Why ‘national security’ concerns are unlikely to impede the Melrose/GKN takeover

(by David Reader) After Melrose plc last week formalised its £7.4bn hostile takeover bid for the Armed Forces supplier GKN plc, Business Secretary Greg Clark is facing renewed pressure from the Labour Party and the UK’s largest trade union, Unite, to block any forthcoming deal on national security grounds.[1] Moreover, in response to questions over the transaction, the Prime Minister has herself declared that ‘the government as a whole will always act in the UK national interest’ when faced with such takeovers. Yet, although there is every possibility that the resulting merger would be subjected to national security scrutiny, there is only a very remote chance that the transaction would be blocked outright.

If completed, the Melrose/GKN deal would represent the largest hostile takeover on UK shores since Kraft completed its £11.5bn acquisition of Cadbury in 2010, a deal that still lingers long in the public conscience as a reminder of just how takeovers can sap the life out of Britain’s ‘crown jewel’ firms. Unsurprisingly, the calamities of Kraft/Cadbury can be heard in the public debate around this latest takeover bid, which has raised concerns over pension deficits, industrial strategy goals and threats to national security. Melrose was always set to be the lead antagonist in this story.

Melrose, a British company, is a so-called ‘turnaround’ firm, whose slogan is “Buy, Improve, Sell” – which tells you everything you need to know about its modus operandi. But it is good at what it does and has, over many years, forged a widely respected reputation for reversing the fortunes of perennial underachievers with its effective management practices. GKN, in contrast, has stagnated in recent times and there are reports that some of its biggest clients (which include military customers in addition to the likes of Boeing, Airbus, Rolls-Royce, Porsche and Mercedes-Benz) have lost patience with the GKN’s current management team.

So, if there is a good chance that Melrose can ‘repeat the trick’ and improve the fortunes of GKN, why are Labour and Unite calling for the deal to be blocked on national security grounds? Both Labour and Unite are, of course, vehement advocates for workers’ rights and the long-term interests of GKN employees is no doubt a key motivating factor in this case. But, perhaps mindful that ‘employment’ does not constitute a ground for the Business Secretary to intervene in the public interest under the Enterprise Act 2002, they have chosen instead to advocate the ‘national security’ pathway, which is already established under section 58(1) of the Act.

The basis of Labour and Unite’s argument under this national security pathway is the supposition that – should Melrose complete the takeover – GKN would likely be the subject of asset-stripping and suffer from a lack of long-term investment which would ultimately ‘damage the government’s industrial strategy and national defence interests’.[2] Indeed, while the “Buy” and “Improve” elements of Melrose’s slogan raise little alarm, it is the “Sell” component that has fuelled concern that GKN’s businesses will be ‘dismembered and sold on’ to (if Melrose’s track-record is anything to go by) overseas investors in the next five years or so.[3] Given GKN’s ongoing contractual obligations to the British Armed Forces, the risk of the merger leading to asset-stripping and under-investment is – in and of itself – a credible basis for Greg Clark to issue a public interest intervention notice in order to, at the very least, take a closer look at the national security dimension of the transaction. But there are several reasons for believing that Melrose/GKN would overcome any national security scrutiny of this kind.

The definition that UK merger law ascribes to ‘national security’ is notably narrower than the interpretation applied in many other developed countries. For instance, when a foreign takeover is reviewed on national security grounds in the US, it is not uncommon for authorities to take account of industrial policy considerations in order to limit foreign ownership in economically important sectors. France is another that has sought to restrict foreign investment in key sectors in the name of ‘national security’. On occasion, these broader approaches have been ridiculed for bearing more resemblance to a ‘national interest’ standard, which can raise suspicions of illegitimate economic patriotism and protectionism.

