3 May 2023
Lending Focus - May 2023 – 4 of 6 Insights
On 14 March 2023, the UK House of Commons & the UK Government agreed a memorandum of understanding (the Memorandum) which details how actions taken under the National Security and Investment Act 2021 (the Act) will be overseen by Parliament.
The Investment Security Unit (ISU) was created by the Act to examine investments and acquisitions that may affect national security. The Memorandum provides that a Business, Energy and Industrial Strategy (BEIS) Select Committee will be given powers to analyse and comment on actions taken by the ISU. A subcommittee, the national security and investment subcommittee (the Subcommittee) of the BEIS Select Committee will perform this role.
In a nutshell, the Act (which came into force on 4 January 2022) allows the Government to intervene in business transactions (including, but not limited to, acquisitions and takeovers) in order to protect national security.
"National security" is intentionally not defined in the Act to afford the Government wide powers to assess any acquisition of control that it considers presents a risk in this area.
The Act applies to specified transactions or investments that involve the acquisition or control of a right or interest in a:
"Qualifying Entity" - widely defined to include any entity other than an individual, whether UK incorporated, or incorporated overseas, provided it carries on its activities in the UK or supplies goods or services in or to the UK; and/or
"Qualifying Asset" - which can include land, movable property, trade secrets, algorithms etc. and will include assets used in connection with activities carried on in the UK or the supply of goods or services to persons in the UK.
Certain events are "trigger events" under the Act (and will trigger the operation of one or more of the regimes under the Act) where they involve the acquisition of a level of control that brings the transaction within the regime, given the potential risk to national security posed by that acquisition of control. "Qualifying Acquisitions" include:
the crossing of certain thresholds in terms of a shareholding stake or voting rights in a Qualifying Entity (for example an increase above 25%)
the acquisition of voting rights that enable or prevent the passing of a class of resolution governing the affairs of the Qualifying Entity
the acquisition of material influence over a Qualifying Entity's policy
the acquisition of a right or interest in, or in relation to, a Qualifying Asset, providing the ability to use the asset or direct or control how the asset is used.
Transactions in certain sensitive sectors of the economy in which a Qualifying Entity carries on specified activities, where the transaction results in a change of control of that entity, are required to be notified to the Secretary of State by way of the mandatory notification procedure (Mandatory Notification). The transaction must be cleared before it may proceed. The Mandatory Notification procedure only applies to Qualifying Entities, and not Qualifying Assets.
The sensitive sectors of the economy have a broad reach and include AI, Military and Dual-Use Goods, Energy, Civil Nuclear, Cryptographic Authentication, Data Infrastructure and Computing Hardware. The question of whether an entity is carrying out specified activities in a sensitive sector can be difficult to determine. BEIS provided guidance in its Market Guidance Notes July 2022 to April 2023 to assist with this process.
If an acquisition which warrants a Mandatory Notification is completed without the approval of the Secretary of State, that transaction will be void and criminal and civil penalties may also be imposed.
The Government also has a "Call in" right where it reasonably suspects a change of control has occurred or will occur in any sector of the economy which has or may give rise to a national security risk.
The Government's "Call in" powers apply to a wider set of transactions and entities than the Mandatory Notification procedure - the regime is not limited to specified sectors and the power may be exercised where there has been a change of control in relation to a Qualifying Asset and/or a Qualifying Entity.
The Government has wide powers in relation to any transaction that it does "Call in". it can prohibit the transaction, unwind all or part of the transaction and/or impose conditions on it including amendments to relevant documentation.
Where a transaction is not covered by the requirement for a Mandatory Notification, the parties are not required to inform the Government, but can make a voluntary notification under the Act (a Voluntary Notification). This process may be used where the parties consider there is a risk the transaction may be subject to the exercise of the Government's "Call in" powers in the future and therefore make a Voluntary Notification in anticipation of that.
It is primarily aimed at foreign investment in the UK but is not limited in scope in this respect – UK acquirers can fall within its scope, particularly as they may have links to hostile actors based outside the UK.
There is no de minimis sum set beyond which a transaction will fall within its scope. Transactions entered into by start-ups and small entities may therefore be challenged under the Act.
It has a broad reach – covering acquisitions plus other types of transaction including investments by way of share subscription and may also be triggered by events such as the exercise of enforcement rights where they involve the acquisition of the requisite control.
We look now at how the Act may be relevant to a finance transaction where the transaction raises national security concerns:
The Government indicated, in its "National Security and Investment Act: Statement for the purposes of section 3" on 2 November 2021 that "loans, conditional acquisitions, futures and options are unlikely to pose a risk to national security and so are unlikely to be called in". A loan drafted on market standard terms is unlikely to be subject to the regime, however the following may present an issue:
a loan containing unusual provisions relating to the acquisition of material influence by the lender
a loan provided for the purpose of the acquisition of a target entity which is a Qualifying Entity (and thus requires a Mandatory Notification) or of a property or other asset which is a Qualifying Asset (and thus may be subject to the exercise of a "Call in").
Certain rights afforded to the lender under any security entered into by it in connection with a financing may result in a trigger event:
Asset security – If a change of control takes place in relation to a Qualifying Asset, the Government may be permitted to exercise its "Call in" rights: lenders are typically not given the right to direct or control the asset at the time of taking the security, but where the asset is or could be used in connection with a sensitive activity in a sensitive sector, or is a sensitive site or proximate to a sensitive site, any assumption of the requisite control (for example on enforcement) by the lender over such asset will be at high risk of being subject to a Call in.
