Brexit: Hard Landing/Soft Landing or Down the Rabbit Hole: What’s Ahead?

17 October 2016 Dashboard Insights Blog
Author(s): Sophie Lignier Howard W. Fogt David T. Ralston Jr

This is the third in an ongoing series of blog posts by Foley & Lardner LLP on the implications of the June 23, 2016 referendum decision in the United Kingdom (“UK”) to exit the European Union (“EU”) (“Brexit”). Prior articles reviewed developments leading up to the Brexit vote, possible alternatives/outcomes, likely competition law and procedure implications as well as risks/uncertainties for standardization and innovation posed by Brexit.

This article reports on the current status of Brexit, on preliminary positions taken by the UK and the EU as well as on the shape Brexit may take when the exit process ultimately comes to fruition. Will the UK make a decisive hard, clean break from the EU to regain its “independence” (the “hard landing”)? Will the UK seek to negotiate a limited withdrawal from the EU, maximizing the advantages of EU participation while eliminating what may be perceived as the negative, unacceptable elements of EU membership (the “soft landing”?) Or, will the outcome resemble Alice’s nightmare journey down the “rabbit hole” to a “wonderland” world where nothing is as it seems and even the clocks appear deceptively wrong? “Time” will tell. However, at this point it looks like the old adage about making sausage once again rings true – it isn’t going to be pretty.

As noted previously, UK’s terms of exit and of its future relationship with the EU will be the subject of negotiations triggered by notice of its withdrawal from the EU pursuant to Article 50 of the 2009 Treaty of Lisbon. Theresa May, the UK Prime Minister, very recently signaled that the UK will give notice of its intent to leave the EU by the end of March 2017, perhaps as early as January 2017. Once this notice is given, a two year period will begin to run during which the UK’s future relationship with the EU will be negotiated. Many people, on both sides of the Channel, are pushing for a longer period of disengagement in which substantive and procedural agreements could be negotiated during such a transition.

In theory, more time, cooler heads preaching moderation and more responsible leadership to the Brexit process are likely desirable. Is that, however, possible? Seemingly, such a “mature” approach would require unanimous consent of and necessary action by all 28 EU member states. However, the odds of such a rational outcome, obviously desirable, seem a stretch at this point. No one should count on such a result.

In addition to announcing possible timing of its Brexit notice, the UK Prime Minister has announced additional points of process and some “red” lines in the sand from a UK perspective. These statements, for example, promising a “Great Repeal” of the 1972 European Communities Act (through which EU laws and regulations have direct legal effect in the UK), “controlling” immigration (a current very hot button) and freedom from the jurisdiction of the European Court of Justice (return of the UK to an “independent and sovereign” state) were mostly polemical – political fodder for UK’s rabid “Brexiteers.” These pronouncements are long on rhetoric and short on substance or practicality.

In return, there have been signals from key EU members suggesting points of sharp conflict that will make for tough bargaining ahead. Indeed, the positions of continental authorities appear to be hardening. Among the EU salvos in response to PM May’s statements were no “cherry picking” by the UK among EU member state rights and obligation, no UK negotiations with any third parties (e.g., USA) on possible future freed trade deals until the Brexit process is completed and, ultimately, no Brexit outcome leaving the UK in a better position vis-à-vis how it is today. As French President Hollande recently put it bluntly, there “must be a price for Brexit.” Finally, the EU President Tusk put the continental position even more starkly, saying in effect that the only way for the UK to exit the EU is through a hard landing – a clean, hard break. For him, there will be no middle ground on Brexit.

Thus, strong push back from the EU will limit the UK’s room to maneuver even if it maintains friendly relations with a number of EU member states (e.g., Denmark and the Netherlands). In particular, keep in mind that any Brexit deal providing concessions (e.g., continued free trade, free movement of services, zero tariffs and harmonized standards) has to be approved unanimously by the other 27 remaining EU members and the European parliament. To put it bluntly, the UK will not call the shots on how Brexit ends up.

What’s ahead?

At this juncture, all that can be said is that Brexit presages a very difficult and contentious few years, at a minimum, for the UK, the EU and its trading partners – less transparency, less consensus, greater costs and increased uncertainty. Before we look at some of the possible models for the relationship between the UK and the EU post-exit, let’s recall briefly some of the central principles on which the EU was created and has functioned.

The EU was founded on the basis of four so-called freedoms – the free movement of people, goods, services and capital within the EU member’s combined territory. These four freedoms intended and today require:

  • The elimination of custom duties between member states and quantitative restrictions on the import and export of goods, with all measures having equivalent effect;
  • The establishment of a common customs tariff and a common commercial policy toward third countries;
  • Institution of a system ensuring that competition in the common market is not distorted; and
  • The approximation [harmonization] of laws of the member states to the extent required for the proper functioning of the common market.

At the core of the coming Brexit negotiations is at least one seemingly simple core question: Will the Brexit process permit the UK to exit the EU and still benefit from and be responsible to maintain some but all not of these “freedoms” – the free movement of people, goods, services and capital? Put into simple, stark terms, will the UK be able to pick and choose among these freedoms, e.g., could the UK opt-out of guaranteed free movement of people within the EU and still derive the benefits of the free movement of goods, services and capital?

