Our overview of what the NSI Act means for investors, and how the notification and review process will work against a backdrop of tightening of foreign direct investment regimes globally
On 29 April 2021 the National Security and Investment (NSI) Bill received Royal Assent. The NSI Act 2021 introduces significant legislative reforms which will overhaul the ability of the UK Government to review transactions on national security grounds, and potentially prohibit their completion or require remedies to allow them to proceed. This is against a backdrop of tightening of foreign direct investment regimes globally.
Once fully implemented (expected by the end of 2021), the NSI regime will introduce a new notification and review process, including mandatory notification (and a corresponding prohibition on completion prior to clearance) for the acquisition of shares/voting rights in entities carrying on specified activities in the UK in 17 sectors (including energy, transport, communications, defence, artificial intelligence and other tech-related sectors). This is combined with an extensive call-in power enabling the Government to intervene in qualifying transactions in any sector, with no materiality thresholds. This represents an important new execution risk factor in M&A, with a similar risk profile to merger control rules. Whilst the majority of commercial lending arrangements are not expected to raise national security concerns, the Government has made clear that loans are not exempt from scrutiny under the new regime. There is currently a lack of detailed guidance on how the regime will apply to financing arrangements, but it is likely that it will be relevant in the following two scenarios:
- where acquisition financing is provided to an underlying transaction to which the NSI regime applies; and
- where lenders acquire control over qualifying entities or assets in connection with a restructuring. In this briefing, we consider each of these scenarios, focussing on the key considerations for lenders and practical guidance on how to address potential risks.
Brief overview of the new NSI regime
Our detailed general overview of what the NSI Act means for investors, and how the notification and review process will work, is available here. The key points can be summarised as follows:
- Broadly speaking, the new regime will apply to any acquisition of “material influence” in a company (which may be deemed to exist in relation to a low shareholding, potentially even below 15%) as well as the acquisition of control over assets (including land and intellectual property), which potentially gives rise to national security concerns in the UK.
- It will apply equally to both UK and non-UK investors (although the Government has acknowledged that UK investors will be less likely to give rise to national security concerns in practice), and may capture acquisitions of non-UK entities or assets in certain circumstances.
- A mandatory notification obligation (and a corresponding prohibition on completion prior to clearance, known as the “standstill” obligation) will apply to certain transactions involving target entities which carry on specified activities in the UK in 17 specified sectors (including energy, transport, communications, defence, artificial intelligence and other tech-related sectors). Such transactions include the acquisition of a shareholding/voting rights of more than 25% (increased from 15% or more in the original NSI Bill). Precise definitions of the specified activities will be set out in Notifiable Acquisition Regulations, which are due to be laid before Parliament shortly.
- The proposed sector definitions have been significantly narrowed following a public consultation and the Government is continuing to engage with stakeholders in a number of sectors, including communications and energy as it finalises the definitions (see our previous briefing).
- This mandatory notification obligation will be combined with an extensive call-in power enabling the Government to call in qualifying transactions for review, which extends to any sector and is not subject to any materiality thresholds in terms of target turnover or transaction value. Acquirers will also have a corresponding option to voluntarily notify a qualifying transaction to obtain clearance, which may be advisable in the interests of legal certainty where potential national security concerns arise.
- Sanctions for non-compliance with the NSI regime will be severe. Where a transaction is subject to the mandatory notification obligation, completion prior to clearance will result in the transaction being deemed automatically void. In addition, non-compliance with the regime may result in fines of up to 5% of worldwide turnover or £10 million (whichever is the greater) and imprisonment of individuals for up to five years, as well as director disqualification for up to 15 years.
- Formal commencement of the new regime will be delayed until later this year (exact date to be confirmed). However, the Government will have retroactive powers to call in for review at the commencement date (or potentially up to five years thereafter) any qualifying transaction completed between 12 November 2020 and the commencement date. This means that it is critical for investors – and lenders – to consider the potential application of the new regime for all transactions completed from 12 November 2020 onwards which could potentially raise national security concerns (broadly defined).
