Tag: Mergers

UK National Security and Competition: To file or not to file?

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With the adoption of the National Security and Investment Act 2021 (NS&I Act), the UK will for the first time require mandatory filing of all transactions in 17 strategic sectors.  The Government will also gain the ability to investigate a wider range of transactions in any sector of the economy if it considers there is a national security risk, including transactions that were completed between November 2020 and when the Act comes into force.  The new regime will not come into force until the Investment Security Unit at the Department for Business (BEIS) is ready and necessary guidance has been published, which will most likely be towards the end of the year.

The NS&I Act will require mandatory notification of any acquisition of shares or voting rights in a company active in these sectors if one of the relevant thresholds of 25%, 50% or 75% is passed, regardless of the nationality or identity of the purchaser or any applicable merger control thresholds.  Only the national security implications of notification transactions will be considered. 

The new national security screening regime will be in direct contrast to the voluntary notification aspect of the general UK merger control rules, which will continue to apply to the competition and other public interest aspects of transactions affecting the UK.  This article pulls together our thoughts on how purchasers and sellers should proceed in the period before the mandatory notification regime comes into effect. 

So where do you start?  Fundamentally, parties should first consider whether there the Competition and Markets Authority (CMA) has jurisdiction to review a merger under the competition regime.  This is most easily established if the UK turnover of the target is above ÂŁ70m or above ÂŁ1m in certain sectors with potential national security implications. 

More controversially, the CMA will also have jurisdiction to review any merger where a UK share of supply of 25% or more is being created or increased as a result of the merger.  This is not a market share test and, as confirmed by the UK Competition Appeal Tribunal in the recent Sabre v CMA case, the CMA has a very wide discretion to define supply however it sees fit to establish jurisdiction.  This includes, for example, the ability to take into account UK employment of personnel engaged in pharmaceutical R&D projects or the right of a UK customer to receive services even where no services are in fact provided.  The CMA is able to develop its jurisdictional assessment in an iterative way throughout its investigation and may keep trying different approaches, using information gathered using its compulsory powers, until it has found a definition that it considers is defensible.  In practice, the CMA is able to assert jurisdiction using the share of supply test over almost any merger that it is interested in.

Whether the CMA will be interested in a merger depends on whether it considers that there may be a substantive competition problem.  In the past, this was based on a reasonably predictable assessment based on market shares and the presence of horizontal or vertical overlaps.  In recent years, the CMA’s approach has become more assertive and less predictable, especially with regard to transactions in the tech and pharmaceutic sectors, where there is significant interest in spotting so-called “killer acquisitions”.

So how is this relevant to consideration of wider public interest aspects, which for the remainder of 2021 will include national security?  The short answer is that the Government has the ability to intervene in transactions that raise specified public interest concerns, including (currently) national security, media plurality, the stability of the financial system, and the country’s ability to combat a public health emergency.  In cases where such concerns have been identified, the Government may issue a “public interest intervention notice”.  This has the effect of opening up a parallel track to the competition review to cover public interest aspects and transfers decision-making at key points in the investigation from the CMA to a Secretary of State.  While such intervention is purely at the discretion of ministers, it is worth noting that the CMA must notify the Government of any transaction it is reviewing that it considers raises public interest issues.

In addition to the above, the CMA is pushing for the Government to introduce a new mandatory notification regime specifically for acquisitions by large technology companies.  While legislation to introduce such a regime remains a long way off, if it is passed at all, the CMA has effectively introduced a de facto mandatory regime for such transactions in the meantime, as a result of its intense scrutiny of the sector.

How does one navigate the overlapping regimes, in the absence of mandatory merger control notification?  In principle, this is a complex process that will be very case specific. Summarising the key factors in a very concise way, we would highlight the following factors:

  1. Is there conceivably a substantive competition issue?  If not, it would be unusual to notify or otherwise engage with the CMA, unless the acquirer is a large technology or life sciences company or if there is a clear public interest issue (such cases are usually  easily identifiable).
  2. Is there conceivably a national security issue? If no CMA engagement is proposed, BEIS may be approached informally to discuss mergers with national security risk features, to flush out the risk of an intervention or of a retrospective review once the NS&I Act is in force.  Such cases include mergers where the target produces products, or develops technology, that it sells to the UK Government, that may have military or dual-use applications or that is subject to export control restrictions or where the identity or nationality of the buyer raises concerns.  In practice these elements are intertwined, in that a sensitive technology being acquired by a lower-risk acquiror can be as problematic as a less sensitive technology being acquired by a higher-risk buyer.  When making this assessment, it is relevant to consider whether the transaction will complete before the NS&I Act comes into force.

