Corporate Law Update

• The Government intends to launch the UK’s new national security regime on 4 January 2022 and publishes a host of guidance on the regime
• In particular, the Government is consulting on the circumstances in which it will call acquisitions in under the new regime
• A decision to allocate partnership profits was subject to a duty to act rationally
• The FRC’s Financial Reporting Lab publishes a new report on stakeholder, decision and section 172 reporting
• Draft legislation is published to close a “lacuna” in certain financial promotion exemptions
• The Government is consulting on changes to the UK’s merger control regime
• Companies House re-introduces same-day services for capital reductions
• The Takeover Panel publishes minor changes to the Takeover Code
• The FCA publishes its business plan for 2021/2022
• The Takeover Panel publishes its annual report for 2020/2021
• ESMA publishes an updated version of its Prospectus Regulation Q&A
• ESMA publishes guidance on prospectus disclosures by special purpose acquisition companies (SPACs)

Covid-19 is affecting the way people conduct their business, retain their staff, engage with clients, comply with regulations and the list goes on. Read our thoughts on these issues and many others on our dedicated Covid-19 page.

National security regime to commence on 4 January 2022

The Government has announced that the UK’s new national security screening regime will commence on 4 January 2022.

The regime is set out in the National Security and Investment Act 2021, which received Royal Assent this year to become law but the majority of which has yet to be brought into effect. For more information on the regime, see our previous Corporate Law Update.

Guidance on the regime

In advance of the regime coming into force, the Government has also published several pieces of guidance for businesses that may be affected. These include the following.

• An overview of the new regime. This guidance sets out what types of acquisitions are covered by the new rules, when the Government needs to be informed, and how the Government will scrutinise an acquisition.
• An overview of the extra-territorial aspects of this regime. This guidance explains how the new regime affects people based, and acquisitions that take place, outside the United Kingdom.
• Interaction with regulatory requirements. This guidance explains how the new regime interacts with existing regulatory regimes, including under the Enterprise Act 2002 and the Takeover Code and the regimes administered by the Competition and Markets Authority, the Financial Conduct Authority and the Prudential Regulation Authority.

In addition, the Government has published sector-specific guidance for the higher education and research-intensive sectors.

The Government is also consulting on a statement of policy intent setting out when it intends to use its “call-in power” to screen acquisitions. We cover this separately in the next item below.

Mandatory notifications in sensitive sectors

Alongside this, the Government has published draft regulations setting out the 17 sensitive sectors in which it will be mandatory to notify an acquisition that hits the thresholds under the regime.

The Government has previously consulted on these sectors and published its official response to that consultation. See our previous Corporate Law Update for more information. After further targeted engagement with stakeholders following that response, the Government has refined the proposed descriptions of the 17 sensitive sectors.

The descriptions of the 17 sensitive sectors are set out in schedules to the draft regulations. Those sectors are now as follows:

