Regulatory scrutiny is an increasingly important area of focus for buyers and sellers in M&A transactions. From the outset of a deal, the parties will be keen to understand whether regulatory approval is required or recommended to be obtained prior to closing, how long it will take to obtain approval and the ability of the relevant regulator to block the transaction or otherwise impose conditions to closing that may change the commercial terms of the deal (as well as the likelihood of the same). This article looks at the regime under the Enterprise Act 2002 for government control over investment in the United Kingdom.
While there has been political focus on the government strengthening its powers to intervene in transactions involving foreign acquisitions of UK companies and assets, unlike certain other G20 countries – including the United States and France – there is no specific law governing or restricting foreign investment in the United Kingdom. Foreign nationals or foreign-controlled companies are treated in law exactly the same as UK citizens or UK companies. Foreign and UK investors alike must comply with the merger control regime in the Enterprise Act. It is through this regime that the government exercises control over investment in the United Kingdom.
Government power to ‘call-in’ deals for review
The government can intervene in mergers, reviewable under the Enterprise Act or at the EU level, if it reasonably expects there to be exceptional public interest concerns relating to national security, financial stability or media plurality. The ability to intervene in EU reviews will no longer be available after the end of the Brexit withdrawal period. Under the Enterprise Act, the government may exercise its power to intervene only if the following jurisdictional thresholds are met:
- the target’s annual UK turnover exceeds £70 million; and
- the merger will create or enhance a 25% or more UK share of supply.
Where the above thresholds are not met, the government still has the power to intervene in mergers, but only in limited circumstances relating to certain defence contractors, media companies or specific national infrastructure sectors.
Lower thresholds for military and technology sectors
On 17 October 2017 the Department for Business, Energy and Industrial Strategy (BEIS) published a green paper setting out proposals to reform and strengthen its powers to scrutinise investments in critical businesses and infrastructure that could provide opportunities for foreign investors to “undertake espionage, sabotage or exert inappropriate leverage”.
While the majority of the proposals remain to be enacted, following initial reforms that came into force in June 2018, the BEIS secretary of state (the business secretary) is now able to ‘call-in’ for review transactions relating to military and dual-use goods, computer processing units and quantum technology if:
- the target had a UK turnover of over £1 million in the preceding fiscal year; or
- the transaction will create or enhance a UK share of supply of 25% or more.
Unlike the broader test described above, the specific test for military and dual-use goods, computer processing units and quantum technology applies a significantly lower turnover test and the ‘share of supply’ test would catch a transaction even if the acquirer’s market share prior to the transaction was nil.
Advent’s acquisition of Cobham
Whilst the Competition and Markets Authority (CMA) and the business secretary have wide discretion regarding the interpretation of the ‘share of supply’ threshold described above, since the enactment of the Enterprise Act there have been fewer government interventions on public interest or national security grounds.
If the next stage of the government’s proposals are enacted later in 2020 or in early 2021, this number is expected to rise significantly and transacting parties can expect a greater level of scrutiny across a wider range of transactions than has historically been the case. The recent government review of Advent’s takeover of Cobham provides a good insight into the scrutiny a bidder can expect where a target is active in a potentially sensitive sector.
On 25 July 2019 Advent, a US private equity firm, announced its intention to acquire Cobham, a defence and aerospace supplier to the UK government, in a takeover to be implemented by way of a scheme of arrangement. The scheme circular included a condition that the transaction would not be referred for a CMA Phase 2 investigation. A Phase 2 reference imposes a statutory bar on closing. Closing during Phase 1 is otherwise permitted unless expressly prohibited by a CMA interim enforcement order.
On 16 September 2019 the scheme was approved by Cobham’s shareholders. Immediately following shareholder approval, the business secretary issued a European Intervention Notice (EIN) requiring the CMA to assess whether the transaction raised any national security concerns.
After reviewing the CMA’s report and holding discussions with Cobham and Advent senior management, the business secretary announced on 19 November 2019 that the transaction posed two key national security risks. First, in relation to security of information, personnel without security clearance would be able to access sensitive government information regarding the provision of services to the Ministry of Defence and emergency services. Second, in relation to security of supply of ongoing services, Advent could underinvest in Cobham or prevent it from supplying products and services critical to the operational readiness of the Royal Navy and the Royal Air Force.
To address these concerns, Advent offered a range of legally binding undertakings:
- Strategic capability – Cobham would continue to supply the UK government and meet all existing contractual obligations. A UK entity would directly control the supply of these products and services which would not be developed or supplied from outside the United Kingdom.
- Information on a potential sale – the parties would notify the UK government within five business days if a decision were taken to commence a sale process or on receipt of an offer to acquire Cobham UK or any part of its business.
- Protection of information – the parties would maintain and strengthen existing security arrangements to protect sensitive UK government information.
- Composition of Cobham board – at least half of Cobham directors, including the chair, would be UK nationals, resident in the United Kingdom and a sufficient number of directors would also be security-cleared UK citizens able to discuss security-sensitive issues at board level.
- Compliance – appointment of a British citizen with security clearance as an independent security controller responsible for facilitating, overseeing and reporting annually on compliance with the UK government’s security requirements. The UK government would also be entitled to enter and inspect premises and documents connected with sensitive material.
The government opened a public consultation regarding these undertakings and ultimately concluded, on 20 December 2019 after three months of enquiries, that they satisfactorily addressed the concerns that it had asked the CMA to investigate.
The government intervened in five transactions in 2019 alone, a significant increase on the seven interventions between 2004 and 2017. This increase, taken together with the prospect of further changes to the merger regime in 2020, can be set against the backdrop of other G20 countries extending their powers. Germany, Italy, Japan and the United States have recently extended their powers to intervene in transactions on national security grounds. An EU-level investment screening framework is also due to come into full effect in the fourth quarter of 2020. These moves are, in part, driven by current trade tensions and the desire by Western governments to scrutinise more closely acquisitions of military, dual-use or critical infrastructure, particularly by Chinese investors. Reforms are being accelerated in response to the current COVID-19 crisis as governments look to enhance the tools available to them to prevent opportunistic moves on vulnerable domestic targets. The European Commission has also urged national governments within the European Union to use their screening regimes “to the fullest extent” in order to “prevent a sell-off of strategic EU assets”.
Changes to the UK merger regime will be informed by the current crisis and by Brexit; the government’s ability to review and potentially require remedies to be offered across a broader range of transactions may prove a useful tool as it assesses how to reshape UK industrial policy as the country transitions out of the European Union.
No transaction has yet been referred for a Phase 2 or blocked on national security grounds. Even if the risk of prohibition is relatively low, parties should nevertheless be prepared for potentially lengthy and data-heavy investigations. In the case of Advent’s acquisition of Cobham, the government took three months to review and conditionally clear the transaction, not having formally intervened until two months post-announcement. In the slightly earlier take private of Inmarsat, the review also took three months from the issue of an EIN to conditional clearance. In order to avoid disruptive late stage interventions, parties should consider the merits of engaging with the CMA and, where appropriate, the government, as early as possible in the deal process.
Advent’s acquisition of Cobham also illustrates how far reaching remedy offers may need to be in order to secure conditional clearance. Transacting parties would be well advised to assess, during the deal planning phase, what range of remedies may be required, how straightforward it will be to implement these remedies and, crucially, whether they undermine the commercial case for making the investment.