To notify or not to notify? And to whom?

That is indeed the question.  The answer will be easier to determine once the NS&I regime is in force, since from that point a national security notification must be made if the transaction falls within one of the defined sectors.  The question of whether to make a competition notification will from that point be an entirely separate consideration.  While it is not possible to make an NS&I notification before the regime is active, as set out above it is already possible to seek comfort from BEIS if there is an identifiable national security risk.  As a result, the question of whether to notify the CMA and/or to informally consult with BEIS officials will remain somewhat connected for the time being. 

It is important to note that the receipt of informal comfort from BEIS officials indicating a lack of national security concerns will not remove the obligation to notify the transaction once the new regime comes into force.  Equally, it does not remove the CMA risk, which needs to be considered separately.  A CMA review can be a very drawn-out process, typically including extensive pre-notification discussions, evidence submission and document production.  The CMA also charges substantial fees for reviewing a transaction.  As a result, a CMA notification should not be taken on lightly.  Since a CMA filing remains a voluntary step, many parties decide, quite legitimately, to close the transaction without any CMA engagement.  In such cases, the purchaser takes on the risk of a later CMA review, while hoping that the deal never reaches the attention of the CMA.  Alternatively, the CMA has developed an informal hybrid approach, under which parties can submit a briefing paper to a preliminary review unit to flush out any concerns in advance of closing.

Where all this leads, almost inevitably, is more complex merger agreements, with flexible and convoluted conditions precedent and extended longstop dates to govern what happens between exchange and closing.  Once a transaction is closed, the risk is on the purchaser.  Typically the seller will at that point have taken the sale proceeds and be largely immune from any subsequent scrutiny, since it will be commercially difficult to share that risk through earn-outs or other price adjustments. 

As always, looking at all the possibilities and being prepared for intervention from both the CMA and BEIS will enable purchasers to make an informed assessment.  Many acquisitive companies are preparing the ground by making more frequent informal approaches to the CMA and BEIS in order to establish a good compliance profile, even if their current deal may not merit it.  Who knows, the next one may be more difficult!

To get a copy of the article, click here.

Webinar: Foreign direct investment in Germany and the investor status of the UK

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On 13 May, Oliver Bretz hosted our monthly live webinar #FDI on the European Foreign Direct Investment Screen #EUFIS, which affects most mergers and investments at this critical time. Oliver had the pleasure of chairing the Microsoft Teams debate alongside Dimitri Slobodenjuk who provided an interesting update on the changes to the German FDI control system.

The discussion also focused on the status of UK investors and UK Private Equity in the EU during the Transition Period.

Notes from the webinar can be found here.

ARISE EUFIS, SON OF CIFIUS

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Dr. Alan Riley and Oliver Bretz

This article argues that EUFIS, the EU Foreign Investment Screening is modelled on CIFIUS, in that it is a political rather than an administrative process. Merging companies should take it into account if there is a risk of their long-stop date being extended beyond the autumn of 2020. Early engagement with DG Trade, especially in relation to remedies, will be an important step

Compared to CIFIUS on this side of the Atlantic, the adoption of the EU Foreign Investment Screening (EUFIS) has gone almost unnoticed. This may be due to the fact that it is seen as a distant threat, coming into force in late 2020. However, for deals that are currently being negotiated with long-stop dates into 2020 one may need to start looking at this issue quite seriously.

It should also be noted that the European Commission will have no formal decision-making powers. Instead, it will be the coordinating entity between the different foreign investment review systems of the Member States. That co-ordinating role will give it a significant influence over the process. That influence is underpinned by the Commission’s right to publish opinions of its view of the proposed transaction. Given also the Commission’s role as defender of the overall European interest, and its technical capacity it is also likely to become the focal point for the development of acceptable remedies. It is also clear from the experience of CFIUS in Washington that the investment review process will be far less administrative and technical and far more political, with all the uncertainties that this brings.

EUFIS will also for the first time put DG Trade on a par with DG Competition in merger cases, including in relation to remedies. Under the EU Merger Regulation, Member States may take “appropriate measures” to protect public security, the plurality of the media, and prudential rules. Any other public interests must be approved by the European Commission on a case-by-case basis.It will need to be seen how the review period will fit with the timelines of the EU Merger Regulation and national Takeover codes. DG Trade will have to evolve specific procedures for pre-notification and the negotiation of potential remedies.

