On 23 June 2016, the United Kingdom voted to leave the European Union. Although the English High Court decided on 3 November 2016 that the UK Government must obtain the approval of the UK Parliament before it can trigger the Brexit process governed by Article 50 of the EU Treaty, the Prime Minister, Theresa May, continues to target the end of March 2017 as the date by which the UK will notify the European Council of its intention to leave the EU and officially start the Brexit process.
While the ultimate shape of the UK’s relationship with the EU following Brexit remains unclear, it is clear is that UK mergers and acquisitions (M&A) activity will be, and, in some respects, already has been, affected by the ramifications of the referendum result. What is not clear at this stage is when the changes to the legal landscape will take place and in what form.
From a purely legal perspective, as UK M&A is subject to limited amounts of EU-derived law and regulation, M&A laws and regulations, both in terms of private and public M&A, are unlikely to be materially affected by Brexit or change significantly in the short term. From a commercial perspective, however, Brexit presents both risks and opportunities, with its effect varying between companies and industries, in some cases stirring activity, in others encouraging caution.
The general uncertainty introduced by Brexit has created many additional considerations which need to be taken into account both prior to embarking on an M&A transaction in the UK and also during the transaction. Sellers and buyers, for example, will need to consider the possibility that the nature and value of certain types of assets to be sold or acquired as part of a transaction may change once the UK exits the EU, inevitably impacting valuation. For example, pan-European intellectual property rights, such as registered and unregistered community designs and EU trade marks may lose some of their value by virtue of no longer having effect in the UK post-Brexit.
One of the ways to potentially protect against such risks is to introduce conditionality provisions tied to Brexit. In respect of transactions expected to close after Brexit has occurred, overseas buyers may try to obtain general economic material adverse change protection when there may be a reasonably long period between signing and closing to counteract major currency fluctuations and making express reference to Brexit. Buyers generally will want to provide themselves with increased flexibility, given the various potential outcomes of the UK's exit negotiations.
Another way would be to specify post-closing obligations which shall only apply up to and until the UK actually withdraws from the EU. Finally, the parties could provide for modified arrangements after the UK leaves the EU; for instance, a licensing agreement could be specified to cover the entire EU including the UK until Brexit, and be limited to the EU excluding the UK post-Brexit.
Brexit will also naturally affect the commercial and legal assessment of a potential M&A opportunity, with additional emphasis being placed on the due diligence stage of a transaction. Buyers may need to consider new areas of focus when looking at diligence issues including, but not limited to, the definition of geographical scopes of key commercial contracts such as agency, distribution, supply, and licensing agreements, and supplier/customer dependency. Existing material adverse effect/change provisions in key contracts will receive enhanced scrutiny as the UK’s exit from the EU may trigger such provisions, in turn allowing a counterparty to terminate or vary the relevant contract.
Brexit will also result in new challenges for target businesses which may include, but are not limited to: (a) potential tariffs being imposed on goods exported to, or imported from, the EU; (b) difficulties in moving EU staff to and from the UK (including administrative burdens associated with visas); and (c) the fate of EU grants/loans, particularly where the eligibility criteria limit the availability of the funds to recipients within the EU.
It is expected that warranty and indemnity provisions contained in the sale and purchase documentation for pre-Brexit transactions will be tailored to take into account the UK’s exit from the EU. As a whole, there is no doubt that Brexit due diligence will also inform and affect deal valuation, deal-specific tax considerations, corporate restructurings, and overall transaction structures.
Brexit will also have an impact on various M&A regulatory considerations, such as takeover rules and merger control. While withdrawal from the EU is unlikely to have a significant effect on the substance of the rules applying to public takeovers (primarily because the EU Takeovers Directive implemented by the UK Takeover Code was heavily modeled on the UK Code in the first place), the same cannot be said for merger control considerations.
Currently, large transactions that impact the UK may be filed with the European Commission – under the one-stop-shop principle of the EU merger control regime there is no need for them to also be reviewed in the UK by the Competition and Markets Authority (CMA). Post-Brexit, an EU clearance will not cover the potential effects on the UK market, and this in turn will be likely to lead to an increase in the number of deals reviewed by the CMA under the UK’s voluntary merger regime. Of the 337 notifications made to the EU in 2015, it is estimated that 50-75 would have been notifiable to the CMA in a post-Brexit world. Given that in the financial year 2014/15 the CMA reviewed 82 mergers, this would double its workload. One is also likely to see parallel notifications to the CMA and EU Commission which, in turn, will increase the cost, regulatory burden, and uncertainty inherent in M&A activity.
Finally, there is also a risk that the UK merger control process may become more politicised (stemming from recent comments by Theresa May which suggest an appetite for using the UK’s merger control regime for more general industrial policy reasons), which could, in turn, impact deal clearance certainty and necessitate the use of political avenues to secure clearances.
Market Reaction and Outlook for the Future
As expected, the markets initially reacted negatively to the news of Brexit.
The U.S. $2.1 trillion decline in the value of global equity markets on the day after Britain voted to leave the EU was the biggest daily loss ever. The International Monetary Fund also downgraded the UK’s economic growth forecasts for 2016 and 2017 by 0.2 and 0.9 percentage points, respectively—the largest reduction of all the advanced economies.
The longer-term outlook very much depends on getting greater clarity on the ultimate Brexit terms. Until there is more clarity on the nature of the UK's relationship with the EU post-withdrawal, many potential purchasers will continue to adopt a wait-and-see approach while continuing to assess potential buying opportunities as they emerge.
Some commentators, however, agree that the decrease in the value of sterling against other currencies and some falls in share prices is likely to result in an increased interest in companies that are based in the UK but generate a large portion of their revenues in currencies other than sterling. Some commentators also believe that the UK's stable financial, regulatory, and legal systems, in addition to the appealing corporate tax rates, have contributed to historical M&A activity and are not likely to change significantly post-Brexit. In other words, the markets will inevitably adjust to a post-Brexit world.