Review Your Supply Chain and Contracts in Light of Brexit
By Stuart Buglass, VP Consulting
Many international businesses have commercial arrangements with a UK connection, a fact that has become newsworthy in the wake of the Brexit referendum. Last month, for example, Business Insider published an article on Britain’s exports to other EU countries, noting that “the UK is embedded in the production line of various EU countries so it will be difficult and costly for the likes of the Netherlands and Belgium to extricate themselves.”
Of course, having a commercial arrangement with a UK connection may entail activities other than directly importing goods from a UK company. Other direct engagements include but aren’t limited to leasing office space and contracting for the supply of services, including software. There are also connections where a UK business is not directly engaged with an organization but is nevertheless influential in its supply chain. Indirect links in your supply chain may be difficult to monitor and control.
It is true that business failures during a normal trading environment are relatively rare, and therefore contingency planning to guard against a break in a supply chain is rarely a priority. This position changes, however, when direct and indirect links are influenced by bigger forces which threaten the trading environment for all businesses, such as major environmental, political and/or social changes.
Brexit can undoubtedly be classed as a major sociopolitical change. Unlike events such as the Arab Spring, however, Brexit’s impact is timetabled. Beyond Brexit’s inevitable ongoing effects on stock markets and currency rates, nothing material related to supply chains will change until the UK actually leaves the EU, which will take place at least two years after the UK formally serves notice to leave through Article 50.
Brexit is therefore unusual in the fact that businesses have a substantial period of time to plan before the change becomes effective. The danger of course is that businesses may spend time and resources speculating and generating contingencies, not all of which will be required. Rather than engage in tail chasing, businesses are well advised to focus on matters that are both known and/or within their control.
The range of “what ifs” that could affect your supply chain in the wake of Brexit can be pretty easily identified. For example, foreign exchange rate fluctuations may increase prices, especially where a supply chain is exposed to the US dollar or to commodities priced in dollars such as oil. To take some other examples: a reduction in semi-skilled labor will increase supply costs; customs tariffs and red tape may make currently contracted delivery timescales unattainable; and licensing landscape changes may mean that some businesses can no longer operate legally under old arrangements.
Any one of these scenarios if realized could materially affect a business in your supply chain. As a supplier, you may find in the wake of a change that your existing contractual commitments become untenable and you simply can’t deliver what has been promised.
But even given these uncertainties, it is possible to protect your business against many of Brexit’s eventualities through the use of robust contractual clauses. For example, you may want to consider including hardship clauses in your contracts. These clauses are designed to provide some breathing space to accommodate material changes beyond the control of either party. In the event of such a change, the clauses require the parties to engage in good-faith negotiations to seek a solution that ensures the survival of the contract.
Your existing contracts may include force majeure clauses. We typically associate force majeure with “acts of God,” such as a natural disaster which extinguishes the existing contract because the obligations can no longer be performed. However, depending on the wording, it may be possible in certain situations to invoke a force majeure clause in circumstances of political or social change. Irrespective of any real effects of the UK leaving the EU, some contracting parties may see Brexit as an excuse to wriggle out of existing contracts they no longer want to be a party to.
To guard against this, businesses (and in particular suppliers) should consider reviewing their contracts’ force majeure clauses. Such clauses should ensure that in the event of force majeure there is an obligation on the parties to engage in discussion to try and save the contract through formal mediation overseen by an impartial mediator. In addition or instead of this, the clauses could expressly exclude Brexit as a means to void the contract.
Organizations should also review other contract terms in light of Brexit, such as the duration of the engagement, the currency for payment and any obligations related to territory. On the territory issue, many contracts make reference to the EU as a defined territory, with the assumption that the UK is included. After Brexit, of course, the UK will no longer be covered under an EU territory reference. As for contract length, those of a shorter duration are preferable during a period of uncertainty given that hardship clauses can’t always guarantee a positive renegotiation.
For contracts governed by UK law, the future ability of a party to enforce a UK judgement in another EU member state will be less straightforward following Brexit. In the absence of an agreement between the EU and the UK, there can be no automatic enforcement of judgements. In light of this, for any engagements where UK law is applied it would be prudent to include an arbitration clause. The UK and all other EU member states are parties to the New York Convention on the recognition and enforcement of arbitration decisions. Therefore, resolving disputes by arbitration could prove to be a highly effective approach in the future.
It should be emphasized that choice of law and jurisdiction are not just relevant to contracts governed by UK law. As previously mentioned, Brexit could have an indirect impact on your supply chain, even in circumstances where your business does not have any formal agreement with UK-contracting parties. Businesses should consider including hardship clauses to guard against indirect effects on their supply chains. But beware that the ability to apply a hardship clause can depend on the law governing the contract. For example, such clauses are more easily enforced under the laws of European countries than under New York law. So companies that include a hardship clause need to consider which countries’ laws are more willing to recognize them.
Brexit commentary has dominated the business press for months, and there continues to be much speculation regarding its potential effects. This blog post has suggested some positive steps you can you can take now to protect your organization from Brexit’s eventualities. Here is a brief summary of those steps:
- Identify the direct and indirect UK links in your supply chain
- Identify the “what-ifs” in your supply chain relevant to Brexit, such as possible foreign exchange rate fluctuations and a rise in supply costs due to a reduction in semi-skilled labor
- Review your contracts within your supply chain (and your templates for future engagements) and make them Brexit friendly through favorable hardship clauses and other means