Article / 4 Oct 2022
consider new guidance on the reach of the Government’s powers to intervene in transactions on the grounds of national security and report on the first transaction blocked under those powers; and
examine two recent restructuring plans as these gain traction in the market as a tool for reorganising the debts of companies in financial difficulties.
At the start of 2021, the National Security and Investment Act (NSI) introduced a regime under which the Government can intervene in a transaction on the basis that it poses a risk to the UK’s national security. The NSI regime is already having an impact on transaction processes and timetables but recent guidance from BEIS sheds further light on the types of events caught by the regime.
The market guidance notes published by BEIS in the summer were designed to answer questions and provide additional advice following the first six months of the NSI regime operating in practice. The notes highlight that the reach of the NSI regime goes beyond simple acquisitions of shares. In particular, each of the following events could constitute an acquisition of control caught by the regime.
The appointment of a liquidator or receiver: although rights held by an administrator or by creditors are ignored under the NSI regime, the notes explain that the winding up of an entity by a liquidator, or the enforcement of secured assets by a receiver, are activities that, in some circumstances, could raise national security risks. For example, if a liquidated entity holds shares in a solvent company operating in one of the 17 specified sectors, the liquidator or receiver will control the voting rights attached to those shares, triggering a requirement for a mandatory NSI notification if the other relevant tests are met.
Indirect acquisition of control: an acquirer may acquire control over an entity of interest via an unbroken chain of majority stakes above that entity. For example, consider a structure where a buyer acquires 51% of the shares in Topco which in turn holds 51% of the shares in Midco which itself holds 51% of the shares in Subco, an entity operating in a specified sector. By acquiring a majority stake in Topco, the buyer will have acquired indirect control of Subco triggering a requirement for a mandatory NSI notification if the other relevant tests are met.
Group reorganisations: even where there is no change in an entity’s ultimate beneficial owners, transactions forming part of a group restructuring could be caught by the regime. For example, consider a reorganisation where a new holding company is inserted into a group structure so that the shareholders of Company A, an entity of interest under the NSI regime, exchange their shares in that Company A for shares in a new Holdco, with Company A becoming a wholly-owned subsidiary of Holdco. A mandatory notification could be required even though the ultimate beneficial owners of Company A are the same before and after the transaction.
Types of voting rights and mandatory notifications: helpfully, the guidance notes confirm that, when considering the acquisition of voting rights which could trigger a requirement for a mandatory notification under the NSI regime, it is generally only voting rights attached to shares which are relevant. This is welcome news for investors, confirming that the typical contractual rights taken in an investment or shareholders’ agreement to protect a minority interest will generally not trigger a requirement for a mandatory notification. If, however, those contractual rights give the investor the ability to materially influence the policy of the entity and other risk factors are present (for example, regarding the activities carried on by the target), then this could suggest that a voluntary notification would be wise.
Granting security over shares: granting security over shares where the title to those shares is not passed to the secured lender will not require a mandatory NSI notification. In that situation, the secured lender does not acquire control of the voting rights attached to those shares so the relevant NSI trigger event is not satisfied.
The notes also provide additional guidance on how to complete the notification forms and the level of information required.
As acquirers and practitioners alike become more familiar with the NSI regime it is clear that its reach may be considerably wider than might first have been appreciated. The acquisition by a hostile state of the entire issued share capital of a UK company carrying out sensitive activities is clearly going to be of interest to the UK government. But the transfer of such an entity from one intermediate holding company to another within an existing UK group would also trigger the same requirement for a mandatory notification. Whilst it would be hoped that such a transaction would be cleared to proceed, the consequences of failing to notify are severe – including civil penalties, criminal sanctions for the directors involved and, crucially, the relevant transaction being void. The new market guidance notes are a reminder that the NSI regime needs to be considered early in all corporate transactions to avoid the considerable adverse consequences of failing to comply.
Earlier this year BEIS published its first annual report assessing the operation of the new regime for the screening of, and intervention in, UK transactions on the grounds of national security (the NSI regime). That report examined the operation of the regime for its first three months post-implementation.
At the time, BEIS confirmed that 222 notifications had been made under the NSI regime, with 17 transactions having been called in, of which 14 transactions were still under review.
BEIS has now published a notice of final order under which, for the first time, it has exercised its powers to block a transaction on the grounds of national security.
The proposed transaction involved the University of Manchester and Beijing Infinite Vision Technology Company Limited (the acquirer), a Chinese company which, according to its website, uses “3D rendering technologies to deliver realistic still image, animation and virtual reality for residential, cultural and commercial projects”.
Demonstrating the broad reach of the NSI regime, the proposed transaction was not a traditional acquisition of shares but a licensing of intellectual property rights. The University had entered into a licence agreement under which the acquirer was able to use the intellectual property in certain vision sensing technology in order to develop and sell licensed products. As such it was not a transaction which required a mandatory notification under the NSI regime. But, where an acquirer gains certain rights or control over intellectual property, a voluntary notification could be made in order to avoid the risk of that transaction subsequently being called in for review. In this case, it appears the University took the decision to voluntarily notify the licensing arrangement to BEIS.