BEIS has advised, in its Market Guidance Notes July 2022 to April 2023 that "whilst the grant of a security over shares could create an equitable interest in such shares, such an interest would not appear to grant any control over the shares, as referred to section 8(1) of the [Act] until the happening of an event that would provide control". If legal title is transferred or control passes in some other way, a notifiable acquisition may however take place. It is unusual for a legal mortgage to be taken in this jurisdiction, but the impact of the Act should be considered where such security is taken and on the enforcement of rights in relation to the shares which may involve the requisite assumption of control.
Voting rights in share security: where security is taken over shares in a Qualifying Entity and the lender exercises voting rights, this may involve an acquisition under the Act (where the relevant control thresholds set by the Act are met). In a transaction in relation to which the Act may be relevant, where share security is being taken, and wording providing for the automatic vesting of voting rights is included in the charging document (as is usual), wording should be included in the voting rights clause to avoid an acquisition of control under the Act as a result of the lender automatically assuming those rights on the occurrence of an event of default or acceleration.
The executive is considered to be the organ with the greatest ability to determine whether an activity presents a risk to national security and is therefore given the powers to do so.
The courts are given powers of judicial review in relation to decisions taken by the Government under the Act but the time limit applicable to such challenges is shortened – claims will need to be brought not more than 28 days after the grounds to make the claim arose unless the courts give permission for the claim to be brought after the expiry of that time limit.
Between the Act coming into force and the signing of the Memorandum, a BEIS Committee has conducted two public evidence sessions plus private briefings and correspondence with the Government and experts.
The Memorandum (although non-legally binding and which will be discussed and renewed upon each formation of a new Government) is intended to provide clarity as to how the Government's actions under the Act will be supervised/scrutinised without undermining the (likely confidential) nature of information revealed by such scrutiny. A balancing act needs to be undertaken between transparency in the interests of the public on the one hand matters of national security on the other and there is no one size fits all solution.
The process will be as follows:
The Subcommittee will request information from the Secretary of State.
The Secretary of State will provide the requested information but it will not (other than in an exceptional circumstances) include any information that relates to national security or is commercially sensitive. This is in line with principles that prevent sensitive information being shared other than on a strict "need to know" basis.
The Subcommittee will report on actions taken by the Government in a broad report, which will, given the limitations in the information provided by the Secretary of State, not (1) contain commercially sensitive information; (2) contain information that is sensitive in terms of national security nor (3) comment on individual cases.
The report will only be published by the BEIS Select Committee with Cabinet approval.
Individual cases: in exceptional circumstances, when information is requested on individual cases, a broad summary of the requested case and the relevant risk factors that have been considered may be provided. This will not include any sensitive information. Any information on an individual case will only be granted to the Subcommittee on completed cases, once a final order (ie the restriction/blocking/unwinding) has been made and any time for appeal has passed.
Given the nature of the secrecy required in this area, the reports published will be heavily redacted and will contain information in aggregate format, as opposed to naming parties.
In certain (and exceptionally rare) cases, information may be provided only to the chair of the Subcommittee on terms equivalent to the Privy Council or through notification under the Official Secrets Act 1989. The chair would then be able to make an informed decision but would not be able to disclose any of the information that led to that decision being made.
The Secretary of State can withhold any information following any request, provided a rationale is provided as to why such information has been withheld.
Before any report is published, it must pass through a number of drafts whereby the Secretary of State will review the wording/redacting and may comment on it – the Secretary of State can reply with factual corrections but will not seek to alter the tone of the report or the conclusions drawn.
The aim of seeking to protect the investment screening process from any actual or perceived political influence is laudable, given the balance between the national security interests the Act is seeking to protect and the commercial rights of parties seeking to transact in sectors which may be covered by the Act, where there is in fact very little likelihood of their actions posing a threat to national security.
It is unclear at this stage whether the higher degree of scrutiny in relation to the Act will have an impact on finance transactions, and indeed generally. There are limitations to the process:
It will only be available once a transaction has completed (unless otherwise agreed between the Subcommittee and the Government) - this limitation to completed transactions rather than those that are currently being investigated is, as confirmed in a news article dated 23 March 2023 detailing the Subcommittee's responses to FAQs "consistent with the approach of international counterparts that have had equivalent scrutiny regimes in force for some time, such as the United States, and where it has provided confidence that decisions have not been politicised."
The far-reaching limitations on the information that may be shared with the Subcommittee may limit the effectiveness of its review to more procedural matters.
It is hoped that the existence and exercise of the review process may result in greater clarity on aspects of the Act that those entering into finance transactions may find difficult to navigate, for example the approach that should be taken to the making of a voluntary notification, given the broad circumstances in which the Government's exercise of "Call in" powers may be exercised. The Government's statutory statement assists when considering whether a transaction may be called in, but it is impossible to predict with any certainty when a Government will exercise a "Call in" right and therefore when a voluntary notification may be advisable, particularly in acquisition financing transactions or where the loan agreement contains unusual provisions which may make it susceptible to a "Call in". Any further clarity in relation to the potential exercise of "Call in" rights in relation to lending transactions would be welcomed!
In terms of the mandatory notification procedure, the Government's market guidance on the operation of the regime, updated on 27 April 2023 is helpful, as the Government can be contacted for a view if there is significant uncertainty on whether an acquisition is notifiable under the mandatory notification regime. The Government will not comment on hypothetical scenarios nor give a substantive response where this is not possible or appropriate, but in other circumstances, this is a very helpful development.
Find out more
To discuss the issues raised in this article in more detail, please contact a member of our Banking and Finance team.
3 May 2023
3 May 2023
by Nick Moser
3 May 2023
3 May 2023
3 May 2023
by Annie Harvey
3 May 2023