All things being equal, Scottish banking transactions pose no greater a risk to national security than their English counterparts. And yet, how Scots law share security is taken has placed Scottish banking transactions centre of the net cast by the National Security and Investment Act 2021 (NSIA) in a way not experienced by banking transactions south of the border, where equitable charges are recognised.
Taking fixed security over shares in a Scottish company (or, potentially, one further down in a group structure) that falls within one of the 17 sectors designated as higher risk under the NSIA will trigger a mandatory notification under the Act. This is because, unlike the position for shares in English companies over which an equitable share charge can be, and typically is, taken, there is no concept of equitable security in Scots law (as there is in English security law). A right in security over shares in a Scottish company can only be created by the security holder becoming the registered owner of those shares. Under the NSIA the acquisition of shares (or of voting rights in relation to shares) above certain thresholds in a company in one of the 17 designated sectors is a trigger for having to obtain Secretary of State approval before the transaction (or ‘acquisition’) can proceed. Without that approval, the acquisition of the shares will be void and, as a consequence, no Scottish security right will be created.
And there, the problem lies. A transaction of this type is treated as one with a potential risk to national security under the NSIA, even though the security holder would not (at least until, and if, enforcement occurs) be able to exercise voting rights in relation to the shares. The NSIA is intended to catch acquisitions of control yet the voting rights that confer shareholder control over the actions of the company would remain with the granter of the security until enforcement (should that occur). A standard form Scottish share security will delegate back to the security granter the right to exercise the voting rights attached to the shares (subject to a proviso not to exercise rights in a manner that would prejudice the security holder’s interest) up to the point of enforcement.
The Scottish banking sector has responded with caution to this additional layer of NSIA complication for transactions. Where the company whose shares are being secured and its subsidiaries do not appear to fall within the designated sectors, lenders are increasingly seeking warranties from their borrower and group to that effect. Where the relevant companies are (or may be) in a designated sector, seeking approval under the NSIA adds time (an initial 30 working-day assessment period to review the taking of the security, extendable up to 105 working days), costs and a degree of uncertainty to standard Scottish banking transactions where relevant companies are in a designated sector and share security is being taken.
Faced with the prospect of having to make an NSIA application, lenders that would otherwise seek to take Scottish share security generally take one of two approaches. They either avoid taking Scottish share security completely, relying instead on other elements of their security package (principally their floating charge), or they take unperfected share security (whereby ownership of the security shares is not transferred to the security holder unless and until an enforcement event). Both approaches are designed to avoid (at least initially) the need to seek Secretary of State approval, but neither is satisfactory from a lender’s perspective. In the first scenario, where no fixed share security is taken at all, reliance on their floating charge leaves the lender in a weaker position on insolvency than they would be with a fixed charge. In the second scenario, where security is taken on an unperfected basis, the lender holds no right in security unless and until enforcement and even then, the lender can only perfect their security (and take ownership of the shares) once Secretary of State approval is obtained. In effect the unperfected security approach simply kicks the NSIA can down the road. Perfecting security a substantial period of time after signing also opens up complex hardening period issues, which lenders are always keen to avoid.
A third and, in our experience, less common approach is for the security holder to seek Secretary of State approval of the acquisition of the shares pursuant to a Scottish share security. This option could be taken to meet a lender’s security policy requirements and/or could reflect increased confidence in the approval process as the NSIA beds in. The first full annual report (released in July this year) provides a degree of comfort on turnaround times and the types of transactions that are attracting closer Secretary of State scrutiny.
Our experience is that applications for clearance of Scottish share security transactions are taking place within the initially-quoted 30-working day period, and while kinks in the approval process are still being ironed out, the Investment Security Unit (which administers the NSIA) is responsive to initial queries to streamline the application process and guards against any requisition or further queries once an application has been submitted.
Seeking approval has to be factored into transaction timelines and commercial factors will determine whether an application to the Secretary of State is to be made as a condition precedent or subsequent. Given the potential for the application process to take longer than the initial 30 working days, most lenders appear to be more amenable to the application to the Secretary of State being included as a condition subsequent. The time period in which the application has to be completed under a condition subsequent varies from transaction to transaction, but tends to be the full 105 working-day period granted to the Secretary of State to review any application.
Looking ahead, we anticipate the Moveable Transactions (Scotland) Act 2023 (MTA) putting an end to this distortion of market practices around Scottish share security in banking transactions. The MTA creates a new fixed security – the statutory pledge – which is perfected by registration, without the need for the secured assets to be transferred to the security holder.
In its current draft, due to legislative competence issues, the MTA does not allow a statutory pledge to be taken over shares in a Scottish company but UK secondary legislation is expected to bring shares within the scope of the MTA regime for statutory pledges. Once that happens, lenders will be able to take security over shares in Scottish companies without the shares having to be legally transferred to them – registration in a new Register of Statutory Pledges (currently being set up by the Registers of Scotland) will perfect a lender’s security right in the shares. As a consequence, taking security over shares in Scottish companies will cease to be a trigger for mandatory notification under the NSIA.
For this reason, we expect significant lender take-up of this new form of fixed security for shares in Scottish companies, not only in new banking transactions but also in replacement of existing unperfected share securities taken on that basis to avoid NSIA implications until enforcement. The MTA is expected to come into force in the second half of 2024 and the intention, we understand, is for the UK secondary legislation to dovetail on timing with the MTA.