A cautionary tale: internal restructures and The National Security and Investment Act 2021

What is The National Security and Investment Act 2021?

The National Security and Investment Act 2021 (“NSIA”) allows the government to scrutinise, and potentially block, acquisitions and investments where the target business operates in any of the 17 areas of the economy specified in The National Security and Investment Act 2021 (Notifiable Acquisition) (Specification of Qualifying Entities) Regulations 2021 (“NSIA Regulations”), which could impact on national security.

These ‘sensitive areas of the economy’ are wide-ranging. They include:

• Artificial intelligence
• Communications
• Critical suppliers to the government
• Computing hardware
• Data infrastructure
• Defence.

Where an acquisition or investment changes the control of a target business which operates in any of the 17 specified areas of the economy, the buyer must submit a mandatory notification to the Investment Security Unit. There are no financial thresholds, which means even low-value transactions fall within the scope of NSIA.

The threshold for change of control can be as low as 25%, and transactions below this threshold could also be caught where there is a change in “material influence”. An example of this is where the increase in an investment vehicle’s stake in BT Group Plc from 12% to 18% triggered a mandatory notification requirement.

Importantly, the change of control threshold also applies to internal restructures, even where the ultimate beneficial owner does not change.

Mandatory notification – why is it important?

Where the mandatory notification requirement is triggered, it is crucial that both a notification is made and the transaction is placed on hold until the transaction is cleared by the Secretary of State.

If a notifiable transaction completes before clearance is granted, the person who gains control of the target business commits a criminal offence. The maximum penalty is five years in prison for individuals and corporate fines of up to £10m or 5% worldwide turnover, whichever is higher.

If the government suspects a transaction has completed where a mandatory notification was required, it has the power to “call-in” the transaction for up to five years after completion.

In circumstances where a mandatory notification is required, the transaction is void and the buyer must submit a Retrospective Validation Application Form.

Case study: failure to notify

A company director contacted HCR Law after receiving an Information Notice from the Investment Screening Unit relating to a recent internal restructure of Company A.

Company A was incorporated with three shares, owned by Company B, Company C and Company D. Over time, additional shares were issued but the percentage ownership remained the same and resulted in Companies B, C and D each holding 100 shares.

An internal restructure took place and Company D acquired:

• 94 shares from Company C
• 100 shares from Company B.

As a result, Company D held 98% of the shares in Company A.

As the directors and shareholders of Company A considered this an internal restructure among longstanding business partners, they did not engage legal advice and proceeded with the share transfers.

However, Company A is a cyber security consulting business and, at the time of the restructure:

• Held government contracts which required it to process and store official sensitive data
• Was engaged in a research partnership with the National Cyber Security Centre
• Was developing document collaboration systems for defence-sector clients
• Its employees were all required to be vetted to a minimum security clearance level of ‘Security Check’.

These activities fell within the scope of Gateways 7, 9 and 10 of the NSIA Regulations.

The requirement to submit a mandatory notification under NSIA was therefore triggered. However, as the transaction had completed without a mandatory notification being made, not only was a Retrospective Validation Application required, but also the transaction was void.

We acted on behalf of Company D to prepare and submit a Retrospective Validation Application.

Practical advice

Businesses need to be aware of the significant impact the NSIA regime can have on acquisitions and investments, including internal restructures. The scope of the NSIA Regulations is wide, and often technical. Although the ISU has published guidance to help businesses identify transactions which fall within the scope of the NSIA regime, in practice the definitions are not straightforward and often transactions are caught under multiple Gateways.

Businesses should seek legal advice to identify whether a mandatory notification is required under the NSIA regime as soon as possible, when looking to acquire or invest in a business which may fall within the 17 specified areas of the economy.