As national security reviews grow in impact, investors need to be mindful of potential adverse consequences resulting from such reviews
A savvy investor should consider taking specific steps in structuring and planning its transactions to incorporate protections regarding applicable national security reviews.
International M&A deal advisors are acutely aware of the growing impact of national security reviews on cross-border M&A transactions, particularly in light of the vibrant investment flows between China, the United States and the EU. Some consider such reviews to be the "new merger control."
National security reviews have the potential to drastically change the nature of an M&A transaction or to derail it completely. The impact of a national security review and its outcome can range widely and may include an actual or de facto prohibition of the transaction if it is deemed necessary by the relevant authority to protect vital national security interests (an example of a de facto prohibition was the attempted sale of Lumileds by Philips to a consortium of Chinese investors, which was called off because the parties were unable to secure clearance by the Committee on Foreign Investment in the United States (CFIUS)).
More commonly, however, reviewing bodies address national security concerns by imposing conditions or mitigation measures on the target and/or the acquirer. These conditions and mitigation measures may include divestiture of the target's sensitive assets or other measures (e.g., intellectual property transfers, ring-fencing of certain data/information relevant to the target's customers, governance restrictions, audit requirements or limitations on future investments).
With these risks in mind, a savvy investor should consider taking specific steps in structuring and planning its transactions to incorporate protections regarding applicable national security reviews.
National security reviews add an additional layer of complexity to an M&A transaction and increase potential uncertainties and risks to be considered when structuring the transaction. Regarding timing, parties should consider the review period under the national security review process once the submission for such review has been formally accepted by the relevant authority (understanding that, in practice, securing such formal acceptance requires preparation and often pre-coordination with the relevant authority, which can cause delays). The overall timeline for national security reviews may vary significantly based on the applicable phases of the given national security review process. If clearance cannot be obtained prior to the applicable deadline for the transaction, such as the end (or long-stop) date or, in the case of a public tender offer, prior to the expiration of the acceptance period or the date on which shareholder withdrawal rights become available, then the parties risk that the transaction may not be completed.
In addition, the significance of these timing considerations may vary depending on whether clearance by the relevant authority is mandatory or voluntary (the latter being the case for filings with CFIUS and the German Ministry for Economic Affairs and Energy, among other authorities). For a voluntary review, the parties must consider the risks of closing the transaction prior to the receipt of clearance.
REGULATORY MATERIAL ADVERSE CHANGE (MAC) CLAUSES AND RELATED CONDITIONS
While the absence of a prohibition by a governmental authority of the proposed transaction is a customary condition precedent (CP) for any transaction, an acquirer would typically also want to specify in the transaction agreement the circumstances relating to the regulatory review process under which it would not be required to consummate the proposed transaction.
From the acquirer's perspective, CPs and covenants relating to the regulatory review process serve to protect the acquirer from having to consummate the transaction under circumstances where the government has imposed regulatory conditions or required mitigation measures that would change the nature of, or the business rationale for, the proposed transaction. Depending on the market practice in the relevant jurisdiction, the contract provisions intended to protect the acquirer from these risks may take the form of regulatory material adverse change clauses (regulatory MACs) and/or covenants that specify the level of effort that the acquirer must expend in order to obtain the necessary regulatory approval. These types of provisions are designed to allocate the regulatory risk between the target company and the acquirer and often provide for quantifiable thresholds (e.g., based on the target's consolidated sales and/or revenues) relating to the government-imposed regulatory conditions or mitigation measures that, if exceeded, would allow the acquirer to abandon the deal (either outright or after payment of a penalty in the form of a reverse break-up fee).
In the case of public tender offers conditioned on the absence of a regulatory MAC, in many jurisdictions, such CPs are allowed only if the regulatory MAC provision is sufficiently precise and can be assessed by an independent expert.
As for covenants related to the level of efforts the acquirer must expend in order to obtain the necessary regulatory approvals, the obligation imposed on the acquirer may range from "hell or high water" commitments, which require the buyer to take all requisite action to obtain regulatory approval, to provisions that expressly state that the acquirer will not be obligated to agree to any government- imposed conditions and mitigation measures, including divestiture of assets, properties or lines of business, so that the acquirer has the option of either complying with any governmental requirements or abandoning the transaction.
BALANCING THE ACQUIRER'S AND TARGET'S INTERESTS
CPs, such as regulatory MACs, and covenants relating to the parties' obligations to obtain regulatory clearances and, if applicable, implement the government-imposed regulatory conditions and other mitigation measures, are often accompanied by reverse break-up fee arrangements which, in some cases may be backed by financial security or escrow arrangements, depending on the financial wherewithal of the acquirer. These provisions are designed to allocate certain financial risk to the acquirer if the transaction is not consummated due to regulatory reasons. While most investors are accustomed to the concept of reverse break-up fee arrangements, the risk that such arrangements will be triggered increases as thresholds for national security reviews and intervention become lower worldwide.
Depending on the applicable national security review regime, industry and products or services involved in a transaction, parties will often need to address on a case-by-case basis the level and extent to which each party should bear the regulatory risk.
RING-FENCING AS A BROADER TREND
A recent trend in dealing with anticipated national security reviews is the use of "ring-fencing" provisions in the transaction agreement. These ring-fencing provisions limit the acquirer's ability to either control or gain access to certain specified aspects of the target's business, assets or operations. These provisions are a form of self-regulation by the transaction parties to preemptively address and alleviate the likely national security concerns of the relevant authority regarding the particular transaction, as seen in some recent European transactions.
Ring-fencing measures are often aimed at protecting the target's intellectual property and know-how by increasing or establishing management's oversight duties. They may also include mandatory physical restrictions and cyber security plans or auditing processes. Such measures are frequently intended to address concerns that sensitive know-how is at risk and the existing safeguards at the target (e.g., management oversight) are not considered adequate. In fact, ring-fencing measures may also be imposed contractually by customers voicing their concerns in the event of a major transaction affecting their supplier.
Ring-fencing arrangements may, therefore, serve a number of purposes and help reconcile the interests of numerous stakeholders (including, in some cases, political interests) if a transformational transaction is being considered. Ring-fencing can also be done as a mitigation measure in response to specific concerns raised by a regulatory authority regarding a transaction.
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