Reducing M&A risks in relation to national security reviews: Ring-fencing as a potential solution

By Markus Hauptmann, Dr. Tobias A. Heinrich and Farhad Jalinous

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National security reviews have become particularly significant for cross-border M&A transactions, especially between China, the US and the EU. Some consider such reviews to be the “new merger control,” adding a further layer of complexity to M&A transactions and increasing potential uncertainties and risks to be considered when structuring a transaction.

United States

In the US, the Committee on Foreign Investment in the United States (CFIUS) reviews “covered” transactions involving US businesses for potential national security threats. Although the CFIUS review process is ostensibly voluntary, CFIUS can “invite” the parties to a transaction of interest to file or initiate reviews directly. The process consists of a draft “prefiling” that typically takes several weeks and allows CFIUS staff to provide initial feedback on a filing. This comprises an initial 30-calendar-day review period, a potential additional 45-calendar-day investigation phase and, in rare instances, a 15-calendar-day presidential review period. If there are national security concerns, CFIUS can impose mitigation requirements, recommend the parties abandon the deal, or refer the case to the president with a recommendation to block the transaction.


Cases in which Chinese deals were prohibited or canceled by CFIUS have included acquisitions of US (affiliated) companies in close physical proximity to sensitive military installations, those that are part of US critical infrastructure, and those involving technology with both military and civilian applications. While CFIUS’s scope is legally limited to national security only, the term is not defined by law and CFIUS tends to interpret its jurisdiction broadly. There is also a chance of tougher scrutiny under the new US administration, making the CFIUS process more aggressive and possibly extending its reach beyond national security concerns.

European Union

The EU does not have a supranational framework for reviewing foreign investment and approaches vary greatly among Member States. Germany generally offers a liberal investment climate and limited restrictions on foreign investments. However, there is growing scrutiny by the German Federal Ministry for Economic Affairs and Energy (Bundesministerium für Wirtschaft und Energie, BMWi) of acquisitions by investors that are not members of the EU or EFTA. This may be seen as a response to another peak of Chinese M&A activity in Germany that occurred in 2016 and a lack of reciprocity seen by German government officials. Pending further changes in the current legislative environment, so far, only very few decisions were actually blocked by the BMWi, based on an actual and sufficiently serious threat to public order or security in Germany.

National security reviews and practical consequences

A national security review has the potential to drastically change the nature of an M&A transaction or even derail it completely. Its outcome can include an actual or de facto prohibition of the transaction or conditions or mitigation measures imposed on the target and/or the acquirer, including divestiture of the target’s sensitive assets.

These risks should be addressed by incorporating protection against national security reviews in a transaction. Parties should consider the statutory review period will only begin once the submission for such a review has been formally accepted by the relevant authority (understanding that, in practice, securing such formal acceptance requires preparation and often prior coordination with the relevant authority, which can cause delays). The overall timeline for national security reviews may vary significantly and depends on the applicable phases of the given process. If clearance cannot be obtained prior to the transaction deadline – the end (or long-stop) date – or, in the case of a public tender offer, prior to the expiration of the acceptance period or the date on which shareholder withdrawal rights come into effect, the parties risk a failed transaction.

While the absence of a prohibition on the proposed transaction by a governmental authority is a customary condition prece-dent (CP) for any transaction, an acquirer would typically also want to specify in the transaction agreement the circumstances relating to the regulatory review process under which it would not be required to consummate the proposed transaction.

The acquirer’s perspective

From the acquirer’s perspective, CPs and covenants relating to the regulatory review process serve to protect the acquirer from having to consummate the transaction under circumstances in which the government has imposed regulatory conditions or mitigation measures that would change the nature of or the business rationale behind the proposed transaction. Depending on market practices in the relevant jurisdiction, the contract provisions intended to protect the acquirer from these risks may take the form of regulatory material adverse change clauses (regulatory MACs) and/or covenants that specify the level of effort that the acquirer must expend in order to obtain the necessary regulatory approval. These types of provisions are designed to share the regulatory risk between the target company and the acquirer and often provide for quantifiable thresholds (e.g., based on the target’s consolidated sales and/or revenues) relating to the government-imposed regulatory conditions or mitigation measures that, if exceeded, would allow the acquirer to abandon the deal (either outright or after payment of a penalty in the form of a reverse breakup fee).

In the case of public tender offers conditioned on the absence of a regulatory MAC, such CPs are allowed in many jurisdictions only if the regulatory MAC provision is sufficiently precise and can be assessed by an independent expert.

As for covenants related to the level of efforts the acquirer must expend in order to obtain the necessary regulatory approvals, the obligation imposed on the acquirer may range from hell-or-high-water clauses, which require the buyer to take all requisite action to obtain regulatory approval, to provisions that expressly state the acquirer will not be obligated to agree to any government-imposed conditions and mitigation measures. This gives the acquirer the option of either complying with any governmental requirements or abandoning the transaction.

Such CPs and covenants are often accompanied by reverse breakup fee arrangements designed to allocate certain financial risk to the acquirer if the transaction is not consummated for regulatory reasons. While most investors are accustomed to the concept of reverse breakup fee arrangements, the risk that such arrangements will be triggered increases as thresholds for national security reviews and intervention sink worldwide.

Ring-fencing provisions

A recent trend in dealing with anticipated national security reviews is to add ring-fence provisions to the transaction agreement. These provisions limit the acquirer’s ability to either control or gain access to certain specified aspects of the target’s business, assets or operations. These provisions are a form of self-regulation by the transaction parties to preemptively address and alleviate the likely national security concerns of the relevant authority regarding the particular transaction. The measures can include management’s oversight duties to protect the target’s intellectual property and know-how, mandatory physical restrictions, cyber security plans or auditing processes. In fact, ring-fencing measures may also be imposed contractually by customers voicing their concerns in the event of a major transaction affecting their supplier. Ring-fence arrangements may, therefore, serve a number of purposes and help reconcile the interests of numerous stakeholders (including, in some cases, political interests) if a transformational transaction is being considered.