by Oliver Bretz, Michael Reiss, Benjamin Yip, Euclid Law
When the National Security and Investment Act 2021 received Royal Assent this year, it had become painfully apparent that its potential scope would be very wide and potentially extend beyond traditional M&A transactions. What few expected was its potential application to financing transactions.
The new notification regime is not yet in force and is not expected to be until later this year. However, the UK government will have the retrospective power to call-in transactions where there is a trigger event that may raise national security concerns. One of the trigger events is the acquirer being able to exercise material influence over the target’s policy.
The UK government has indicated its intention to apply the same merger control concept of “material influence” under the NS&I regime. We will therefore have to examine whether material influence could potentially exist in financing transactions, which will never become subject to any mandatory notification because they do not involve the acquisition of shares.
Material influence in the UK merger context occurs where one party gains a sufficient degree of influence over a target’s management of its business, including its strategic direction and its ability to define and achieve its commercial objectives. The assessment requires a case-by-case analysis of the overall relationship between the acquirer and the target. The key factors considered in the case law include the following:
· the level of shareholding by the acquirer in the target. Shareholdings of less than 15%, with no board representation or other governance rights, are less likely to give rise to material influence, unless there is clear evidence of other factors that indicate the ability to exercise material influence over policy.
· whether the acquiring party has the right to block special resolutions and whether it is able to do so in practice. This will be assessed on the basis of the distribution and holders of the remaining shares, the identity of other shareholders, including the status and expertise of the acquirer and its likely influence on other shareholders, the patterns of attendance and voting at recent shareholders’ meetings, the existence of any special voting or veto right attached to the shareholding and any other special provisions in the company’s constitution conferring an ability materially to influence its policy;
· whether the acquirer has obtained board representation, which either alone or in combination with the shareholding confers on the acquirer the ability to materially influence the policy of the target entity; and
· any other relevant agreements or arrangements with the company that enable the acquirer to materially influence such policy. For instance, agreements for the provision of consultancy services to the target and other relevant customer/supplier relationships, as well as financial arrangements making one party so dependent on the other that the latter gains material influence over the company’s commercial policy, may confer material influence. Indicatively, material influence could arise where a lender could threaten to withdraw loan facilities if a particular policy is not pursued, or where the loan conditions enable the lender to exercise rights beyond what is necessary to protect its investment (e.g. by options to take control of the company or veto rights over certain strategic decisions).
From the above list, it seems that it would be highly unlikely that a traditional financing transaction could be called in for National Security Review. But not so fast!
We have seen Partnership Agreements from specialist funders that give the lender a very significant say over the technology of the Target. We have also seen Board Appointment rights, where the Board Director has very significant expertise in the relevant sector. Couple that with some lender protection rights and a potential right to convert to equity at any point in the future, and you can see how one might be approaching material influence threshold. It is of course open for the Department for Business to develop the material influence concept over time and to take a view that is more stringent than that of the CMA.
Aside from material influence, the regime identifies two other “trigger events” which are potentially relevant to financing transactions and which could result in call-ins by the Department for Business – either on a standalone basis or overlapping with the material influence trigger. One is where a party obtains the right to control another party’s asset or to direct how it is used. This could be relevant as at the initial financing transaction or subsequently, such as where collateral is seized on a default by the borrower. Another “trigger event” is the acquisition of voting rights that “enable or prevent the passage of any class of resolution governing the affairs” of the Target. The legislation’s reference to “any class of resolution” is broad and could even include lender protection rights against a Target making certain constitutional changes by resolution. This means any such rights conferred on a lender need to be examined carefully.
They key point is this: financing transactions will not become subject to the mandatory notification regime (when it comes into force) because they do not involve the acquisition of shares (although a subsequent debt-for-equity swap on a borrower’s default could be caught). However, this makes them potentially more vulnerable to a call-in by the Department for Business at a later stage, as they could involve (a) the exercise of material influence, (b) control over certain assets and/or (c) the lender’s ability to block certain resolutions of the borrower. The Secretary of State has the power to call-in any transaction which falls within the scope of the regime, regardless of whether it has been notified, to assess its risk to national security within six months of the Secretary of State becoming aware of the transaction, (within a long-stop of five years for non-mandatory notifications).
Therefore, the only way that this risk can be mitigated is to give notice to the Department of the trigger event, which will then reduce the period for intervention from 5 years to 6 months.
Of course, this would not be appropriate in all instances but should certainly be considered where (i) the target risk or acquiror risk is high; and (ii) the rights go beyond normal commercial lender protections.
The national security Genie is well and truly out of the bottle – and no amount of regret will ever put it back!