New Framework for Foreign Investment Screening in the U.K.: A Primer on the National Security and Investment Bill
More than two years since publishing the National Security and Investment White Paper, the U.K. government has finally published a response to its consultation on reforms to the U.K. investment screening process together with, most importantly, the draft National Security and Investment Bill.
Our previous legal update examined the White Paper in detail. This present update provides a general overview of the contents of the bill, which significantly enhances the power of the U.K. government to screen foreign investment. We intend to examine the key aspects of the new regime in more detail in future updates.
This is of immediate interest to businesses investing directly or indirectly in the U.K. (whether through equity investment or asset acquisition) as, unusually, the U.K. government’s new call-in power applies to investments completing on or after 12 November 2020, regardless of when the bill eventually comes into force.
New Investment Screening Regime: Executive Summary
The bill grants the U.K. government the right to call in certain investment transactions for review where they may give rise to a risk to national security. Transactions subject to review include equity investments and acquisitions of particular assets. It establishes a mandatory notification regime for transactions in certain sensitive key industry sectors. Failure to give notice of such transactions will mean the transaction, if completed, is legally void and exposes the parties to criminal and civil liability. For transactions not subject to the mandatory notification regime, the parties can voluntarily notify. Where parties choose not to notify, the government may still call in the transaction (even after it has completed) up to six months after becoming aware of it, with a long-stop date of five years from the date of completion.
Section 1 of the bill gives the U.K. government the right to issue a call-in notice to an acquirer and the target entity. The right applies provided a two-stage statutory test is met. The government must reasonably suspect both of the following:
- A trigger event has taken place (or arrangements are in progress or contemplation that, if carried into effect, would result in a trigger event taking place) in relation to a qualifying entity or qualifying asset.
- The event has given rise to, or may give rise to, a risk to national security.
While the bill does not propose to extend this power to the wider concept of “national interest,” it is unfortunate that the bill does not provide a definition of “national security.” Case law on questions of national security in other contexts have tended to give the executive a degree of latitude in its assessment of these questions. For its part, the government has issued a statement of policy intent on how it expects to use its call-in power, focusing on target risk, trigger event risk and acquirer risk.
Time Limit on Call-In Power
For “notifiable acquisitions” (see below), which are subject to the mandatory notification regime, the call-in power is not time-limited.
For all other acquisitions, a call-in notice can be given up to the end of the period of six months beginning with the date on which the government became aware of the trigger event. There is a long-stop date for the exercise of the call-in power, after which no call-in notice may be given, regardless of awareness, at the end of the period of five years beginning with the date on which the trigger event took place.
A “qualifying entity” is very widely drawn. It includes “any entity, whether or not a legal person, that is not an individual…” It includes partnerships, unincorporated associations and trusts.
A trigger event occurs where a person gains control of a qualifying entity in one of the following ways:
- Where the percentage of the shares the person holds in the qualifying entity increases: (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 more than 75%.
- Where the percentage of the voting rights the person holds in the qualifying entity increases: (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 more than 75%.
- Where the acquisition is of voting rights in the entity that enable the person to secure or prevent the passage of any class of resolution governing the affairs of the entity.
- Where the acquisition enables the person materially to influence the policy of the entity.
- Where the acquisition is in relation to a qualifying entity “of a specified description” (essentially those within specified, key, sensitive industry sectors — see below) and as a result the percentage of the shares or voting rights the person holds increases from less than 15% to 15% or more. This trigger event only applies to notifiable acquisitions under the mandatory regime.
The bill is intentionally drafted widely so as to ensure that the holding of a right or interest covers joint interests and arrangements, indirect holdings, interests held by nominees, connected persons, conditional rights and (in certain cases) rights attached to shares held by way of security. Accordingly, there is potential for a significant number of notifications for funds and asset managers in relation to their future investments. In addition, transaction parties will need to consider the issue of beneficial ownership of, and material influence over, prospective acquirers.
A “qualifying asset” includes land; tangible moveable property; and ideas, information or techniques that have industrial, commercial or other economic value. It includes where these assets are located outside the U.K., if they are used in connection with activities carried on in the U.K. or the supply of goods or services to persons in the U.K.
A trigger event will occur where a person gains control of a qualifying asset in one of the following ways:
- Where the person is able to use the asset (or use it to a greater extent than prior to the acquisition).
- Where the person is able to direct or control how the asset is used (or direct or control how it is used to a greater extent than before the acquisition).
With the exception of land and certain other assets (such as those assets subject to export controls), a person will not be regarded as gaining control of a qualifying asset where it is an acquisition by an individual for purposes that are wholly or mainly outside his or her trade, business or craft.
Notifiable Acquisitions and Mandatory Notification
The bill requires that acquirers must proactively notify the government of certain types of prospective transactions, known as “notifiable acquisitions” (section 14(1)). Notifiable acquisitions involve qualifying entities only and not qualifying assets. Any notifiable acquisition that is completed without approval will be legally void.
A notifiable acquisition is one where one of the five trigger events set out above occurs in respect of a “qualifying entity of a specified description.”
Key Sensitive Industry Sectors
A “qualifying entity of a specified description” refers to one that carries out activities in the U.K. that the government has deemed to be especially sensitive, such that all trigger events involving such entities must be expressly notified to the government. The obligation to notify the government lies with the prospective acquirer.
