Application of the U.K.’s National Security and Investment Act to M&A Transactions

Although the U.K.’s National Security and Investment Act 2021 (NSI Act), which sets out the U.K.’s new national security investment screening framework, received Royal Assent on April 29, 2021, the vast majority of the NSI Act’s provisions, including the U.K. government’s call-in power and the obligation on acquirers to make a mandatory notification in certain circumstances, will only enter into force at the beginning of next year on January 4, 2022. Ahead of this key date, we further examine the key trigger events set out in the NSI Act and the ways in which they may catch different types of M&A and other investment transactions.

Trigger Events

The new screening framework will apply to transactions involving both entities and assets and the trigger events for each category of investment target are distinct.

A “qualifying entity” includes any entity whatsoever that is not an individual, regardless of whether it is a legal person. It includes a company, a limited liability partnership, any other body corporate, a partnership, an unincorporated association and a trust. Entities formed or recognised under the laws of a country or territory outside the U.K. will not constitute qualifying entities provided they (a) do not carry on activities in the U.K., and (b) do not supply goods or services to persons in the U.K.

For qualifying entities, a trigger event will occur where a person gains control of that entity by (1) acquiring a right or interest in, or in relation to, the entity and, as a result, (2) one of the four cases below arises:

1. The percentage of shares that person holds in the entity increases:
   1. from 25% or less to more than 25%
   2. from 50% or less to more than 50, or
   3. from less than 75% to 75% or more
2. The percentage of the voting rights that person holds in the entity increases:
   1. from 25% or less to more than 25%
   2. from 50% or less to more than 50%, or
   3. from less than 75% to 75% or more
3. The acquisition is of voting rights in the entity that (whether alone or together with other voting rights held by the person) enable the person to secure or prevent the passage of any class of resolution governing the affairs of the entity.
4. The acquisition, whether alone or together with other interests or rights held by the person, enables the person materially to influence the policy of the entity.

A “qualifying asset” is any of (a) land, (b) tangible moveable property, and (c) “ideas, information or techniques which have industrial, commercial or other economic value.” The NSI Act gives specific examples of assets falling within (c), which include trade secrets, databases, source code, algorithms, formulae, designs, plans, drawings and specifications and software.

A trigger event in respect of a qualifying asset will occur where a person gains control of that asset by (1) acquiring a right or interest in or in relation to that asset and, as a result, (2) that person is able to either:

1. Use the asset or use it to a greater extent than prior to the acquisition.
2. Direct or control how the asset is used, or direct or control how it is used to a greater extent than prior to the acquisition.

What constitutes “acquiring a right or interest in”?

The question which naturally arises (and which is clearly of importance to prospective acquirers from the U.S. and other jurisdictions) is what exactly constitutes “acquiring a right or interest in” a qualifying entity or a qualifying asset. Prospective acquirers need to be clear on this point to determine both whether a trigger event has taken place and, if so, whether it is therefore obliged to notify the prospective acquisition under Section 14 of the NSI Act (if the activities of the qualifying entity fall within one or more of the 17 critical sectors of the economy identified by the U.K. government¹) and/or whether the trigger event gives rise to a risk to national security under Section 1 of the NSI Act.

Schedule 1 of the NSI Act sets out a comprehensive list of circumstances in which a person will be held to hold or acquire a right or interest. We have selected certain circumstances which are more commonly seen in M&A transactions.

1. Indirect Holdings: Any interest or right held indirectly by a person will be deemed to be held by that person. This has two important implications for prospective acquirers:
   1. Prospective acquirers cannot avoid the application of the screening framework by using a locally incorporated (i.e. U.K.-incorporated) vehicle to purchase the target entity or asset.
      
      For example, if a U.S. company (A) proposes to acquire or invest in a U.K. target (B) using a U.K. investment vehicle (C) which A wholly owns, A will be deemed to hold the relevant interests and rights held by C in B under this provision.
      
      
   2. U.S. (or other non-U.K.) target deals may be subject to the U.K.’s screening framework where that U.S. (or non-U.K.) target has a U.K. subsidiary or U.K.-based asset.
      
      For example, suppose a U.S. target (A) has a wholly owned Luxembourg subsidiary (B), which in turn wholly owns a U.K. operating company. A Chinese company (C) proposes to acquire 51% of A using a wholly owned U.S. acquisition vehicle. In this situation, upon the acquisition, C would be deemed to hold the rights and interests which B owns in the U.K. operating company. Accordingly, this would constitute a trigger event under the NSI Act and the investment would need to be assessed by C to determine whether a notification is necessary or would be prudent. If a notification were required (or prudent), the transaction and transaction documentation would need to be structured to reflect this.
   As indicated from the example above, the concept of “indirectly” owning an interest or right extends beyond wholly owned subsidiaries. A person will be deemed to hold an interest or right “indirectly” if that person has a “majority stake” in an entity and that entity fulfils one of the following conditions:
   
