The National Security and Investment Act 2021 (the NSIA) is a landmark piece of legislation which was introduced in January 2022 to create a statutory framework to enable the UK Government to scrutinise and intervene in acquisitions and investments which potentially put at risk national security in the UK.
The key details of the NSIA are explained in an article which was published on this site last October.
The purpose of this article is to build on and supplement the article linked above by setting out and considering some of the key issues which the NSIA creates for insolvency practitioners (IPs) and restructuring transactions. As such, the two articles should be read together.
The structure of this article will be as follows. First, we will provide a brief and high-level overview of the NSIA regime, focusing particularly on the most relevant provisions within the legislation for the purposes of IPs and restructuring transactions. Second, we will describe and unpack the key issues which the NSIA creates for IPs and restructuring transactions. Third, we will offer some practical advice on how to mitigate and work around these issues. Fourth, we will outline by reference to the Annual Report (as defined below) how the NSIA regime has functioned since its enactment, before then offering some concluding thoughts.
A notification may need to be made to the Secretary of State (SoS) where a “trigger event” occurs. A trigger event will occur where:
- (i) a person or entity gains control over a qualifying entity or asset; or
- (ii) arrangements are in progress or contemplation which, if carried into effect, affect a gain of control in respect of a qualifying entity or asset.
A gain of control will occur if the person or entity obtains:
- (i) an increase of at least 25% in respect of its shareholding or voting rights in a qualifying entity;
- (ii) voting control or policy control over a qualifying entity; or
- (iii) the right to control or direct the use of qualifying assets.
A qualifying entity is an entity which conducts activities in the UK or supplies goods or services to persons or entities in the UK. Qualifying assets include land, tangible property, and ideas, information or techniques which have industrial, commercial, or other economic value.
If a trigger event occurs, depending on the nature of and the context surrounding the trigger event, a notification may be required (see “is notifying the secretary of state mandatory or voluntary?” in our article linked above).
If the notification is made pursuant to the mandatory notification regime, a notification must be made, and it must be made by the person or entity gaining control. If made pursuant to the voluntary notification regime, the notification will be discretionary, and may be made by either the party gaining control or the selling party.
If a notification is made, the SoS will have 30-working days (starting from the date that the SoS informs the notifying party that the notification has been accepted) to screen the notification and decide whether or not to:
- (i) clear the transaction; or
- (ii) exercise its call-in power and undertake a full, in-depth review of the trigger event.
If the SoS decides to exercise its call-in power, the SoS will have a second 30-working day period to undertake the review. This period can be unilaterally extended by the SoS by a further 45-working days if the SoS believes that the trigger event risks giving rise to a national security threat and more time is needed to assess it.
It should be noted that there is currently no formal mechanism for expediting a review (whether the initial screening or pursuant to the SoS’s call-in power) by the SoS. However, in the most recent update to the Guidance (as defined and linked below), it is stated that “in exceptional situations, where evidence of material financial distress gives rise to genuine urgency, it may be possible to expedite the assessment process. This will only take place where appropriate and supporting evidence is provided to, and accepted by, the government”.
If a transaction which is subject to the mandatory notification regime completes without clearance from the SoS, then unless the SoS provides retrospective validation, the transaction will be void.
A trigger event which is caught by the voluntary notification regime can complete without a notification being made. However, if a voluntary notification is not made, the transaction remains vulnerable to a call-in by the SoS for a period of five years after the occurrence of the trigger event. This is because the SoS can exercise its call-in power within six months of becoming aware of the trigger event provided this takes place within five years of the occurrence of the trigger event.
IP appointments: taking office
The NSIA contains a carve out which expressly provides that the appointment of administrators shall not constitute a trigger event. This means that on the appointment of administrators, a notification need not be made. However, this carve out is narrow in scope – it is limited to administrator appointments only. This is significant because it means that the appointment of liquidators, administrative receivers, fixed charge receivers and trustees in bankruptcy can each potentially constitute a trigger event and therefore trip the NSIA notification regime.
In fact, guidance issued by the UK Government (linked here and here) (the Guidance) actually makes express reference to the appointment of liquidators and receivers as potential trigger events. This is on the basis that on appointment, liquidators and receivers may obtain certain rights over qualifying entities or assets which result in a gain of control for the purposes of the NSIA.
The appointment of a trustee in bankruptcy is also a potential trigger event. This is because the appointment of a trustee in bankruptcy may, depending upon the assets which comprise the bankruptcy estate, result in a shareholding of over 25% in a qualifying entity vesting in the trustee.
