The National Security and Investment Act 2021 (“NSIA” or “the Act”) came into force in the UK on January 4, 2022. The NSIA extends the powers of the UK government to review certain acquisitions and investments for national security reasons . The NSIA applies when a target entity is in one of the 17 sensitive sectors defined in the law and is carrying on business in the UK. The UK Government’s authority applies to transactions entered into in the period after November 12, 2020.
The 17 sensitive sectors defined in the NSIA are: advanced materials, advanced robotics, artificial intelligence, civil nuclear, communications, hardware, critical UK government suppliers, cryptographic authentication, data infrastructure, defence, energy, military and dual-use, quantum technologies, satellite and space technologies, UK emergency service providers, synthetic biology and transport.
The importance of the NSIA cannot be underestimated. Where a reportable transaction is not reported to the UK government or completes without UK government approval, it will automatically be voided and subject to civil penalties (the greater of 5% of the overall turnover of the purchaser or £10 million) and/or criminal penalties may apply.
However, to date, the impact of the NSIA on restructuring and insolvency cases has received little coverage.
THE INSOLVENCY EXCLUSION IN THE NSIA
Paragraph 2 of Schedule 6 of the NSIA confirms that control exercised by a director while the company is in administration does not fall within the trigger events set forth in the NSIA. This exclusion is very limited as it does not refer to other forms of insolvency proceedings in the UK (eg liquidation). It also does not refer to other types of enforcement such as the appointment of a receiver over company assets. Further, the exclusion is limited only to the appointment of directors and not to transactions entered into by directors.
Where an agent is to be appointed, who is not a director, to a company that falls within one of the 17 strategic sectors defined in the NSIA, notification may be required under the NSIA.
Conduct of an official
In the UK, a director can often be appointed to a company by a creditor (usually following default under a finance facility and under powers contained in a security document) or by the directors of the company itself following a company’s insolvency. A director generally seeks to obtain the best result for the company’s creditors and, in doing so, to realize maximum value for the company’s assets. Due to the insolvent nature of the company, it is highly likely that the administrator would seek to sell the business and assets of the company.
Under the NSIA, sales of assets by an insolvency practitioner are only likely to trigger voluntary notifications (when other NSIA criteria, such as business type, are met). Additionally, the Government Statement for the Purposes of Section 3 of the NSIA, issued on November 2, 2021 (SoS statement), sets out how the government intends to exercise its appeal powers under the NSIA. He confirms that the UK government expects to “rarely” request asset acquisitions, compared to entity acquisitions.
However, due to the risks and penalties that may arise from the NSIA, a buyer may require to submit a voluntary notification. Such notification would provide certainty as to the scope of the NSIA with respect to the transaction. However, the filing of the notification can have a significant impact on the timing of the transaction.
This is contrary to a sale of shares which may result in mandatory notification if other criteria set out in the NSIA are met. While the notification requirement and risk rests with the buyer, this will undoubtedly have a significant impact on the timing of any distressed stock sale.
THE IMPACT ON CREDITORS
The SoS statement provides reassurance to lenders in providing financing to businesses that fall within the scope of the NSIA. It is said:
“The parties should be aware that loans, conditional acquisitions, futures and options are not likely to pose a risk to national security and are therefore not likely to be called. [by the UK Government].”
The creation of security should, in most cases, fall outside the scope of the NSIA unless the effect of the security is to immediately grant the security holder a degree of control or significant influence over the borrower or the secured assets. However, difficulties may arise when rights to the documents are subsequently exercised.
The forced execution of a security of action may constitute a triggering event when:
I. There is acquisition of 25% or more of the borrower’s shares and/or voting rights;
II. There is an extension of existing shares or voting rights beyond 25%, 50% or 75%; and or
III. There is vesting of sufficient voting rights to enable a lender to approve or oppose a shareholder resolution.
Therefore, the application of the share guarantee is likely to be subject to the scheme within the NSIA as its effect is often to create an interest in the company. In addition, the granting of any voting rights to the holder of the security, for example following a default, may also trigger a notification obligation.
As noted above, the provision of a debt security, such as a convertible loan to an investor, is unlikely on its own to trigger the notification requirements under the NSIA. However, the actual conversion of the loan into capital may fall under the notification regime.
Debt-for-equity swaps, whereby lenders use existing debt in exchange for a borrower’s stock, may also trigger notification obligations under the NSIA. This is likely the case when an eligible entity is the target and the relevant thresholds, defined in the NSIA, are met. As such, the timing of the consummation of a debt-for-equity exchange may be determined and extended by the notice periods required for the notification requirement under the NSIA.
Ready to become an owner
Equity lending refers to a lender’s strategy of acquiring secured debt from a borrower in order to control or possibly own the target entities and their assets. The strategy is typically implemented by executing collateral in the event of default under the debt facility. Again, an acquisition of interest or control in the borrower may trigger mandatory notification requirements under the NSIA. Thus, when notification is required, the steps to assert the security may be prolonged, which could jeopardize the lender’s strategy.
The effect of the NSIA is to increase risk for creditors seeking to enforce security or other rights and for buyers seeking to acquire an equity interest in an entity belonging to one of the 17 sensitive sectors. It also potentially leads to a significant delay in the procedure in the event of notification, which could negatively impact the options available to creditors and/or the company in times of distress. Careful analysis will need to be undertaken to determine if the NSIA applies to an entity and the proposed transaction/application. The harsh penalties imposed by the NSIA mean that planning and compliance with UK law is of paramount importance.