England: The National Security & Investment Act 2021: Impact on Finance Transactions

The new regime

Key legislation entered into full force on 4 January 2022, with the potential to affect finance transactions.

The National Security and Investment Act 2021 (NSI Act) introduces to the UK a new investment screening regime, which requires that certain types of transaction are notified to, and cleared by the Secretary of State for Business, Energy and Industrial Strategy (the SoS) prior to completion.

Transactions subject to this mandatory notification requirement involve the acquisition of "control" in a business undertaking defined activities in seventeen specific areas of the UK economy that are deemed "high risk" from a national security perspective.

The SoS also has the power to call-in relevant transactions for review on the grounds that they have or could give rise to a risk to national security. With this in mind, parties may opt to notify transactions voluntarily to the SoS, in order to seek prior clearance before completing a given transaction.

Where the SoS reviews a transaction, it can proceed to make such orders as it considers necessary and proportionate in order to prevent, remedy or mitigate a risk to national security. These powers are extensive, and could include the imposition of conditions upon a given transaction, or a transaction ultimately being prohibited in its entirety.

In addition, if the mandatory notification requirement applies and is breached (e.g. the acquirer completes without clearance), this results in:

• the transaction being legally void (although retrospective validation from the SoS could be sought);
• officers of the acquirer (e.g. directors) who consented to, or neglected to prevent the breach, facing the risk of criminal prosecution, or civil penalties; and
• the acquirer itself (i.e. the acquiring business) facing the risk of a civil penalty in relation to the breach of up to the higher of £10 million, or 5% of the acquirer's worldwide turnover (including the turnover of businesses owned or controlled by the acquirer).

Given the potential impact of any such measures on a borrower's business and ability to repay its debt funding, as well as the lender's security (e.g. if the transaction is legally void), it will be important for all parties to be aware of the risks arising under the NSI Act from the outset.

While the number of finance transactions impacted by the NSI Act is expected to be low, the broad application of the regime, and the extent of the available powers, means that it has the potential to impact finance transactions in a number of ways.

We consider these in our article below, exploring:

• Which powers of the SoS could affect finance transactions?
• Which finance transactions could be affected by the NSI Act?
• Recommendations

Which powers of the SoS could affect finance transactions?

Finance transactions could be affected by either the mandatory notification requirement or the SoS's call-in powers.

Mandatory notification requirement

The mandatory notification requirement, and the need to obtain clearance prior to completion, applies to transactions where:

• a party acquires a right or interest in, or in relation to, a corporate entity which is either:
  • a UK entity (e.g. a UK registered company); or
  • an entity formed or incorporated outside of the UK but which carries on activities in the UK, and/or supplies goods and/or services in the UK (each a "Qualifying Entity"); and
• the level of "control" to be acquired in the Qualifying Entity satisfies any of the following thresholds:
  • the acquirer's shareholding (or equivalent), or voting rights, in the Qualifying Entity will increase from:
    • 25% (or less) - to more than 25%;
    • 50% (or less) - to more than 50%;
    • less than 75% - to 75% or more; or
  • the acquirer's voting rights in the Qualifying Entity will enable it to pass or block resolutions governing the affairs of the entity; and
• the Qualifying Entity undertakes defined activities in the UK ("Notifiable Activities") in one or more of seventeen high risk areas of the UK economy identified by the Government.^[1] The scope of the Notifiable Activities are defined within The National Security and Investment Act 2021 (Notifiable Acquisition) (Specification of Qualifying Entities) Regulations 2021 (the "Notifiable Acquisition Regulations"), and a broader overview of the Notifiable Activities is provided within accompanying guidance issued by the Department of Business, Energy and Industrial Strategy.

The Notifiable Activities can be amended as the Government considers appropriate for the purpose of ensuring that the mandatory notification requirement applies to those areas of the UK economy where national security risks are expected to arise.

The call-in power

The call-in power enables the SoS to call-in and review qualifying transactions (before or after completion) where there is an acquisition of "control" in relation to a Qualifying Entity, or certain assets, and this acquisition has, or could give rise to, risks to national security.

Notably, in addition to the levels of "control" outlined above in connection with the mandatory notification requirement, "control" in the context of the call-in power also includes:

• the acquisition of the ability to exercise 'material influence' over the strategic direction of a Qualifying Entity, with material influence potentially being obtained with the acquisition of a shareholding and/or voting rights of less than 25%; and
• the acquisition of a right or interest in, or in relation to, certain assets whereby the acquirer is able to use the assets, or direct or control the use of the assets (or do so to a greater extent than before the transaction).

For acquisitions falling outside of the mandatory notification requirement that complete on or after 4 January 2022, the SoS has a period of five years from completion to call-in the transaction.

If parties consider a transaction to be at risk of a call-in, they may wish to make a voluntary notification to the SoS pre-completion, so as to seek to obtain unconditional clearance, or otherwise confirm the basis of any conditions that the SoS would wish to impose (i.e. to enable the transaction to complete).

