Brexit: Finance / Restructuring & Insolvency

Leveraged finance and syndicated investment grade loan documentation typically has a life cycle of 5-7 years, so some outstanding debt may have been documented without contemplating Brexit. Loan documents previously included terms drafted on the assumption that a reference to the "European Union" (or the "EEA") included the UK. For instance prohibitions on borrowers making acquisitions or joint ventures may have been subject to carve-outs for acquisitions / JVs in the EU. Similarly, borrowers are deemed to make repeating representations, some of which touch on compliance with EU derived laws. Such terms may yet require review in order to avoid accidental or 'technical' defaults.

Multi-lender loan documentation typically follows the templates published by the Loan Market Association (LMA). In November 2020 the LMA published a helpful summary of the planned changes to its suite of English law facility documentation after IP completion day. These changes are minor and mostly relate to the changes to EU legislative references – necessary because EU law ceased to have any effect in English law from IP completion day. So for instance definitions of "Audit Laws", "IFRS" and "CRD IV" are tweaked to refer the relevant English law provision. Other documentation points are summarised below.

Brexit may trigger a review of security arrangements in cross-border transactions, for instance where EU-registered intellectual property is critical to the security package. In some jurisdictions, after the end of the transition period there may be issues with UK institutions without local authorisation performing agency roles in certain EU countries, in the absence of passporting rights. Issues may also arise where a UK domiciled entity lends (or provides other financial services) to a borrower domiciled in the EU and has outstanding commitments (e.g. there is an undrawn facility or obligation to provide some other regulated financial service). 

A number of EU countries maintain a separate regulatory regime for commercial lending, with lenders being required under domestic legislation to have licences to lend. Where the lender is required to seek authorisation as a result of purely domestic legislation then this is unlikely to be affected solely by Brexit. 

However, in other cases, some UK based lenders have in the past made use of an EU banking services "passport" to provide services into such jurisdictions by virtue of being regulated entities in the UK. UK firms lost these "passporting" rights with effect from IP completion day, as the UK became a "third country" and the TCA does not provide for access to the EU single market for UK financial services firms. A number of EU financial services regimes do have third country equivalence frameworks which may mean that in time, and subject to the European Commission's assessment of the relevant UK regime as equivalent, firms may regain access to the single market (although this will not be as good as a passport). The EU banking legislation, however, does not contain such a third country regime for commercial lending, deposit taking or other core banking functions.  Neither, in the absence of such a regime, has the EU proposed introducing any kind of alternative measures that would mitigate the impact of loss of passporting rights for UK based lenders. Finance providers therefore risk exclusion from EU credit markets and consequently the range of sources of finance available to borrowers could be restricted by Brexit.

Intermediation structures (whereby a non-EU entity does business with an EU counterparty through a separate EU firm) may offer a solution for UK entities to access the EU credit markets, provided that neither EU states nor the UK take Brexit as an excuse to change their current rules as regards the provision of credit and other bank services by third-country entities.

To guard against passporting being lost, in 2018 the LMA published a form of "designated entity clause" which has since been included in cross border facility documentation where relevant, to allow lenders to perform their lending obligations in other jurisdictions through affiliates.

Article 55 of the EU Bank Recovery and Resolution Directive (2014/59/EU) requires EU member states to ensure that EEA financial institutions incorporate contractual recognition of write-down and conversion language into most agreements creating non-EEA law governed liabilities. In advance of IP completion day, some parties began to pre-emptively include bail-in language in English law finance documents (given that the UK ceases to be part of the EEA). In November 2020, the LMA published revised bail-in language for inclusion in its facility documentation. The new language could be relevant in two situations.

Firstly where lenders include EEA financial institutions, the Clause is required to be included in documentation governed by the law of a non-EEA country (which, after IP completion day, includes English law).

Secondly the Clause now also features recognition of the write down and conversion powers under the UK's bail-in regime in respect of the in-scope liabilities of UK financial institutions entering into non-UK law agreements. This is because a relevant UK entity may be a party to a finance document governed by the law of an EEA member country or other third country (for example, a security document) and therefore be required by UK legislation to include a Bail-in Clause in respect of such documents.

Given that participations in loans are subject to regular trading, it is easier to routinely include the full Bail-In Clause in facility documentation at the outset, rather than running a case by case analysis of which parts could be relevant.

As seen at crucial threshold points since the 2016 Brexit referendum, the uncertainties surrounding Brexit have increased the risk of currency fluctuations, making it more difficult for some parties to meet unhedged payment obligations denominated in other currencies. The volatility of sterling since the referendum has created winners and losers and this will be increasingly felt by companies as existing exchange-rate hedging falls away.

Withholding tax: Brexit is unlikely to change the current withholding tax position on interest payments from a UK borrower to an unconnected foreign lender or from a non-UK borrower to an unconnected UK lender (subject to foreign law change), so, for most bank loan transactions and documentation, the position will not change.

However, the Interest and Royalties Directive (2003/49/EC) provides for the elimination of withholding tax on intra-EU cross-border interest payments between 25% associated companies. After IP completion day, EU Member States could impose withholding tax on interest payments to a UK parent company from a subsidiary in the EU (for instance). The directive has been enacted into UK law and so equivalent outbound interest payments should continue to be free of UK withholding tax. Where the directive did not apply, the position would be governed by the UK's network of double tax treaties with other EU member states. Most provide for a 0% withholding tax rate, so the position would be the same, but the UK's treaties with Italy and Portugal (amongst others), do provide for higher rates (between 5-10%) on interest payments, depending upon the circumstances of the payment.

