The Mergers & Acquisitions Review: United Kingdom
Overview of M&A activity
In the UK, the lack of clarity surrounding Brexit continued to hinder dealmaking in 2019, which fell in value terms by 27.2 per cent from 2018, from £184.1 billion across 1,657 deals to £134.1 billion across 1,403 deals.2 However, in line with wider global trends, UK tech M&A continued its growth, with the highlight being the £6.8 billion takeover of Just Eat by Takeaway.com.
In 2020, the covid-19 crisis slowed the M&A pipeline dramatically. Domestic and cross-border M&A involving UK companies in Q2 2020 saw 152 completed transactions, a sizeable decrease of 311 when compared with the previous quarter's haul of 463, and 292 fewer than in the same quarter in 2019 (444).3 Nevertheless, the UK and Ireland saw the most M&A activity in terms of deal value in Europe, with the aggregate value of deals in H1 2020 totalling €87.9 billion (a third of the total deal value across the EU).
Value of outward M&A in Q2 was £4.4 billion, a £0.3 billion increase on the previous quarter and £2.7 billion higher than in Q2 2019.4 The value of inward M&A in Q2, £2.1 billion, was the lowest value recorded since Q4 2014. This was also down £3 billion compared with Q1 2020.
In public M&A, only 12 firm offers were announced for Main Market or AIM companies, with two-thirds of these offers having been announced in Q1.5 In the same period in 2019, 33 firm offers were announced. As well as deal volume being significantly down, deal values were much lower, with only one bid having a value over £1 billion (compared to seven bids with such value in the first half of 2019). Aggregate deal value was just £2.6 billion, the lowest half-yearly aggregate value for UK public M&A transactions since H1 2009.6 Although there are some signs of public M&A returning, target boards remain conscious of opportunistic approaches against the backdrop of still depressed share prices.
At the time of writing, though the UK M&A market has seen a higher level of activity than may have been expected at the beginning of the covid-19 crisis, until the uncertainty lifts, activity will remain subdued and dealmakers cautious.
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General introduction to the legal framework for M&A
The Companies Act 2006 provides the fundamental statutory framework, and with the law of contract forms the legal basis for the purchase and sale of corporate entities. In addition, the City Code on Takeovers and Mergers (Takeover Code) regulates takeovers and mergers of certain companies in the United Kingdom, the Isle of Man and the Channel Islands. The Takeover Code has statutory force and the Takeover Panel (Panel) has statutory powers in respect of transactions to which the Takeover Code applies. Breach of any of the Takeover Code rules that relate to the consideration offered for a target company could lead to the offending party being ordered to compensate any shareholders who have suffered loss as a consequence of a breach. In addition, breach of the content requirements of offer documents and response documents may constitute a criminal offence. The Panel also has the authority to issue rulings compelling parties who are in breach of the requirements of the Takeover Code to comply with its provision, or to remedy the breach. These rulings are enforceable by the court under Section 955(1) of the Companies Act. The Takeover Code has a wider scope than the EU Takeovers Directive, and applies if the offeree (or potential offeree) is a UK public company and, in some instances, if the company is private or dual-listed.
The Financial Services and Markets Act 2000 (FSMA 2000) regulates the financial services industry and makes provision for the official listing of securities, public offers of securities, and the communication of invitations or inducements to engage in securities transactions. Following substantial amendments to the FSMA 2000, brought about on 1 April 2013 when the Financial Services Act 2012 (FS Act) came into force, financial regulation is split between two bodies: the Financial Conduct Authority (FCA), which regulates conduct in the retail and wholesale markets, and the Prudential Regulation Authority, which is responsible for the prudential regulation of banks and other systemically important institutions. As a consequence of the FS Act, more than 1,000 institutions (including banks, building societies, credit unions and insurers) are now dual-regulated. The FCA Handbook (containing the Listing Rules), the Prospectus Regulation Rules sourcebook (containing the Prospectus Regulation Rules) and the Disclosure Guidance and Transparency Rules Sourcebook (containing the Disclosure Guidance and Transparency Rules), promulgated by the FCA (the competent authority for the purposes of Part VI of the FSMA 2000), includes various obligations applicable to business combinations involving listed companies, and contains rules governing prospectuses needed for public offers by both listed and unlisted companies. The Listing Rules, in particular, set out minimum requirements for the admission of securities to listing, the content requirements of listing particulars and ongoing obligations of issuers after admission. The Criminal Justice Act 1993 contains the criminal offence of insider dealing and, from 3 July 2016, the EU Regulation on Market Abuse (MAR) (with the Listing Rules, the DTRs and the Takeover Code) regulates the civil regime for insider dealing.
Merger control rules are contained in the Enterprise Act 2002, although they do not generally apply to mergers in relation to which the European Commission (Commission) has exclusive jurisdiction under the EU Merger Regulation. In addition, specific statutory regimes apply to certain areas, including water supply, newspapers, broadcasting, financial stability, telecommunications and utilities, and these separate regimes may have practical implications in merger situations.
The framework outlined above is based on the position as at the date of writing with the UK still bound by EU law. However, with the end of the transitional period approaching on 31 December 2020, a period that preserved the status quo notwithstanding the UK's departure from the EU on 31 January 2020, the position will change from 1 January 2021. Although, as of that date, most EU law to which the UK is subject will be 'on-shored' so that UK law is initially aligned with the EU, it may diverge over time.
Strategies to increase transparency and predictability
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Developments in corporate and takeover law and their impact
i Takeover Panel: changes to the Takeover Code and practice
As noted in the previous edition of The Mergers & Acquisitions Review, there have been recent amendments to Rule 29 and the approval of provisional legislation that will come into force following the UK's exit from the EU on 31 December 2020.
