Introduction
The defence industry operates within a complex regulatory and commercial landscape that requires careful navigation of multiple interconnected considerations; from establishing effective routes to market and managing stringent export control requirements, to addressing unique corporate governance challenges and banking complexities.
This overview examines the key operational and compliance aspects that defence companies encounter when bringing products to market and structuring their businesses for growth.
Route to market
The routes to market are not dissimilar to other manufacturing and hardware-based businesses. Many defence companies will adopt a combination of the following:
- Primary sales: the company manufactures the products in a specific country (potentially via a local subsidiary) and supplies the products either: (i) direct to governments (or their military) if a direct sale is permitted; or (ii) to local subsidiaries wholly owned by the company, where sales to governments need to be from a local entity or where the specific contract contains so-called offset requirements mandating local manufacture.
- Distribution/finishing: the company manufactures the products in a specific country (potentially via a local subsidiary) and supplies the product to a distributer (which, in some cases, may be a big prime). Unfinished products may also be sold to a third party for finishing, prior to onward sale by that third party.
- Joint ventures: the company enters into a corporate or commercial joint venture arrangement with another entity (in a different jurisdiction if necessary), with both parties contributing any or all of expertise, know-how, IP and/or manufacturing capability.
- Licencing arrangements: the company licences the IP for the product to a third party for manufacture manufacturer.
Export control considerations
The UK places controls on trade in strategic goods, software, and technology (including military and dual-use items). The controls imposed by the UK are set out in regulations and subordinate legislation and give effect to the UK's international and multilateral commitments on transfers and trade in military and dual-use items, including under the framework of the Australia Group and Wassenaar Arrangement, and the UK's national and strategic policy objectives.
Goods, software, and technology that have both civil and military uses are considered to be 'dualuse' items. The goods, software, and technology that the UK considers to be 'military' for the purposes of its controls are those listed in Schedule 2 to the Export Control Order 2008 (known as the UK Military List). An item is considered to be 'military' if it exceeds the thresholds for control set out in the UK Military List. Not all military items are required to be specially designed or modified for military use.
The controls can capture both the transfer of IP (as controlled technology) and software, as well as physical components and equipment and apply regardless of whether the transfers from the UK are intragroup or to third parties
In addition to these export controls, the UK imposes additional trade controls on the involvement of UK persons in the trade of military goods from one third country to another third country. These trade controls are sometimes referred to as brokering controls.
The UK prepublishes open general licences that may be used by all exporters without a formal application, provided that the exporter registers its use of the general licence before export and meets the conditions set out in the licence. Where no open licence is available for a particular export, an exporter will need to apply for an individual licences, which are exporter specific.
Given the similar international and multilateral commitments in relation to export controls and trade controls (and the UK's historic membership of the EU) there is a broad alignment of export control and trade control regimes for both military goods and dual-use goods between the UK and EU, and EU members states have similar controls in place to the UK. However, there are still some differences in design (in particular for military items) and how the regimes are applied in practice, and local legal advice is essential. Beyond the EU, there are broad similarities with the US, and other states that are members of the Wassenaar Arrangement, though again there are differences and local advice is essential. The US regime for military items (The International Traffic in Arms Regulations) is particularly complex and significantly wider-ranging than equivalent regimes in the UK and elsewhere in the EU.
Corporate governance
Due to the nature of the industry, shareholders, investors and directors are often sensitive about their information being made available publicly. Whilst certain personal information can be withheld from public view at Companies House under existing English law (eg residential addresses), the names, dates of birth and nationalities of directors and persons with significant control are visible from the public register. There are limited circumstances (for example, where an individual's personal safety is at risk) where identifying information may be removed from the public register – however, the process for doing so can be lengthy. It is understood that the UK government is intending to legislate to allow greater protection for individuals at personal risk of harm – but any new legislation will take some time to pass, and so no changes are forthcoming in the immediate term.
One solution sometimes adopted by defence companies is to adopt a smaller board of directors, who leverage the knowledge and experience of the members of an advisory board. Whilst the members of the advisory board are not directors and therefore have no authority to act on behalf of the company, the structure does allow more flexibility in terms of appointments.
Bank accounts
Despite investment into defence companies (including newly formed defence companies with an ambition to scale rapidly) is on the increase, the ability of defence companies to obtain banking facilities (which are obviously key in terms of the ability to receive funding) can be slow due to the need to comply with enhanced KYC and customer due diligence processes. This is particularly acute if any of the founders or statutory directors are politically exposed individuals.
These timing considerations need to be factored into the investment process from the outset. Certain banks are able to move more quickly depending on internal appetite, and so it is worth consulting your advisors in advance.
Conclusion
Successfully operating in the defence sector requires a comprehensive understanding of the multifaceted challenges that span commercial, regulatory, and operational domains. Given the intricate nature of these requirements and the variations between jurisdictions, obtaining specialist legal and commercial advice is essential for defence companies seeking to navigate this complex landscape effectively.
Early planning is particularly crucial when considering the extended timelines often associated with regulatory compliance and banking arrangements in this sector.
At Taylor Wessing, we are proud to advise many of the companies and investors driving this transformation - from early-stage innovators to global primes - and to support the legal, regulatory and strategic needs of those leading the future of defence.
