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Brexit strategy: the EU referendum and construction contracts

The UK and Gibraltar have voted to leave the European Union. That decision still needs to be formalised and the UK Government has stated this will be achieved through notification under Article 50 of the Lisbon Treaty. That, in turn, commences official exit negotiations with the EU.

It has been debated whether or not Article 50 will ever be triggered. However, absent a significant about-turn from the public, it is hard to imagine a significant number of politicians derailing the referendum’s outcome. It is simply a matter of time. As for what happens next, your guess is as good as mine. Will membership of the EU be replaced with that of the European Economic Area or the European Free Trade Association? Or will we arrive someplace else entirely?

Much has been written about Brexit’s potential consequences for the construction market but, in brief, the industry will endure. Demand for new housing and developments will recover. Equally, upgrades to transport and energy infrastructure are necessary to boost the regions and help Britain sustain its competitiveness.

How long will the UK stay bound by EU laws?

Upon issue of the Article 50 notice, the UK has two years to resolve its future relationship with the EU. The UK and the European Council can extend the deadline, which is niggardly, but the latter’s consent to that cannot be assumed. After all, the provision has never been exercised before.

EU treaties cease to apply once the UK’s withdrawal treaty comes into force or if no accord is secured by the deadline. The latter scenario would be undesirable because it would create uncertainty over the transition. In all probability, we can expect the process to take several years. During this period, the UK remains a member state and is governed by EU rules.

Upon departure, Parliament will repeal the European Communities Act 1972, which will effectively repudiate all EU laws. However, many European laws are not directly applicable and have therefore been transposed into British law through primary or secondary legislation, such as the Pollution Prevention and Control Act 1999 or the Construction (Design and Management) Regulations 2015. These will continue to apply. If these are to be amended or repealed, additional legislation will be required.

Of course, David Cameron’s successor as Prime Minister will probably seek informal discussions with Brussels ahead of any Article 50 notice to establish the potential deal that can be achieved. If such entreaties bear fruit, expect the timetable to be pushed out even further.

How are construction agreements affected?

While the UK carries on as a member state, there are no immediate legal repercussions that must be addressed in contracts. Nonetheless, with the clock now ticking, it is sensible to consider how Brexit could impact on existing and future procurement arrangements.

Force majeure and change of law clauses

Construction contracts may include force majeure provisions. For example, in the JCT contracts a force majeure may entitle the contractor to an extension of time or, if sufficiently prolonged, the contractor’s engagement to be terminated by either party. In such context, it would seem unlikely that the referendum result could qualify as a force majeure by itself. That might change if, for example, it impacted on the availability of finance necessary to progress the project. Regardless, it would be surprising if a project participant allowed itself to be put in such a position.

The subject of who takes change of law risk during the construction period can be a bone of contention. While change in law clauses may have consequences for project agreements and facilities management contracts, there have been no changes to UK law arising from the referendum. This may differ in several years’ time. A new government may seek to reduce EU-derived “red tape” and “box-ticking” following Brexit to encourage and expedite development, for example in the realms of the public procurement rules and sustainability (such as the Energy Performance in Buildings Directive, which has not yet been fully implemented in the UK). However, it is equally possible that the UK may choose to maintain a substantial body of EU rules, particularly if the government wishes to retain access to the single market as part of its withdrawal agreement.

EU law

Some contracts will have been written requiring one or more of the parties to comply with EU laws with direct effect or the judgment of the European Court of Justice. Depending on how these provisions have been written, it may be appropriate for parties to seek to amend them following Brexit to the extent that any obligations are yet to be performed.

After Brexit, the ECJ will cease to have jurisdiction over the UK. This may have little effect for many because the Court is rarely involved in construction matters. To the extent that it is, this tends to be restricted to providing preliminary references for national courts in relation to public procurement issues.

Choice of law, jurisdiction and enforcement of UK court judgments

The Hague Convention on Choice of Court Agreements has been ratified by Singapore, Mexico and the EU and should continue to apply following Brexit by virtue of being incorporated into British law through the Civil Jurisdiction and Judgments (Hague Convention on Choice of Court Agreements 2005) Regulations 2015.

It is a similar story for the 2007 Lugano Convention governing jurisdiction and enforcement for civil and commercial matters between particular EU member states (including the UK) and EFTA countries (except Liechtenstein). This was transposed through the Civil Jurisdiction and Judgments Regulations 2009.

However, this is not the case for the Brussels I Convention nor its successor, the “recast” Brussels Regulation, which performs a similar role to the Lugano Convention between EU member states. Together with the European enforcement order (a fast-track procedure for uncontested claims), the Brussels Convention has been a key factor for many UK construction parties to opt for litigation rather than arbitration when contracting with an EU counterparty overseas.