In addition, while there have been no further legislative changes to the Code regarding the increased disclosure obligations, which, as outlined in the previous edition, came into force on 1 January 2018, there has been a shift in practice in reaction to this legislation. It has been noticeable that the Panel does now expect parties to disclose substantially more information – about, for example, the future of their business – than they may previously have been accustomed to providing.
It is also worth considering how wider trends impact takeovers in practice. In particular, the increasing influence of the Pensions Regulator (which now has greater powers to intervene in transactions) and the global rise in protectionism are both likely to affect how takeovers are conducted. It is foreseeable that legislation will be updated in the future to reflect these trends, but in the meantime practitioners should consider how such changes may impact the structure of their transactions.
On 17 October 2018, the Takeover Panel introduced a series of amendments to Rule 29 (on asset valuations). The amendments do not materially alter the current application of Rule 29; rather, the changes primarily codify existing practice and provide increased clarification. Subject to some remaining variations, the amendments broadly bring Rule 29 in line with Rule 28 (on profit forecasts). These variations include, for example, the requirement for parties to undertake asset valuations fully; unlike Rule 28, there is no cover for ordinary course profit forecasts, which enable parties to circumvent the reporting requirements under Rule 28.
Brexit – planned amendments
On 6 March 2019, Response Statement (RS 2018/2) was published, in which the Panel adopted the majority of the changes proposed by the Code Committee in relation to the UK's withdrawal from the EU. The amendments will take effect on exit day (within the meaning of Section 20 of the European Union (Withdrawal) Act 2018), which we now know will be 31 December 2020. The amendments will therefore be effective from 1 January 2020.
Two particularly notable points arise from the Response Statement. First, the rules regarding shared jurisdiction and the rules aligning the treatment of EEA shareholders with other overseas shareholders will be removed. Second, it is interesting that the Panel decided not to get rid of the EU conditions, a decision that the Panel has acknowledged is for purely pragmatic reasons.
We have seen an expansion of Foreign Direct Investment (FDI) screening regimes across the globe, a trend that was growing pre-crisis but has been accelerated to deal with issues highlighted by the pandemic and growing concern about investment from potentially hostile states. In June 2020, the UK government expanded its powers under the Enterprise Act 2002 to enable it to intervene on public interest grounds in transactions that might affect the UK's pandemic response, which could extend beyond the immediate health response to businesses active in internet services and the food supply chain, for example. The UK government has also expanded its ability to intervene in transactions in certain parts of the technology sector. It has also reaffirmed its intention to implement a wider foreign investment regime in a new National Security and Investment Bill, initially published in July 2018 and set out in the Queen's Speech in December 2019, while the EU Commission is also consulting on a new bloc-level one-stop-shop system to review foreign-subsidised acquisitions and the impact of foreign subsidies on EU markets.
This growing focus on investment controls in the UK and elsewhere is becoming an increasingly important part of deal planning, with implications for deal strategies and timetables, and one that looks likely to be here to stay; however, it may also create opportunities for competitive advantage for bidders that do not trigger reviews or present prima facie national security concerns.
Us antitrust enforcement: the year in review
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Foreign involvement in M&A transactions
Inward M&A decreased notably in 2019: foreign acquisitions of UK companies were valued at a total of £53.8 billion, compared with £78.8 billion in 2018, though this is mainly attributable to Comcast Corporation's acquisition of Sky plc for over £30 billion.7 The value of outward M&A also fell from £23.8 billion in 2018 to £20.9 billion in 2019 after there were no very-high-value deals (considered to be above £10 billion) in either year.8
In Q2 2020, the value of inward M&A was just £2.1 billion, the lowest value recorded since Q4 2014 (£1.9 billion) and down £3 billion from Q1 2020 (£5.1 billion).9 Outward M&A accounted for £4.4 billion in Q2 2020, an increase of £0.3 billion on Q1 2020 and £2.7 billion higher than Q2 2019.10 Two notable outward acquisitions that completed during Q2 2020 were Synthomer plc's acquisition of Omnova Solutions Inc and Bodycote plc's acquisition of Ellison Surface Technologies.
Significant transactions, key trends and hot industries
i Invoking MAC condition: Rule 13.5(a) – Takeover Panel ruling
In the offer for Moss Bros Group plc by Brigadier Acquisition Company Limited (Bidco), a bid vehicle owned by a consortium comprising Meonshi Shina and others, Bidco sought a ruling from the Takeover Panel to invoke several conditions of its offer so as to lapse its offer for Moss Bros. Bidco argued that the impact of a prolonged closure of Moss Bros' retail outlets and deterioration of its financial position up to the date of the scheme document had been materially adverse. Bidco also highlighted certain specific scheme conditions relevant to the ongoing covid-19 situation, primarily the material adverse change (MAC) condition. The Takeover Panel ruled that Bidco should not be permitted to invoke conditions to its offer for Moss Bros so as to lapse its offer, as Bidco had not established that the circumstances that gave rise to its right to invoke the conditions were materially significant to it in the context of its offer, as required by Rule 13.5(a) of the Code.11
The ruling is a reminder that there remains an extremely high threshold applied to materiality when bidders seek to lapse bids by invoking MAC conditions. One point worth considering in this context is that the bidder ought reasonably to have been aware of the risks posed by the covid-19 pandemic and negotiated conditions around the risk, given that the firm intention announcement came a day after the World Health Organisation declared covid-19 a global pandemic. It falls to reason that the effects of the pandemic on the Moss Bros business would have been priced into the offer price.
ii Warranty and indemnity insurance
The use of warranty and indemnity (W&I) insurance in private M&A transactions has taken on greater importance in recent years. The London W&I insurance market (which comprises over 25 insurers) now has an estimated combined capacity for a single risk in excess of £1 billion.12 Insurance broker Paragon estimates that 949 transactions used W&I insurance in 2019, compared with 870 in 2018 and 353 in 2014.13 One such transaction was Bovis Homes Group plc's acquisition of Galliford Try plc's Linden Homes and Parternships & Regeneration businesses for £1.075 billion.
