National Security and Investment Bill

Lord Hodgson of Astley Abbotts Excerpts

Committee stage
Tuesday 9th March 2021 Grand Committee

Moved by

[Lord Hodgson of Astley Abbotts]

21: Clause 7, page 5, line 14, leave out paragraph (b)
Member’s explanatory statement
This amendment ensures that only those entities that carry on activities in the UK are qualifying entities.

[Lord Hodgson of Astley Abbotts (Con) [V]]

My Lords, in moving Amendment 21 I will speak also to Amendments 27 and 32.

The first two of those amendments would amend Clause 7, which is entitled “Qualifying entities and assets”. Amendment 32 is a consequential amendment to Clause 9. As has been the case with all the amendments I have tabled, they are designed to give greater clarity to the detail of the proposed regime and maintain the delicate balance between national security and investor rights, which we have all talked about at some length.

I add to noble Lords’ views that the level of knowledge about the provisions of this Bill is pretty low. Last week, I was in the north of England at a conference involving a number of senior professional firms. I do not think that they had hoisted in the reduction in thresholds. They still thought that it was a regime that would apply primarily to large companies. When I raised the point made by my noble friend Lord Lansley—that the regime began to come into force on 12 November last year—they looked fairly astonished.

Turning to the amendments, as before, I am grateful to the noble Lord, Lord Clement-Jones, for his support and to the Law Society for its help in drafting them. First, I will speak to Amendment 21. Under Clause 7(3), an overseas entity is a qualifying entity if, among other things, it

“carries on activities in the United Kingdom”.

It would be useful if we could have some guidance on the meaning of “qualifying entity” under the provisions of this Bill. There is a useful definition in the Bribery Act; it may be possible to bring that across to give clarity to this Bill as well.

Clause 7(3)(b) also provides that an overseas entity that supplies goods or services to persons in the United Kingdom would be a qualifying entity. Other major jurisdictions do not apply their national security laws to investments in foreign entities. The argument is that the Bill should only treat overseas entities that carry on activities in the United Kingdom as qualifying entities, rather than include entities that simply export to the United Kingdom. To achieve this, Clause 7(3)(b) should be removed.

Amendments 27 and 32 would replace Clause 7(6)(a) and (b) with new wording. The background to this is as follows. Clause 7(4)(c) and Clause 7(6)(b) together provide that non-tangible assets, such as ideas, information or techniques, are qualifying assets if used in connection with the supply of goods or services to persons in the United Kingdom. This provision could inadvertently cover UK businesses that buy, procure or use technological products or services supplied by third-party providers. Under this scenario, a UK company that buys in foreign artificial intelligence technology to help to deliver its business objectives could be covered, as could a UK company that uses foreign computer software in, for example, building and maintaining a database.

The situation I just described could be further complicated if a UK business plans to purchase another UK company covered by that scenario. Although it is a UK to UK transaction, under the nexus set out in Clause 7 these types of deals will be covered and caught under the new regime. Solicitors will have a duty to flag that up as a risk when advising corporate clients, which means that many more companies are likely to seek a voluntary judgment from the Secretary of State for reasons of certainty. This is likely to significantly increase the number of applications for a judgment made to the Secretary of State, and so is likely to slow down business. On the other hand, if a deal goes ahead and the ruling is made after it is completed, it could have significant consequences for the organisations in cost and outcomes.

This possible application of the regime to acquisitions by domestic acquirers is unusual compared to other jurisdictions where Governments have taken national security powers. Concerns relating to national security and domestic investments are likely to be able to be dealt with much more expeditiously under existing regulations—for example, confiscation proceedings under the Proceeds of Crime Act or the director disqualification regime. Amendments 27 and 32 would give effect to this simplification. I beg to move.

[Lord Clement-Jones (LD)]

My Lords, I start with an apology to the Minister. Amendment 26 in the previous group was a rogue and should have been deleted, because Amendment 27, introduced so well by the noble Lord, Lord Hodgson, superseded it. The PBO produced a much better format, so Amendment 26 was left like an orphan in a previous group, but it has been extremely helpful in getting a foretaste of the Minister’s arguments in this group, so I apologise to him, but there is nothing like hearing a good argument twice, and no doubt we will be all that wiser for it.