The risk that an appointment of an IP (other than an appointment of administrators) will constitute a trigger event – and therefore require a notification to the SoS – will be particularly acute if the qualifying entity or asset (which is subject to the appointment) falls within, or is connected to, one of the 17 mandatory sectors.
For more details about the nature and scope of the 17 mandatory sectors, and for advice about how to interpret these sectors, see this guidance note published by the UK Government.
Business and asset sales
If the trigger event is in respect of the sale and purchase of a business and assets, the sale and purchase will not be caught by the mandatory notification regime. Instead, it will be subject to the voluntary notification regime. This means that it will be for the buyer and seller (note that both the buyer and seller can make a notification under the voluntary regime) to determine whether or not a notification to the SoS should be made.
The Guidance explains that the SoS “rarely” expects to exercise its call-in power in respect of the acquisition of a business and assets as compared to the acquisition of a qualifying entity. The Guidance also makes clear that business and asset purchases will likely only be at risk of a call-in if the target business and assets:
- (i) are used (or have the potential to be used) in connection with activities in the 17 mandatory sectors; or
- (ii) are proximate to a sensitive site (e.g., a critical national infrastructure site, military facility or government building).
The upshot of the above is that in respect of a company which is in an insolvency process:
- the IPs which have been appointed to it and which affect the sale of its business and assets should be conscious of the voluntary notification regime; and
- a buyer purchasing the business and assets of that company should bear the NSIA in mind.
The sale and purchase of the shares of a company which is in an insolvency process is rare. However, in the event that a restructuring transaction is structured as a share purchase, the NSIA needs to be carefully considered. This is because the sale and purchase of shares can be caught by the mandatory notification regime and by definition, this means that any failure to comply with the NSIA risks the transaction being voidable.
As explained above, the obligation to make a mandatory notification rests with the buyer. However, this does not mean that IPs can act or proceed without caution in this context. This is because if an IP completes a share sale and a mandatory notification is not made, this means that the transaction may be voidable, which in turn raises a series of uncertainties in relation to:
- (i) the ability of the IP to distribute any realisations arising from the sale; and
- (ii) the IP’s position if a distribution has already been made (pursuant to the sale) at the time that the transaction is made void.
Advice for IPs
Prior to being appointed, IPs (including administrators) should determine whether or not the qualifying entity or assets falls within, or is connected to, one of the 17 mandatory sectors. Owing to the complex and technical nature of some of these sectors (e.g., advanced robotics), this may require engagement with senior management and other key parties within the company which is subject to the appointment.
Notwithstanding the exception which provides that the appointment of administrators shall not constitute a trigger event, it is still important for administrators to understand the nature of the company and the operation of its business and assets pre-appointment. This is so that they can, at the earliest possible stage, ascertain the extent of, and the potential implications which might arise out of, the application of the NSIA to any potential restructuring transaction involving the company. This is important because of the significant implications which the application of the NSIA can have for restructuring transactions involving business and asset sales (see “business and asset sales” below).
If the qualifying entity or assets falls within or is sufficiently closely connected to one of the 17 mandatory sectors, it would be prudent for the IP to comply with the mandatory notification regime, as a failure to submit a notification where it is mandatory may risk the appointment being rendered void.
Business and asset sales
Although business and asset purchases do not attract mandatory notification, a prudent buyer may nevertheless insist that a voluntary notification is made. This is because if a voluntary notification is made, this precludes the SoS from issuing its call-in power post-completion, and this in turns creates certainty for the buyer.
However, if a notification is made, this creates a risk in respect of the transaction timetable, potentially delaying completion by up to – in a worst-case scenario – three to four months (note the significant periods of time afforded to the SoS (outlined above) for initially screening the transaction and then deciding whether to exercise its call-in power, and the absence of a formal mechanism for expediting these procedures). This is particularly significant given the time sensitives which are often involved in the sale of the business and assets of companies in an insolvency process, and the uncertainty which is created by the wide scope for delay.
Any potential and uncertain delay to completion is also significant to the extent that it risks IPs incurring significant holding costs to support the company through the delay period (even if the company is traded at a reduced level or mothballed). In practice, these holding costs are likely to be passed on to the secured creditor(s) or a potential buyer, and this is problematic for two reasons. First, these holding costs have the scope to materially diminish value for stakeholders. This is because if they are picked up by:
- (i) a secured creditor, that secured creditor will be funding merely to mitigate their own loss; and
- (ii) a potential buyer might propose that any holding costs are offset against the purchase price, and to the extent that they aren’t, this might deter potential buyers (i.e., the holding costs might be seen by potential buyers as inflating the purchase price).