W&I insurance is increasingly being used to support 'the full spectrum of transactions' irrespective of size.14 A driver for the growth of W&I is that sellers seek a clean break to clear funds. With buyers demanding the comfort of warranties and indemnities that are as extensive and unqualified as possible, W&I insurance assists in unblocking 'stalemate' issues surrounding the allocation of risk, where previously the differences between parties' positions could easily have resulted in a deal not proceeding. As many businesses seek quick access to funds in light of the covid-19 pandemic, it might be that this trend increases in the coming year.
iii Shareholder activism
As noted in previous editions, the past few years have seen a considerable increase in shareholder activism. This often features shareholders seeking to secure higher offers for a target company prior to their backing of a bid. Throughout 2019 and in the early part of 2020, we saw further examples of shareholder activism in the context of public M&A.
In 2019, Cat Rock Capital targeted Just Eat, pushing for a merger with its rival Takeaway.com, while Eminence (a top-10 Just Eat shareholder) launched a campaign of its own opposing the merger, illustrating how activists attempt to shape M&A activity according to their own investment strategies and interests. Activist activity also focused on the demand for board seats in light of perceptions of underperforming management. The most notable example of this was Sherborne's attempt to have its founder Edward Bramson appointed to the Barclays board, indicating that activists are not deterred from directing their attentions to large companies in highly regulated industries.15
In February 2020, Anglo American plc's offer for Sirius Minerals plc saw Odey Asset Management LLP, which had a 1.29 per cent interest in Sirius, publish an email setting out its view that the offer of 5.5 pence per share did not represent fair value for Sirius shareholders.16 It was also highlighted by Odey that there was a low turnout at Sirius' AGMs, magnifying the power of Sirius shareholders who did vote.17 Despite Odey's attempts to drive the offer price up, the resolutions were passed by the requisite majorities in March 2020 and the deal went ahead.
Given the uncertain long-term impact of covid-19 and the volatile markets, activist shareholders have been largely silent since Q1, but it is expected that as markets stabilise, shareholder activists will continue to play an important participative role in M&A transactions.18
iv Sector trends
Given the decreased deal volume in H1 2020, it is difficult to draw meaningful conclusions on trends in sector focus within the M&A market. In the public market and including possible offers, six of the 22 possible and firm offers announced in H1 2020 were in the healthcare and pharmaceutical sectors and six were in the computing and IT and media and telecommunications sectors.19 The largest firm offer, in the property sector, was Freshwater Group's offer for Daejan Holdings, which valued the share capital of the target at £1.3 billion.
It is anticipated that, in line with wider global trends, both the telecoms, media and technology (TMT) and the pharma, medical and biotech (PMB) sectors will remain resilient through the crisis, while the consumer and leisure sectors are likely to continue to struggle.
Financing of m&a: main sources and developments
The increase in private-equity-backed acquisitions seen in 2019 was a positive development for the UK M&A debt financing market: of the 55 firm offers announced in 2019 that involved a cash consideration component, approximately 62 per cent (34 transactions) included a debt financing element. This represents a slight increase on 2018 levels, where 55 per cent of deals involving a cash consideration component included some form of debt financing. As in 2018, the use of short-term bridge facilities remained popular in 2019, particularly for larger deals and sponsor-backed transactions; the facilities are typically refinanced in the bond markets, with longer-term loan refinancing or, in some instances, share issues. It has become increasingly common for the refinancing to take place before completion of the acquisition. Structures will be influenced by the currency of the offer and the planned refinancing strategy; facilities denominated in sterling remain common, although dollar- and euro-denominated facilities were increasingly seen in 2019 (particularly for sponsor-backed transactions). Margins were, unsurprisingly, variable depending on both the structure of the facilities and the rating of the offeror and complexity and size of the transaction.
One point that can prompt discussion is Rule 24.3(f) of the Takeover Code, which requires that offer documents must contain a description of how an offer is to be financed and the source or sources of the finance. In particular, an offer document must provide details of the key terms of the debt, including the interest rates and any step-up or variation provided for (which would include market flex rights). Following the publication of the announcement of a firm intention to make an offer, any documents relating to the financing of the offer must be published on a website no later than 12 noon on the following business day (Rule 26.2(b)). The disclosure of any market flex provisions included in the financing arrangements can be a contentious issue. Disclosure of negotiated flex rights pursuant to Rule 26.2 may lead to higher funding costs, as it can put potential syndicate members on notice of the arrangers' ability to increase the interest payable (within the agreed parameters).
Rules 24.3(f) and 26.2 were introduced in 2011; in its 2012 review of the 2011 amendments to the Takeover Code, the Panel noted that as a result of the concerns outlined above, dispensation had been granted from the Rule 26.2 requirement in relation to the disclosure of flex rights. This gives the parties a period of up to 28 days to complete syndication before publication of the offer document, which must then include details of the flex in accordance with Rule 24.3(f). Whether this 28-day concession will be long enough to complete syndication will depend upon the proposed timetable.
i Covid-19: employment implications for M&A
The covid-19 pandemic has forced many businesses to make significant changes to their employment arrangements, whether by furloughing employees, freezing or cutting pay, bonuses and other benefits, or changing working patterns. There has also been the challenge of making workplaces covid-secure and negotiating when and how employees return to the workplace. Some businesses have already had to make redundancies, and many others are facing that prospect in the coming months.
