The UK Government has made a rare intervention in the proposed acquisition of aerospace and defence company Cobham plc by U.S. private equity firm Advent International, on national security grounds.
Cobham has a number of contracts with the Ministry of Defence (the ‘MOD’) and the British military for a range of services, including specialist air-to-air refuelling, electronic warfare systems and training in relation to software used in combat aircraft.
Legal basis for Government intervention
Article 21(4) of the EU Merger Regulation1 enables Member States to protect, inter alia, national security interests in relation to transactions that have an EU dimension and which, therefore, fall within the European Commission’s exclusive jurisdiction.
Under section 67 of the Enterprise Act 2002 (the ‘Enterprise Act’), the Secretary of State may exercise the power conferred by article 21(4) and issue a European Intervention Notice (the ‘Notice’). This Notice enables the Government to investigate the public security aspects of a proposed deal even where there may not be a competition issue.
In June 2018, the Government introduced the first of two stages relating to the implementation of the national security regime to review mergers and acquisitions, especially those involving foreign direct investment. This resulted in the amending of merger thresholds, which allowed the Government to intervene more easily in transactions within sectors identified as raising national security concerns. These sectors were UK military, UK dual-use, radioactive source and EU dual-use, and examples of businesses falling within these sectors include those which develop military and dual-use technology, quantum technology and computing hardware.
The Government may only justify intervention on national security grounds under the following conditions:
- two or more enterprises cease or will cease to be distinct entities as a result of being brought under common ownership or control; and either
- the target’s existing share of supply of goods or services in the UK must be at least 25 per cent, where share of supply includes both purchase and sale;2 or
- the UK turnover of the target business must be greater than £1 million.3
The amended thresholds only apply with respect to the four sectors specified above. Furthermore, the legislation also states that it is sufficient for the target alone to possess a share of supply that is at least 25 per cent. No overlap between the target and the acquirer is necessary and hence the new tests do not require an increase in the share of supply.
For all other sectors, the turnover threshold for intervention remains at £70 million, and the 25 per cent share of supply test would require an overlap.
The new thresholds will also apply to any competition assessment that is carried out by the UK Competition and Market Authority (the 'CMA') in any of the four sectors raising national security concerns. However, when assessing a merger on competition grounds, the CMA does not believe that there is any need to treat mergers involving relevant enterprises differently from mergers in other sectors.4
The CMA will only begin investigations on its own initiative where there is both a national security concern and the possibility of a substantial lessening of competition as a result of the merger.
It will not investigate a transaction on national security grounds in the absence of competition concerns unless requested to do so by the Government. National security concerns may, therefore, still give rise to a Phase I or Phase II CMA investigation where the Government issues a public interest intervention notice. Once the investigation is complete, the Government may accept undertakings, order remedies, or block the transaction altogether.
Alongside a review by the CMA to decide whether the Cobham transaction meets the relevant jurisdictional criteria and whether the transaction gives rise to competition issues, officials from the Department of Business, Energy and Industrial Strategy (with input from the MOD and Home Office) will conduct a Phase I public interest review.
It will then be for the Secretary of State to make a determination on whether to clear the transaction, accept certain undertakings, or refer the transaction for an in-depth Phase II review by the CMA. Should a Phase II review be ordered, the CMA will review public interest and, if applicable, competition concerns, following which the Secretary of State must then make a final decision.
The CMA submitted its final report to the Secretary of State on 29 October 2019.
A growing trend
Although rare, Government intervention in transactions similar to Cobham is not without precedent. Earlier this year, the Government announced an investigation into the deal between Inmarsat and Connect Bidco on grounds of national security. In the two years preceding that announcement, the Government launched similar investigations into the tie up between Hytera Communications and Sepura, and the proposed acquisition of Northern Aerospace by Gardner Aerospace. Between 2004 and 2017, the Government intervened in a further six transactions.
Notwithstanding the relative infrequency with which the Government has previously intervened, it seems that proposed legislative changes could make intervention a much more common occurrence.
A month after the introduction of the supplementary thresholds in respect of the CMA’s jurisdiction under the Enterprise Act (considered above), the Government introduced a White Paper5, which recommended further significant changes to the law in this area.
Proposals set out in the White Paper would create a review system for certain categories of investment, acquisition or other transaction that is separate from the CMA’s jurisdiction. While the CMA could continue to review transactions from a competition perspective (subject to the ability of a Government minister to intervene and overrule), it would no longer have jurisdiction over national security aspects.
Like the CFIUS regime in the U.S., the system envisaged by the White Paper would operate a voluntary notification mechanism, whereby parties to a transaction could request review by the Government with the option of accompanying informal discussions. However, the Government could ‘call in’ transactions where they may pose a risk to national security. Three types of risks have been identified:
- Target risk – refers to the acquisition of ownership or control over entities, assets or land that, due to its nature or location, may give the acquirer the ability to undermine national security through the disruption of essential services or the disclosure of sensitive information.
- Trigger event risk – refers to the acquisition of significant influence or control that may give the acquirer the means or ability to undermine national security. Therefore, parties involved in a transaction must focus on whether the acquirer will gain significant influence or control over the entity or asset as a result.
- Acquirer risk – refers to the available information about individuals or entities who may acquire significant influence or control over the target entity or asset.
It would then be for the Government to confirm that the deal may proceed, allow the deal to progress subject to certain conditions or block the transaction. The Government strongly encourages parties to notify it of any planned transaction and to engage in discussions prior to closing, in order to receive advice as to the possible scrutiny the transaction may have to undergo.
In addition, the Government would be able to initiate a review, either before or within six months after the closing of the transaction, as per the White Paper. The Government would also have the power to unwind completed transactions or impose other remedies to alleviate national security concerns and protect national interests.
Should the changes proposed in the White Paper make it into legislation, interventions by the Government as seen in relation to the Cobham deal are likely to become increasingly frequent. The Government anticipates that, under the proposed new CFIUS-style regime, it will receive 200 voluntary notifications per year and is likely to undertake a full national security review in respect of half of those cases.6
- Council Reg. (EC) 139/2004 (OJ 2004 L24/1, 29.1.2004).
- The Enterprise Act 2002 (Share of Supply Test) (Amendment) Order 2018, available at legislation.gov.uk.
- The Enterprise Act 2002 (Turnover Test) (Amendment), available at legislation.gov.uk.
- Department for Business, Energy & Industrial Strategy, “National Security and Investment: A consultation on proposed legislative reforms” (July 2018), available at assets.publishing.service.gov.uk.
Client Alert 2019-259