Tag: National Security and Investment Act

Britain’s government is trying to protect national security

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Without throttling investment that will be tricky

On January 4h a new investment-screening law came into effect, heralded by the government as “the biggest shake-up of the uk’s national-security regime for 20 years”. That is no exaggeration. It marks a shift away from economic openness towards suspicion and intervention. Kwasi Kwarteng, the business secretary, said it would show members of the public that “their security remains our number one priority”. What could go wrong?

The government is seeking to stop assets vital to national security falling into hostile hands. A report in 2017 warned that “ownership or control of critical businesses or infrastructure could provide opportunities to undertake espionage, sabotage or exert inappropriate leverage”. The context is concern about Chinese investment, and pressure to fall into line with allied countries such as America, Australia and Germany that have already tightened up.

Becket McGrath had the pleasure of discussing the UK’s new National Security and Investment Act with The Economist. “Just over a week in to the scheme, it’s a relief to see that the Government’s notification platform is working and the Investment Screening Unit is doing a good job at processing filings quickly […]. The really interesting thing now will be to see which deals get called in for more detailed review”.

Clicl here to read the article (subscribers only).

The UK’s National Security & Investment Act Regime: Emerging Themes in Practice

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For a law which does not fully come into force until 4 January 2022, its approaching footsteps have been making plenty of noise before it walks through the door. The Euclid Law team has been advising many clients on whether their transactions are caught, assessing substantive risk, liaising with the Department for Business, Energy & Industrial Strategy (BEIS) and submitting filings. Some themes are already emerging from our experience which we are sharing here. We welcome views and reactions from others.

The Christmas rush

As well as the mad dash to buy a turkey before supply chains crash, some deal-makers have been rushing to complete transactions before 4 January 2022. This makes a lot of sense when all other aspects of the deal point to simultaneous exchange and completion. Complete on or after 4 January 2022, by contrast, and this deal timetable is out of the question if the target business happens to fall into one of the 17 mandatory filing sectors. And where the deal obviously raises no substantive national security concerns, the extra time and cost of a mere technical filing is best avoided. So, if it’s not too late, it’s worth completing certain transactions during the first days of the New Year.

To learn more about the 2022 changes, click here.

Countdown running for entry into force of new UK national security investment screening regime

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The UK’s new national security investment screening regime will enter fully into force on 4 January 2022.  From that date, the National Security and Investment Act 2021 (the ‘NSI Act’) will give the Government the power to review a wide range of investments in businesses that are active in the UK or acquisitions of related assets.  While the new regime has the ultimate objective of preventing transactions that could harm the UK’s national security, it will impact a much wider range of deals. 

Under the new regime, investments in entities that are active in the UK in 17 specific sectors will have to be notified to the Government and cleared before completion.  The notification obligation applies regardless of whether the investor is foreign or UK-based and severe civil and criminal penalties will apply if notifiable transactions are not notified.  The underlying transaction will also be void as a matter of English law. 

Although 4 January may feel like a long way off, it is now less than three months away.  The new NSI regime will have a potentially significant impact on timetables and deal certainty for transactions where closing is due to take place after that date.  As a result, it may well be relevant to transactions that are currently being negotiated.  It is also notable that, once the regime is in force, the Government will have the power retrospectively to review and call in any transaction that completed on or after 12 November 2020 (the date on which the bill was originally introduced to Parliament).

Filings will be mandatory where the target is active in any of the following sensitive sectors:

Advanced materialsCritical suppliers to governmentMilitary and dual-use
Advanced roboticsCritical suppliers to the emergency servicesQuantum technologies
Artificial intelligenceCryptographic authenticationSatellite and space technologies
Civil nuclearData infrastructureSynthetic biology
CommunicationsDefenceTransport
Computing hardwareEnergy 

The assessment of whether a qualifying entity is involved in a specified sector will involve careful analysis of the target’s business alongside the relevant statutory definitions. These are extremely detailed and prescriptive, with some running to several pages. 

To download and read the full paper, click here.

To Infinity and Beyond: The Extra-territorial Application of the UK’s National Security Regime

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By Oliver Bretz and Becket McGrath

With the coming into force of the UK National Security Regime on 4 January 2022, the UK will subject 17 sectors to mandatory notification and clearance requirements.  In addition there is a wide power to call-in other transactions.

A lot has already been written about the implications of having a national security regime that applies without any thresholds and regardless of the identity of the purchaser so we will not repeat that here.

What has received a lot less attention is the potential extra-territorial effect of the regime, which should be of concern to companies and third-country States at a political level.

On 20 July 2021 the UK published Guidance on how the National Security and Investment Act 2021 could affect people or acquisitions outside the UK.

Qualifying Entity

The Guidance defines a qualifying entity as being one that carries on business in the UK (including from a regional office or research facility), or supplies goods and services to people in the UK (including an overseas company that produces goods for exporting to a company in the UK or is responsible for distributing them to the UK company).

Having a sales subsidiary in the UK or supplying to a distributor in the UK would therefore be a sufficient nexus with the UK.  The extra-territorial scope is therefore very wide.

The Guidance goes on to state that if one of the following is met, the entity would definitely be a qualifying entity if it:

 supplies goods or services to the UK

·      carries out research and development in the UK

·      has an office in the UK from which it carries on activities

·      oversees the activities of a subsidiary that carries on activities in the UK (unless it is independent from the parent entity being acquired)

·      supplies goods to a UK hub which sends the goods onto other countries (unless the UK hub only places orders for goods to be sent to other countries)

·      has staff that travel to the UK for business

·      supplies goods that pass through the UK

It should be noted that UK investors, a UK Stock Exchange listing or a the existence of a common parent with a UK subsidiary is not sufficient to be regarded as a qualifying entity.