Second, as the length of the delay will be impossible for the IP to define at the time any notification is made, the IP will be unable to accurately ascertain the amount of the holding costs required and is therefore likely to proceed with caution. This means an IP might request funding which incorporates a contingency, and this risks perpetuating the first problem described above.
In light of the above, IPs may need to consider the viability of disposing of specific assets which are caught by the NSIA separately from those assets which are not. This will be a particularly pertinent consideration where the appointment is in respect of large companies and groups of companies. This will enable IPs to minimise, or to at least isolate, the delays which the voluntary notification regime might have on certain business and asset sales.
If a voluntary notification is made, the IP should ensure that the government is:
- (i) alerted to the context of the transaction; and
- (ii) provided with evidence of the financial distress involved, as soon as reasonably practicable. To the extent possible, this will help to expedite the screening and review process (see “overview” above).
Examples of evidence of financial distress are included in the Guidance, and include:
- (i) confirmation of the IPs engagement;
- (ii) analysis provided by external legal, restructuring and insolvency advisers about the company’s position; and
- (iii) evidence that funding options other than a sale or merger are not feasible or available.
It might also be helpful for the IP to explain the damage which might be caused to the value of the company and its assets if the screening and review process is not completed promptly (noting that in the absence of an expedited screening and review process, there is a wider scope for any information about the extent of the company’s financial distress to get into the public domain, and this in turn risks jeopardising the attempt by the IP to preserve value).
IPs should ensure that share sales which are caught by the mandatory notification regime are structured so that completion cannot occur until the transaction is cleared by the SoS.
As explained above, if a mandatory notification is made, the IP should ensure that the government is made aware of the context of the transaction and provided with evidence of the financial distress involved as soon as reasonably practicable.
Application of the NSIA to date
On 16 June 2022, the Department for Business, Energy & Industrial Strategy published the NSIA Annual Report (the Annual Report). This provided an overview of how the NSIA regime functioned in its first three months in operation. The Annual Report is linked here.
The Annual Report shows that the average amount of time which it took for the SoS to perform the initial screening of a notification was between three and five working days for mandatory notifications, and between four and twelve working days for voluntary notifications. For the SoS to confirm if it would proceed with exercising its call-in power, the SoS took an average of 24-working days in the context of mandatory notifications, and 23-working days in the case of voluntary notifications.
Given that restructuring transactions are most often structured as business and asset sales, and noting that the Guidance stipulates that the SoS “rarely” expects to exercise its call-in power in the context of a business and asset sale, it is welcome that notifications which are made to the SoS pursuant to the voluntary notification regime are being screened primarily within a two-week time frame. As the Annual Report was published prior to the recent announcement by the UK Government that it was introducing scope for expediting the screening and review processes, we expect this time frame to become shorter still.
The Annual Report also shows that the SoS exercised its call-in power only a small number of times, and only in a narrow range of sectors. Of the 222 notifications which were made to the SoS in the period 4 January 2022 to 31 March 2022, 17 were subject to the SoS’s call-in power, and the majority of those call-ins were in respect of entities or assets with a connection to:
- (i) the military;
- (ii) defence; and/or
- (iii) critical suppliers to the UK Government.
The NSIA gives rise a series of significant implications for IPs and restructuring transactions which span the length of an insolvency process, creating potential risks around the appointment process, transaction timetables, and by virtue of the power which the NSIA confers on the SoS to undo certain transactions, it even creates a post-completion risk. IPs and other actors in a restructuring and insolvency context must be alert to the requirements of the NSIA, and must be proactive in seeking to deal with them.
The reference in the Guidance to the newly created scope for expediting the screening and review process is welcome, but it is not yet satisfactory.
The Guidance makes clear that an expedited process will only be available in “exceptional” circumstances where the acquisition involves a party in “material” financial distress. Whilst the Guidance gives some examples of evidence which can be used to demonstrate “exceptional” circumstances and “material” financial distress, it does not provide any insight as to what constitutes either. The Guidance also fails to provide for a formalised, structured process for making an application for expedition – the Guidance simply states that “the government will consider all representations made by the relevant parties” and on a “case-by-case basis”. These two shortcomings are particularly significant when considering the importance of certainty in restructuring transactions.
The parameters of, and the practices and precedents involved in, the expedited screening and review process and the notification regime will inevitably become clearer in time. For now, though, IPs should be mindful of the NSIA, and should take account of the advice set out above.
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