What does no-deal Brexit mean?

The political slogan coined by Theresa May ‘No deal is better than a bad deal’ has taken hold in discussions on Brexit. Although this option was not aired during the EU referendum campaign, it now has fresh legs, following the appointment of Boris Johnson as Prime Minister. As the future of the UK remains unclear, businesses are considering what a no-deal Brexit will mean for their operations.

While the timeline for Britain’s exit from the EU may have shifted from March to October, the possibility of a no deal outcome is alive and kicking, with fresh impetus following the change of guard at No. 10.

Leaving without a deal remains the default legal position unless:

• Parliament agrees to ratify the Withdrawal Agreement (i.e. the UK/EU terms of separation) (very unlikely); or
• the current Prime Minister brokers in time a different divorce deal with the EU which Parliament is prepared to ratify (extremely unlikely); or
• he secures a further extension of the Article 50 notice period by 31 October.  This will require unanimity of all the EU27 (possible).

As things stand, the EU is nothing if not consistent in saying that they will not reopen the Withdrawal Agreement. That is unlikely to change, even with a new Commission and Council President in place, as it is a considered position of the collective interests of the EU27. At most, they may extend the transitional period of the Withdrawal Agreement to 2022. But that is unlikely to gain a majority for ratification in the UK Parliament. The EU27 have also consistently indicated that they would also be prepared to re-open the accompanying Political Declaration, which sets out a framework for the future EU-UK trading relationship.

Cancelling Brexit altogether (by Parliament revoking the Article 50 Notice) would of course be another option. Currently, there is little political appetite for this to happen without another referendum.

What is a no-deal Brexit?

A no-deal Brexit would mean the UK will leave the EU with no agreements in place regarding how the UK and EU should deal with one another. Some confusion has recently arisen in the mainstream media, with some ‘leave’ politicians claiming there are ‘mini-deals’ in place, if the UK leaves the EU on 31 October. There are no mini deals. What has happened is that prior to the possibility of a ‘no deal’ situation in March, the EU issued a number of measures to ensure some ‘basic’ connectivity between the UK and the EU and continued trade, whereby air travel and road freight would still be facilitated, provided the UK reciprocated. These contingency measures are outlined on the Commission’s Brexit Preparedness website.

Regardless of timing, leaving the EU without a deal would automatically lead to a changed reality as the UK adapted overnight to being a third country. This is apparent from the full list of these EU measures – much of which are aimed at recognising the UK as a third country.

The UK would no longer be in the Customs Union (i.e. a free trade area with common export duties with third countries). This means that UK exports would have EU external tariffs imposed on it. For certain products, this may mean that they would no longer be competitive. The UK would be free to impose its own tariffs on imported goods. Some commentators have said the UK could set these at zero – but under the WTO non discrimination rules, this would have to apply to all imports. Third countries would have little incentive to negotiate a free trade agreement with the UK, as the UK had already granted them tariff free trade. This is possibly one of the reasons that Canada is currently reluctant to agree to a “roll-over” of the EU-Canada Free Trade Agreement (CETA).

As the UK would no longer be a member of the single (or internal) market (i.e. free movement of goods, services, people and capital), the goods it produces will require fresh authorisation and certification. In certain markets, those manufacturers that have not already done so may find it necessary to relocate in the EU. The rights of UK citizens living in the EU, and EU citizens living in the UK would be unclear, absent domestic legislation. They are likely at least to have to register as residents in the state in question.

It would mean leaving many EU institutions like the European Court of Justice and Europol.

The UK would cease to be a member of a host of other EU agencies, which administer EU rules and policies in a variety of sectors such as the European Medicines Agency, the European Chemicals Agency and the European Aviation Safety Agency. Furthermore, while the UK would no longer contribute £9 billion annually to the EU budget, as it would no longer be an EU Member State, it would not be eligible for any EU subsidies, such as the Common Agricultural Policy, which gives £3 billion per annum to British farmers.

Under a no-deal exit, many commentators have speculated that the UK could simply withhold payment of the £39 billion divorce bill. Indeed, the current Prime Minister referred to this £39 billion as giving the UK “extra lubrication”. This misunderstands the nature of the ‘bill’. In fact, it is a sum that is due to be paid over many years as certain liabilities fall due. The better view is that if the UK were to fail to meet its liabilities that it accrued while it was in the EU, this would be harmful for its reputation as a reliable trading partner. The EU would also be unwilling to engage in trade negotiations until the UK indicated its commitment to meet its liabilities. So too, other third countries may be unwilling to negotiate Free Trade Agreements with the UK while its status in relation to the EU was uncertain.

The UK would also lose the benefit of free trade agreements that the EU has in place – such as with Japan, Canada and Mercosur. Limited alternative arrangements have been agreed with a small number of countries, most importantly Switzerland and Norway (goods only).