Acquisition finance: provision of financing to an underlying transaction to which the NSI regime may apply
Primary responsibility for assessing whether the NSI regime could apply to the acquisition or investment being financed will fall to the parties to the transaction. However, given the potential implications of noncompliance with the regime, this will also be important for lenders to diligence.
Underlying transaction requires mandatory notification
If there is a mandatory notification obligation for the underlying acquisition or investment being financed, lenders may want to include an NSI regime condition precedent and possibly other contractual mitigants in the finance documents: if the borrower/acquirer completes the transaction prior to obtaining clearance (in breach of the “standstill” obligation), the underlying transaction will be automatically void (unless retrospective validation can be obtained).
Underlying transaction falls outside the scope of the mandatory notification obligation
If the underlying transaction falls outside the scope of the mandatory notification obligation, lenders should nonetheless consider the risk of the transaction being called in for review, and whether a voluntary notification should be made by the parties. Whilst there is no automatic prohibition on completion prior to clearance in this scenario, if the transaction is called in for review an interim order may be imposed which could restrict what the parties can do with the relevant shareholding/voting rights or assets pending the conclusion of the investigation. This could prevent the acquirer from using assets or exercising voting rights.
Where national security concerns are identified, the Secretary of State may conclude that conditions should be imposed in order for the transaction to proceed. Such conditions could include, for example, altering the amount of shares an investor is allowed to acquire, restricting access to commercial information, or controlling access to certain operational sites or works. As a last resort, the Government will also have the power to prohibit or unwind a transaction.
An interim order may effectively prohibit completion if it is imposed before this has occurred and is deemed necessary to prevent “pre-emptive action” which could limit the ability of the Secretary of State to impose conditions on the transaction to address national security concerns if required.
The call-in power may be exercised at any time up to six months after the Secretary of State becomes aware of the transaction (for example, as a result of coverage in a national news publication), provided this is within five years of the acquisition of control. Depending on the risk profile of the underlying transaction, it may therefore be advisable for a lender to consider including contractual mitigants in the finance documents, even if the mandatory notification obligation is not engaged.
Impact of the NSI review process on deal timing
There could be significant timing and potentially cost implications to compliance with the NSI regime. The Government has emphasised that it will carry out any review quickly and efficiently; however, the review process could take up to 105 working days (or even longer in certain circumstances). There is an initial period of 30 working days following acceptance of a notification (whether mandatory or voluntary) within which the Secretary of State must decide either to clear the transaction or to issue a call-in notice for a more in-depth investigation. If a call-in notice is issued, there is then a further 30 working days for a detailed assessment, which is extendable by up to a further 45 working days.
This review timeframe could be extended further if, for example, the clock is stopped when a further information request is issued following a call-in notice, or if the Government is unable to reach a conclusion within the 105 working days and seeks a further extension with the consent of the parties (although such consent does not have to be given, in practice parties seem likely to consent if there appears to be a reasonable chance of agreeing remedies, if the alternative is the prohibition of the transaction).
Potential application of the NSI regime to enforcement of security and lenders’ contractual rights
The Government has emphasised that the majority of commercial lending arrangements are not expected to raise national security concerns, and that in the rare circumstances where they do pose concerns, the Secretary of State generally only expects to intervene when “an actual acquisition of control” will take place, such as where a lender seizes collateral (the term used in the Government’s current statement of policy intent).
There is currently a notable lack of detailed guidance on this point, which it is hoped will be addressed in an updated version of the Government’s draft statement of policy intent (due to be published for public consultation shortly). However, it appears that – in line with the approach taken in a number of other major jurisdictions, including the United States and Australia – the NSI regime is not intended to apply to commercial lending arrangements at the point at which lenders take security over shares or assets.
Where it may be engaged is where lenders subsequently seek to enforce security over shares or assets, and the acquisition of control by the lenders or a third party purchaser of the secured shares or assets amounts to a qualifying transaction which may give rise to national security concerns.
There is an important distinction in how the NSI regime potentially applies to enforcement of security over shares in a company (where the mandatory notification obligation may be engaged in certain circumstances) and enforcement of security over qualifying assets (to which the mandatory notification obligation will not apply).