From an M&A perspective, the pandemic has led to many purchasers seeking specific warranties about what measures the seller has taken in relation to its staff to manage the impact of the pandemic. These measures may have the potential to create significant financial and reputational damage for the target company and the purchaser if not handled appropriately, and in some cases may require specific indemnity protection. All this has meant that employment issues are taking on greater significance in an M&A context than they may have done before the pandemic.
ii TUPE: split employment?
The Transfer of Undertakings (Protection of Employment) Regulations 2006 (TUPE) apply to certain asset transfers and service provision changes, and form one of the key considerations from an employment perspective on an M&A transaction. On a TUPE transfer, the contracts of employment of in-scope employees will be automatically transferred to the purchaser. Where there is a transfer of part of an undertaking, and employees work partly in the transferring business and partly in the retained business (or partly in another part of the business that is transferring to a different purchaser), there needs to be an analysis of what happens to those employees. This analysis is often quite nuanced, with the role and responsibilities of the employees being relevant, as well as the proportion of their hours spent working for each side of the business. However, the traditional analysis is that the whole employment contract of each employee must either transfer to the purchaser (or one of them) or remain with the retained business. A recent decision of the Court of Justice of the European Union (CJEU) has, however, cast some doubt on that analysis, and envisaged the possibility of a transferring employee having their employment contract split between multiple transferee employers following a TUPE transfer, in proportion to the tasks performed by the employee.
ISS Facility Services NV v. Govaerts  EUECJ C-344/18 (26 March 2020) involved a cleaning services manager who split her time across three different sites. The client went through a retendering process and awarded separate contracts such that cleaning for two of the sites went to one provider and the other site went to a different provider. The CJEU stated that, rather than trying to work out at which site the claimant was principally engaged and transfer her employment contract to that provider, she could (in theory) be employed by both new service providers on a part-time basis. If that proved impossible or operated adversely to her interests in practice (this would need to be determined by the Belgian national courts), she could treat herself as constructively dismissed and sue both service providers.
Although the case involved multiple transferees, the premise could apply equally to the transfer of part of a business, where (for example) head office staff work partly for that business and partly for the retained business. The outcome in Govaerts has been viewed as somewhat controversial in the UK, where the courts have in the past rejected the possibility of employment contracts being split on the transfer of part of the business. However, in light of the CJEU decision (which is still 'good law' for the UK courts during the Brexit implementation period), employees with split roles could claim that both transferees (or the transferor, or both) would be their employer, and therefore liable for a portion of their subsequent salary or dismissal costs.
It is difficult to assess the likelihood of such a claim being brought or succeeding, given the recent and novel nature of the CJEU decision. Businesses should, however, be aware of the potential for this kind of argument (and liability) arising, and carefully analyse the nature of the work that employees do for each part of the business in order to assess the likely exposure.
iii Brexit: employment implications for M&A
As the end of the Brexit implementation period on 31 December 2020 approaches, much uncertainty remains about what impact Brexit will have on UK employment law. A significant proportion of UK employment law is derived from (and guaranteed by) European law, and will cease to be so guaranteed from 1 January 2021. The scope for changes will depend on what agreement, if any, is reached between the UK and the EU about the scope of our future relationship. The level playing field for workers' rights is one of the sticking points in the negotiations, and at the time of writing the UK remains unwilling to agree to align UK employment law as closely with EU employment law as the EU negotiators insist is required. At the time of writing, the chances of there being no deal at the end of the implementation period are growing.
No deal would leave the government with greater scope to make changes to UK employment law, many of which may impact on M&A transactions. These include most notably TUPE, with likely candidates being a loosening of the restrictions on changing terms and conditions, and (potentially) on pre-transfer redundancies. There may also be more scope to make changes to the rules on informing and consulting employees on collective redundancies, which can cause particular difficulties in insolvency transactions. There will almost certainly be an impact on European Works Councils (EWCs), with the UK becoming a third country and unable to participate in EWCs in the same way following a no-deal exit. Businesses with EWCs will need to bear this in mind, particularly when undertaking M&A activity that falls within the scope of EWC consultation.
More broadly, businesses will also need to be aware of the impact of free movement ceasing at the end of the implementation period, and the introduction of the new points-based immigration system on 1 January 2021 for EU and non-EU workers coming to the UK.
iv New pensions legislation to increase scrutiny of the pensions impacts of corporate activity
The government is planning to intensify the Pensions Regulator's scrutiny of how corporate activity may affect pension provision, through the 2019–2021 Pension Schemes Bill, which has finished its passage through the House of Lords and, at the time of writing, is being considered by the House of Commons.20
The bill proposes new civil penalties of up to £1 million, and new criminal penalties of up to seven years' imprisonment. Under the current bill, the new criminal offences are particularly broad: a person (regardless of their relation to the pension scheme in question) who 'without reasonable excuse' intentionally acts to prevent the recovery of the whole or any part of a statutory Section 75 debt (a debt that becomes due under Section 75 of the Pensions Act 1995 from a sponsoring employer to a pension scheme in certain circumstances, including the insolvency of the employer), including, for example, by preventing the debt from becoming due or compromising the debt, will have committed a criminal offence. Furthermore, a person will have committed a criminal offence where he or she engages in a course of conduct that detrimentally and materially affects the likelihood of accrued pension benefits being received, if he or she knew or ought to have known about that consequence and did not have a reasonable excuse for his or her conduct. As drafted, these offences could capture a wide range of corporate actions taken in relation to a company's defined benefit pension liabilities. During the parliamentary process, the government responded to criticisms of the wide scope of these new offences by explaining that the Pensions Regulator would publish guidance setting out its approach to prosecuting these new offences prior to these powers coming into force.