Effects of a no-deal Brexit

Looking specifically at the impact on trade, a no-deal outcome would mean there would be no rules in place as to how UK businesses could trade with EU businesses and vice versa. The UK would have the same status as a third country with the EU, and as such, the UK would have to trade with the EU on the basis of World Trade Organization (WTO) rules. Much of the EU regulation put in place to plan for a no deal is aimed at resetting the UK’s status as a third country. The average EU tariff is relatively low – an average of 2.8% for non-agricultural products – but much higher for some sectors – such as 11.9% for clothing; 10% for cars; 38% for meat, and 39% for dairy.

As the UK would no longer be in a customs union with the EU, routine checks for goods at the UK border would be put in place for such issues as phyto-sanitary checks – leading to increased delays at busy ports such as Dover and knock-on effects to the nation’s wider transport network.

Crucially, no deal would also mean the UK service industry losing its guaranteed access to the EU single market.

One of the biggest areas of contention around a no-deal scenario is the potential impact on the Irish/Northern Irish land border.

As it stands, under WTO rules, there need to be border checks on goods passing between the two countries, as the UK would be a third country to the EU and not part of the EU free trade zone. Any border checks are likely to compromise the commitments to free trade under the Belfast/ Good Friday Agreement, where removal of border checks was an important part of the peace process.

There have been suggestions that technology could play a major role in policing and maintaining an invisible border but as of yet, no concrete solutions have been put forward. Furthermore, even if technology solutions and so called ‘trusted trader’ regimes could be put in place, they will not be forthcoming within a reasonable time scale, if at all. Such solutions were considered at length in the course of negotiations of the Withdrawal Agreement and none were considered possible. Such solutions will also not mitigate against the need for border checks due to smuggling and illegal immigration. The incentive for smuggling will increase as the UK’s tax and regulatory regime diverges from that of the EU. Again, recent pronouncements from the current Prime Minister make clear the appetite for the UK to diverge its regulations from that of the EU, in relation, for example, to anti-genetic modification rules.

Looking at the law, the position is clearer. Under no deal, the vast majority of existing EU laws would be transposed into UK domestic law. There may be asymmetries, as concessions will be given to EU states, but EU will not be reciprocating as the UK will no longer be an EU member. These anomalies will take some time to remove. The UK courts will be bound by the rulings of the European Court of Justice (ECJ) that took place before Brexit; and subsequent judgments may be taken into account when relevant, but it is not mandatory for UK courts to do so. The UK will still come under the auspices of the European Court of Human Rights, which is a non-EU body.

Consequences of no deal for businesses

While some commentators underline the importance of leaving the EU on 31 October regardless of whether a deal can be secured, business organisations have broadly spoken with one voice over their fears of what a no-deal exit could mean for UK plc.

Britain’s biggest manufacturing organisation, Make UK, has described leaving without a deal as ‘economic lunacy’. Meanwhile the CBI has warned that no-deal would do ‘severe damage’ to business. Separately the IoD has repeatedly called on businesses to step up their no-deal preparations, fearful that many firms have failed to take advantage of the delay in the process by making adequate contingency plans.

The Bank of England estimates a worst-case Brexit could shock the economy into a 5% contraction within a year, evoking echoes of the global financial crisis. In a less severe but still disruptive no-deal Brexit, it estimates output would fall by around 3%.

Over the longer term, the Bank says the economy could be 8% smaller by 2035 after a no-deal Brexit than if it stayed in the EU.

In the long term, it is still unclear what the nature of the trading relationship between the UK and EU will be, and it may take some years to negotiate. This is because the UK wishes, from a regulatory perspective, to move in a different direction to the EU. To quote Boris Johnson, from his first speech as Prime Minister, this is a “course on which the country is now set”. This will make it more difficult for the EU to allow open access to its markets. It may not be possible for the UK to sign up to the aspirations of the current Political Declaration, which indicate a close regulatory alignment with the EU. How the UK is to reconcile its obligations under the Good Friday Agreement, yet still pursue an independent trade policy while maintaining the integrity of the United Kingdom is also not at all apparent.

We have also seen that many third countries are loath to agree or discuss trading arrangements with the UK until such time as it is clearer what the UK-EU trading relationship will be.

One thing is certain however, as 31 October rapidly approaches, the debate about the merits and practicalities of leaving the EU without a deal and the economic and political consequences will only intensify.

While the circumstances of the UK’s departure from the EU remain unclear, it is vital that businesses consider the potential outcomes; consider their security of supply of products and services and their routes to market and take action to prepare for both a deal and no-deal scenario.

Gowling WLG’s dedicated Brexit Unit helps clients to navigate this period of uncertainty and plan for the future, providing advice in areas such as strategic planning, contingency risk management and managing transactions.

If you would like to discuss your plans for Brexit, please contact a member of our Government and Public Sector team.