Brexit by topic | Finance, Restructuring & Insolvency, Derivatives & Structured Products

Brexit: Finance / Restructuring & Insolvency

Overview

Unless the Article 50 period is extended yet again, the UK is currently set to leave the EU on 31 January 2020 at 11pm GMT. However, if the latest version of the Withdrawal Agreement is ratified, the impact of Brexit will, for most purposes, be postponed due to the transition period. This transition period is currently set to end on 31 December 2020. The Withdrawal Agreement provides that during transition, the UK would continue to be treated as if it were still an EU member for the purposes of a range of directly application EU legislation which is core to the smooth running of financial transactions.

Impact of Brexit on existing loan and security documentation

Leveraged finance and syndicated investment grade loan documentation typically has a life cycle of 5-7 years, so some loans currently in place may have been documented without contemplating Brexit. Existing debt documents commonly include terms which are drafted on the assumption that a reference to the "European Union" includes the UK. For instance prohibitions on borrowers making acquisitions or joint ventures may be 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 require review in order to avoid accidental or 'technical' defaults post-Brexit.

Multi-lender loan documentation typically follows the templates published by the Loan Market Association. The LMA has announced that it is not planning to make any changes to its English law documentation before any proposed change in English law actually takes effect. 

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, 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 rEU and has outstanding commitments (e.g. there is an undrawn facility or obligation to provide some other regulated financial service).

Business MAC and Market MAC clauses

A 'business MAC' clause entitles lenders to react to an unforeseen change in the business or performance of a borrower by calling an event of default and potentially accelerating a loan. It is very difficult for lenders ever to be sure that the circumstances entitle them to rely on this provision. Even in the financial crisis in 2007–2008, only a handful of finance document MACs were called. It is also more difficult to invoke a MAC on the basis of circumstances which you knew about when the MAC was agreed to (e.g. if a loan agreement was signed when the referendum was already on the horizon) and so such clauses are unlikely to be invoked as a consequence of Brexit.

'Market MAC' clauses appear in commitment letters relating to new deals and allow potential lenders to withdraw from a deal if there is a hiatus in financial markets prior to the signing of final form documentation. If the Withdrawal Agreement fails to be ratified and there is a hard Brexit, such clauses may yet come into play in the event of significant disruption.

Lending restrictions and passporting

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 made use of an EU banking services "passport" to provide some services into such jurisdictions by virtue of being regulated entities in the UK.  It is expected that such passporting will ultimately be lost post-Brexit although if a "transitional period" is finalised as part of any agreed withdrawal terms with the EU, the UK may retain some access on a short-term temporary basis to EU financial markets.  Longer term, however, such finance providers risk exclusion from EU credit markets and consequently the range of sources of finance available to borrowers could be restricted post Brexit.  Whether the loss of passporting would affect loan facilities under documentation entered into or loans extended prior to the UK's withdrawal is not clear.

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 rEU 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. The LMA has published a form of "designated entity clause" for inclusion in facility documentation, allowing lenders to perform their lending obligations in other jurisdictions through affiliates (to guard against the risk of passporting being lost).

Bail In

Article 55 of the EU Bank Recovery and Resolution Directive 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. Some parties have been pre-emptively including bail-in language in English law finance documents in advance of Brexit (as the UK will cease to be part of the EEA).

Political uncertainty, market volatility and transaction volumes

As we have already seen since the 2016 referendum, the uncertainties surrounding Brexit increase the risk of currency fluctuations, making it more difficult for some parties to meet unhedged payment obligations denominated in other currencies. The weakening 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. 

The political uncertainty in the lead up to exit day, given that "no deal" remains a possibility, makes volatility in UK equities, bonds and sterling increasingly likely. Companies and their stakeholders are increasingly likely to postpone significant investment decisions in this period, impacting on transaction volumes.

Tax

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. Following an exit from the EU, rEU Member States could impose withholding tax on interest payments to a UK parent company from a subsidiary in the EU (for instance), and the UK could, theoretically, choose to impose withholding tax on outbound payments of interest in the same situation (should the UK decide to remove the exemption). 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, Belgium, 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. Whilst Stamp Duty is a UK tax, the UK is currently subject to the Capital Duties Directive (69/335/EEC), which prevents 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 would be free to impose this and other capital duties.

VAT: Although VAT is an EU derived tax, VAT clauses in finance documentation are unlikely to be impacted by Brexit. The UK is likely to retain VAT post-Brexit and while some changes to the UK domestic rules may be made in due course 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. The LMA may update this standard definition in due course to refer specifically to VAT imposed by the UK. There should also be a construction of law clause that provides that any references to any statute or statutory provision shall be construed so as to include a reference to such statute or statutory provision as it may be amended, modified, consolidated, restated, re-enacted or replaced.

Governing law

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. Post Brexit, the courts of rEU member states will continue to give effect to English law in the same way as they do currently, 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 Rome II ((EC) 864/2007), applicable to non-contractual obligations.

Cross-border recognition of UK insolvency proceedings

The Withdrawal Agreement states that the recast European Insolvency Regulation ((EU) 1215/2012) will apply to insolvency proceedings opened before the end of the transition period. If implemented, this will provide some short term comfort for insolvency practitioners. However since the recast EIR is based on reciprocity, the Government has announced that it will cease to apply on "exit day". There is therefore no guarantee that, thereafter, UK insolvency proceedings will be respected elsewhere in Europe. The UK may be forced to rely on the vagaries of private international law in each rEU member state, which would increase the risk of competing insolvency proceedings between the UK and the rEU, due to the removal of the rule requiring automatic recognition of insolvency proceedings. There could also be increased uncertainty for English insolvency practitioners seeking the assistance of courts in rEU.

Mutual recognition of UK judgments

If the Withdrawal Agreement is ratified, the current EU-wide rules for determining which court has jurisdiction to deal with a dispute (contained in the Recast Brussels Regulation) will continue to apply on a reciprocal basis in both the UK and the rEU with respect to any proceedings instituted before the end of the transition period. The same goes for rules aimed at ensuring that judgments handed down by the courts of member states are recognised and enforced throughout the EU. Thereafter (or in the event of a hard Brexit), there is a risk of the loss of automatic EU recognition of UK judgments as the Hague Convention (which the UK plans to accede to) will not apply in all cases (see Disputes tab). Some types of English court judgment will become less readily enforceable in the rEU than is currently the case. It will also become more difficult to serve English legal proceedings on rEU based counterparties. This could make the English law scheme of arrangement procedure a less attractive restructuring option for overseas companies in rEU.

Financial Collateral Arrangements

The Financial Collateral Arrangements (No 2) Regulations 2003 (SI 2003/3226), which implement the Financial Collateral Directive, will remain valid post-Brexit but the recognition of English law financial collateral arrangements elsewhere in the EU will be uncertain.

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