Although the UK’s withdrawal from the EU could include a deal to preserve such rights, a cautious approach would be to consider the use of arbitration to eliminate future concerns. This would preserve a sure means of enforcement, albeit through the differing avenue of the New York Convention.

Unlike UK litigation, in arbitration the ability of parties to join together disputes involving different parties or contracts would need to be dealt with either in the construction contract or arbitration agreement. If a key project participant is headquartered in another member state, it may be worthwhile including equivalent provisions in the contracts of other project team members, even if based in the UK, to ensure that such joinder provisions are effective between contracts.

Value added tax

An output tax imposed on end users for goods and services, VAT has been around for so long that it is easy to forget that it originated as a consequence of EU membership. As a general rule, if goods are acquired for business use in the UK from another member state, it is the UK’s VAT rate that is applied (and vice versa). With regard to services across the single market, it is usually the situation that the applicable rate of VAT is that of the member state where the supplier performs the services.

If access to the single market is maintained after Brexit, do not count on the manner in which VAT works altering substantially. If the UK chooses to switch to a conventional sales tax, depending on the withdrawal terms or tax treaties agreed, there exists a danger of “double taxation” following Brexit, where goods and services are subject to tax in both the UK and the relevant EU jurisdiction.

Market conditions following the referendum

Of most immediate concern is the commercial impact of the referendum.

Currency markets are affected by political strife. Not surprisingly, sterling has been hit in the wake of the referendum result and the fallout for the government and the Labour party. Depending on how long this lasts, UK developers and contractors that rely on overseas suppliers may face higher costs due to a less favourable exchange rate. Conversely, the pound’s devaluation may convince some overseas investors that UK real estate currently represents good value.

Given the popularity of fixed-price arrangements, the exchange rate may hurt those without the appropriate fluctuation or currency exchange clauses to allow their prices to rise should goods and materials become more expensive to obtain. Contractors should also be able to pass these costs on to their employers to the extent their overseas supply chain consists of nominated sub-contractors. Even so, such provisions are rare outside of multi-year contracts.

The EU began as a customs union and there are no restrictions or tariffs over the movement of goods between member states. According to the Royal Institution of Chartered Surveyors, 59% of the UK’s construction materials imports originate from the EU. Depending on the terms of Brexit, UK businesses may be faced with quotas or tariffs when importing from or exporting to the EU, which could increase costs. In addition, the UK will lose the benefit of any trade agreements the EU has negotiated with other countries.

A key pledge of the official “Leave” campaign was that Brexit would end the automatic right of other EU citizens to live and work in the UK. This is one of the EU’s four fundamental freedoms and it has benefited the UK’s construction industry in recent years:

  • In 2012, the Department of Business Innovation and Skills reported that the UK’s construction industry is the second largest in the EU, exporting more than £7 million worth of services each year.
  • In January 2016, the Construction Industry Skills Training Board forecast that the country will create 230,000 new skilled and unskilled jobs over the next five years.

How these posts will be filled if EU immigration is limited is a pertinent question. The government and industry’s aims to boost the number of apprenticeships and female workers in the sector have thus far led to mixed results. The shortage of labour could stoke construction inflation as particular trades increase in demand, for example, bricklaying. For private sector projects, contractors may find themselves contractually burdened with the requirement to obtain any necessary work permits or visas for their personnel, in a similar vein to international projects.

While Brexit appears several years away, it may influence the present market in subtler ways. Continental contractors have been among those most heavily involved in some of the UK’s largest construction projects, including HS2, Crossrail, the Thames Tideway Tunnel and Hinckley Point C. A considerable number of European construction workers have also settled in the UK. It remains to be seen whether these will decide to explore opportunities in other countries due to the uncertain outlook over Brexit.

Moreover, the UK has benefited from European Investment Bank loans, as well as various EU structural funds aimed at stimulating regional growth. Without access to these, important infrastructure projects may be imperilled. That’s not to say that the UK could not develop home-grown solutions, however. In theory, money could be reallocated following the removal of the UK’s net contribution to the EU. We could also see, for instance, a resurgence in PFI as a means to finance public developments. Because state aid rules would no longer apply, the government could subsidise particular industries and companies without the fear of sanction for distorting competition and trade within the EU.

What is apparent, nonetheless, is that with a new government comes a new budget. The current government had pledged funding for Crossrail 2 and Transport for the North, a national living wage plus a reduction in corporation tax to 17% by 2020. How will those promises fare under a new Prime Minister?

In the short-term, with contractors traditionally pricing for inflation in their margins, the threat of volatility over currency, labour and materials costs may cause them to be more cautious with premiums and contingencies going forward. In turn, developers and funders may demand greater performance security to offset a greater threat of supply chain insolvency from such added cost pressures.

Conclusion

We should not forget that there will always be opportunities in a post-Brexit world. As everyone waits for the dust to settle, the industry should already be planning for how construction arrangements should look in light of a changed paradigm.

Olswang LLP Francis Ho

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