"Even deals being negotiated now – in advance of the law coming into force - may be subject to a claw-back review up to five years later."
If passed by Parliament, the Bill will introduce for the first time a distinct regime and standalone powers relating to the review of foreign direct investment in the UK, replacing the existing merger control rules dealing with national security.
Penalties and the challenges of compliance
Nearly one third of the Bill as presented to Parliament (21 out of 66 clauses) relates to penalties for companies and individuals for failure to notify, and far-reaching enforcement powers. This is a surprisingly high proportion and indicates the seriousness of the Government’s intent. Individuals face prison sentences of up to five years for failing to comply with mandatory notification obligations, while their businesses could be fined up to 5% of worldwide group turnover or £10m, whichever is the higher.
In the context of those penalties, the new law presents a double challenge: first, from now on – even before the Bill becomes law – to plan and timetable deals (involving both acquisitions of businesses as well as of assets) in compliance with the requirements of the new law; and second, to comply with the requirements of investigations by the Secretary of State using information gathering or witness compulsion powers.
These challenges are aggravated because the Bill does not define national security risk, nor the basis on which the Secretary of State – in effect, the new regulator – will decide. The 17 sectors proposed to be subject to mandatory notification are defined not in the proposed law but in proposed secondary legislation, to which a lower level of Parliamentary scrutiny applies, and which can be changed more easily. There is no safe harbour: in principle, any person, UK or otherwise, making an acquisition of a “qualifying entity” could be within scope until the Government defines classes of exempt acquirers.
The new regime has a pronounced political aspect: the new regulator is the Secretary of State, rather than the independent non-ministerial regulators, such as the Competition and Markets Authority, Ofgem, CAA, ORR etc. Appeals on major decisions (e.g. to intervene in a transaction) will be restricted to judicial review, with all the limitations on scrutiny that implies.
"Nearly one third of the Bill as presented to Parliament (21 out of 66 clauses) relates to penalties for companies and individuals for failure to notify, and far-reaching enforcement powers."
Wide scope of compulsory notification
The new law creates two tiers of regulation. The first tier applies across the economy and creates a call-in power where trigger events occur. The second tier applies to a subset of the economy and to an overlapping set of trigger events.
Trigger events and “control”
A trigger event occurs when a person (wherever from – not just overseas) gains control either of a “qualifying entity” or a “qualifying asset”. A qualifying entity is any entity, whether or not a legal person, that is not an individual, and includes a company, LLP, any other body corporate, a partnership, an unincorporated association and a trust. A qualifying asset can be land, tangible (in Scotland – corporeal) moveable property, or ideas, information or techniques which have industrial, commercial or other economic value, and may include trade secrets, databases, source code, algorithms, formulae, designs, plans, drawings and specifications, and software.
The definition of Control has four parts:
1. Increase in shareholding:
a) From 25% or less to more than 25%;
b) From 50% or less to more than 50%; or
c) From less than 75% to 75% or more.
2. Increase in voting rights:
a) From 25% or less to more than 25%;
b) From 50% or less to more than 50%; or
c) From less than 75% to 75% or more.
3. Blocking rights: where 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. Material influence: where 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, unless the person already holds such an interest or right.
"Following receipt of a notification, the Secretary of State will have up to 30 working days to decide whether to investigate possible national security concerns (i.e. to ‘call-in’ the transaction)."
Limitation rules on exercise of call-in power
The Secretary of State’s exercise of the call-in power is subject to limitation rules whose exercise depends on when the relevant trigger event took place.
If the trigger event took place any time between 12 November 2020 and the day before the law takes effect (commencement day), the limitation period is six months, where the Secretary of State became aware of the trigger event before commencement day, and if the Secretary of State became aware of the trigger event on or after commencement day, the limitation period is six months beginning on the day when the Secretary of State became aware of the trigger event and may not be given after the end of five years beginning with commencement day.
If the trigger event takes place after commencement day, the limitation period is six months beginning with the day on which the Secretary of State became aware of the trigger event, and may not be given after the end of five years beginning with the day on which the trigger event took place.
Second tier of mandatory notification
In addition to this first tier, there is a second tier of regulation that applies to a sub-set of the economy, and an overlapping set of trigger events. Where the transaction falls into this second tier, it will be called a “notifiable acquisition” which must, from commencement day, be notified to the Secretary of State: by contrast, a transaction that is subject only to the first tier is not subject to mandatory notification but the parties may make a voluntary notification.
Notifiable acquisitions relate to the acquisition of qualifying entities, and not qualifying assets; attach to the first three trigger events (relating to shareholdings, voting rights and blocking rights but not material influence); and also relate to an additional, lower threshold for notifiability: the acquisition of a right or interest in or in relation to a qualifying entity and as a result the percentage of the shares or voting rights that are held increases from less than 15% to more than 15%.