• Advanced materials. This includes a wide array of different substances, including advanced composites, metals and alloys, engineering and technical polymers and ceramics, technical textiles, metamaterials, semiconductors, photonic and optoelectronic materials and devices, graphene and related 2D materials, nanotechnology, certain “critical” chemical elements, and certain other materials.
• Advanced robotics. This captures technology that is autonomous in nature and is capable of using its sensors to carry out sophisticated surveillance and data collection in respect of any aspects of its environment.
• Artificial intelligence. This captures businesses that carry out research into, or develop or produce goods, software or technology that use, artificial intelligence. The regulations describe this as technology enabling a device or software to be programmed or trained to perceive environments through the use of data, interpret data using automated processing designed to approximate cognitive abilities, and make recommendations, predictions or decisions.
• Civil nuclear. This is defined by reference to a series of specific activities, including operating a civil nuclear facility or handling civil nuclear materials or information.
• Communications. This encompasses businesses that provide a public electronic communications network or service or with supply associated facilities, as well as businesses that repair or maintain submarine cabling or cabling stations. It also captures high-volume top-level domain name registries, domain name system resolver services and domain name system authoritative hosting services, and internet exchange points with a 30% or greater market share.
• Computing hardware. This effectively covers the design, production and maintenance of computer processing units (CPUs) and associated intellectual property. This includes services providing or managing roots of trust for CPUs and the fabrication of memory circuits.
• Critical supplies to government. This captures public contracts with the UK Government with a high level of security classification.
• Cryptographic authentication. This encompasses research into, and the development and production of, products that employ cryptography as a means of authentication. It does not cover products ordinarily supplied to consumers.
• Data infrastructure. This is a complex sector, but broadly it includes any infrastructure that is used to exchange data in connection with a contract with certain specified public sector bodies or to exchange data between public electronic communication networks.
• Defence. This covers goods and services provided for defence or national security purposes, but only if the business is a government contractor or sub-contractor or if the Government specifically informs the business that its activities are within scope.
• Energy. This encompasses a wide range of activities, including upstream petroleum operations, electricity generation, distribution, transmission and interconnection, gas processing, transportation and supply, LNG importation and exportation, and downstream oil, gas and fuel marketing activities. In most cases, size thresholds apply to exclude smaller businesses.
• Military and dual-use. This is limited to researching, developing and producing goods or technology that are controlled by UK export control legislation.
• Quantum technologies. This sector brings in a variety of activities all based on quantum technology, each of which is defined quite specifically. They include quantum communications, quantum connectivity, quantum imaging, sensing, timing or navigation, quantum information processing, computing or simulation, and quantum resistant cryptography.
• Satellite and space technology. This encompasses a variety of space-based activities, including manufacturing, placing, maintaining and manoeuvring satellites and providing satellite communication links.
• Suppliers to the emergency services. This covers a wide range of activities and services provided to the emergency services, which (for these purposes) includes (among other things) police bodies, fire and rescue authorities, border forces and the National Crime Agency.
• Synthetic biology. This is defined as the “process of applying engineering principles to biology to design, redesign or make biological components or systems that do not exist in the natural world”. The regulations give a non-exhaustive list of example activities, which include gene editing, gene therapy, and data storage using DNA.
• Transport. This covers port, harbour and airport owners and operators.

The Government intends to publish guidance on these sectors in the autumn.

Government consults on call-in power under new national security regime

The Government is consulting on the use of its “call-in power” under the UK’s new national security screening regime. That regime is planned to come into force from 4 January 2022 (see item above).

Background: how will screening work?

Under the National Security and Investment Act 2021, the Government, operating through its new Investment Security Unit (ISU), will have the power to call an acquisition in for screening if it satisfies one or more “triggers” in the Act. This includes some acquisitions that took place before the Act received Royal Asset and became law.

The deadline for the Government to call an acquisition in is six months from when it becomes aware of the acquisition or five years from the date of the acquisition, whichever is earlier.

In most sectors, there will be no requirement to notify the Government of an acquisition that meets the triggers, although the parties are free to do so if they wish. However, if the acquisition takes place in one of 17 specified sectors, notification will be mandatory (see item above).

If the Government decides to call a transaction in, it will have 30 working days to decide whether to allow it to proceed. It will be able to extend that period by a further 45 working days if it reasonably considers it necessary to do so. The Government and the acquirer will be able to agree an additional voluntary extension if the Government is satisfied that a risk to national security has arisen and it requires additional time to consider whether to make a final order.

The Government will be able to impose orders on transaction parties while it screens an acquisition. These would include (for example) requiring parties not to consummate a transaction and not to disclose any information to anyone.

If the Government is satisfied that an acquisition involves both a trigger event and a risk to national security, it will be able to impose a “final order”. This will allow the Government to attach conditions to a transaction or to block or unwind a transaction.

Consultation

The consultation puts forward the Government’s proposals for how the Government will use the call-in power. These are set out in a draft “Statement of Policy Intent”. Once formalised, the Government will need to have regard to this statement before it exercises its call-in power.