As the noble Lord, Lord Hodgson, has introduced the amendments so well, he has made it clear that they are intended to do two things: to ensure that qualifying assets are only assets used in connection with activities carried on in the UK, but not the supply of goods or services to persons in the UK; and, secondly, to prevent “in connection with” being interpreted in a way that treats all assets within the relevant supply chain as being within scope, even if owned and controlled by unconnected third parties, which may have no visibility of the activities of businesses further down the supply chain.

As drafted, the territorial scope of the Government’s call-in power is extremely broad, extending to non-UK entities that supply goods or services to persons in the UK, and assets situated outside the UK that are used in connection with activities carried on in the UK or the supply of goods or services to persons in the UK. This extraterritorial application is out of line with the approach taken in most other foreign investment regimes, which focus only on acquisitions of corporate entities registered in the relevant jurisdiction. It is also unnecessary. There are a number of other more appropriate ways to protect against a threat to the UK’s national security in connection with a transaction involving a non-UK registered company or assets that are not located in the UK, such as export/import controls, the network and information systems regime for critical infrastructure and other licensing requirements relating specifically to national security. From a practical perspective, it may also be difficult in many cases for an acquirer to analyse fully all aspects of the supply chain in order to self-assess the risk of a particular transaction being called in for review.

Furthermore, referring to supplies of goods or services captures all aspects of the supply chain, however minor. It is difficult for an acquirer of a business fully to analyse the supply chain, and including this as part of a mandatory regime with criminal sanctions is disproportionate. The proposed requirement for control by the person exercising the relevant activities is necessary to prevent “in connection with” being interpreted in a way that treats all assets in the relevant supply chain as being in scope, even if owned and controlled by unconnected third parties that may have no visibility of the activities of businesses further down the supply chain.

There are other more appropriate ways to protect against a threat to the UK’s national security in connection with a transaction involving a non-UK registered company or assets that are not located in the UK. As I said, most other foreign investment regimes have managed to crack that issue. I very much hope that the Government will think again.

--- Later in debate ---

[Lord Grimstone of Boscobel (Con)]

I thank the noble Lord, Lord Fox, for that question. I assure him that it is not stupid. I think the answer is in what I said towards the end of my speech. The Bill explicitly limits the application of remedies to persons outside the UK to those who have a clear connection with the UK, for example, UK nationals or companies, or those who carry on business in the UK. That provides the nexus back to the UK, which I think the noble Lord was searching for.

[Lord Hodgson of Astley Abbotts (Con) [V]]

My Lords, I thank all noble Lords who have participated in this debate. I was extremely relieved to hear from the noble Lord, Lord Clement-Jones, that Amendment 26 was a rogue amendment. He and I had both put our names to it originally and I withdrew mine. When I found that he had left his there, I thought he had seen some angle and I was going to be blown apart and take a torpedo amidships. I am grateful to hear that it was a rogue amendment.

I am grateful to my noble friend the Minister for the examples. I am still reaching for the implications of the question asked by the noble Lord, Lord Fox. I am not yet convinced that the qualifying entity idea has been probed enough, given that it has proved effective in the Bribery Act and has a similar purpose there. I will read what he has to say, think about it and maybe bring this back for a further discussion. In the meantime, I beg leave to withdraw the amendment.

Amendment 21 withdrawn.

--- Later in debate ---

Moved by

[Lord Hodgson of Astley Abbotts]

29: Clause 8, page 6, leave out lines 20 to 22 and insert “enable the person to secure or prevent the passage of any resolution in respect of any matter governing the affairs of the entity that is equivalent to a matter that can be passed by way of ordinary resolution or special resolution under the Companies Act 2006.”
Member’s explanatory statement
This amendment tightens the scope of the trigger event so that it does not capture minority investor veto rights that would not give rise to national security concerns.

[Lord Hodgson of Astley Abbotts (Con) [V]]

My Lords, in moving Amendment 29, I shall speak also to Amendment 72. They take us back to some of the issues touched on in our earlier debate on the group beginning with Amendment 15A, and the way that control is exercised in companies and what it means. These two amendments are designed to tease out and provide clarity and protection for third-party investors, who may find that they have invested in a company that, in turn, has been caught up in the provisions of the Bill. I seek the Government’s explanation for how this will work.