They also relate to economic sectors to be defined by statutory instrument.
Review timetable
Following receipt of a notification, the Secretary of State will have up to 30 working days to decide whether to investigate possible national security concerns (i.e. to ‘call-in’ the transaction). Once the transaction has been called in (whether it was notified or not), the Government has up to 30 working days to undertake a detailed national security assessment of the transaction. This period can be extended by 45 working days, and possibly longer where agreed with the acquirer.
The new law will allow the Government to intervene in and impose remedies on a much wider array of deals than it can today.
Remedies
The Government will be able to impose remedies to address national security risks, including orders requiring certain actions to be taken by relevant parties or, as a last resort, blocking or unwinding the deal. Possible conditions that may be imposed appear similar to undertakings that have been offered under the existing regime (where the Government can intervene only on specified public interest grounds under the Enterprise Act 2002), such as altering the level of shareholding an investor is allowed to acquire, restricting access to commercial information, or controlling access to certain operational sites or works.
Sectoral targets in the energy and transport sectors
The Government’s consultation on the 17 sectors is notable for the breadth of potential transactions and entities likely to be subject to mandatory notification. Note that the precise definitions (included verbatim for the energy and transport sectors below) is likely to change following consultation.
"The energy scope targets oil, gas and petroleum, as well as electricity generation, transmission, interconnection, distribution and supply. A large number of entities are likely to be within scope."
Energy
The energy scope targets oil, gas and petroleum, as well as electricity generation, transmission, interconnection, distribution and supply. A large number of entities are likely to be within scope:
- An entity involved in the ownership and operation of:
a) terminals, upstream petroleum pipelines and infrastructure which forms part of a petroleum production project, with a throughput of greater than 3,000,000 tonnes of oil equivalent per year;
b) infrastructure (such as import jetties) which forms part of a gas importation and storage project which, if at maximum capacity, could output 20 million cubic meters of gas per day for at least 50 days, where: “gas” has the same meaning as in section 2 of the Energy Act 2008; “gas importation and storage project” means a project carried out by virtue of a licence granted under section 4 of the Energy Act 2008;
c) “petroleum”, “petroleum production project”, “terminal”, and “upstream petroleum pipeline” have the same meaning as in section 90 of the Energy Act 2011 and “tonne of oil equivalent” is a unit of energy defined as the amount of energy released by burning one tonne of crude oil.
d) Energy distribution and transmission networks that deliver secure, reliable electricity and gas to customers, ensuring continued supply as far as possible in the supply chain;
e) Energy suppliers that provide energy to significant customer bases, where “significant customer bases” means 250,000 or more final customers;
f) Gas and electricity interconnectors, long range gas storage and Gas Reception Terminals, including Liquefied Natural Gas that contributes to the security of supply;
g) Electricity undertakings that:
i) carry out the function of supply; or
ii) carry out the function of generation via individual generators that would have a total capacity, in terms of input to a transmission system, greater than or equal to 100 megawatts; or
iii) carry out the function of generation via generators that, when cumulated with the generators of affiliated undertakings, would have a total capacity, in terms of input to a transmission system, greater than or equal to two gigawatts.
"The transport sector definition relates only to maritime ports and airports as well as air traffic control services, and the threshold is low, and consequently many ports and a significant number of UK airports are within scope."
Transport
The transport sector definition relates only to maritime ports and airports as well as air traffic control services, and the threshold is low, and consequently many ports and a significant number of UK airports are within scope. The Proposed definition is as follows.
- An entity which owns or operates a maritime port or harbour which handles at least 1 million tonnes of cargo annually in the most recent relevant year for which the Annual Port Freight Statistics records are published by the Department for Transport, Category 1 goods as listed in paragraph (2.c) or vessels capable of carrying at least 12 passengers. Within such maritime ports or harbours, a company which owns and operates terminals, wharves or other port related infrastructure except where that company does not handle Category 1 goods.