The SoS has issued a Statement^[2] setting out how it intends to exercise the call-in power (the "Call-In Statement"). The combination of the Call-In Statement, and current Government guidance indicates that:

• The SoS is most likely to use the call-in power in relation to acquisitions of:
  • Qualifying Entities where the acquirer:
    • obtains the ability to exercise material influence over a Qualifying Entity undertaking Notifiable Activities; or
    • acquires a Qualifying Entity that undertakes activities closely linked to Notifiable Activities and the closer the link, the more likely the SoS may reasonably suspect that the Transaction gives rise to national security risks.
  • certain assets which are, or could be, used in connection with Notifiable Activities, or activities closely linked to Notifiable Activities.
• Acquisitions of land could potentially give rise to national security risks where the acquired land is, or is proximate to, a sensitive site (e.g. critical national infrastructure sites, or government buildings), and the intended use of land may be taken into account by the SoS. There is currently no definition or register of "sensitive sites", and so parties will therefore need to carry out appropriate due diligence to confirm the extent of any possible national security risks arising in this context.
• Loans, conditional acquisitions, futures and options are unlikely to pose a risk to national security in and of themselves, and so are unlikely to be called-in. However, the exercise or enforcement of these aspects, or the existence of related rights, could present risks (as considered further below).
• Acquisitions by a lender will be of greater concern to the SoS where the lender presents an "acquirer risk" - i.e. if the lender has characteristics that suggest that there is, or may be, a risk to national security from the acquirer obtaining control of the relevant Qualifying Entity or assets. The SoS will have regard to aspects including the lender's: (i) ultimate owner; (ii) pre-existing holdings; and (iii) activities, including its links to entities which may seek to undermine or threaten the UK's national security.

For more background on the NSI Act , please see the following resources which have been created by partners from our EU, Trade & Competition team who are also contributors to the UK Chapter of ICLG's publication, Foreign Direct Investment Regimes 2022:

• The UK's NSI Act : Key aspects to consider when planning transactions
• The UK's National Security and Investment Act - key issues for in-house teams

Which finance transactions could be affected by the NSI Act?

Acquisition finance: If a loan will or may be used to fund an acquisition of shares or assets then due diligence should be conducted to ascertain whether the relevant acquisition either triggers the mandatory notification requirement, or would be an appropriate candidate for voluntary notification (having regard to those factors outlined above). Depending upon the outcome of this exercise, changes may need to be made to the timeline and documentation; for example, to make completion of the transaction conditional upon obtaining clearance from the SoS, and to include representations and undertakings to directly address risks in the context of the NSI Act.

For completeness, parties should be aware that the NSI Act is applicable to intra-group reorganisations, and may also have extra-territorial effect (e.g. where Qualifying Entities or assets are outside of the UK, and either: (i) carry on activities and/or supply goods or services in the UK; or (ii) are used in connection with activities carried on in - and/or goods or services supplied in - the UK).

It will therefore be important to consider the entirety of a transaction plan with this broad application of the NSI Act in mind.

Granting loans or taking security: The grant of a loan or taking of security is not generally expected to trigger the application of the NSI Act, unless one of the following applies:

• The arrangement gives the lender the ability to exercise "material influence" over the borrower. In these circumstances, parties should consider whether a voluntary notification is desirable in order to be certain whether or not the transaction would be called-in for review.
  
  To qualify as 'material influence', it is expected that the rights afforded to the lender would: (i) need to go beyond the standard undertakings contained in LMA documentation; and (ii) enable the lender to materially influence policy relevant to the borrower's behaviour in the market, including the borrower's strategic direction, and its ability to define and achieve its commercial objectives. Parties creating bespoke documentation should therefore keep this potential trigger in mind at the drafting stage.
• The arrangement gives the lender the right in defined circumstances to take ownership of the shares, and/or the ability to exercise or direct voting rights, and either:
  • these defined circumstances have arisen; or
  • the lender is able to control when these defined circumstances arise.
  In both scenarios, the lender will be treated as holding the relevant shares and/or voting rights. With this in mind, depending upon the level of the relevant shares and/or voting rights held by the lender, and the activities of the borrower, either scenario could potentially trigger a mandatory notification requirement, or enable the SoS to exercise the call-in power (if national security concerns arise). For completeness, the mere existence of rights which enable the lender in defined circumstances to take ownership of the shares, and/or the ability to exercise or direct voting rights (i.e. where those circumstances have not arisen, and where the lender is not able to control when they arise) should not fall within the scope of the NSI Act.
• Security over assets (other than shares) is granted, which involves a transfer of title or gives rights to the lender to use the asset, or direct or control how the asset is used during the security period. This has the potential to enable the SoS to exercise the call-in power (if national security concerns arise).