Amendment 29 amends Clause 8, “Control of entities”. There is concern about the clause arising from the wide definition of control contained in subsection (6). The real background is as follows. Investments in unquoted companies are normally governed by an investment agreement. When all goes well and the investment performs as expected, the investment agreement remains in a drawer and is never looked at but, sadly, not all investments perform as hoped, and not all directors and managers behave impeccably. Investors need protection against egregious behaviour by company managements.

What form could such behaviours take? It could be a proposal to make an acquisition—not one involving national security issues—the size of which would put the original company at risk if it were to go wrong. It could be a decision to spend a large sum of capital on a scheme that is ill thought out and ill considered, potentially putting the entire venture at risk. It might be a decision by the management to award themselves large salary increases. It might be a decision to recruit to a senior position in the company someone who has a public reputation that is not impeccable or who is perhaps related to one of the existing management team. For obvious reasons, investors need special protection against such behaviours and, as a last resort, the power to block them. It is not clear whether the existence of such blocking powers could bring the company within the control of entities provisions of Clause 8.

These protections for investors have nothing to do with national security; they are concerned with corporate governance and behaviour. An inability to allow those protections will surely be a significant disincentive to third-party investors, so Amendment 29 provides clarity that such protections will not be caught by the Bill. The arguments I have just rehearsed lie behind Amendment 72, which amends Clause 26—“Final orders and final notifications”. It seeks to make it clear that any unwinding or divestment order made by the Secretary of State in no way undermines investor rights of the sort I have been describing. I beg to move.

[Lord Lansley (Con)]

I shall refer only to Amendment 30, in my name, in this group. Earlier, we discussed the question of material influence. At this point in Clause 8, the fourth case to which we referred—the control of an entity—is, under subsections (8) and (9), effectively material influence. Looking at this, I could not understand why this bit of Clause 8 did not simply replicate Section 29 of the Enterprise Act, which is concerned with obtaining control by stages. I will not read the whole thing, but it is essentially about where a transaction or, in this case, a series of transactions—I will come back to that point—can be treated as occurring simultaneously, but which enables a person

“directly or indirectly to control or materially to influence the policy”

of the enterprise, or enables that

“person or group of persons to do so to a greater degree”.

We have here different language, and I would like the Minister to kindly explain how it works. I can see that it will be a person together with others, because of course it brings in holding an interest or a right by virtue of Schedule 1—working together with others—so that might be sufficient to say “directly or indirectly”. So, that might be covered by a common purpose, the connected arrangements and so on. But subsection (9), as it qualifies subsection (8), appears to suggest that if somebody already exercises a material influence over an entity, the fact that they increase their material influence by stages is not defined as control, unless it is one of the other cases set out in the clause. I think that is a gap. I think it ought to be included, and the clause ought to be constructed in a manner similar to the way in which the Enterprise Act enables control to be acquired by stages. I am not particularly asking for my drafting to be incorporated, but I invite Ministers to see whether it will be simpler to take out subsections (8) and (9) and insert something drawn from and similar to Section 29 of the Enterprise Act when we come back to this at Report.

--- Later in debate ---

[Lord Hodgson of Astley Abbotts (Con) [V]]

[Inaudible.] I am always slightly nervous when I hear Ministers talk about creating bespoke regimes because it brings to mind the gaps we might inadvertently allow to appear. The length the Minister has had to take to try to explain the way Clause 8 will work—I thank him very much for doing so—indicates that we need to look again at its practical implications. In essence, we are trying to decide whether the shoe pinches and whether it pinches in an unhelpful way. I am not sure that the “substantially all” get-out clause will always work, because in some cases investors will have very substantial rights or protection that might affect substantially all the activities of the company. But that is something one needs to take advice on. I am extremely grateful to the Minister for the trouble and time he has taken to answer the debate. For the time being, I beg leave to withdraw the amendment.

Amendment 29 withdrawn.

--- Later in debate ---

[Lord Bruce of Bennachie (LD) [V]]

My Lords, I speak to Amendments 31 and 33, which relate to the continuing debate on Clause 8 and Clause 9 on the control of assets. The effect of Amendment 31 would be to ensure that an event is triggered only where the person gains actual control of a qualifying entity, and it would exempt securities and other situations where no effective control is obtained.