- In paragraph 1:
a) “entity” may include a private company, a Board governing a Trust port or a port owned by a local authority.
b) “operates” means to control the functioning of a machine, process or system.
c) “harbour” includes estuaries, navigable rivers, piers, jetties and other works in or at which ships can obtain shelter or ship and unship goods or passengers, in accordance with s313 of the Merchant Shipping Act 1995.
d) “Category 1 goods” are:
i) Human Medicines, covering Prescription-only, Pharmacy and General Sales List Medicines, clinical trials and children’s vitamins (for import and export)
ii) Medical Devices and Clinical Consumables (for import and export)
iii) Vaccines (for import only)
iv) Nutritional Specialist Feeds, including Infant Milk Formula (for import only)
v) Biological materials such as blood, organs, tissues and cells (for import only)
vi) All Veterinary Medicines authorised under the Veterinary Medicines Regulation 2013, including finished and un-finished products, and Active Pharmaceutical Ingredients (for import and export)
vii) It also includes unauthorised medicines permitted for import under the Veterinary Medicines Directorate’s Special Import Scheme (for import only).
viii) Critical food chain dependencies, e.g. chemicals and key additives used within the food supply chain (for import only as required).
ix) Chemicals for water purification and treatment (for import only as required).
x) Critical spare parts for the energy sector (for import only as required).
xi) Items required for Military or National Security purposes (for import or export as required).
- An entity which owns or operates an airport in the United Kingdom which handled at least six million passenger movements or 100,000 tonnes of freight annually in the most recent relevant year for which records are published by the Civil Aviation Authority.
- An entity which provides en route air traffic control services or which owns such a provider.
- In paragraph (3):
a) “airport has the meaning set out in section 66 of the Civil Aviation Act 2012;
b) “freight” means goods transported in bulk in passenger aircraft or aircraft used for the transportation of cargo only;
c) the owners of an airport are:
i) a company which owns the airport (“C”);
ii) any holding company of C (“H”); and
iii) any parent company of C or H;
d) the “operator” of an airport is the entity with overall responsibility for its management;
e) “relevant year” means 2018 or such later year as may be specified in regulations made by the Secretary of State.
- In paragraph (4):
a) “en route air traffic control services” mean services provided pursuant to a licence under section 6 of the Transport Act 2000;
b) the owners of an en route air services traffic provider are:
i) a company which owns such a provider (“C”);
ii) any holding company of C (“H”);
iii) any parent company of C or H.
"This mandatory notification procedure in particular will increase the regulatory and compliance burden on affected businesses, given the low trigger event thresholds."
Substantive analysis of national security risks
The new law will allow the Government to intervene in and impose remedies on a much wider array of deals than it can today. The detail of how the Government will decide which deals to intervene in has still to be developed, in other words, what sort of national security risk is at issue. There is some guidance on this. In its consultation, the Government indicates a “number of risks from nefarious investment” including “an enhanced ability to undertake espionage in the sector, targeting intellectual property, identifying vulnerabilities in our systems, and accessing other sensitive information, which could harm the safety and effectiveness of the transport system.” It goes on: “[t]here are risks around an ability to undertake disruptive or destructive actions which could harm security, such as the denial or degrading of key services or supply lines which could compromise our critical national infrastructure. This could endanger lives through creating problems in the movements of critical goods or compromising passenger safety and undermine public trust in a safe transport network.”
The challenge will be to understand whether a given acquirer raises national security concerns. The test explained by the Government’s “Statement of policy intent” is whether a party has the practical ability to use an acquisition to undermine national security. It states further: “the Secretary of State recognises that even thorough commercial due diligence will not necessarily capture national security concerns. Therefore, detailed assessments will be the responsibility of the Secretary of State.”
In doing that detailed assessment, the Secretary of State will consider those in ultimate control of the acquiring entity; the track record of those people in relation to other acquisitions or holdings; whether the acquirer is in control of other entities within a sector or owns significant holdings within a core area; or any relevant criminal offences or known affiliations of any parties directly involved in the transaction. The intent is to consider an entity’s affiliations to hostile parties, rather than a relationship with foreign states. This is where business policy and foreign policy come together, and it may be difficult for parties in many deals to reach a safe conclusion on the national security risks in advance of its scrutiny by government.
"Early consideration of foreign investment review in transaction planning is essential."
Conclusion
The proposed new regime is broad, and introduces – for the first time in the UK – a mandatory notification procedure for transactions in a wide range of sectors. This mandatory notification procedure in particular will increase the regulatory and compliance burden on affected businesses, given the low trigger event thresholds.
Aside from the burden imposed on companies investing in the UK the new law will also increase the personal liability of directors and corporate risk. In planning an acquisition that is or may be in scope of the new rules, careful attention must be given to the risks of intervention, and the risks inherent in dealing with (giving evidence to) a politically-influenced regime backed by strong investigative and criminal penalties. Careful engagement with the Government, including very close attention to any evidence provided to an investigation, as well as to the creation and retention of corporate documents will be essential. Therefore, early consideration of foreign investment review in transaction planning is similarly essential: it maximises the chances of a shorter review period and an acceptable outcome, and it reduces the risk of non-compliance.
This article was authored by Jeremy Robinson, a former regulatory and public law partner in our London office.
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