The draft statement has been substantially revised since the previous version published by the Government. They key points arising out of the statement are set out below.

• When deciding whether to call an acquisition in, the Government will assess each acquisition on a case-by-case basis. It will not use its call-in power to interfere arbitrarily in investment.
• The call-in power may be used only on acquisitions that give rise to or may give rise to a risk to national security. It is not part of a system for screening all acquisitions in the economy.
• The Government is more likely to exercise its call-in power in relation to acquisitions within any of the 17 sensitive sectors of the economy and in areas of the economy that are linked to, but not strictly within, those 17 sectors.
• Other acquisitions are unlikely to be called in, as national security risks are expected to occur less frequently in these areas.
• When deciding whether to call an acquisition in, the Government will consider primarily three risk factors: target risk, acquirer risk and control risk. The three factors will be assessed alongside each other and will influence the weight given to each.
• In assessing target risk, the Government will consider what the target business does or is capable of doing and whether this could pose a risk to national security. This may involve considering risks arising from the target’s proximity to sensitive sites.
• In assessing acquirer risk, the Government will consider characteristics such as the sector in which the acquirer operates, its technological capabilities, and links to entities that may seek to undermine or threaten the UK’s interests, democracy, safety, military advantage, reputation or economic prosperity. This will include understanding who ultimately controls the acquirer. Characteristics such as a history of passive or longer-term investments may indicate low or no acquirer risk.
• In assessing control risk, the Government will consider whether the amount of control acquired has given or may give rise to a risk to national security. A large amount of control may increase the possibility of a target being used to harm national security or distort a market in a way that threatens national security.
• The Government will not make assumptions based on an acquirer’s country of origin, but ties or allegiance to a hostile state or organisation will be taken into account.
• The same tests will apply when deciding whether to call in the acquisition of an asset, rather than an entity. However, the Government expects to call in acquisitions of assets rarely and significantly less frequently than acquisitions of entities.
• Acquisitions outside the UK are less likely to give rise to national security risks and so are less likely to be called in. The risk to national security will be related to how strongly the entity or asset is connected to the UK.
• The Government will apply the same risk factors when deciding whether to call in an acquisition that has already taken place. This will be assessed based on the risk to national security at the point of the decision, not when the acquisition took place.

The Government has asked for responses by 31 August 2021.

Decision to allocate partnership profits had to be taken rationally

The High Court has held that, when deciding how to allocate profits to the members of a limited liability partnership under the terms of the partnership deed, the management needed to act rationally.

What happened?

Tribe v Elborne Mitchell LLP [2021] EWHC 1863 (Ch) concerned a limited liability partnership (LLP) incorporated in the UK which operated as a law firm.

As is common, the firm’s governance and constitution, including the allocation and distribution of any profits it made, were governed by a members’ agreement (sometimes called a “partnership deed”).

Under the members’ agreement, partners in the firm would first be allocated a “fixed share” – that is, a specific, identified amount – from the firm’s profits (assuming sufficient profits to pay those amounts).

After the fixed shares had been paid, up to 40% of the firm’s profits would be allocated to a “discretionary fund”. These funds would be allocated and paid according to a two-step procedure:

• The firm’s senior partner would make recommendations to the partners as to how profits within the discretionary fund should be allocated. The senior partner was required to “have substantial regard for financial performance” but otherwise was entitled to determine recommendations (in the words of the members’ agreement) “at his discretion”.
• If required, the partners would approve the allocation of funds by an “ordinary resolution”.

Following the allocation of the discretionary fund for the 2015 and 2016 financial years, one of the firm’s former partners complained that the funds had not been allocated properly.

In particular, the former partner claimed that the senior partner’s decision when making a recommendation and the partners’ decision to pass an ordinary resolution approving that allocation were both exercises of a contractual discretion and so subject to the so-called “Braganza duty”, and that both decisions had been made in breach of that duty.