On 14 February 2019 Trade Commissioner Cecilia Malmström said: “I’m very pleased that the European Parliament has given its backing to this initiative. Foreign investment is essential to the health of the European economy. At the same time, it is clear that we have to address the concerns about the security risk posed by certain investments in critical assets, technologies and infrastructure. Member States and the Commission will have a much better overview of foreign investments in the European Union and, for the first time, will have the possibility to collectively address potential risks to their security and public order.” (emphasis added)

In summary, EUFIS creates a cooperation mechanism where Member States and the Commission will be able to exchange information and raise concerns related to specific investments. The Commission will be able to issue opinions when an investment threatens the security or public order of more than one Member State, or when an investment could undermine an EU project or programme of interest to the whole EU. There are also provisions for cooperation on investment screening, including the sharing experience, best practices and information on issues of common concerns. EUFIS also sets out some minimum requirements for Member States who wish to maintain or adopt a screening mechanism at national level, whilst leaving the ultimate decision to Member States.

The EUFIS process is intended to take around 35 working days and contains the following steps: (i) the Member State where the investment takes place has to provide information on the investment and upon request has to notify cases which undergo national screening (ii) other Member States can then request additional information and provide comments (iii) the European Commission can request additional information and issue opinions (summarising its views and the comments from other Member States).

The Regulation also lists several EU funded projects and programmes which may be relevant for security and public order, and which will deserve a particular attention from the Commission. That list includes for instance Galileo, Horizon 2020, Trans-European Networks and the European Defence Industrial Development Programme. The list will be updated as necessary.

The Regulation sets an indicative list of factors to help Member States and the Commission determine whether an investment is likely to affect security or public order. That list includes the effects of the investment on critical infrastructure, critical technologies, the supply of critical inputs, such as energy or raw materials, access to sensitive information or the ability to control information, the freedom and pluralism of the media.

Member States and the Commission may also consider whether the investor is controlled by the government of a third country, whether the investor has previously been involved in activities affecting security or public order, or whether there are serious risks that the investor could engage in criminal or illegal activities.

The Regulation does not require Member States to introduce investment screening mechanisms. Member States may maintain their existing screening mechanisms, adopt new ones or remain without such national mechanisms.

Only 14 EU Member States currently have national investment screening mechanisms. Several are in the course of reforming existing schemes or of adopting new ones. The precedent from the adoption of the EU Merger Regulation in September 1990, was that almost all Member States rapidly adopted their own national merger regime. As all Member States would want to be able to credibly influence other states investment decisions and the Commission process, it is likely in the run up to the coming into force of EUFIS those states without an investment regime will create one. This in turn could create a further hazard for smaller deals affecting only a national market, where clearance will be required in almost all Member States by the merger and the foreign investment regulator.

The Regulation does provide for some key requirements for national screening mechanisms including transparency of rules and procedures, non-discrimination among foreign investors, confidentiality of information exchanged, the possibility of recourse against screening decisions and measures to identify and prevent circumvention by foreign investors. Member States with current screening procedures include Austria, Denmark, Finland, France, Germany, Hungary, Italy, Latvia, Lithuania, Netherlands, Poland, Portugal, Spain and the United Kingdom (until such time as it leaves the European Union and becomes a foreign investor under EUFIS).

From the CFIUS experience it can be assumed that Member States will have to evolve sophisticated national review systems that are able to make complicated assessments on very fast-moving technologies in a very short timeframe. That is not an easy endeavour, it can be expected that the Commission will increasingly take some of the burden. That raises the question whether DG Trade is itself equipped to make these assessments and whether it needs additional staff and expertise.

Where EUFIS could make a significant difference is in the area of remedies. Where a merger triggers multiple national reviews, the Commission will almost inevitably become the coordinator on remedies. Experience suggests that the Commission will need to evolve remedies that can deal with these issues through measures such as (i) appropriate black-boxes and information barriers (ii) independent board directors with national security clearance (iii) appropriate national oversight. How these factors will be used is up for grabs in a process that is likely to be intensely political. However, as there is an obligation not to discriminate between investors, a body of precedent is likely to start evolving, perhaps even through the adoption of guidelines and remedies templates – in exactly the same way as has happened under the EU Merger Regulation.