When considering whether to clear or block a notified transaction, BEIS has previously stated that it will do so based on an assessment of three risk factors:
In its notice of final order, BEIS indicated that in this case the relevant technology had dual-use applications, that is it could be used for both civil and military purposes. This is one of the 17 sensitive sectors that the Government is particularly interested in under the NSI regime. BEIS went on to confirm that the technology could be used to build defence or technological capabilities which it believed may present a national security risk to the UK.
As a result of these concerns, BEIS made an order preventing the licensing of the intellectual property rights from proceeding.
The decision highlights that the Government can, and will, take a more interventionist approach under the NSI regime. It appears to have been concerned about the possibility of sensitive technology falling into Chinese hands and being used in a way that could pose a risk to the UK. Whilst the University’s prudent approach in making a voluntary notification ultimately led to the transaction being blocked, it prevented a post-completion investigation under which the Government could have required the transaction to be unwound or imposed other conditions.
In Re Houst Ltd [2022] EWHC 1941 (Ch) the High Court has sanctioned a restructuring plan under Part 26A Companies Act 2006, imposing the scheme on a dissenting class of creditors on the basis that they would be no worse off under the relevant alternative.
The case involved a company which provided property management services for short term or holiday lets. The Covid-19 pandemic had a significant adverse effect on its business, meaning it was both cash flow and balance sheet insolvent and leading to three creditors threatening to issue winding up petitions.
Accordingly, the company proposed a restructuring plan under which, amongst other things:
The judge found that the “relevant alternative” if the plan were not imposed would be a pre-pack administration sale. In that scenario, the bank would be likely to receive around £225,000 and HMRC would likely receive 15p per £1 in respect of its preferential debt. There would be nothing left to satisfy the rest of the bank’s debt or any other creditors.
At the various class meetings held to approve the plan, five of the six classes voted in favour but HMRC voted against it. This meant the plan could only be sanctioned if the cross-class cram down requirements were satisfied.
The two conditions which must be met to impose the plan on the dissenting class of creditor were that:
The judge found that these conditions had been satisfied. The dividend due to HMRC under the plan was more than it was likely to receive in the relevant alternative of a pre-pack administration sale. Although HMRC had objected to the plan in an email before the court, it had failed to provide evidence to challenge the company’s valuation evidence regarding the relevant alternative and appeared to have accepted that it would in fact be better off under the plan. In addition the plan had been approved by the bank, a creditor that would receive a payment, or have a genuine economic interest in the relevant alternative.
So the judge exercised the court’s discretion to sanction the plan and cram down HMRC as a dissenting class of creditor.
The Part 26A restructuring plan has become a useful tool for companies in financial difficulties that are capable of being rescued as a going concern. As seen in this case, they enable the company to enter into an arrangement with ‘in the money’ creditors without being held to ransom by creditors which are ‘out of the money’. Although they require the involvement of the court, potentially adding to the timetable and related costs, they are extremely flexible and can be tailored to the individual circumstances of the relevant company and its creditors.
As noted in this month’s update concerning the Re Houst Ltd case, since it was introduced by the Corporate Insolvency and Governance Act 2020, the restructuring plan has become a useful tool for companies looking to restructure their debts, enabling them to reach an agreement with ‘in the money creditors’ and not be thwarted by those creditors that are ‘out of the money’.
But a recent case shows that a plan does not affect third parties, such as a guarantor, who will remain liable for compromised debts.
The first company to take advantage of the cross-class cram down provisions and impose a plan on dissenting creditors was Virgin Active in Re Virgin Active Holdings Limited [2021] EWHC 1246. In that case, of the five classes of landlords, only one approved the restructuring plan. Nonetheless, the court sanctioned the plan on the basis that the dissenting landlords would be out of the money, and therefore no worse off, in the relevant alternative.
But when the former tenant of the Virgin Active premises at Centaur House in Leeds had assigned the relevant lease to Virgin Active, that tenant had guaranteed Virgin Active’s liabilities under the assigned lease. Virgin Active’s obligation to pay the rent due under the lease of the Leeds premises had been compromised as part of the above restructuring plan imposed on the dissenting landlords. So, in Oceanfill Limited v Nuffield Wellbeing Limited and another [2022] EWHC 2178 (Ch), the landlord brought a claim for those amounts against the guarantor.
The key issue for the court to determine was whether the restructuring plan:
The court agreed with the landlord, holding that a restructuring plan (like a scheme of arrangement under Part 26 Companies Act 2006) takes effect by operation of law. It is a statutory scheme that, in this case, releases the tenant from liability under the lease by providing that those liabilities are not payable by the tenant. But it is only effective between the landlord and the tenant, and the landlord’s rights against third parties (such as a guarantor) are unaffected.
Although the restructuring plan had released the tenant, Virgin Active, from future liabilities under the lease, it had not also released the guarantor who was not a party to that plan. So the judge granted summary judgment in favour of the landlord.
This was the first time that the court had directly considered the impact of a restructuring plan on a third party. In reaching its conclusion, the court was influenced by the similarity between restructuring plans under Part 26A and schemes of arrangement under Part 26. There was long standing authority that schemes under Part 26 took effect by operation of law and there was no reason to justify treating restructuring plans under Part 26A differently.
First published in Accountancy Daily.