Stamp Duty: The Stamp Duty clauses in loan documentation should be unaffected by Brexit and the LMA has proposed no related changes to its templates. Whilst Stamp Duty is a UK tax, the UK was until IP completion day subject to the Capital Duties Directive (69/335/EEC), which prevented the UK charging a 1.5% SDRT charge on issues of shares and securities to depositary receipt issuers and clearance services (even though this charge is in the UK legislation). Outside of the EU, the UK is free to impose this and other capital duties now that transition period is concluded. However, HMRC has confirmed that the charge will remain disapplied following the end of the transition period and that this will remain the position unless stamp taxes on shares legislation is amended.

VAT: Although VAT is an EU derived tax, VAT clauses in finance documentation are unlikely to be impacted by Brexit. The UK is retaining VAT after IP completion day and while some changes to the UK domestic rules are expected to be made these should not affect standard VAT clauses in loan agreements, provided that VAT is defined (as currently in the LMA standards) to mean: VAT imposed in compliance with the VAT Directive (2006/112/EC); and also any other similar tax imposed in any jurisdiction. In November 2020 the LMA published an expanded "VAT" definition, for use in its various templates, to also include specific reference to VAT imposed by the Value Added Tax Act 1994 and any other similar tax imposed in any jurisdiction.

Cross border loan transactions in Europe are commonly expressed to be governed by English law. The loan markets have had a long-standing preference for English law's commercial orientation and its emphasis on upholding and respecting parties' commercial bargains. English commercial contract and trust law is largely unaffected by EU law and so Brexit should not affect these benefits. The courts of EU member states will continue to give effect to English law in the same way as they did previously, because the Rome I Regulation ((EC) 593/2009) requires EU member states to give effect to the contract parties' choice of law, regardless of whether that law is the law of an EU member state or the law of another state. Similar rules apply to the Rome II Regulation ((EC) 864/2007), applicable to non-contractual obligations. These rules were retained in UK domestic law from IP completion day.

The recast European Insolvency Regulation ((EU) 1215/2012) now only applies to insolvency proceedings opened before IP completion day. The transition period introduced by the Withdrawal Agreement offered some short-term comfort for insolvency practitioners. However since the recast EIR is based on reciprocity, it has now ceased to apply to new proceedings in the absence of a new deal with the EU (the TCA is silent on cross-border recognition of insolvency proceedings). There is therefore no guarantee that, in the future, UK insolvency proceedings will be respected elsewhere in Europe in a consistent manner. Instead the outcome for recognition of proceedings depends on the vagaries of private international law in each EU member state. This increases the risk of competing insolvency proceedings between the UK and the EU, due to the removal of the rule requiring automatic recognition of insolvency proceedings. This also creates increased uncertainty for English insolvency practitioners seeking the assistance of courts in EU.

The previously applicable EU-wide rules for determining which court has jurisdiction to deal with a dispute (contained in the Recast Brussels Regulation) cease to apply on a reciprocal basis in both the UK and the EU with respect to any proceedings instituted after IP completion day. The same goes for rules aimed at ensuring that judgments handed down by the courts of member states are recognised and enforced with minimal friction throughout the EU. There is now a risk of the loss of automatic EU recognition of UK judgments as the Hague Convention (to which the UK has acceded) will not apply in all cases (see Disputes tab).

Pursuant to the Hague Convention, EU member states are only required to respect the parties' choice of court and enforce English judgments on a contract containing a "two-way" exclusive jurisdiction clause concluded after the date on which the Convention enters into force in the UK. This is problematic because, on loan finance transactions, it is common to employ a "one-sided" exclusive jurisdiction clause, which allows lenders to take proceedings in any court of competent jurisdiction but restrict obligors to taking proceedings in the courts of England only. Such clauses would be outside the scope of the Hague Convention. Nevertheless the expectation is that parties to loan documentation will generally continue to favour a one-sided exclusive jurisdiction clause because it is so favourable to lenders and is likely to be binding in most cases. Such clauses remain as the default option in LMA templates, for instance.

So called "Non-Hague Judgments" of English courts are not necessarily unenforceable in EU member states. Rather, their enforceability now depends on the national rules in the relevant EU jurisdiction relating to enforcement of judgments given in states with which the EU member state has no treaty on reciprocal enforcement. Such rules already applied to New York judgments, for instance. Broadly speaking those national rules generally allow enforcement of a foreign judgment, albeit not in such a straightforward manner as previously enjoyed under the Recast Brussels I Regulation. However, appropriate local law advice would now be required to form an assessment of the potential enforceability or otherwise of a Non-Hague Judgment pursuant to the national rules of any EU member state.

In parallel, the UK has set in motion the procedures necessary for it to accede to the 2007 Lugano Convention. If a positive response is received to the UK's application (which is currently in doubt – the TCA is silent on this point), it should, in principle, ensure the continuation of the Brussels regime on jurisdiction and the (smooth-running) enforcement of judgments.

In summary, some types of English court judgment will now be less readily enforceable in the EU than was previously the case. It is now more difficult to serve English legal proceedings on EU based counterparties. This could make the English law scheme of arrangement procedure a less attractive restructuring option for overseas companies in EU.