How Best to Deal with The Retroactive Powers in The New UK National Security Regime and Pre-Commencement Acquisitions?
26th April 2021
The National Security and Investment Bill (“NSI Bill”) is due to complete its passage through Parliament in May 2021 and it is anticipated it will receive Royal Assent soon after. A number of necessary statutory orders will then be made under the new Act and the legislation is due to enter into force by the end of the year (2021).
The NSI Bill seeks to establish a new, standalone statutory regime to allow the UK Government to scrutinise and intervene in certain acquisitions and investments for the purposes of protecting national security (NSI Regime). It will replace the current powers of the UK Government to intervene on the grounds of national security under the Enterprise Act 2002.
The NSI Bill confers retroactive powers on the UK Government to call in for review on national security grounds (and, if needed, impose remedies in relation to) certain transactions that complete between 12 November 2020 and the day before the NSI Regime commences. The call-in power will be exercisable in relation to pre-commencement transactions for up to five years from the date on which the NSI Regime commences. This is reduced to six months from commencement if the UK Government is made aware of the transaction prior to commencement.
The NSI Regime contained in the NSI Bill provides for a mandatory notification system requiring proposed acquirers of shares or voting rights in companies engaged in certain activities in the UK in certain key sectors of the economy to obtain government clearance before the transaction is completed. Transactions that fall outside the mandatory notification regime will also be capable of being notified for clearance on a voluntary basis if the parties consider that the transaction may raise national security concerns.
Therefore, parties involved in transactions particularly share purchase agreements need to consider whether to informally pre- notify their transactions to Government to reduce the potential call in time periods once the legislation comes into force.
What Transactions Does the NSI Bill Cover?
The NSI Regime will apply to transactions or investments that involve the acquisition of control over certain qualifying entities or qualifying assets. The draft legislation covers certain types of transactions known as trigger events. It covers principally the acquisition of shareholdings or control by investors in entities which carry on relevant activities in the UK, but it can also extend to assets owned by relevant entities.
For the purposes of the legislation a qualifying entity includes any entity (whether or not a legal person but excluding individuals) that is either formed or recognised in UK, carries on activities in the UK or supplies good or services to persons in the UK. Assets in scope of the Bill include land, tangible moveable property, and (covering intellectual property) any idea, information, or technique with industrial, commercial, or other economic value which are used in connection with activities in the UK.
The legislation will apply to the following transactions:
- the acquisition of votes or shares in a qualifying entity exceeding a threshold of 25%, 50% or 75%.
- the acquisition of voting rights that enable or prevent the passage of any class of resolution governing the affairs of the qualifying entity.
- the acquisition of a right or interest which gives the acquirer material influence over a qualifying entity’s policy.
- the acquisition of a right or interest in, or in relation to, a qualifying asset which gives the acquirer the ability to: (i) use the asset or use it to a greater extent than prior to the acquisition; or (ii) direct or control how the asset is used, or direct or control how the asset is used to a greater extent than prior to the acquisition.
Once the new NSI regime enters into force it will be mandatory for investors to notify relevant transactions in certain key sectors to the UK Government. Investors must submit a formal pre-notification, providing as much relevant information as possible for clearance of the acquisition to the National Security and Investment Unit. The transaction must not complete before it is cleared. There will be sanctions for non-compliance with the regime, which include fines of up to 5% of worldwide turnover or £10 million – whichever is the greater – and imprisonment of up to 5 years. Transactions covered by mandatory notification which take place without clearance will be legally void and unenforceable.
The definition of key sectors for the legislation will be contained in an accompanying statutory instrument to the Act. This will define certain sectors and key activities in those sectors that will be covered by the mandatory notification provisions. According to the Government list of the mandatory sectors published in March 2021 the following will be covered:
- Advanced Materials
- Advanced Robotics
- Artificial Intelligence
- Civil Nuclear
- Computing Hardware
- Critical Suppliers to Government
- Critical Suppliers to the Emergency Services
- Cryptographic Authentication
- Data Infrastructure
- Engineering Biology
- Military and Dual Use
- Quantum Technologies
- Satellite and Space Technologies
The NSI Bill gives the UK Government powers to call in relevant transactions in the wider economy outside the mandatory sectors. The Government can call in a transaction up to 5 years after completion or if the Government is made aware of the transaction up to 6 months after becoming aware of the transaction. Investors entering into relevant transactions in the wider economy have no obligation to renotify their transactions, but they are subject to the call-in powers set out above. However, it is prudent for them to consider whether their transaction may have national security implications and if so whether it should notify the transaction.