Interestingly, the former partner also argued that, in making these decisions, the firm’s partners had to have regard to the principles set out in Re Charterhouse Capital Ltd [2015] EWCA Civ 356.

That case summarised a principle more commonly known to lawyers as the rule in Allen v Gold Reefs of West Africa Ltd, which states that, when the members of a company resolve to amend the company’s constitution, they must comply with various conditions. These include (among other things) that they act in good faith in the interests of the company.

Although similar to the Braganza duty, the rule in Allen v Gold Reefs is framed less in terms of exercising a contractual discretion and more as a protection to prevent the majority of a group of persons abusing their power to the disadvantage of the minority. It is usually pled and treated separately, as it relates specifically to amending a company’s articles of association, although in recent years the principle has also been considered in the context of amendments to loan notes.

What did the court say?

The court agreed that the Braganza duty applied to the senior partner’s decision to make recommendations as to allocations among the partners. This meant that, in making his recommendations, the senior partner had been duty-bound not to “take into account irrelevant matters or ignore relevant ones”. His recommendations could not be “outside the range of reasonable proposals that might be made in the circumstances”.

However, the senior partner had complied with that duty. In the judge’s view, his recommendations did not need to be perfect or include all possible analyses. They merely needed to be full enough to allow for a debate between the partners. They could address non-financial matters, provided that the senior partner paid “substantial attention” to financial performance (which itself went merely beyond billings).

Separately, and interestingly, the judge also said that the rule in Allen v Gold Reefs and Re Charterhouse applied to the partners’ decision to ratify or modify the proposed allocation by way of ordinary resolution. The effect of this was similar. That decision could not “take into account irrelevant matters or ignore relevant ones”, and it could not be “outside the range of reasonable decisions that might be made in the circumstances of allocating the discretionary fund”.

Having decided that the senior partner’s recommendations were reasonable, it was fairly straightforward for the judge to conclude that the partners’ decision to adopt those recommendations was also reasonable.

What does this mean for me?

LLPs and partnerships are commonly used in a variety of circumstances to provide professional services. These include legal, accountancy and medical services, as well as within the private equity and venture capital industry.

In some ways, the decision on the Braganza duty is not surprising. The duty has previously arisen in relation to bonus allocations and payments under employment-related insurance policies. Profit allocation is a logical area in which the rule would apply.

Importantly, the decision shows that, when allocating profits in these circumstances, partners will be held to a particular standard and cannot act capriciously or irrationally. However, provided they follow a basic, reasonable and explicable process, it should be difficult to challenge any ultimate decision as to profit allocation. This might include the following.

• Consider the basis of previous decisions. Although the decision-maker will not be required to follow the same procedure each time, the route by which previous decisions have been made and whether all relevant parties have acquiesced in them may be informative.
• Document the decision and its basis. Generally, the courts will not interfere with the commercial merits of a decision, but they will assess the level of scrutiny applied. It will be easier to demonstrate to a judge that a decision was made properly if the decision-maker can point to the factors they took into account.
• Consider setting out the parameters for the decision in the contract. If at the drafting stage, it may be worth stating explicitly in the relevant contract what factors the decision-maker can (or must) take into account and which they can (or must) ignore. However, it would be important not to straitjacket the decision-maker, and any factors should probably be expressed to be non-exhaustive. The contract should also state explicitly that any decision is or remains at the decision-maker’s discretion.

The court’s decision on the rule in Allen v Gold Reefs is an interesting development. The point was not argued before the court, and so it is important not to place undue reliance on the judge’s comments. However, if upheld, this could be a significant development.

Historically, the rationale for this rule was to prevent the majority of a group of persons from using its power to oppress the minority. Scenarios in which this might happen include where the majority of a company’s shareholders amend its articles in a way that favours only their own interests and not those of the company, or where a majority of the holders of a series of loan notes agrees amendments to the terms of the notes that favours only that majority. In these scenarios, if the decision is not taken in good faith, the court can effectively unwind it.