Enforcement of security over shares
Potential application of the mandatory notification obligation
The proposed enforcement of security over shares or potentially the exercise of rights under share charges could give rise to a mandatory notification obligation (which would result in a prohibition on completion of the acquisition of control over the secured shares, pending the conclusion of an investigation under the NSI regime) where this would amount to a “notifiable acquisition”.
This will be the case where:
- the percentage of shares or voting rights held by the acquirer in a company carrying out specified activities in the UK in one of the 17 specified sectors increases and crosses the 25%, 50% or 75% thresholds; or
- voting rights are acquired in a company carrying out specified activities in the UK in one of the 17 specified sectors that enable the acquirer to secure or prevent the passage of any class of resolution governing the affairs of the company.
It does not matter for this purpose whether any potential national security concerns arise in connection with the acquisition in question; a mandatory notification must be submitted, and the Secretary of State will then review the acquisition and decide whether to issue a call-in notice triggering an in-depth review.
The key questions which will determine whether a mandatory notification obligation arises on enforcement of security over shares will be whether and when security enforcement would result in a qualifying acquisition of control. The answer to these questions is likely to depend on the enforcement process used; it is not limited to a sale of the shares, and could, for example, arise if voting rights were exercised by the lenders at an earlier stage, post default.
If the mandatory notification obligation is engaged, the Secretary of State will have 30 working days from acceptance of the notification to decide whether to issue a call-in notice and undertake a more in-depth review. If national security concerns are ultimately identified, conditions may be imposed on the acquisition of control (ie the enforcement of security), and as a last resort this could extend to prohibiting the acquisition.
However, it is important to note in this context that, in practice, unconditional clearance is expected to be granted in the vast majority of cases (the Government’s impact assessment suggests that approximately 10 transactions each year will require remedies, out of an estimated 1,000-1,830 notifications plus additional transactions called in on the Government’s own initiative). In most cases, the more pressing issue will be the potential impact of delay in the acquisition of control pending a clearance decision. As outlined above, an initial decision will be taken within 30 working days, but clearance may ultimately take up to 105 working days from acceptance of the notification, or even longer in certain circumstances.
In genuinely urgent cases, where it is clear that no national security concerns will arise in practice, it is anticipated that the Government will seek to reach a decision significantly more quickly than the 30 working days provided by the statutory timetable (although there is no guarantee of this).
There is a potential timing mitigant: a mandatory notification could be submitted at any point before the acquisition of control (subject to the acquirer being in a position to provide sufficient information to complete the notification form and enable the Secretary of State to decide whether to call the transaction in for an indepth review), thereby initiating the statutory review timetable well in advance of an actual acquisition of control. Also, lenders are able to seek informal guidance from the new Investment Security Unit within the Department of Business, Energy and Industrial strategy, again at any point before the acquisition of control.
Potential call-in/voluntary notification where mandatory regime not engaged
Where the mandatory notification obligation is not engaged (either because the company whose shares are secured does not carry out specified activities in the UK in one of the 17 specified sectors, or because the relevant shareholding/voting rights thresholds are not met), there will be no automatic prohibition on the acquisition of control over secured shares prior to clearance. However, the Secretary of State may still call in the acquisition for review on his/her own initiative if it amounts to a qualifying transaction and he/she has a reasonable suspicion that national security concerns may arise.
For this purpose, the definition of a “qualifying transaction” is notably wider than the “notifiable acquisitions” outlined above to which mandatory notification applies: it includes the acquisition of “material influence” (which may arise in relation to a lower shareholding/percentage of voting rights than the threshold for mandatory notification, potentially even below 15%) in a company in any sector, and may extend to non-UK companies if they supply goods or services to persons in the UK.
In determining whether the exercise of voting rights enables lenders to materially influence the policy of the company whose shares are secured, the Government has indicated that it will draw on the case law on “material influence” in the context of the UK merger control regime. Recently updated guidance from the Competition and Markets Authority on its jurisdiction and procedure under the merger control regime suggests that material influence could be deemed to arise if the lenders are able to exercise rights over and above those necessary to protect their investment. Specific examples given include options to take control of the company or veto rights over certain strategic decisions. However, it remains to be seen what approach will be taken in practice to this issue in the context of the NSI regime.