The Pensions Regulator has the power to require an employer (or a connected or associated person) to contribute a specified amount to a pension scheme, where (in summary) that employer or person is party to an act (or failure to act) whose main purpose was to avoid or reduce a Section 75 debt, or otherwise has a materially detrimental effect on the likelihood of accrued pension benefits being received. The bill contemplates extending this power to situations where an act (or failure to act) would have reduced a pension scheme's recovery if a Section 75 debt becomes due, or where the act (or failure to act) would have reduced the value of the employer's resources, if the reduction is material relative to the amount of the estimated Section 75 debt. This change is intended to protect pension schemes from a deterioration in the financial position of their sponsoring employers. However, as drafted, they may have wide-ranging consequences where a corporate transaction reduces the assets available to an employer. As with the new criminal offences outlined above, guidance from the Pensions Regulator will be crucial in determining the potential exposure of employers (and their connected and associated persons) to regulatory intervention.
Another change will increase the scope of the current notifiable events regime by requiring employers to make a declaration of intent, addressed to the pension scheme trustees and shared with the Pensions Regulator, in relation to certain business transactions, describing the information that has been shared with the pension trustee in relation to the transaction and the adverse effects that the transaction might have on the pension scheme, and stating how the employer proposes to mitigate any such impact on the pension scheme. While full details of the new requirements have not yet been published, notification will be required at an earlier stage in the transaction process than under the current regime (which requires a notification as soon as reasonably practicable after the relevant decision is made).
v New funding code for UK pensions schemes
The Pensions Regulator is expected to publish a new funding code, which will focus on the long-term funding objective of pension schemes. Parties to commercial transactions involving defined benefit pension schemes will need to bear in mind that pension trustees will be focused on being able to reach their long-term funding target (i.e., a buy-out of benefits with a third-party insurer, or funding self-sufficiency).
vi Funding challenges caused by the covid-19 pandemic
At the start of the covid-19 pandemic, the Pensions Regulator announced a number of regulatory easements, and published guidance that gave pension trustees greater scope to accept a deferral or suspension of employer deficit recovery contributions to their defined benefit pension schemes. In guidance published on 16 June 2020, the Pensions Regulator estimated that 10 per cent of schemes had accepted deferrals or suspensions of contributions.21 In the coming months, as pension trustees are better able to assess the long-term impact of the pandemic on employers, the Pensions Regulator expects pension trustees to scrutinise carefully any requests to extend any deferrals or suspensions, and to ensure that pension schemes are treated equitably, in particular by reference to the treatment of creditors and shareholders.
With the end of the transition period in sight, 2020 may have seemed an opportune moment to review the competitiveness of the UK's tax system in order to ensure that the UK remains an attractive investment hub post-Brexit. Indeed, the UK government appears to be taking some steps in this direction, having announced a review of the UK funds regime and the VAT treatment of financial services, but the outbreak of covid-19 has shifted priorities.
i An autumn Budget in the spring
In November 2016, then UK Chancellor Philip Hammond announced that the UK would move to a single major fiscal event each year. From autumn 2017, there would be an annual Budget to be delivered in the autumn. But this new fiscal timeline was derailed just three years later by the general election with the postponement of the autumn 2019 Budget until March 2020. By then, Rishi Sunak was the newly appointed Chancellor and the covid-19 crisis had begun to unfold.
As part of the March 2020 Budget, it was announced that the UK corporation tax rate would remain at 19 per cent for the next two financial years (rather than decreasing to 17 per cent as planned), that entrepreneurs' relief and the use of carried-forward losses would be further restricted, that HMRC be given preferential creditor status in respect of certain taxes on insolvency, and a number of new taxes, including a 2 per cent digital services tax, an economic crime levy and a plastic packaging tax, would be introduced. On the positive side, it was also announced that writing down allowances would, in certain circumstances, become available in respect of intangible assets acquired as part of a business acquisition on or after 1 July 2020. The government further announced that it would create a working group to review the VAT treatment of financial services and that it would review the UK funds regime. Views have already been sought on the attractiveness of the UK as a jurisdiction to establish intermediate asset-holding companies.
In July 2020, Sunak announced further fiscal measures, including temporary VAT and stamp duty land tax reductions, in order to kickstart the UK economy following the national lockdown triggered by covid-19. July 2020 also saw the publication of a number of consultations, including on VAT grouping (raising the possibility of compulsory VAT grouping to level the playing field), and of draft legislation, including for a number of anti-tax-avoidance measures.
The next fiscal event will be the Budget. The Budget should have taken place in November 2020, but on 23 September 2020 the cancellation of the autumn 2020 Budget was announced. It is therefore expected that the next Budget will take place in the spring of 2021. Speculation in the press is that the Chancellor will need to raise taxes to finance earlier support measures. There are rumours that the UK corporation tax rate may be increased and that the capital gains tax rates (currently 10 per cent or 20 per cent in most circumstances) may be aligned with income tax rates (currently between 20 per cent and 45 per cent).
ii Capital gains tax and entrepreneurs' relief
The UK tax system has a long tradition of treating capital gains differently from income. The distinction is particularly important for individuals, given that, at least at present, capital gains are taxed at lower rates than trading income, earnings, interest and dividends and, in each tax year, capital gains up to the annual exempt amount (currently £12,000) are not subject to tax. It is for this reason that retail shareholders tend to prefer capital over income returns – so much so that public companies used to undertake B-share schemes to give shareholders a choice between the two types of return. While such schemes are no longer possible (from April 2015, transactions with a choice of return have been treated as giving rise to income receipts), ensuring that shareholders receive capital as opposed to income returns is still an important structuring consideration in public transactions.