For example, the UK in its recent announcement said that it will use Brexit to “control immigration.” Would the EU permit the “four freedoms” to be thinly sliced apart like pieces of bologna in striking a Brexit deal that would permit the UK to restrict the free movement of EU member state citizens into and out of the UK? If the EU gave the UK that concession, what would the implications be for EU dealings with the remaining member states? Why would the EU even entertain seriously agreeing to such a concession? To complicate things, there will be important elections in France, Germany and the Netherlands during 2017 where this issue of free movement of people will be addressed as well.

While immigration (free movement of people) is one hot-button that was a driving force in the UK Brexit debate, it was and will not ultimately be the only issue on which the negotiations will turn. Take the UK’s proposed “Great Repeal” of the 1972 European Communities Act, which the UK proposes to repeal. What does that mean? The European Communities Act provides that EU laws (e.g., a regulation or even a directive) are automatically binding in the UK. If there is a conflict, the EU law governs. At this juncture, the “Great Repeal” is intended to stop/terminate the automatic application of EU law in the UK. As we have previously noted, whatever the Brexit outcome may be, there will, when the UK exits, still be a substantial body of EU-generated (uniformed, harmonized) laws, regulations and standards. The UK says that after the “Great Repeal,” it will adopt these EU laws as UK laws (if only to fill a large vacuum) and then proceed to repeal them, piecemeal. There are literally thousands of such laws, regulations, etc., that affect virtually every facet of UK life, particular UK business life.  Getting rid of “foul-smelling” EU-tainted legislation is likely to be a lengthy and contentious process filled with much uncertainty and disruption.

What about the call to regain UK sovereignty free from the jurisdictional tentacles of the European Court of Justice? Well, maybe, but then again, maybe not. Even if Brexit may cut back to some extent on the power of the European Court of Justice to make decisions affecting UK interests, there will still be many, many occasions in which the EU Court of Justice will have the say, (or, at least a final word). This is particularly true given the current and unavoidable economic ties between the UK and the EU. The EU Court’s jurisdictional reach extends to any course of conduct (e.g., a cartel, a large multinational merger, an international distribution system that has trade effects and is implemented in the EU0. Large mergers and acquisitions having a “community dimension” (even if between UK companies) will, except in very narrow circumstances, have to seek clearance to consummate from the EU Commission pursuant to EU legislation that imposes a mandatory global bar on closing (subject to substantial penalties enforced ultimately by the EU Court of Justice if the parties “jump the gun” and close before EU approval).  What about a pan European distribution system or IP licensing system? The UK effort, particularly in commerce, to assert its independent sovereignty will frequently confront the continuing power and extraterritorial effect of EU law.

What are the choices facing the UK and the EU?

Currently, one widely discussed alternative among many is the European Economic Area (“EEA”), whose members are presently Norway, Iceland and Lichtenstein. The problem with that alternative is that it seemingly gains the UK very little and, of course, the current EEA members may well not want such a large elephant as the UK under their EEA tent. EEA membership requires members to embrace the four freedoms (including the free movement of people),  to contribute to the EU budget, albeit at a reduced rate, to abide by most EU regulation, while at the same time having little say or ability to influence the EU legislative process (whether through the EU parliament, the EU councils or the EU Commission).  At this juncture, the EEA model would seem to be a non-starter.

If the EEA is off the table, what are the other alternatives? Post Brexit, the UK could become a member of the European Free Trade Association (“EFTA”) (like Switzerland). It could negotiate post Brexit a free trade customs union with the EU (like the ones currently in place – e.g. Morocco, Tunisia, Israel and Turkey, etc.). It could fall back on its current membership of the World Trade Organization (“WTO”) and the European Patent Convention (“EPC”). There may ultimately emerge a variant of some or all of the above, a so-called “bespoke” or custom tailored approach. Obviously, the UK cannot dictate the outcome alone. It has to strike a deal with all of the other 27 EU member states.

Putting aside for the moment the ultimate choice or framework that will be negotiated (EEA, EFTA, WTO, etc.), there are a myriad of dense, complex “nitty-gritty” (often seemingly mundane) issues that need to be resolved across the board. Timely resolution of even some of these housekeeping issues will be a Herculean undertaking.

As the foregoing should make clear, both the UK and the EU are taking initial hardline bargaining positions. At this juncture, it appears that the UK and the EU are on a collision course presaging a hard-landing or even a trip for all concerned down the rabbit hole.

What’s the bottom line for business, in general, and the automotive sector, in particular?

Brexit means change and uncertainty which traditionally have be anathema to business. Take a recent concrete example. Carlos Ghosn, head of Renault-Nissan (the largest motor vehicle manufacturer in the UK) has said that Renault-Nissan will make no further investments in its major facility in the UK until it is assured by the UK government that it will not face tariffs on its motor vehicle exports to the EU which account for a substantial majority of the plant’s production. In response, the UK PM now promises such assurances to Renault-Nissan. How and in what form are reasonable questions.

What do such assurances mean for other motor vehicle manufacturers in the UK? Do they get the same deal? There are, of course other impacts beyond the motor vehicle sector. What about other sectors in the economy? Will Brexit result in a custom tailored sector-by-sector approach? Currently, almost 80% of the UK’s GDP involves services. Take financial services as an example. This service sector accounts for more than 10% of UK GDP. The food industry and others are facing similar daunting challenges as well. These are some of many, many examples of the uncertainties and potentially disruptive effects, large and small, that Brexit poses for the UK, the EU and all their trading partners.

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