Implications for the financial sector
Since the referendum result, we have seen significant volatility in the international financial markets as a reaction to the decision. However, the UK financial sector’s global appeal is perhaps less dependent on the UK’s standing in Europe than others. Nonetheless, the manner in which Brexit is implemented will have a significant impact on the mechanics of cross-border transactions.
In this article, we highlight some of the key provisions in loan documentation that could be affected:
- Material Adverse Effect (MAE)
The MAE qualification pervades most well negotiated loan documentation and therefore it is questionable whether Brexit itself would be sufficient to trigger a default due to MAE. Some strong borrowers have been trying to negotiate their MAE clauses to guard against this, but whether or not this is accepted by lenders will depend on individual circumstance; there is perhaps an important distinction to be drawn between the calling of referenda and the implementation of their results.
- Force majeure
Although it is current market practice in England not to have a force majeure clause in loan agreements, such termination events do appear in some interest rate hedging contracts (e.g. the 2002 ISDA Master Agreement). A minority of these have been sufficiently tampered with during the drafting process that Brexit could allow a party to invoke such a clause to avoid its obligations or at least suspend them.
- Increased costs
This is perhaps the hardest point to call. Will there be an increase in costs for banks as a result of Brexit due to increased regulation, or even a re-assessment of regulation? The answer is difficult to predict, but one thing is clear: lenders will try to push any costs that do arise onto the borrower, so particular attention should be paid to the drafting of such increased costs clauses.
- Governing law and jurisdiction clauses
The popularity of English law, as the governing law of contracts on cross-border transactions, is arguably due more to the nature of English law than to the UK’s membership of the EU. So while Brexit itself shouldn’t significantly impact this popularity, the exit model will play a significant part as the UK government will have to decide whether to implement legislation to mirror the Rome I and Rome II conventions. This will also be true of the Recast Brussels Regulation, which applies to the choice of English jurisdiction and the enforcement of English law judgements within the EU. Will the UK government elect to accede to the Lugano Convention, which regulates the enforcement of judgments as between EU and EFTA states? Whatever the case, it is likely that the English courts will remain an attractive proposition for contracting parties regardless of the UK’s status in Europe.
- Prepayment requirements
Loan agreements commonly give a lender the right to demand prepayment of a loan (or the lender’s participation) if it becomes illegal for it to continue to perform its obligations to the borrower. While a relatively remote risk, this scenario could potentially arise for EU-resident lenders lending to UK borrowers (or vice versa) post exit. Borrowers would be well advised to review any such exposure and seek to mitigate it by pushing for the ability to first substitute the participation of any such lenders claiming illegality.
- Other potential areas
o Withholding tax – borrowers are typically required to gross up any finance payments when local law requires them to withhold tax. It is uncertain whether EU member states will impose such withholding on borrowers with UK lenders once the UK is outside of the EU.
o References to EU law and the UK as a member state – care should be taken to ensure any such references are correct.