Exercising material influence over an entity: The extent of a lender's involvement with a borrower sometimes changes during the life of a loan, and there are potential call-in risks associated with circumstances where a lender increases their input, and begins to influence a borrower's strategic and operational decisions (for example, if a borrower's business is failing, and the lender starts to attend and influence decisions taken in board meetings). A call-in right may arise in these circumstances, if the acquisition of material influence gives rise to national security concerns. It is therefore recommended that lenders familiarise themselves with the call-in risk factors (outlined in the section above) and build ongoing monitoring of NSI Act risks into their relationship management processes.

Enforcement of security: The realisation of security will potentially constitute an acquisition of control for the purposes of either the mandatory notification requirement (in respect of shares), or the exercise of the call-in power (where the transfer of shares or assets does not trigger the mandatory notification requirement, but may give rise to a risk to national security).

There is a carve-out in Schedule 1 of the NSI Act at paragraph 6(2) for rights that are "exercisable" by an administrator or by creditors while the entity is in "relevant insolvency proceedings". However, parties should be aware that:

• this applies to rights that are "exercisable", and not those that are actually being exercised – e.g. the appointment of an administrator would be outside of the scope of the NSI Act, but any subsequent disposal of assets by the company in administration may be within its scope;
• the term 'relevant insolvency proceedings' includes administration and certain overseas insolvency proceedings. It does not extend to other types of UK insolvency processes (e.g. liquidations or LPA appointments), or to other enforcement action that is being taken by a secured creditor.

While the Call-In Statement offers guidance, there remain a number of areas where it is unclear how the call-in power will be exercised. Although additional guidance is expected to follow later this year, and this is to be welcomed, in the absence of certainty at this time parties may wish to consider the possibility of notifying voluntarily, if they consider that planned arrangements would be capable of being called-in by the SoS (even if the risk of call-in appears to be low).

The notification process is likely to create some challenges for insolvent disposals, which typically do not have the luxury of time on their side. It will therefore be necessary to consider whether a notification is required, or desirable, at the earliest possible stage. For example, while the administrator can only make an application once appointed, it might be beneficial for the company to make a voluntary notification (in a form agreed with the proposed administrator) prior to appointment, if the relevant terms are settled.

Changes during the life of a loan: Parties should take care if changes are made to the finance parties, or documentation, during the life of a loan and the terms of a loan or security contain rights that could trigger a mandatory notification requirement, or enable the SoS to exercise the call-in power (if national security concerns arise). Risks should also be re-assessed if either: (i) the borrower's business becomes involved in, or becomes closely linked to, any of the Notifiable Activities; or (ii) relevant assets (including not only land forming part of the security but also 'proximate sites') are subject to a change of use in connection with Notifiable Activities (or closely linked to such activities) in order to seek confirmation that the changes would neither trigger a mandatory notification requirement, nor face a material risk of the SoS exercising the call-in power, (e.g. on a disposal as part of an enforcement process). We recommend that lenders address these points as part of their ongoing monitoring of the lending relationship.

Recommendations

The legal obligation to make a mandatory notification ultimately rests with the acquirer. However, the potential impact of either:

• the mandatory notification requirement being breached (including the transaction being legally void, unless retrospectively validated), or
• a transaction unexpectedly being called-in by the SoS,

means that all parties are advised to consider the potential application of the NSI Act throughout any transaction.

This could include for example:

• building in an NSI Act review at the start of any transaction in order to establish whether a mandatory notification requirement is triggered, or a voluntary notification (with associated conditionality) would be desirable. Relevant factors include:
  • the nature of the borrower's business, and its links to the UK, including in the context of Notifiable Activities;
  • the structure of the transaction, and the nature of the rights that are being acquired by the lender (or other third parties), as well as any rights that would be exercisable in the future; and
  • the backgrounds, interests and activities of the parties to the transaction acquiring the relevant rights;
• adjusting the transaction timeline to allow appropriate time for clearances to be sought, as may be relevant;
• amending documentation to provide for clearances to be obtained and/or to add representations and undertakings to address NSI Act risks, insofar as possible;
• putting in place ongoing monitoring in order to ensure that lenders are aware of any changes that may be relevant to the NSI Act "risk profile" of a transaction (e.g. in relation to the business of the borrower, the use of any real estate (or proximate sites), and the ownership of the parties).

The vast majority of finance transactions are expected to be low risk for the purposes of the NSI Act , but please contact us if you would like any further information in relation to the NSI Act , or would like advice from our experts on identifying and managing notifications.

Footnotes

[1] These seventeen areas of the UK economy are currently: advanced materials; advanced robotics; artificial intelligence; civil nuclear; communications; computing hardware; critical suppliers to the UK government; cryptographic authentication; data infrastructure; defence; energy; military and dual-use; quantum technologies; satellite and space technologies; suppliers to the emergency services; synthetic biology; and transport. See the Notifiable Acquisition Regulations.
[2] National Security and Investment Act 2021: Statement for the purposes of section 3 published 2 November 2021

Chris Brierly, Partner
Birmingham

Samuel R Beighton, Partner
London

Julian C Pallett, Of Counsel
London