   • Holds the interest or right, or
   • Is part of a chain of entities:
     • each of which (other than the last) has a majority stake in the entity immediately below it in the chain, and
     • the last of which holds the interest or right.
   “Majority stake” means (1) holding a majority of voting rights, (2) being a member of the entity and having the right to appoint or remove a majority of the board of directors of that entity, (3) being a member of the entity and controlling alone, or pursuant to an agreement with other shareholders or members, a majority of the voting rights of that entity, or (4) having the right to exercise, or actually exercising, dominant influence or control.
2. Nominee Interests, Joint Arrangements and Common Purposes: Unsurprisingly, where an interest or right is acquired by a nominee on behalf of a prospective acquirer, the interest or right will be deemed to be held by the prospective acquirer and not the nominee. More interestingly, where interests and rights are held by persons subject to a joint arrangement or merely a common purpose, each party to the joint arrangement (or each party which shares the common purpose) will be deemed to hold the combined interest or rights. For qualifying entities, a “common purpose” includes cases in which the persons “co-ordinate their influence on the activities, operations, governance or strategy of the entity.” For qualifying assets, a “common purpose” includes cases in which the persons “co-ordinate their influence on the way in which the asset is used.”
   
   For example, it may be that a consortium of three prospective acquirers propose to each invest in a U.K. target such that, following the acquisition, they will each hold 10% of the shares and voting rights in the U.K. target. However, as part of the consortium arrangement (whether formally by written agreement or merely by way of an informal understanding as to a common goal), the parties agree to exercise their rights as shareholders in the U.K. target jointly or in coordination. In this situation, even though individually none of the prospective acquirer’s investments meet the threshold of a trigger event, the fact that there is a joint arrangement in place and/or a shared common purpose means that each prospective acquirer will be deemed to hold 30% of the shares and voting rights in the UK target. Accordingly, notifications in respect of each prospective acquirer would potentially be required.
3. Rights Exercisable Only in Certain Circumstances: Rights or interests that are exercisable only in certain circumstances will be deemed to be held only (a) “when the circumstances have arisen and for so long as they continue,” or (b) “when the circumstances are within the control of the person.” Accordingly, prospective acquirers (and also target companies) should appreciate that while an investment may not immediately meet the threshold of a trigger event when made, the circumstances and terms associated with the investment may, at a later date, constitute a trigger event in respect of which the national security risk needs to be evaluated and/or a notification is mandated.
   
   For example, suppose an Emirati private equity fund makes an investment into a U.K. target in consideration for a 20% shareholding. Of itself, this may not constitute a trigger event. However, under the terms of the investment agreement or in the articles of association of the U.K. target, the private equity fund may be entitled to exercise additional rights where a “swamping event” exists (e.g. if EBITDA or the net asset value of the U.K. target for the previous 12-month period falls below certain thresholds, or if a founder leaves). Where a swamping event exists, it is usual for a private equity fund to have rights such as appointing any number of directors it deems necessary and/or requiring all or certain other shareholders to vote in accordance with it at any shareholders’ meeting. In this situation, a trigger event would occur simultaneously with the swamping event because the private equity fund would be deemed to hold those swamping event rights in that event, regardless of whether it actually exercises them. Somewhat helpfully, however, the NSI Act excludes rights exercisable by an administrator or by creditors from the scope of the scope of this provision where the target entity is in “relevant insolvency proceedings.”
4. Connected Persons: Predictably, two or more persons who are connected with each other are each deemed to hold the combined rights and interests of the connected persons collectively.
   1. Undertakings: Two or more undertakings will be connected if they are “group undertakings”. This means that an undertaking (A) will be connected with another undertaking (B) where B is a parent or subsidiary of A or where B is a subsidiary of any parent of A (i.e., A and B are “sister” companies).
   2. Individuals: Where a prospective acquirer is an individual, two individuals will be connected where they are spouses, civil partners, cohabitees or relatives of each other, or where one is the spouse, civil partner or cohabitee of a relative of the other, or where one is a relative of the other’s spouse, civil partner or cohabitee, or where one is the spouse, civil partner or cohabitee of a relative of the other’s spouse, civil partner or cohabitee. “Relative” means a brother, sister, uncle, aunt, nephew, niece, or lineal ancestor or descendant.
   Unusually, the provisions on connected persons do not provide that undertakings and individuals can be connected with each other.

Conclusion

The foreign investment screening regime established under the NSI Act has the potential to affect not just the acquisition of U.K. target companies or U.K.-based assets. The concept of control under the NSI Act — the holding of a right or interest in an entity or asset — is widely drafted. Prospective acquirers must be alert to:

1. U.S. (or other non-U.K.) target deals being subject to the U.K.’s screening framework where that U.S. (or non-U.K.) target has a U.K. subsidiary or U.K.-based asset.
2. the relationships and arrangements between prospective acquirers, particularly on consortium deals and multiple-party joint ventures.
3. post-investment, whether circumstances have or may arise that may constitute trigger events.

Criminal and civil liability — up to five years’ imprisonment and/or an unlimited fine — can result from a failure to make a mandatory notification where required. From a commercial perspective, the power for the U.K. government to review (and potentially unravel) a completed transaction within six months of it becoming aware of the trigger event (provided this is within five years of when the trigger event took place) means that this analysis is not something which prospective acquirers can afford to overlook.