This decision here shows that the courts might be prepared to apply the rule to a wider range of decisions by the economic owners of a business. In this case, the decision was one through which the majority, if so inclined, could oppress the minority: the members’ agreement effectively gave the majority of the LLP’s members the power to enhance their own remuneration at the expense of the minority, even if this did not involve an amendment to the members’ agreement.

It is not clear whether the courts would be prepared to apply the rule more broadly to other kinds of decision. An obvious parallel is a decision by a company’s shareholders to approve a final dividend, although generally the shareholders in that situation will not be able to vary dividend entitlements as between individual shareholders (as these will be set by the company’s articles).

But other decisions by members of a company, LLP or partnership may involve more qualitative judgments. Examples might include approving the terms of a share buy-back, director’s service contract or capital reduction, or the sale of the principal assets of a fund. Should the courts apply the rule in Allen v Gold Reefs to these kinds of decision, this would represent a significant in-road into the concept that an economic participant is generally free to vote in a way that protects their own interests.

For the time being, members of an LLP, partnership or company should bear in mind, when taking a decision that affects all members, that they should act in the best interests of the business and the membership as a whole and not in a way that unduly places their interests above others’.

FRC publishes lab report on section 172 reporting

The Financial Reporting Council’s Financial Reporting Lab has published a new report on investors’ expectations of companies when reporting on stakeholders, decisions and section 172.

For financial years beginning on or after 1 January 2019, large companies (both public and private) must include a “section 172(1) statement” in their strategic report. The statement must explain how the directors had regard to the various factors which they are required to consider when discharging their duty under section 172 of the Companies Act 2006 act in a way which they consider, in good faith, would be most likely to promote the success of their company for the benefit of its members.

Those factors include (among other things) the interests of the company’s employees, the need to foster good relations with its suppliers, customers and others, the impact of its operations on the community and environment, and the need to act fairly as between the company’s shareholders.

Separately, companies above a certain size are required to report on how they engaged with employees, customers and suppliers during the financial year in question.

The key points arising out of the Lab’s report as set out below.

• Information on stakeholders. Many investors believe they currently do not get sufficient information, or that information has gone through “social washing” or is too generic.
  
  Reporting should cover the stakeholders relevant to the company’s success, how they influence its business model and strategy, how the company builds and maintains strong relationships with stakeholders, measures and monitors those relationships and understands stakeholders’ needs and concerns, and what could affect the company’s relationships with its stakeholders.

• Information on decisions. Investors want information on decisions taken by management, as decisions link directly to the company’s strategy and have implications for its future.
  
  Decisions and disclosures should be connected to the company’s purpose and aligned with its business model and strategy, take into consideration risks and opportunities, and consider how different stakeholders will be impacted.
  
  Reporting should cover significant decisions taken during the year and how they link to the company’s purpose and strategic priorities, with specific details of each decision, as well as the process the board undertook to reach principal decisions and how it oversaw decisions that were delegated to management.

• Section 172. Investors expect companies to report more significant and difficult decisions than usual in light of the COVID-19 pandemic. The report states too many statements have focussed on stakeholder engagement in a process-oriented way without considering outcomes.
  
  Section 172(1) statements should explain the company’s route to long-term success and highlight the board’s role in this. Investors reported that section 172(1) statements are more useful when they cover both stakeholder engagement and the other aspects of section 172, discuss how stakeholders and other factors are considered when making principal decisions, operate as a stand-alone source of information, and fit into a connected narrative linking to business model, strategy, governance and culture.

Draft legislation published to close “lacuna” in financial promotions regime

A draft of the Markets in Financial Instruments, Benchmarks and Financial Promotions (Amendment) (EU Exit) Regulations 2021 has been laid for sifting. The purpose of the Regulations is to close a gap in the UK’s financial promotions regime resulting from the UK’s withdrawal from the European Union.

