This article was written by KWM associates Jack Tsang and Jenny Goodrich
The desire by governments to intervene in the M&A process is increasing across the world. This has resulted in part from high levels of outbound investment by Chinese companies, in particular acquisitions of key strategic technologies. However, whilst the US are looking at procedures to strengthen the scrutiny of foreign investment (and in particular Chinese investment), the UK is set to take a less radical approach.
The UK Government recently decided that the existing measures for managing national security risks of inbound investment needed to be strengthened. The first step involved making amendments to the jurisdictional thresholds under the Enterprise Act 2002 (“Act”) where such amendments expanded the Government’s powers, enabling it to review and intervene on, if appropriate, mergers involving the acquisition of businesses supplying products in the military, dual-use, quantum technology and/or computer hardware sector.
The UK Government’s proposed changes to the jurisdictional thresholds form part of an extensive plan for it to widen national security controls on foreign investment and we await confirmation of what new long-term Government measures are to be implemented as the second step - details of which are due to be published in a White Paper later this year.
The UK Government published a Green Paper ‘National Security and Infrastructure Investment Review’ on 17 October 2017 proposing short and long-term proposals to reform how Government can ensure that national security is not undermined by inbound mergers or investments, having first identified that in certain sectors of the UK economy, the jurisdictional thresholds under the current merger regime in the UK are no longer working effectively as a threshold for intervention on national security.
Two public consultations followed, the first focusing on the changes to the Act and the second on longer term options. The Government has responded to the responses to the first consultation and is still considering the responses to the second consultation. The long-term reforms are expected to be far more significant and wide-reaching across a broader scope of sectors/transaction types and the Government intends to introduce further measures, which may or may not involve expanding the range of sectors which will trigger, a public interest merger review process and/or a mandatory notification regime. The Governments actual intentions remain unclear but will be announced in a White Paper later this year.
Under the Act, the UK Government can intervene in transactions for national security and other public interest concerns as part of the UK merger control regime. The UK has a voluntary merger notification system for review of transactions on both public interest and antitrust grounds whereby the parties involved make their own assessment as to whether to notify a deal for approval prior to completion.
The Competition and Markets Authority (“CMA”) has jurisdiction to review a deal if it has reasonable grounds to suspect that the transaction may give rise to concerns over national security, the stability of the UK financial system or media plurality.
The Old Rules
Prior to 11 June 2018, the CMA had jurisdiction over mergers where either:
- the target business had a UK turnover of £70 million in the last financial year (“Turnover Test”); and
- both the buyer and the target supply the same category of goods or services in the UK (or a substantial part of it accounting for at least 25% of such supply) (“Share of Supply Test”).
If a transaction does not satisfy the above thresholds, the Government’s power to intervene is limited to mergers involving certain public interest and security issues (notably relating to defence) or certain newspaper and broadcasting companies. Under the old rules, the Government has only intervened on national security grounds seven times and of these, six of the cases had clear military grounds for intervention.
Most recently, however, in Hytera Communications Corporation’s acquisition of Sepura plc in 2017, the target company’s operations were mainly in the production of “walkie talkie” devices supplied to the police and the ambulance services. While there was no clear military link in this case, the CMA still felt it was appropriate to intervene. The acquisition was eventually allowed to proceed with conditions, but it perhaps demonstrates the UK Government’s progressively tightening attitude, event before the amendments this year were passed into law.
The New Rules
Amendments, which came into force on 11 June 2018, were made to the tests laid out in section 23 of the Act to ensure that the UK Government has sufficient powers to deal with threats to UK national security. The threshold tests were amended as follows:
- The Turnover Test is lowered whereby the ‘target’ business must have UK turnover of more than £1 million per annum (rather than £70 million); and
- The existing Share of Supply Test will still apply even if only the target business has a 25% or more share of supply i.e. there will not be a requirement for both the buyer and the target to supply the same category of goods or services and the test is met even if the share of supply does not increase as a result of the merger (so long as the Relevant Enterprise has 25%).
Under the new rules, the revised tests will only apply to mergers in three sectors of the UK economy:
The development or production of military items and “dual-use” items (dual-lost being for both military and civilian use) included in the existing UK Strategic Export Control List. This area extends to businesses who holds related software technology or information that can be used in connection with the development or production of such items.
- The design and maintenance aspects of computing hardware, being businesses that own, supply or create intellectual property in the functional capability of multi-purpose computing hardware (which may have an unintended broad interpretation); and
- The development, design, manufacturing or production of goods for use in, or supply of services based on, quantum technology, being quantum computing or simulation; quantum imaging, sensing, timing or navigation; quantum communications, and quantum resistant cryptography.
Northern Aerospace – proposed acquisition
Following consultation with the UK Government’s Business, Energy and Industrial Strategy Department, the CMA served on 18 June 2018 an initial enforcement order under the Enterprise Act 2002 for the purposes of preventing any action in relation to the anticipated acquisition by Gardner Aerospace Holdings Limited of Northern Aerospace Limited (the “Target”). The seller of the Target is owned by private equity fund, Better Capital.
The proposed buyer, Gardner Aerospace Holdings Limited, whose parent company is Shaanxi Ligeance Mineral Resources Co. Ltd, has effectively been blocked from completing the acquisition. Although in practice, the CMA is required to submit a report pursuant to section 44 of the Enterprise Act 2002 by 13 July 2018 setting out further views as to whether or not the deal would result in the creation of a relevant merger situation under the Act and which should not proceed, market commentators are generally of the view that it is unlikely that the deal would be resurrected with this particular buyer.
The specifics of the case are not public but it is clear that there is concern by CMA as to the sale of a UK company holding Ministry of Defence (MOD) contracts to an overseas buyer, possibly from China.
The recent amendments to the Act demonstrates the UK Government’s first step in scrutinising takeovers in the UK by increasing its power to intervene and, if appropriate, ultimately block acquisitions on public interest grounds in three narrow areas of the UK economy deemed to be of particular strategic importance to the UK.
It should be borne in mind that, whilst the UK Government has published guidance intended to provide an indication as to how the national security public interest merger regime will operate in practice, and the approach that the Secretary of State is likely to adopt in considering cases, each transaction will be looked at on its merits on a case by case basis and businesses should consider their own particular circumstances and where necessary seek their own legal advice.
For further details and information on the sections affected by the changes, please see the draft guidance published by the Government and the CMA: https://assets.publishing.service.gov.uk/government/uploads/system/uploads/attachment_data/file/715174/EA02_guidance.pdf