As we have mentioned above the NSI Bill confers retroactive powers on the UK Government to call in for review on national security grounds certain transactions that complete between 12 November 2020 and the day before the NSI Regime commences. Although there no powers are conferred on the Government prior to the commencement of the NSI Regime to order pre- notification of transactions in the mandatory sectors or the wider economy they will still have call in powers for transactions entered into between 12th November 2020 and the commencement of the new NSI Regime.
Therefore, parties entering into share purchase transactions or acquiring strategic assets should factor in the possibility that their transaction may be retrospectively called in for review, and potentially made subject to remedies, for up to five years from the date the NSI Bill enters into force. This period can be lessened to six months if details are made known to the Government. For those transactions that will be signed and exchanged but are unlikely to complete before the NSI Regime enters into force, the parties will also need to consider whether it is appropriate to include a condition precedent in their agreement to reflect the application of the notification regime.
In the case of pre- commencement transactions parties should consider the following:
Make a jurisdictional assessment. The parties should determine whether the proposed transaction will be within the scope of the Government’s call-in power under the NSI Regime. Is the target company either: (a) incorporated in the UK; or (b) formed under the laws of another jurisdiction but carries on activities in the UK or supplies goods or services to persons in the UK. If the transaction relates to an asset does that asset have an appropriate nexus to the UK. In addition, the parties need to ask does the transaction fall within a trigger event as defined by the draft legislation.
Need to Consider National Security Issues: If the proposed transaction is likely to come within the scope of the NSI Regime, the parties will need to evaluate whether there is a substantive risk of the transaction being called in for review on national security grounds after the NSI Regime has entered into force. As mentioned above once the NSI Regime has commenced, the Government has call-in powers in relation to any pre commencement relevant transactions that completes between 12 November 2020 and commencement of the regime, if the Government (exercising its powers through the Secretary of State for Business, Enterprise, and Industrial Strategy (“Secretary of State”) reasonably suspects that the trigger event has given rise to a national security risk. The Government has indicated that it does not expect to use its pre-commencement call in powers much in relation to pre-commencement transactions. Nevertheless, parties should still complete a substantive review of the transaction for potential national security issues. The Government has helpfully set out key considerations to be taken into account by parties when assessing whether their transaction could pose national security risks in its draft Statutory Statement of Policy Intent (SSPI). https://www.gov.uk/government/publications/national-security-and-investment-bill-2020/statement-of-policy-intent The Secretary of State will be required to have regard to this statement when deciding whether to exercise his call-in power.
Target risk. Does the transaction relate to a high-profile company or is it in connection with a sensitive area of the economy where the Government considers national security risks are likely to arise? Those sectors are the ones covered by the mandatory notification obligations under the draft legislation. Therefore, pre-commencement transactions involving the acquisition of control over target companies involved in any of these high-risk activities are likely to be subject to a heightened risk of retrospective call-in.
Trigger event risk. Parties need to consider the type and level of control being acquired and how in practice this could give rise to national security risks. The draft SSPI indicates that parties who are unsure of whether a trigger event may pose a risk should consider what the control the acquirer will gain over the target company would enable a “hostile actor” to do to the detriment of national security.
Acquirer risk. Does the identity of the acquirer pose any national security concerns? The Government will look at the identity of the acquirer, who is in ultimate control of the acquirer, the nature of their connections to potential hostile actors, their track record when involved in past investments and any pre-existing interests in the same activities or markets which could give them particular leverage. They will also consider whether the acquirer has been found guilty of any criminal offences in the past.
Consider seeking guidance from ISU. Guidance can also be obtained by contacting the newly formed Investment Security Unit (ISU). Informal advice and guidance on the application of the NSI Regime of the proposed transaction can be obtained from the ISU by emailing the following address (firstname.lastname@example.org). Parties cannot formally notify a transaction prior to the commencement of the NSI regime but they can seek from the ISU a non-binding view about whether the transaction is likely to be retrospectively called in once the new regime has commenced. In addition, putting the Government on notice as to the details of the transaction is likely to reduce any possible call-in period to six months from the 5 year period.
