[co-author: Graham Nicholson]

Background

The UK Government has been consulting on a new regime which will grant it wide powers to intervene in deals on grounds of national security. The consultation period in relation to the Government's proposals has recently closed and we have been considering the implications for Private Equity.

Pending introduction of the necessary legislation to implement the new regime, the Government has amended the merger regime for transactions involving goods or services for (or potentially for) military use, computing hardware and quantum technology, by lowering the target turnover threshold from £70m to £1m and changing the share of the supply test so that these sectors can now be reviewed for national security concerns if the target has a turnover of more than £1m or a  share of supply of 25% or more (alone or together with the acquirer) in the UK. These sector specific amendments to the merger regime will be repealed when the broader national security investment regime is implemented.

Key features of new regime

Key features of the proposed national security investment regime include:

• Applies to the acquisition of assets, and, in certain circumstances, loans as well as share acquisitions

• No turnover or market share thresholds

• Not sector specific

-     but guidance does suggests the risks are seen to be in "core areas" including national infrastructure (nuclear, defence, communications, energy and transport) and certain advanced technologies, but it might also include critical suppliers to businesses in the core areas

• Voluntary regime, no obligation to notify

BUT

• "Call in" powers

-     the Government has the power to "call in" a deal before or within six months' of completion of a transaction if a "trigger event" occurs and there is a reasonable suspicion that the trigger event may give rise to a risk to national security

• Trigger events

The trigger events in relation to a corporate transaction are the acquisition of:

-     More than 25% of an entity's shares or votes

-     Significant influence or control (which it is proposed may include the right to appoint a director to the board)

-     Further significant interest or control (including further acquisitions leading to holdings of over 50% or 75% of an entity's shares or votes, or the acquisition of additional rights e.g. board appointments)

• When will the trigger events raise concerns about a risk to national security?

Draft guidance in a "Statement of Policy Intent" published by the Government states that whether there is a reasonable suspicion that the trigger event may give rise to a risk to national security will be based upon three risk assessments:

-     The "target risk" – could the entity (or asset) be used to undermine the UK's national security?

-     The "trigger event risk" – does the trigger event risk (the acquisition) have the means or ability to undermine the UK's national security?

-     The "acquirer risk" – may the acquirer pose a risk to national security?

• Full unwind

Remedies potentially include a "full unwind" of the transaction.

What might it mean for Private Equity?

Funds will need to get to grips with the new regime

Funds regularly investing in the sensitive "core" areas will need to understand the new regime and work out their approach to the regime as practice develops. Given the scope of the regime is potentially wide, all funds that intend investments in "core" areas, will need to have the national security risk regime on their radar, so as not to trip up over it advertently.

PE fund buyer

A  PE fund contemplating acquiring a company in a core, sensitive area (or even a key supplier to such a company) will need to consider whether it, its co-investors or its debt providers are likely to be deemed to raise an acquirer risk (to national security) and if so whether to notify a proposed transaction.  The Government's proposals are currently unclear about whether the fund's limited partners will be considered relevant in making the acquirer risk assessment. We assume this will be unlikely where a fund has a typical institutional investor base (in light of the LPs' lack of control), but significant LPs with links that may pose a national security concern, could potentially fall within scope. There are also potential issues in relation to the acquirer risk which debt providers may pose in the Government's proposals. Hopefully the legislation, when introduced, will seek to clarify these issues.

Current proposals include the possibility of an unwinding of the transaction (the seller re-acquiring the target), rather than simply a disposal obligation on the acquirer. If this particular proposal is implemented, any buyer which might be considered to pose a national security risk will almost certainly choose to notify the transaction and will therefore be severely disadvantaged in an auction for a sensitive target.

When acquiring a sensitive target, a PE fund buyer's exit opportunities will be subject to (and therefore limited by) the new regime.

PE fund seller

A PE fund running a sale process for a sensitive asset will need to consider the risks of a national security investment referral when assessing potential buyers.  If the value proposition of a buyer that might be deemed to pose a risk to national security is sufficiently compelling to risk a referral, documentation will need to take account of the referral process in terms of conditionality and, potentially, break fees.

If there is any perceived risk of call in of the transaction, and the "full unwind" remedy finds its way onto the statute book, then it is unlikely buyers will enter into unconditional transactions. Even where the risks are seen as marginal, a PE fund would have to decide whether the full unwind risk would be a risk too far, which may depend upon where it sits in its own lifecycle and unused investment capacity.

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