The definition of “control” in Clause 8(1), as has already been said, is framed very widely. It refers to 25%, 50% and 75% shareholding or voting thresholds, which correspond to those applied in the context of the people with significant control regime. Clause 8 also includes provisions adapting the above scenarios to cater for entities that do not have a share capital, such as partnerships.

This should be read alongside Schedule 1, which I suspect the Minister might allude to, which provides for particular cases in which a person is to be treated, for the purposes of the Bill, as holding an interest or right. In particular, paragraph 7 of Schedule 1 states:

“Rights attached to shares held by way of security provided by a person are to be treated as held by that person … where apart from the right to exercise them for the purpose of preserving the value of the security, or of realising it, the rights are exercisable only in accordance with that person’s instructions, and … where the shares are held in connection with the granting of loans as part of normal business activities and apart from the right to exercise them for the purpose of preserving the value of the security, or of realising it, the rights are exercisable only in that person’s interests.”


However, this clarification does not fully account for the situation where a lender becomes the registered holder of shares in security, as is the case with the legal mortgage over shares under the law in England and Wales, or a shares pledge under the law of Scotland.

Where the shares in an entity are transferred in security to a lender, the lender may find first that they have gained control of the entity under scenario one, notwithstanding the fact that under the terms of the security actual control remains with the security provider, for example, through the voting rights being exercisable only in accordance with the security provider’s instructions, as envisaged by paragraph 7 in Schedule 1 and that secondly, they would have triggered the second limb of the notifiable acquisition test.

As paragraph 7 of Schedule 1 refers only to:

“Rights attached to shares held by way of security,”


arguably it covers only the rights attaching to shares and not the ownership of the shares themselves—in other words, the rights rather than the ownership. As a legal mortgage over shares is unusual in England and Wales, but a shares pledge is the only way to obtain fixed security over shares under Scots law, this issue disproportionately affects Scots law fixed security over shares; that is, fixed security over shares in Scottish companies. As I have said in previous interventions on this Bill, the importance of the financial services sector and therefore the law of Scotland requires this to be addressed.

Effectively, we are talking about a situation where, for example, a bank providing a loan to a business takes security over shares unrelated to that business. In that context, the bank neither seeks nor exercises control of the shares; similarly if a parent company for example gives security to its bank over the shares of a wholly-owned trading subsidiary. In this case, the parent company retains direct day-to-day control, which would pass to the bank only in the case of default. Yet, as drafted, there is a risk that taking a fixed security over Scottish shares could trigger the provision, which would be highly disadvantageous to the Scottish economy specifically.

Given that a notifiable acquisition that is completed without the approval of the Secretary of State is void, the Law Society of Scotland argues that paragraph 7 of Schedule 1 should be extended to cater for the situation where shares are held in security by a lender. Paragraph 7 should similarly be extended to carve out security over qualifying assets since the security could be read as giving the security holder rights equivalent to those set out in Section 9. It would be helpful to include an express carve-out that nothing here is triggered simply by the act of holding any asset in security.

The society recognises what the Government are trying to achieve and addresses the situation where the borrower defaults and the terms of the security usually dictate that the asset will be sold. The transaction will therefore form a trigger event in the same way as any other transfer. I guess in rare circumstances, the holder of the security—that is, the lender—might seek to appropriate the asset. However, such appropriation could be caught within the meaning of a trigger event and if it were determined that the lender in question was not a suitable person to acquire ownership and control of the entity, the society considers that it would be possible for the conditions attached to the transfer to stipulate that the new owner would be obliged to sell their shares. They would thus be compensated for the value of their shares and any national security risk would be avoided.

I turn to Amendment 33, which has a similar purpose addressed to assets—namely, to ensure that transactions constitute a trigger event only where the person gains actual control of a qualifying entity and to exempt securities or other situations where no effective control is obtained. Where a lender holds as asset in security that lender may find that it has gained control of that asset, notwithstanding that under the terms of the security actual control remains with the security provider where they are in possession of the security. The second limb of the notifiable acquisition test may be triggered even when no effective control has passed.