Despite the fact that the decisions will ultimately be taken at national level, the mere existence of EUFIS will give the Commission a degree of oversight and power in the process, which should not be underestimated.

Leaving the Problem Behind – a possible alternative to Remedies in UK Merger Control

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In 2004 I was involved in Convatec/Acordis, an anticipated UK merger, which was referred to a Phase II investigation by the then Competition Commission.  The transaction gave rise to a very limited overlap in alginate fibres, but was otherwise without concern.

https://assets.publishing.service.gov.uk/media/555de45ded915d7ae200012d/convatec.pdf

Instead of continuing with the Phase II reference, the parties  modified the transaction.  The original agreements were amended so that the alginate fibre business was retained by the Seller.  The remainder of the business remained subject to the acquisition.

https://assets.publishing.service.gov.uk/media/55194c2de5274a142e00037d/14-04.pdf

Faced with these facts, the Competition Commission concluded that it was under an obligation to cancel the reference, which it duly did.  This was obviously an attractive alternative for the parties, compared to the cost, delay and uncertainties involved in a potential reference.

Since then a lot of changes have been made to UK merger control regime and this article looks again at whether leaving the problem business behind is a suitable alternative to (i) an uncertain Phase I remedies process; and (ii) a potential Phase II reference.

THE LEGAL FRAMEWORK

For the purpose of this section, we have to assume that the CMA has taken a provisional decision under Section 34 ZA(1)b of the Enterprise Act (as amended).  Such a Decision is usually worded as follows:

“On the date of the SLC Decision, the CMA gave notice pursuant to section 34ZA(1)(b) of the Act to the Parties of the SLC Decision. However, the CMA did not refer the Merger for a phase 2 investigation pursuant to section 33(3)(b) on the date of the SLC Decision in order to allow the Parties the opportunity to offer undertakings to the CMA in lieu of such reference for the purposes of section 73(2) of the Act.”

Section 33 provides as follows:

Duty to make references in relation to anticipated mergers

  1. (1)  The OFT shall, subject to subsections (2) and (3), make a reference to the Commission if the OFT believes that it is or may be the case that—
    1. (a)  arrangements are in progress or in contemplation which, if carried into effect, will result in the creation of a relevant merger situation; and
    2. (b)  the creation of that situation may be expected to result in a substantial lessening of competition within any market or markets in the United Kingdom for goods or services.

The important point here is that at the point of the decision under Section 34ZA(1)(b), the reference pursuant to Section 33(3)(b) has not yet been made – but the parties have received notice so that they can propose remedies.  Could they modify the transaction instead?  What would be the impact of such a modification on the duty to refer under Section 33?

The CMA Guidance CMA 2 on jurisdiction and procedure provides as follows:

“15.2 If an anticipated merger is abandoned during the course of the CMA’s Phase 1 investigation, the CMA can issue a decision finding that its duty to refer does not arise because there is no relevant merger situation. If an anticipated merger is abandoned following a reference to Phase 2, the CMA can cancel the reference and stop the inquiry. The CMA has no power to cancel an investigation of a completed merger.

15.3 Section 37(1) of the Act requires the CMA to cancel a Phase 2 reference if it considers that the proposal to make arrangements of the kind mentioned in the reference has been abandoned. Where it is claimed that the arrangements have been abandoned and new arrangements are proposed or contemplated, the CMA must be satisfied that the arrangements that are described in the terms of reference have, in fact, been abandoned and that the new arrangements are not merely an amended form of the arrangements that were referred. (emphasis added)

 15.4 In order to be satisfied that the parties have abandoned the merger (at either Phase 1 or Phase 2), the CMA will require written assurance from the parties to the transaction to that effect. […] ”

As a result of the change to the merger it becomes more difficult for the CMA to prove the second condition of Section 33, because its theory of harm (usually price rises due to horizontal unilateral effects) no longer exists. Indeed, the non-merging of the overlapping business broadly reflects the CMA’s counterfactual (i.e. that business being run separately as a competitor).