The sectors in scope of the mandatory regime (i.e., the qualifying entities “of a specified description”) will be set out formally in secondary legislation. The government has published a consultation on this topic, which indicates that prospective acquirers of entities in any of the following 17 sectors would be subject to mandatory notification: advanced materials, advanced robotics, artificial intelligence, civil nuclear, communications, computing hardware, critical suppliers to government, critical suppliers to the emergency services, cryptographic authentication, data infrastructure, defence, energy, engineering biology, military and dual use, quantum technologies, satellite and space technologies, and transport.
As part of the consultation, the government has set out specific definitions for each of these sectors, which remain subject to review. However, it is worth noting that the definitions of some sectors are very widely drawn in the current draft (and in some cases suffer from a degree of circularity). For example:
“Advanced materials” includes breathable fabrics that have a good stretch, are lightweight or are weather resistant. It is unlikely that many prospective acquirers of businesses involved in developing or producing such fabrics would regard their investment as a national security risk, but under the current definition such prospective transactions may need to be notified to the government.
“Advanced robotics” and “artificial intelligence” are defined, respectively, as including “advanced robots (or underpinning components or capabilities) that use artificial intelligence to perform a complex task” and any technology designed to approximate cognitive abilities to perform a complex task. With a “complex task” being one involving image recognition, object identification, natural language understanding and types of statistical prediction. Given these are new and expanding sectors, with increasing numbers of players and new entrants, the scope for being caught by the mandatory notification requirement is significant.
“Critical suppliers to government” include those entities that process or store personally identifiable information of 5,000 or more individuals as part of its provision of goods or services to public sector organizations. This is an example of the sector name underplaying its potential scope. Many businesses that supply public sector organizations would not necessarily regard themselves as “critical suppliers.” However, if as part of the provision of their goods and services they process personal details and information relating to 5,000 or more individuals (which is not a particularly large figure), they will be deemed a critical supplier for the purposes of mandatory notification under the bill.
Notification and Assessment Procedure: Mandatory and Voluntary Regime
Once a prospective acquirer makes a notification (whether under the mandatory regime or voluntary regime), the government must either accept or reject the notice. A notice may be rejected if it does not meet requirements as to the form and content of the notice (which are to be set out in supplementary regulations) or if it does not contain sufficient information to allow the government to decide whether to exercise its call-in power.
If accepted, the government will have a period of 30 working days from that date to determine whether to give a call-in notice in relation to the particular trigger event relating to the proposed investment. At the end of this period, the government must either issue a call-in notice or notify the parties that no further action will be taken in relation to the trigger event, in which case the transaction can proceed.
The consequence of issuing a call-in notice is that the government will undertake a national security assessment of the proposed transaction. It will have an initial period of 30 working days beginning with the day on which the call-in notice is given. The initial period may be extended by a period of 45 working days where the government reasonably considers the additional period is required to assess the trigger event further.
At the end of the assessment period, the government must either make a final order (setting out safeguarding measures in respect of the transaction) or notify the parties that no further action will be taken in relation to the call-in notice.
Powers and Enforcement
The bill grants the government a number of powers in relation to the exercise of its functions under the bill. These include powers to:
- Give notice to a person to provide any information specified or described in the notice that is within that person’s possession or control.
- Give notice to require a person to attend a particular place at a specified time to give evidence.
In both cases, a person is not required to provide information that they could not be compelled to provide in evidence in civil proceedings before a court, and the information or evidence sought must be proportionate. The powers apply to persons within the U.K. and to persons outside the U.K. if the person is: (i) the prospective acquirer, (ii) a U.K. national, (iii) ordinarily resident in the U.K., (iv) a body constituted under U.K. law or (v) carrying on business in the U.K.
The government also has powers to grant interim orders (for example, to prevent a transaction proceeding during the assessment period) and final orders. Final orders will set out provisions that are, in the reasonable consideration of the government, necessary and proportionate to prevent, remedy or mitigate the risk to national security identified. Final orders will be published and so available publicly (subject to the redaction of commercially sensitive information and information contrary to the interests of national security).
Key offences under the bill include:
- Completing a notifiable acquisition without approval.
- Failing to comply with an interim or final order.
- Failing to comply with the requirements of an information notice or an attendance notice.
- Intentionally or recklessly altering, suppressing or destroying information required to be provided under an information notice.
- Intentionally obstructing or delaying making a copy of information provided in response to an information notice.
- Supplying information that the person knows to be, or is reckless as to whether it is, false or misleading.
Where an offence is committed by an entity, that entity’s officers will also be guilty of such offence where it was committed “with the consent or connivance of” the officer or “due to any neglect on the part of” such officer.
Criminal liability attaches to all the above offences. Offences 1 and 2 are potentially subject to up to five years’ imprisonment and offences 3 to 6 are potentially subject to up to two years’ imprisonment. Civil sanctions also apply to these offences, with the government able to issue monetary penalties. For offences 1 and 2, the government may issue monetary penalties up to the higher of 5% of the total turnover of the entity (both in and outside the U.K. and including businesses owned or controlled by the entity) and £10 million. In relation to offence 2, the government may also issue a daily monetary penalty up to the higher of 0.1% of total turnover (both in and outside the U.K. and including businesses owned or controlled by the entity) and £200,000 for each day of noncompliance.