Under Scots law, fixed security over incorporeal moveable property, which in English law is intangible property, can be achieved only be transferring the asset to the creditor. This includes, among other things, shares, insurance policies, contractual rights and intellectual property. For those assets where a real right of security can be treated without the transfer of ownership, such as land, a new real right is still being created in favour of the creditor. This right contains certain inherent negative controls—for example, a prohibition on sale—and certain positive controls: often the borrower must insure the property. I think we all know that this is common practice in mortgage arrangements and, as drafted, there is a risk that taking a fixed security over a Scottish asset could trigger this provision and this also would be highly disadvantageous to the Scottish economy.

Taking this into account, it would also be helpful to include an express carve-out, where nothing is triggered by the act of holding any asset. As stated in relation to the previous amendment, provision can be put in place to ensure that the Government’s interests are protected in the event of a default or the transfer of the assets, if triggered in the normal way. As already stated in the context of Amendment 31, such appropriation would be caught within the meaning of the trigger event. Conditions could attach to the transfer to stipulate that the new owner would be obliged to sell the asset; they would be compensated and national security risk avoided.

It appears that the Law Society of Scotland has identified practical issues for financial transactions under Scots law, which these amendments seek to address while fully recognising the Government’s national security objectives. It is a Scots law difference which could affect Scottish banks and Scottish mortgages but does not appear to have been considered in the Bill’s drafting. I hope that the Minister will be able to take this away and confirm whether the Bill needs to be changed in this way to ensure that the Scottish economy does not suffer what could be significant disadvantage as a result. I beg to move.

[Lord Hodgson of Astley Abbotts (Con) [V]]

My Lords, I have tabled two amendments in this group, Amendments 34 and 35, which I shall now address. Again, they seek to provide clarity on the detailed operation of the Bill. As before, I am grateful for the support of the noble Lord, Lord Clement-Jones, and the Law Society.

Amendment 34 proposes a clarifying change to Clause 10(2)(b). It is argued that the existing wording of the clause means that any changes of ownership within the group of a company falling into one of the relevant sectors will require a notification. For example, an ultimate parent company might hold an interest in one such company through a wholly-owned subsidiary and, as a result of a decision to reorganise the group, it is decided that the parent should hold the interest directly. The holding company has the shares transferred to it. Any such holdings which are acquired after the commencement date, when the Bill becomes an Act, will have been through the security screening process, so there is surely no need for further consideration of what is essentially a paper transaction.

That leaves us with the question of how to deal with similar intragroup transfers where the initial investment was made before the commencement date. In such cases, of course, no screening will have taken place. Amendment 34 would require such changes to go through the standard notification and approval process.

Amendment 35 again seeks to provide clarity about how the Bill will operate in practice. Applying the current drafting of Clause 10 to a group which has multiple separate entities appears to require each of them to make a separate notification of a potential trigger event. That surely cannot be a sensible approach and, if followed, is likely greatly to increase the bureaucratic burden of form-filling and checking, and be a strain on the ISU. Amendment 35 establishes that, in the case of a corporate group, only one trigger event would arise and only one such notification would therefore be required.

[Baroness McIntosh of Pickering (Con) [V]]

I speak in support of Amendments 31 and 33. As I have the same brief, I do not intend to speak for long but I support all the arguments put forward by the noble Lord, Lord Bruce of Bennachie. I also state that I am a non-practising advocate of the Scottish Bar and a member of the Faculty of Advocates. If my noble friend the Minister is not minded to support the amendments, may I suggest that he meet the noble Lord, Lord Bruce, and me—if the noble Lord, as the author of the amendments, is agreeable—and, I hope, representatives from the Law Society of Scotland?

I honestly believe that this is a potential unintended consequence of the Bill, which could seriously disadvantage not just the Scottish legal profession but, more importantly, the financial service sector and financial investment sector in Scotland, which, as the noble Lord said, is sizeable in its contribution to the economy and employment. I endorse everything that he said and congratulate the Law Society of Scotland on bringing this to our attention. My understanding is that if the Bill is enacted as drafted, it could have grievous consequences for Scots law, Scottish practitioners and the financial sector. It behoves the Government to look favourably on the amendments. If not, I hope we can have the earliest possible meeting to discuss these matters in more depth.