In order to deal with that issue, the CMA would have to find that “the Merger” could be expected to lead to a SLC in the retained business.  That is an interesting question.  Every time a business is acquired from a Group, other parts of that Group are being left behind.  Merger control is typically focussed on unilateral, coordinated or sometimes portfolio effects of merging the businesses, but not ordinarily on whether what is left behind will be a less effective competitor.  In theory, it is possible that the act of splitting a previously integrated business would weaken the business left behind to such an extent that another player would be able unilaterally, or the other players in the market would be able in coordination, to raise prices. (Interestingly, such a theory of harm may not even require that the buyer would have the ability to raise prices as a result: it could be a third party competitor unconnected to the transaction.) For this to be the case, however, there would have to be strong evidence that the carve-out or “leaving behind” would undermine the competitiveness of the retained business to a sufficient extent (e.g. because of the consequent destruction of economies of scale or scope, or the starving of future investment that it requires), and there would also have to be something special about the retained business that its weakening as a rival would weaken the structure of competition in the market as a whole (e.g. there are very few other credible competitors or if it is a maverick).

Legally, the fact that the SLC arises not directly from the merging of businesses, but instead from the “leaving behind” of a business is unlikely to be a barrier to finding of an SLC under sections 33 (or 35) of the Enterprise Act. After all, even if it is the business “left behind” that is weakened as a competitor (rather than the target or acquiring business) by the merger, it is arguably still “the creation of the relevant merger situation” which “results” in the SLC.

That said, such a “carve out” theory of harm would be an unprecedented step, not just for the CMA. In Case M.4005 Ineos/Innovene, the European Commission allowed BP to retain a carved-out business whose subsequent sale to the same buyer Ineos under put and call options was referred to Phase 2 (although ultimately cleared unconditionally), without questioning whether the carve-out itself weakened the retained business as a competitive force. It would also raise some interesting issues about whether the UK Merger Notice adequately explores such “carve out” effects.  It would take a very bold CMA to refer a merger on that basis.

PRE-EMPTIVE ACTION

One other option would be for the CMA to make an interim order to preclude pre-emptive action.  The Guidance on interim orders can be found here:

https://www.gov.uk/government/uploads/system/uploads/attachment_data/file/642070/guidance-initial-enforcement-orders-and-derogations-merger-investigations.pdf

  • The Guidance provides as follows:

“2.3 As explained in paragraphs C.5 to C.10 of CMA2, the CMA will only exceptionally impose an IEO in relation to a merger which has not yet completed. This is because the circumstances in which the CMA might consider that an IEO is necessary in relation to an anticipated merger (examples of which are provided in paragraph C.9 of CMA2) are, in practice, relatively rare.

2.4 Where the CMA does impose an IEO in relation to an anticipated merger, this will typically not prevent completion of the transaction from taking place (unless there are unusual circumstances which could mean that the act of completion itself would constitute pre-emptive action).5 In other words, during (and in advance of) the CMA’s phase 1 investigation, the CMA is typically concerned with limiting integration (maintaining pre-merger competitive conditions and ensuring that the CMA is able to implement an effective remedy if necessary) rather than preventing completion itself.”

It is plain from the text of the Guidance that an order preventing the closing of the transaction is (a) very rare and exceptional and (b) only intended for circumstances where limiting integration is the concern.

This is also in accordance with the actual text of Section 72 EA:

(8) In this section “pre-emptive action” means action which might prejudice the reference concerned or impede the taking of any action under this Part which may be justified by the CMA’s decisions on the reference.”

In the light of the CMA’s own guidelines it would not be a proper exercise of discretion to adopt an IEO at prohibiting the retention of a business. That would run counter to the CMA’s own counterfactual, and the main rationale of an IEO is to prohibit further integration. Rather, any IEO would have to be directed at prohibiting the merger of the merging business (highly unlikely), or at ensuring that staff or assets etc remain with the seller, sufficient to support the business (highly unlikely).

CONCLUSION

It has been 14 years since the abandonment decision in Convatec/Acordis.  This article concludes that it is still possible to leave behind a business or activity that gives rise to the substantial lessening of competition after the CMA has taken a Decision under Section 34 ZA(1)b.

In such circumstances the CMA would have to show a new SLC arising out of the “carve out”, which would be a difficult step to take within the current merger control framework.

For those who are wondering why all this is still relevant, I will conclude this article with a quote from Patrick Stanley, the CFO of Acordis at the time:

http://www.maguspartners.com/templates/Press%20Releases/Dealmaker%20Disposals%20May%2004%20copy1.pdf

“Another high point for me was solving the problem that arose when the OFT referred the deal to the Competition Commission. The deal was referred over what was actually a pretty insignificant part of the business – most of the value was in a different part of the operation. Whatever people say, the amount of information required during an investigation by these types of authorities is horrendous.”

 Oliver BretzÂ