The funds and private equity industry is another area in which the capital versus income distinction plays an important role. Traditionally, management incentives have been structured to create capital returns and, in recent years, legislation has been introduced to counteract this trend. In April 2016, the concept of 'income-based carried interest' was introduced so that, unless certain criteria in respect of the investment fund's activities were met, managers' carried interest is taxed as income. Moreover, even where carried interest is treated as capital, higher rates of capital gains tax apply (18 per cent and 28 per cent as opposed to 10 per cent and 20 per cent).
Despite these inroads, the distinction between capital and income remains crucial to the UK tax treatment of individuals and the structuring of transactions. As mentioned above, however, it is rumoured that the UK government may be looking to align income and capital gains tax rates. Indeed, in July 2020, the Chancellor requested a review by the Office of Tax Simplification of the capital gains tax regime, considering in particular 'areas where the present rules can distort behaviour . . . and the interactions of how gains are taxed compared to other types of income'.22 A closer alignment of capital gains tax and income tax would be a major change to the UK tax treatment of individuals, which could turn on its head several decades' worth of received tax-structuring wisdom in an M&A context and beyond.
Entrepreneurs and fund managers would be particularly hard hit. For them, the curtailment of entrepreneurs' relief (ER) in 2019 and 2020 already came as a blow. ER could, in certain circumstances, reduce the applicable capital gains tax rate to 10 per cent, and private equity structures were often set up so as to allow managers to benefit from ER in respect of capital gains realised on an exit. From 6 April 2019, the conditions for ER were tightened. With effect from 11 March 2020, the total amount of gains in respect of which an individual may, during their lifetime, benefit from ER has been limited to £1 million (before that date, the limit had been £10 million), which takes the limit back to where it was in 2008 when ER was originally introduced. ER was also renamed 'business asset disposal relief'.
iii Stamp duty
The UK imposes a tax on the transfer of shares in the form of an interlinked system of stamp duty and stamp duty reserve tax (SDRT). Stamp duty is normally paid in respect of paper and SDRT in respect of electronic transfers, but the details of the interaction between these two taxes, and the application of each, are somewhat more complicated.
Stamp duty, in particular, is generally regarded as archaic and can be baffling to a foreign investor. As the purchaser cannot be recorded as the legal owner of the transferred shares until any applicable stamp duty has been paid, an efficient payment process would seem key. The normal payment process, however, involves sending the original hardcopy transfer instrument to the Stamp Office in Birmingham by post. The document is then stamped, using a special stamping machine, before it is sent back, again by post. In certain circumstances, same-day stamping may be available (meaning that an individual may deliver the document to the Stamp Office in person and pick it up stamped in the afternoon of the same day). It is evident that a reform of this process would make closing an M&A transaction more straightforward.
It will therefore be music to everyone's ears that the government published a consultation in July 2020 inviting views on how stamp duty and SDRT could be modernised.23 The consultation asks in particular whether the temporary changes to the stamp duty payment process introduced to combat the spread of covid-19 (instead of submitting hardcopy documents, it was requested that electronic copies are sent by email) should be made permanent. This would be a welcome step.
A final point to mention in respect of stamp duty and SDRT is the extension of the market value rule. Until 2018, the perceived wisdom was that a distribution of shares would not be subject to stamp duty or SDRT (irrespective of whether group relief under Section 42 of the Finance Act 1930 was available) on the basis that no consideration was given for the transfer. This is no longer correct. A market value rule for transfers of listed securities between connected companies was introduced with effect from 29 October 2018. With effect from 22 July 2020, that rule was extended to transfers of unlisted securities. While the practical impact of the market value rule should be limited to cases where group relief is not available, it is a point to watch out for in pre- or post-closing reorganisations.
iv Case law
The past year saw a number of cases considering tax-related contractual provisions, reminding us to tread carefully when drafting them and when making claims thereunder.
It is normal for a tax indemnity to include conduct of claims provisions, requiring that the purchaser notifies the seller if a tax authority raises a tax assessment against the target, which could lead to a claim against the seller under the indemnity. It is also normal that the tax indemnity would be subject to a time limit. The relevant clause would normally provide that the purchaser may make a claim only if it has notified the seller of that claim before a particular date. The interaction between the time limit and the conduct of claims provisions was considered in Stobart Group,24 and the Court of Appeal confirmed that the two types of clauses require different types of notification. The notification of a tax assessment under the conduct of claims provisions did not also constitute a notice of a claim against the seller under the time limit (although both notifications could be given in the same document). It followed that the purchaser, having notified a tax assessment, but not a claim, was unable to recover.
The purchaser in Dodika25 was unsuccessful on similar grounds. The time limit required that the purchaser's notice of claim stated 'in reasonable detail the matter which give rise to such Claim'. The Slovenian tax authorities had opened an investigation into the target's transfer pricing practices. The purchaser had kept the sellers informed of the enquiry and, in its notice of claim, the purchaser simply referred back to the enquiry's existence. But the High Court decided that the matter giving rise to the claim was not the existence of the enquiry, but the facts unearthed by it. Consequently, the notice of claim was invalid for failure to state 'in reasonable detail the matter' giving rise to the claim and the purchaser's claim failed.
While it may seem that a mere technicality exonerated the seller, it is understandable and important that the notice provisions, as a key part of the seller's contractual protection, are interpreted strictly. From a purchaser's perspective, it is crucial to make sure that these provisions are followed to the letter, even if that means repeating information of which the seller should already be aware on the basis of its involvement in communications with the tax authority.