Under the Financial Services and Markets Act 2000, a person who is not authorised by the FCA must not publish a financial promotion unless it is first approved by an FCA-authorised person. The Financial Services and Markets Act 2000 (Financial Promotion) Order 2005 (the FPO) sets out exemptions to this prohibition, some of which refer to investments of instruments traded on a “relevant market”.

To be a “relevant market” under the FPO, its head office must be in an EEA State or Gibraltar. Following the end of the implementation period, the UK is no longer treated as an EEA State. However, the definition of “relevant market” under the FPO has not been amended to include UK markets.

As a result, certain exemptions that applied previously to UK markets no longer apply. The exemptions affected are those under articles 37, 41, 67, 68 and 69 of the FPO.

The Regulations would remedy this lacuna by replacing references to “relevant market” with references to “relevant UK market”. This effectively inverts the current definition so that it includes markets within the UK but not markets within Gibraltar or the EEA.

The FCA has confirmed that, until this change is made, it does not propose to take enforcement action if a breach of the general prohibition only arises because the relevant exemption no longer applies on account of this omission.

Also this week…

• Government consults on reforms to merger control regime. The UK Government has published a consultation on reforms to its competition and consumer policy. The consultation proposes changes to (among other things) the UK’s merger control regime. We will cover the consultation in more detail in next week’s Corporate Law Update.
• Companies House resumes same-day capital reductions. Following our announcement last week, Companies House has now confirmed that it has resumed same-day registration services for capital reductions. Unless the reduction is supported by a court order, documents should be submitted using Companies House’s “Upload a Document Service”. Documents must be received by 11:00 a.m. for same-day processing. Documents received after this time will be processed the next working day.
• Minor changes to the Takeover Code. The Takeover Panel has published three new instruments that will make minor changes to the Takeover Code. Instrument 2021/3 will amend references to the “Institute of Chartered Secretaries and Administrators” to reflect the body’s new name, “The Chartered Governance Institute UK & Ireland”. Instrument 2021/4 will change the fees and charges payable for approving offer documents and whitewash documents, generally lowering the former by around 25%. Finally, Instrument 2021/5 will make a minor change to reflect appointments to the Takeover Appeal Board. The Instruments come into effect on 2 August 2021. 
• FCA publishes business plan for 2021/2022. The Financial Conduct Authority (FCA) has published its business plan for 2021/2022. The business plan sets out the FCA’s priorities for the forthcoming 12 months. In relation to capital markets, the FCA states that its priorities include revising the listing and prospectus rules frameworks to reinforce the effectiveness of the UK’s wholesale markets and to continue to monitor the markets for market abuse.
• Takeover Panel publishes 2020/2021 annual report. The Takeover Panel has published its annual report for 2020/2021. The report notes that Q1 2020 was one of the quietest quarters on record, with only five firm offers announced, but that there has since been a significant rebound in activity, with a total of 48 firm offers announced during the year (still below the prior year but not significantly out of kilter with the five-year average). The report also highlights a trend towards an increasing number of bids by private equity and similar investors, which accelerated in 2021, with approximately half of the offers for larger companies (>£100 million market capitalisation) by these kinds of investor. 
• ESMA updates Prospectus Regulation Q&A. The European Securities and Markets Authority (ESMA) has published an updated version of its Q&A on the EU Prospectus Regulation. The new questions cover updating information in a tripartite prospectus after the registration document has expired, including information from a new registration document in a tripartite prospectus, reverse acquisitions by empty shell companies, and using the de minimis offer size exemption across multiple EU jurisdictions.
• ESMA publishes guidance on disclosures by SPACs. The European Securities and Markets Authority (ESMA) has published a statement setting out what it considers to be key disclosure requirements where a special purpose acquisition company (SPAC) needs to publish a prospectus under the EU Prospectus Regulation. Although relevant primarily where a SPAC seeks admission to an EU regulated market or to offer its securities to the public within the EU, the guidance may be useful for SPACs seeking to raise finance in the UK.