
• a price adjustment clause  which enables the contract price to be adjusted to changes in the exchange rate. It would potentially be two-way, protecting both the buyer and seller. In relation to any such price adjustment, the formula needs to be very clearly stated so that the desired price adjustment outcome can be guaranteed, rather than causing further uncertainty.  
• a currency option provision, which would allow the buyer or seller to switch to another currency if the main currency within which the contract is denominated fluctuates beyond a certain level. 

In all cases, there needs to be clarity as to: when the adjustment should take place; is it an automatic adjustment or with agreement of the parties; which currency exchange rate is to be used.

Change in law and economic impact

Suppliers of goods and services engaged on longer-term contracts are concerned that the as-yet unknown and unqualifiable impact of Brexit will affect both prices of goods and the legislative framework within which they will be required to operate in the future.

Whilst some suppliers are seeking to back-off the risk of price-volatility by entering into longer-term agreements with their own sub-contractors, the residual risk remains of what should happen if one of those key sub-contractors ceases to supply the goods/services for whatever reason. Perhaps concerns surrounding insolvency of contractors have been heightened with the forecasts of an economic downturn post-Brexit. If one of its key sub-contracts terminates early, the supplier will need to procure replacement supplies at the commercial rates in play at the relevant time. To mitigate, we have seen some suppliers seek clauses which enable them to claim additional costs from their clients where there is an “Economic Change”, being broadly a change in price for materials supplied under the contract where that change in price is the result of Brexit triggered economic changes. Some clauses go further, to include changes in prices which result from “political change as a result of Brexit”.

Where there is an “Economic Change”, the supplier is able to increase the prices charged to its client by reference to its own increase in costs experienced by the supplier. Two points to note when considering these clauses:

• one can anticipate a fair degree of argument as to evidencing claimed increases: ideally the contract would set out a reliable benchmark showing the costs of supply to the supplier as at the date the contract is entered into with the client; and
• some drafting makes reference to the changes in prices being “directly or indirectly” resulting from Brexit: referring only to price increases “directly resulting from Brexit” is a recipe for disagreement, and there is debate about whether a supplier could ever successfully argue that an increase in cost “directly” results from Brexit.

“Legislation Change” clauses will often go hand-in-hand with “Economic Change” clauses. Legislation Change clauses are an adapted form of “change in Law” clauses, which are a frequently seen and established part of medium and long-term contracts. At their essence, Legislation Change clauses will be defined as a change in Law as a result of Brexit, so that if there is an increase in the costs of performance due to a Brexit-related law (perhaps because the post-Brexit regulatory landscape increases the burden on businesses), the supplier can recover the additional cost from the client. As with Economic Change clauses, evidencing the claimed increases and showing a law is a Brexit -related change in Law (as compared to a change in Law occasioned by a change in policy and/or government) could well be problematic.

Take away points

(1) Consider whether there is value, in your sector, of trying to introduce clauses of the above nature into your contracts;

(2) If you see these clauses introduced by your commercial counterparties, take legal advice – we are seeing a range of positions being adopted on these issues;

(3) Supply chain contract management will become increasingly important in the post-Brexit landscape, particularly if the chain of contracts become cross border at some stage (because UK legislation will begin to diverge from EU legislation). But even if they are not cross border, clauses of the above nature appearing at any stage of that supply chain could impose an undue burden on one of the supply chain members.

For any more information please contact Clare Brewer or Jonathan Croley from our Commercial Team on c.brewer@ashfords.co.uk and j.croley@ashfords.co.uk.