This article was produced by Nabarro LLP, which joined CMS on 1 May 2017.
Summary and implications
The vast majority of real estate investments do not require merger control clearances. Yet the ongoing internationalisation of UK asset ownership, together with increasing numbers of joint ventures (JV) between overseas investors (such as sovereign funds) and UK managers and real estate companies, means that a growing number of transactions are being caught by merger control rules. Whilst the number of transactions affected remains small, deal makers need to remain vigilant as the consequences of a misstep can be extremely serious:
- If a compulsory merger control filing is missed, the non-filing party can be fined up to 10 per cent of its global turnover.
- An unexpected merger control filing can delay completion of a deal by at least eight weeks.
- For investments that result in concentrations of market power, the authorities have sweeping powers to prohibit transactions/order asset divestments, in order to remedy any concerns.
Buyers who find themselves making unexpected merger filings will often be those purchasing minority investments to which significant veto rights are attached; or those entering into joint ventures to hold investments – for example, by purchasing a 50 per cent stake in assets like retail parks or mixed-use developments – from an existing owner/operator. Sovereign wealth funds and pension funds can be particularly likely to trigger filings due to the significant sums they have under management.
This briefing provides guidance on how to spot transactions impacted by merger control, and explains the consequences. The earlier a merger filing is identified, the more flexibility the parties will have to address this – for example, by altering the transaction to take it out of merger control jurisdiction, or by negotiating a delay in completion to give time for the need for a clearance.
The relevant merger control rules
If a transaction meets certain jurisdictional thresholds (see below) it may be caught by the EU-Merger Regulation. Irrespective of whether a deal that meets these thresholds actually raises competitive concerns, it must be approved by the European Commission prior to completion.
Under the EU's "one stop shop" principle, national competition law regulators, such as the UK's Competition and Markets Authority (CMA), have jurisdiction to review a transaction only where the EU does not. Where the UK does have jurisdiction, notification to the CMA is voluntary, but notification is usually compulsory at national level in other EU jurisdictions.
Again, failure to make a compulsory filing could result in a fine of up to 10 per cent of the buyer's global turnover.
When does a transaction become a "merger"?
The following three conditions must all be met:
- The transaction must concern a "business".
- There must be a "change in control" over that business.
- The transaction must be big enough to meet relevant jurisdictional thresholds.
1. Is the subject of the transaction a "business"?
The transfer of companies and of assets can both comprise a "change in control" of a "business". For example, the target could be an investment company that manages a real estate portfolio, or the holding company of an estate. Equally, we could be talking about assets such as an office block, a shopping centre or a mixed-use development.
The key question is whether the assets have a so-called market presence that generates turnover (i.e. they must generate rental income). This excludes sites or properties with no sitting tenants.
Merely bearing rent does not usually, on its own, turn an asset into a "business". However, the following factors (none necessarily conclusive on its own) will also need to be taken into account in order to form a view on whether the target is indeed a "business" for these purposes:
- Employees – does the property have dedicated management or maintenance staff that will transfer to the new building owner on completion?
- Customer records – does the landlord of the target property hold information on potential tenants which would transfer on completion?
- Goodwill – does the valuation of the property objectively exceed the sum of the valuation of its individual tenancies? For example, a shopping centre benefiting from consumer recognition may be valued at considerably more than its net lettable area alone might suggest.
- IP – does the asset engender consumer loyalty via the use of its own trading name or website, over and above that of its individual tenants?
- Active asset management – does the landlord carry out active asset management so as to maximise footfall, provide customer-related services or maintain an attractive public realm?
2. Is there a "change in control"?
Once it is established that the transaction concerns a "business", then there will be a change in control where the buyer either takes sole control, or participates in joint control.
Examples of a buyer taking sole control:
- Purchasing a controlling interest in a target real estate company.
- Purchasing a freehold or long leasehold interest in land.
- A JV party buys out its JV partners' stake in a real estate asset.
Examples of a buyer taking joint control:
- A retail park is acquired jointly by two JV partners (e.g. 50:50).
- An interest is acquired in a shopping centre which confers decisive influence (for example, because the shareholder agreement gives each shareholder veto rights over the business plan, key investment decisions or senior appointments).
- No single party controls an office estate, but two or more of the shareholders have sufficiently aligned interests to mean that they routinely vote the majority of the shares together.
A merger filing cannot be avoided by splitting the acquisition of control into a series of incremental transactions. The regulator will consider the economic purpose of all transactions within a two-year period as a whole, to determine whether each transaction would have happened without the others.