The Axa case26 concerned the interpretation of a gross-up for tax on the receipt of a payment under an indemnity for losses resulting from mis-selling of payment protection insurance. The central question was whether 'subject to tax' referred to a theoretical liability at the jurisdiction's headline rate or to tax actually paid, taking into account available reliefs. In the context of the drafting at issue, the High Court settled on the latter interpretation, but neither is entirely satisfactory. The former could lead to a windfall for the purchaser, whereas the latter would give the seller credit for the purchaser's tax assets. Parties may wish to agree on a middle ground and should, in any event, carefully scrutinise the drafting to ensure it reflects the commercial intentions.
i The UK merger regime
Mergers qualify for review under the UK rules if they meet a test relating to the turnover of the target or, alternatively, a 'share of supply' test. Where the UK turnover of the target exceeds £70 million, the turnover test will be satisfied. The share of supply test will be satisfied where the merger creates an enlarged business supplying 25 per cent or more of goods or services of any reasonable description or enhances a pre-existing share of supply of 25 per cent or more.27 In respect of certain defined sectors involving the development of military and dual-use equipment and systems, as well as parts of the advanced technology sector, the turnover threshold is lowered to £1 million and the share-of-supply test is met if the pre-merger share of supply of the target is 25 per cent or more (irrespective of whether that share is increased).
The CMA has the power to carry out an initial Phase I review, and has a duty to refer any qualifying transaction for a detailed Phase II investigation if it believes that the merger will or may give rise to a substantial lessening of competition. Phase I decision-making is undertaken by the senior director of mergers (or another senior CMA official). Phase II decision-making is undertaken by an independent panel of experts drawn from a pool of senior experts in a variety of fields.
Notification is voluntary in the sense that there is no obligation to apply for CMA clearance before completing a transaction. The CMA may, however, become aware of a transaction through its market intelligence functions (including through the receipt of complaints) and impose interim orders preventing integration of two enterprises pending its review. There is a risk that it may then refer the transaction for a Phase II investigation, which could result in an order for divestment.
The CMA strongly encourages parties to enter into discussions in advance of formal notifications to seek advice on their submission to ensure that a notification is complete and to lessen the risk of burdensome information requests post-notification. The CMA aims to start the statutory clock within 20 working days (on average across all cases) of submission of a substantially complete draft merger notice. The average length of the total pre-notification period was 37 working days in the 2019 to 2020 financial year.28 Some cases, however, require much longer pre-notification periods.
Once a transaction is formally notified, Phase I begins, and the CMA has a statutory time limit of 40 working days to reach a decision. The average length of Phase I was 37 working days during the 2019 to 2020 financial year.29 The CMA may extend the 40-working-day period in certain exceptional circumstances, such as if it is waiting for information from the merging parties. The CMA formally paused the statutory timetable in one Phase I case during the 2019 to 2020 financial year.30
If the CMA's duty to refer a transaction to a Phase II investigation is engaged, the parties have five working days from the substantial lessening of a competition decision (SLC decision) to offer undertakings in lieu of a reference to the CMA (although they may offer them in advance should they wish to do so). If the parties offer undertakings, the CMA has until the 10th working day after the parties receive the SLC decision to decide whether the offer might be acceptable, in principle, as a suitable remedy to the substantial lessening of competition. If the CMA decides the offer might be acceptable in principle, a period of negotiation and third-party consultation follows. The CMA is required to decide formally whether to accept the offered undertakings, or a modified form of them, within 50 working days of providing the parties with the SLC decision, subject to an extension of up to 40 working days if there are special reasons for doing so.
At Phase II, the CMA must issue its decision within a statutory maximum of 24 weeks; this period is extendable in special cases by up to eight weeks. If remedies are required, the CMA has a statutory period of 12 weeks (which may be extended by up to six weeks) following the Phase II review within which to make a decision on any remedies offered by the parties.
The CMA has significant powers to impose interim measures to suspend or reverse all integration steps and prevent pre-emptive action in relation to both completed and anticipated mergers. This ensures that, although notification is voluntary in the UK, the CMA is able to prevent action being taken that would result in irreversible damage to competition. Severe financial penalties may be imposed for breaches of any interim orders or undertakings (capped at 5 per cent of the aggregate group worldwide turnover).
The CMA levies substantial filing fees in respect of the mergers it reviews (between £40,000 and £160,000), depending on the turnover of the target business.
ii Treatment of mergers by the CMA
The CMA issued 57 Phase I merger decisions in the 2019 to 2020 financial year, 38 of which were unconditional clearances. Thirteen cases were referred for a Phase II review and undertakings in lieu of a reference were accepted in eight cases.
The CMA issued five Phase II decisions during the same period. Two were unconditional clearances and one was cleared subject to divestiture remedies. The CMA prohibited two mergers, and four cases were cancelled or abandoned at Phase II.
Overall, the CMA intervened (i.e., prohibited or accepted remedies) in around 16 per cent of cases in the 2019 to 2020 financial year, which is around three times the rate of intervention from the European Commission over a similar period. The higher intervention rate can be explained by the voluntary nature of the UK merger control regime, which means that parties may elect not to notify transactions that do not give rise to significant competition issues.
iii Recently published statements and consultations relevant to mergers
In February 2019, Lord Tyrie, the former chair of the CMA, outlined proposals for the significant reform of the UK's competition policy. With regards to merger control, the proposals include mandatory notification in the case of larger mergers that are likely to be the subject of review by multiple competition agencies globally while maintaining the voluntary system for smaller mergers. The rationale for the change is to avoid a situation post-Brexit whereby parties focus on notifications in mandatory regimes, which could put the CMA at a disadvantage when seeking remedies for UK-specific competition concerns if a global remedy package has already been agreed with other competition authorities. The proposals are still subject to consideration by the Department for Business, Energy and Industrial Strategy.