Qualifying Asset

A qualifying asset is defined as an asset that is used in connection with activities carried on in the UK (regardless of where the asset is based or who is carrying on that activity) or used in connection with the supply of goods or service in the UK (regardless of where the asset is based or who is carrying on that activity).  The example in the guidance is a wind-farm supplying electricity to the UK.

This is satisfied where the asset is used:

·      by someone in the UK

·      by someone outside the UK to supply goods or services to the UK or

·      to generate energy or materials that are used in the UK.

The Guidance notes that asset purchases are not subject to compulsory notification and that the call-in of an asset purchase is going to be relatively rare. 

Information Powers

The government can require a person/entity to provide information or to give evidence if any one of the following applies:

·      if the person carries on business in the UK, even if they are not directly involved in an acquisition being investigated

·      if the person is a UK national

·      if the person is an individual ordinarily resident in the UK

·      if the entity is incorporated or constituted under the law of any part of the UK

·      if the person or entity has or is in the process of or contemplating acquiring, a qualifying entity or qualifying asset

The Government can do this by issuing information and attendance notices and the Guidance states that it will use available criminal and civil penalties including fines and custodial sentences against individuals outside the UK.

A company that is not subject to UK mandatory notification because it does not carry on activities in the UK but only provides goods or services to the UK could find itself on the receiving end of an interim order or final order. Equally a transaction that takes place entirely overseas could be subject to UK mandatory notification.

An example

Many will be familiar with the LNG import terminal (LNG Terminal) on the Isle of Grain, which is likely to be of strategic importance to the UK.  However an LNG Terminal does not own the gas that it handles – it merely makes a charge for the gasification process.  If you now take an Algerian state-owned company that merely sells its gas through the LNG Terminal to the UK that wishes to sell a 40% shareholding stake to a Gulf investor, it would be unthinkable that such a transaction would be subject to UK mandatory notification?  Think again.

The relevant steps are as follows:

1)    The state-owned company is a qualifying entity because it carries on business in the UK;

2)    The transaction may be subject to mandatory notification if that state-owned company has an existing up-stream petroleum facility (as defined in the Regs);

3)    The acquisition of 40% is a triggering event.

Whether in practice the UK would be able to compel the notification of such a transaction is a different matter.  Politically that may also be difficult in relation to companies that are majority-owned by another state.  But as always, the risks will be on the UK nationals or UK residents working for that company who may be asked to provide information, which may be subject to strict confidentiality obligations, sometimes backed up by criminal law. 

The UK will have to think long and hard about how it is likely to use those powers, especially if a transaction is not notified in the UK when it should have been.  In addition, in our example, how would the UK enforce the likely remedies set out in the Guidance:

Requiring the state-owned company to not sell more than a certain percentage of its shares; 

·      ensuring the Gulf investor cannot access certain intellectual property;

·      requiring the state-owned company to report regularly to the UK government on compliance.

The answer is of course that it would not and could not – and in this example the risk to UK national security would probably be minimal.   But just replace LNG with uranium fuel rods and Algeria with France and you will see how political this issue may become.

Internal Restructuring of an International Group

If the foregoing discussion has not had anyone worried about regulatory overreach, we would like to introduce the topic of internal restructurings.  It is a canon of merger control that internal restructurings, especially of multinational companies, which do not change the ultimate control structure are not caught by merger control.  Not so with the NS&I Act.

The Guidance provides that:

Qualifying acquisitions that are part of a corporate restructure or reorganisation may be covered by the new rules. This is the case even if the acquisition takes place within the same corporate group. This means that even within corporate restructures, it may be mandatory to notify.

So that means that a corporate reorganisation taking place in Brazil could potentially trigger a filing obligation in the UK, which is clearly completely bonkers.  What conceivable UK national security concern may be triggered by such a reorganisation is not discussed in the Guidance and remains a mystery.

Impact of a failure to notify – unenforceability?

So why does any of this matter.  Well, it matters!  Many transactions are conducted under English law and are subject to English jurisdiction.  Even if they are not, the lawfulness of the underlying transaction documents will be relevant to the financing of the transaction, which is most likely going to involve English Law documents and London banks.  Law firms will be issuing legal opinions attesting to the enforceability of the financing documents with all the usual disclaimers and caveats.

The bottom line will be the impact that illegality for failure to notify under the NS&I Act 2021 could have on the transaction and financing documents.  A textbook example of the unintended consequences of well-intentioned regulatory overreach.

Widening the net

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by Becket McGrath

As the National Security and Investment Bill (NSI Bill) nears the end of its passage through Parliament, further details of the regime are becoming clearer. Nevertheless, fundamental questions over how the regime will operate in practice remain. Consideration of the long prehistory of the Bill, and examination of how other new investment screening regimes are bedding in, may shed some light.

Click on the below links to read the full articles from the Competition Law Insight Volume 20, Issues 2 and 3.

Part 1 explores the UK’s new NSI regime as it takes shape and how the NSI Act implements a wholly new regime that will enable the UK Government to review a wide range of transactions for potential national security issues. Transactions involving the acquisition of control over, or of non-controlling investments in, entities active in certain specified sectors will be subject to mandatory notification and government approval before completion

Part 2 dives deeper into the intricacies of the NSI Act upon receiving Royal Assent on 29 April 2021. Although we now know the final form of the Act, significant uncertainties remain over its purpose, operation and impact. More positively, the government has taken some sensible steps to narrow the Act’s scope during its parliamentary passage.

These articles were originally published in Competition Law Insight, Volume 20 Issue 2 and 3, Cover Date 2021 © Informa UK Ltd 2021. For more information visit www.competitionlawinsight.com

Can financing transactions be caught by the UK’s new National Security Regime?

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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!