Effect on the transaction and the parties of any retrospective Call-In under the NSI Regime. If a pre-commencement transaction is within the scope of the NSI Regime, the parties need to be aware that even if the transaction is completed before the NSI Regime commences, there is a still a risk that it could be subject to review on national security grounds following commencement under the retrospective call-in power in the NSI Bill. If this does happen and there are national security risks inherent in the transaction, the transaction could be prohibited and, if completed, unwound. Alternatively, it could be subject to conditions. These conditions could potentially radically reshape the commercial terms of the deal and the parties need to have a strategy as to how these potential eventualities would be handled.
The Call-In process will be subject to statutory time limits. The Secretary of State will have an assessment period of 30 working days (beginning on the day the call-in notice is given and extendable by up to 45 working days in certain circumstances) to determine whether to issue a final order prohibiting the transaction, imposing remedies or notifying the parties no further action is to be taken in relation to the transaction.
The Secretary of State has wide investigation powers to investigate any relevant transaction. If the transaction is called in for review, the parties may be required to supply information or provide witness evidence where necessary to assist the Secretary of State in their assessment of the transaction. In addition to prevent any anticipated threat to national security the Secretary of State may also in appropriate circumstances be able to impose interim orders under the NSI Regime while a full national security assessment takes place. The terms of an interim order can be very wide and may include provisions requiring persons to do, or not to do, particular things, and could include requiring the reversal of any existing integration of acquirer and target company.
Is an NSI Regime-related condition precedent required: Do the parties need to include an NSI Regime condition precedent? This is something worth considering if there will be a lengthy interval between exchanging and completing the transaction during which the NSI Regime may start to operate. This may be particularly necessary if the nature of the target company’s activities and its sector of operation means that the transaction is likely to covered by the mandatory notification regime and cannot legally be completed without consent from the Government. If a clause is to be added it is important to consider whether the condition should address all possible outcomes following notification or call in of the transaction and what redlines there are for buyers and sellers. When looking at the transaction from a seller’s perspective what actions could be taken to mitigate the risk of the transaction being derailed due to government intervention following exchange. For example, ensuring the condition does not allow the buyer complete discretion to walk away from the deal if the Secretary of State requires remedies for the transaction to proceed; and/or incorporating a break fee that will be payable by the buyer if the acquisition agreement is terminated due to a failure to satisfy the NSI Regime condition.
Similar to competition filing obligations, the parties should consider that where an NSI condition is included what steps that each party will be required to take towards satisfying the condition. The NSI Bill currently imposes upon the acquirer the obligation for making a notification in respect of a transaction in the mandatory sectors but a notification under the voluntary regime may be made by the seller, acquirer or target company. It is also important to outline what responsibilities or rights the non-notifying parties to the transaction have. There will be a need for the parties to co-operate with each other in relation to the notification process, and to promptly provide all information and assistance necessary to complete the notification. In addition, it is usual for the non-notifying parties to have the ability to comment on the notification before it is submitted and will keep the other party fully informed regarding the progress of the notification, including providing copies of any correspondence with the ISU or the Secretary of State in relation to the transaction.
The effect of putting in such condition on the deal timetable should also be considered. If completion will be conditional on the transaction being notified and cleared under the NSI Regime (if the NSI Regime comes into force prior to completion), consider the interaction between the longstop date for satisfaction of the conditions to completion and the statutory timetable for clearing or reviewing a transaction under the NSI Regime.
What Effect Will the New NSI regime Have on Due Diligence?
A key question to ask in any due diligence process is whether any entities or assets acquired by, or disposed of by the target company since 12th November 2020 could come within the scope of the NSI regime and could be subject to notification or call in. If subsequentially an acquisition or disposal is called in by the Government and conditions imposed or the transaction prohibited outright this could have a substantial effect on the value of the company.
Consider whether it is appropriate to include any warranties or indemnities to address the risk of any earlier relevant transactions being called in for review on national security grounds after completion of the acquisition agreement, and the possibility of remedies being imposed if a risk to national security is found to have arisen as a result of the transaction.
It is important to ensure that all transactions are screened going forward in relation to national security issues and whether they could be informally pre-notifed to the ISU and whether any conditions precedent should be inserted in the acquisition agreement to take account of the imminent commencement of the new NSI Regime. In addition, appropriate questions now need to be asked about the application of the NSI regime to transactions which may have been entered into by a target company after 12 November 2020 in any due diligence questionnaires.