In contrast, there is no such scope under UK law for the Business Secretary to consider industrial policy concerns when deciding whether to block or permit a merger on national security grounds. Parliament had initially struggled to identify a precise definition for ‘national security’ in debates around the Enterprise Bill,[4] with the Bill’s sponsor even commenting that ‘national security is like an elephant: one knows it when one sees it’.[5] Yet, the Hansard debate reveals that the definition was closely aligned to protecting the personal safety and security of citizens,[6] rather than any form of economic security. Lord Sainsbury confirmed this by remarking that any intervention on the grounds of ‘economic security’ (to protect e.g. an asset that is ‘essential to large parts of the British economy’) would require the Secretary of State to propose a new public interest ground using their powers under (what is now) section 58(3).[7]

The national security ground was never intended as a ‘catch-all’ for industrial policy arguments and, were Greg Clark to block the Melrose/GKN merger on national security grounds in order to (as the Shadow Business Secretary puts it) avoid ‘weakening our industrial base’, his decision could well be overturned on judicial review. The counterfactual – whereby Clark is permitted to use the national security ground to block the merger on de facto industrial policy grounds – would set a dangerous precedent in terms of other industrial policy considerations entering into future merger cases via the national security pathway. In practice, all seven national interest cases under the Enterprise Act have seen the Business Secretary adopt the narrow definition of ‘national security’ and, in all seven cases, the merger has been approved subject to conditions. The Melrose/GKN merger would be likely to follow a similar path.

An alternative approach (which the Shadow Business Secretary has also urged Greg Clark to consider) would be for the Business Secretary to exercise his power to propose a new public interest ground which, subject to Parliamentary approval, would then permit him to intervene and scrutinise the merger on the grounds of, for example, ‘protecting the UK’s defence industry’. But it is important to consider the bigger picture before proceeding along these lines. CCP research has already found that the Business Secretary is likely to be under more pressure to propose new public interest grounds post-Brexit, so introducing a new public interest ground before Brexit will likely present a slippery slope in terms of stakeholders lobbying for other industries also to receive protection. This would not bode well for a stable investment environment in the post-Brexit era.

Any forthcoming Melrose/GKN merger should therefore be subject to the merger provisions that are currently in place. Given that this is likely to result in the merger being cleared (potentially subject to assurances with regard to the delivery of contracts with the Armed Forces), this pathway is unlikely to prove popular with Labour and Unite campaigners. However, it is important to bear in mind that any subsequent attempt by Melrose sell-off all or parts of GKN, possibly to a foreign buyer, will likely be subject to additional national security review in the future (particularly as the government has recently consulted on plans to extend the range of mergers and investments that are subject to review).[8] Moreover, GKN’s dealings with the US military could well mean that the Committee on Foreign Investment in the US (CFIUS) will yet have a say in any deal that emerges.

It is a debate for another day, but the industrial policy rhetoric around the Melrose/GKN bid acts to shine a spotlight on the difficult position that Greg Clark may find himself in as the public interest arbiter and the gatekeeper of the government’s new industrial strategy. Forthcoming CCP research suggests that the solution to this potential conflict of interests may be to remove the Business Secretary’s power to intervene in merger assessments on national security grounds and, instead, to reassign this power to the Defence Secretary or the Home Secretary.[9]

 

[1] In Parliament, Labour MP Richard Burden asked whether the government would intervene in the transaction on national security grounds, to which the Minister for the Cabinet Office replied that it would be “wrong of [him] to speculate”; watch here [at 12:41:58] or read the Hansard debate.

[2] Unite the Union, ‘GKN workers to urge business secretary to block Melrose takeover amid mounting concerns’ (Press Release, 5 February 2018).

[3] Melrose’s Chief Executive has rebuked any suggestion his company is looking to asset-strip GKN, commenting: “Do you think if we had asset-stripped a business like Elster, Honeywell would have bought it?”; John Collingridge, ‘Simon Peckham, Melrose interview: We’re not asset strippers, we just want to improve GKNThe Sunday Times (London, 4 February 2018).

[4] Enterprise HC Bill (2001-02) 115.

[5] Enterprise Bill Deb 30 April 2002, col 356.

[6] Section 58(2) explicitly acknowledges that ‘national security’ includes ‘public security’ within the meaning of Article 21(4) EU Merger Regulation (which has been interpreted as relating to mergers with connections or contractual ties to the military or to the maintenance of public health).

[7] HL Deb 18 July 2002, vol 637, col 1490.

[8] Department for Business, Energy & Industrial Strategy, National Security and Infrastructure Investment Review (Green Paper, 2017).

[9] David Reader, ‘Extending ‘National Security’ in Merger Control and Investment: A Good Deal for the UK?’ (2018) 14(1) Competition Law International (forthcoming). Available on request.

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