Further proposals to change the merger control regime were included in the 'Unlocking digital competition' report published in March 2019 by the Digital Competition Expert Panel that was appointed by HM Treasury. The report recommends that the largest digital companies with strategic market status should be required to make the CMA aware of all their intended acquisitions. The report also recommends the introduction of a balance of harms approach to the UK regime, which would require the CMA to assess the likelihood and the magnitude of the impact of a merger (both positive and negative), with mergers being prohibited where the harmful effects are expected to outweigh any merger benefits. The proposal follows from the review's conclusion that there has been under-enforcement in UK merger control in the past, especially in digital markets. The CMA is not, however, in favour, and has warned about the unintended consequences of introducing such a test.
The CMA also intends to continue 'tidying up' its existing guidance, with a focus on consolidating and refreshing its guidance to reflect current practice. The CMA also intends to make changes to the Phase II process to facilitate a greater degree of international cooperation post-Brexit; for example, by reducing unnecessary duplication in evidence gathering, while preserving the independence of Phase II decision-makers.
iv Brexit and merger control
The UK left the EU on 31 January 2020 following the result of the 2016 referendum. Pursuant to the UK–EU Withdrawal Agreement, a transition period will end on 31 December 2020, unless extended, during which time the UK will be treated for most purposes as if it were still an EU member state. The EU Merger Regulation will continue to apply to the UK throughout the transition period, meaning that the UK turnover of the parties will be taken into account when establishing whether the transaction satisfies the EUMR thresholds. Where these thresholds are satisfied, the European Commission will continue to retain exclusive competence for the investigation of that merger, including in respect of any effects on any UK market. The CMA guidance on the withdrawal agreement sets out the scenarios in which the European Commission will retain jurisdiction over cases it is reviewing but on which it has not yet made a decision towards the end of the transition period. In general, the European Commission will retain jurisdiction over cases formally notified or referred before 31 December 2020 (in practice 23 December 2020). Merging parties have been encouraged to engage promptly with the CMA where a merger might not be formally notified to the European Commission before the end of the transition period.
After the end of the transition period, the one-stop-shop principle will no longer apply, meaning that UK turnover will no longer be relevant to EUMR thresholds, and businesses may need to submit parallel notifications in the UK and the EU to obtain clearance for a deal. The CMA has stated in its Annual Plan 2020–21 that it expects a 50 per cent increase in the number of merger cases and UK elements of international competition enforcement cases from January 2021, as it acquires jurisdiction over cases previously reserved to the European Commission.31 The CMA has, therefore, increased its workforce in order to address the increased case load.
While Brexit uncertainty continued to loom large and hit UK M&A levels in 2019, the covid-19 crisis has taken centre stage in 2020. It is anticipated that certain industries, including TMT and PMB, will remain reasonably resilient through the crisis. The same cannot be said for the consumer and leisure sectors, which are likely to be hit hardest by lockdowns and travel restrictions. With covid-19 cases on the rise again following the easing of lockdown restrictions, UK dealmakers are likely to remain cautious until the outlook of the pandemic is clearer.
1 Mark Zerdin is a partner at Slaughter and May.
2 Mergermarket, 'EMEA Trend Summary FY 19'.
3 ONS – Office for National Statistics, 'Mergers and acquisitions involving UK companies: April to June 2020'.
5 Practical Law, 'Public M&A Trends and Highlights from first half of 2020'.
6 LexisNexis, 'Market Tracker Trend Report: Trends in UK Public M&A deals in H1 2020'.
7 ONS – Office for National Statistics, 'Mergers and acquisitions involving UK companies, annual overview: 2019'.
9 ONS – Office for National Statistics, 'Mergers and acquisitions involving UK companies: April to June 2020'.
11 Practical Law, 'Public M&A Trends and Highlights from first half of 2020'.
13 Practical Law, 'Private M&A trends report: Warranty and indemnity insurance'.
14 Marsh JLT Specialty, 'Transactional Risk Insurance 2019: Year in Review'.
15 Lexology, 'Shareholder Activism & Engagement'.
16 Practical Law, 'Public M&A Trends and Highlights from first half of 2020'.
17 Reuters, 'Hedge fund Odey to vote against Anglo's 'unfair' 405 million stg Sirius bid'.
18 Practical Law, 'Public M&A Trends and Highlights from first half of 2020'.
19 LexisNexis, 'Market Tracker Trend Report: Trends in UK Public M&A deals in H1 2020'.
20 See https://services.parliament.uk/bills/2019-21/pensionschemes.html for the latest updates.
23 https://www.gov.uk/government/consultations/call-for-evidence-modernisation-of-the-stamp-taxes- on-shares-framework#:~:text=Consultation%20description,transactions%20in%20shares%20and%20securities.
24 Stobart Group Limited and another v. William Stobart and another  EWCA Civ 1376.
25 Dodika Ltd and others v. United Luck Group Holdings Ltd  EWHC 2101 (Comm).
26 Axa SA v. Genworth Financial International Holdings LLC and others  EWHC 2024 (Comm).
27 In the 2019–2020 financial year, the CMA asserted its jurisdiction based on the share of supply test in a number of high-profile foreign-to-foreign mergers. In two notable cases, the parties contested the CMA's ability to assert jurisdiction on that basis. In Roche/Spark Therapeutics, the target company was not engaged in the commercial supply of any goods or services in the UK and did not generate any turnover in the UK. Nevertheless, the CMA asserted jurisdiction on the basis of the combined share of the parties of employees working on activities related to the development of certain novel treatments in the UK. In Sabre/Farelogix, although the CMA found that the target had 'no material turnover in the UK', it asserted its jurisdiction on the basis of the supply of certain services to British Airways that facilitated the indirect distribution of airline content to travel agents in the UK.
28 Mergers updates, Law Society Competition Section seminar, 10 March 2020. FY 2019-2020 figures taken from this seminar do not include data for March 2020.
31 CMA Annual Plan 2020–2021 (March 2020).