If enforcement of security will result in a qualifying acquisition of control for the purposes of the call-in power, and potential national security concerns are identified (either in relation to the acquisition of control by the lenders, or the acquisition of control by a subsequent purchaser of the secured shares), lenders may therefore wish to voluntarily notify in the interests of certainty.
As noted above, if the transaction is called in for review (whether following a voluntary notification or on the Secretary of State’s own initiative), an interim order could be imposed pending a final decision on clearance, which may restrict the sale of the shares or the ability of the lenders (or subsequent purchaser of the secured shares) to exercise their voting rights. An interim order may effectively prohibit completion if it is imposed before this has occurred and is deemed necessary to prevent “pre-emptive action” which could limit the ability of the Secretary of State to impose conditions on the transaction to address national security concerns if required.
If national security concerns are identified and the Secretary of State concludes that conditions should be imposed on the transaction, the conditions could include altering the amount of shares which can be acquired, or, as a last resort, prohibiting or unwinding the acquisition of control over the secured shares.
Enforcement of security over qualifying assets
The mandatory notification and “standstill” requirements of the NSI regime only apply to the acquisition of shares or voting rights. They do not apply to the acquisition of control over assets. Where lenders or third party purchasers acquire control over secured assets as a consequence of enforcement, there is therefore no risk that the acquisition of control could be automatically prohibited pending a clearance decision under the NSI regime, irrespective of which sector the assets are used in.
However, the acquisition of control over qualifying assets could nonetheless be called in for review by the Government on its own initiative, if there is a reasonable suspicion that national security concerns may arise (again, whether as a result of the acquisition of control by the lenders themselves or in the context of a subsequent sale of the secured assets). Qualifying assets for this purpose include land, tangible property and IP situated in the UK or used in connection with activities carried on in the UK or the supply of goods or services to persons in the UK.
If the acquisition is called in for review, the potential outcomes are the same as those outlined above in relation to enforcement of security over shares: (i) the Secretary of State may impose an interim order pending a final decision on clearance, which may restrict the ability of the lenders (or subsequent purchaser) to use the assets in question or require them to do particular things, or even effectively prohibit completion pending clearance; and (ii) if national security concerns are ultimately identified, conditions may be imposed to allow the acquisition to proceed, or, as a last resort, the acquisition could be prohibited or unwound.
Where there is considered to be a risk of call-in, voluntary notification should therefore be considered in the interests of certainty.
Key practical questions for lenders
There are a number of key practical questions which should be considered by lenders at an early stage, in order to assess the potential impact of the NSI regime on proposed lending arrangements, and in particular on the lenders’ ability to enforce security in the event of default:
- Does the underlying transaction potentially fall within scope of the NSI regime, and if so, should contractual mitigants be included in the finance documents?
- Could the exercise by lenders of rights in security documents or the enforcement of security by the lenders amount to a “trigger event” ie the acquisition of the requisite degree of control over a qualifying entity or qualifying assets?
- For share charges, does the company whose shares are secured carry out specified activities in the UK within one of the 17 specified sectors ie is it potentially within scope of the mandatory regime?
- Could any acquisition of control during the course of a restructuring be considered to give rise to a risk to national security (broadly interpreted)?
Availability of informal guidance
As noted above, there is currently very limited formal guidance from the Government as to the application of the NSI regime in the context of lending arrangements. We have actively encouraged the Government to provide more detail prior to commencement of the regime, and it is hoped that this may be addressed in an updated version of the Statement of Policy Intent which the Government has indicated it will publish shortly for public consultation.
In the meantime, informal guidance is available from the Investment Security Unit in relation to particular transactions (and this will continue to be available following formal commencement of the NSI regime later this year). The Government has indicated that it will aim to respond to requests for informal guidance within the 30 working day timeframe which will apply to the initial review of a notification following formal commencement of the regime. In genuinely urgent cases, it should be possible to obtain guidance more quickly, but this cannot be guaranteed.
The contents of this publication are for reference purposes only and may not be current as at the date of accessing this publication. They do not constitute legal advice and should not be relied upon as such. Specific legal advice about your specific circumstances should always be sought separately before taking any action based on this publication.
© Herbert Smith Freehills 2021