3. Jurisdictional thresholds must be met
A. EU thresholds
- Combined aggregate worldwide turnover of all parties to a transaction exceeds €5bn; AND
- At least two parties achieve a turnover of more than €250m in the EU.
Second Threshold (only use if the First Threshold does not apply):
- Combined aggregate worldwide turnover of the parties is more than €2.5bn; AND
- In each of three member states the parties’ combined turnover exceeds €100m; AND
- In each of the same three member states the turnover of each of the parties exceeds €25m; AND
- The EU turnover of each party exceeds €100m.
Neither EU threshold will apply where at least two-thirds of each party's EU turnover is derived in the same member state. This would mean, for example, that a JV between two British pension funds who invest principally in the UK to acquire a London office block would not be caught by the EU merger control, even if the other jurisdictional thresholds were met. It would then be necessary to consider instead whether they met the threshold for a UK filing.
Particular care needs to be taken with respect to certain aspects of the application of the EU jurisdictional thresholds.
- "Group turnover" has an extremely wide meaning. Whatever the identity of the company making the acquisition, it is necessary to take into account the turnover ofallother companies controlled by the transaction parties' ultimate parent companies.
- Forfunds, it is necessary to take into account not just the turnover of companies held in the same fund as the acquirer, but also ofallother funds which have the same manager.
- Care needs to be taken when considering theturnover of joint ventures. Because the second limb of the First Threshold takes into accountanytwo companies involved in the transaction, the EU Merger Regulation applies to the acquisition of any business (however small) by two JV partners which each meet the €250m turnover threshold. For example, the thresholdcould be met if two large sovereign wealth funds decided to co-purchase a shopping centre in a market town that had a rental income of only £7m per annum.
Where the transaction falls outside of the jurisdiction of the EU, it could trigger merger control in one or more EU member states. In the UK, the CMA has jurisdiction to review a transaction where:
- the UK turnover of the target exceeds £70m; OR
- the buyer and the target jointly account for at least 25 per cent of the goods or services of a particular description supplied in all of (or a significant part of) the UK.
Because the UK regime is voluntary, parties do not tend to notify routine transactions (i) that clearly do not lead to a competitive overlap; or (ii) where the risk of substantive competitive concerns is clearly low. This is usually the case for real estate transactions, because shares of the supply of particular types of lettable space do not usually tend to be very concentrated. In practice, few transactions that concern real estate interests are notified to the CMA. However, the CMA has an active media monitoring unit, meaning that it is difficult to pass under the radar a transaction that should have been filed.
Parties will usually take four to five weeks gathering information, preparing the merger submission and entering into so-called "pre-notification discussions", irrespective of the regulator involved. After that, statutory timelines diverge:
- In the EU – for straightforward transactions the Commission is required to issue a decision within 25 working days of filing. In total, completion of a transaction could be delayed by at least eight to 10 weeks. However, this could be significantly longer if there are issues.
- In the UK – for straightforward transactions the CMA is required to issue a decision within 40 working days of filing. In total, completion of a transaction could be delayed by around three months. Again, however, this could be significantly longer in the event of serious issues.
The question the regulator needs to consider is whether a transaction will cause a significant or substantial lessening of competition.
Stage 1 – define the relevant market
Product market – which types of asset compete with target? For example, would businesses in a town be prepared to take a lease of period offices, or would they only accept new-build? If they would only accept new-build, and the transaction concerns new-build, then the relative market power of the assets subject to the transaction will be higher.
Geographic market – within which perimeter could customers switch to alternative providers? For example, would office tenants be prepared to take a lease both in the city centre and out of town? If they only accept city premises and the transaction concerns a city block, the market power of the assets subject to the transaction will be higher.
Stage 2 – how will products / services be affected in that market?
In a real estate context, the competition authority would consider whether the transaction could lead to the concentration of market power so as to lead to reduced choice of location, or price rises, for potential tenants. The authority may also consider whether higher rents would be passed on as part of higher prices of products sold by the merging parties' tenants. However, this assessment is invariably complex. Specialist advice should always be sought before seeking to engage with a regulator with respect to a proposed transaction.
Although real estate transactions might not at first instinct seem to require merger control, this is an increasingly relevant concern and consequences can be serious if filings are missed. It is crucial that a systemic approach is used to assess whether merger control is relevant to any potential deal. Within this framework a filing can more often than not be excluded, or if not, at least better prepared for.
Please contact Russell Hoare or any of your usual Nabarro contacts if you require any further information on this topic.