This blog discusses “national security” considerations in cross-border transactions from the perspective of the Committee on Foreign Investment in the United States (“CFIUS”).
Who Is CFIUS?
Established in 1975 by President Ford, over the past 45 years, CFIUS has been evolving into an interagency committee authorized to review certain transactions involving foreign investments in the United States and certain real estate transactions by foreign persons to determine the effect of such transactions on the national security of the United States. CFIUS’s review is a battle and balance of U.S. national security, the economic benefits of such transactions, and the U.S. long-standing commitment to maintaining an open environment for foreign investment.
The committee, chaired by the Department of Treasury, consists of eight other Cabinet members, including the Department of Justice, Department of Homeland Security, Department of Commerce, Department of Defense, Department of State, Department of Energy, U.S. Trade Representative, and Office of Science & Technology Policy. Representatives from certain other federal agencies also hold “observer” statuses.
Operating pursuant to Section 721 of the Defense Production Act of 1950, as amended, along with associated regulations, CFIUS has broad jurisdiction to review all “covered” foreign investment transactions. The President, through the Committee, may suspend, block, modify, or unwind any mergers, acquisitions, takeovers, or joint ventures by or with any foreign person that could result in foreign control of any U.S. business. It is the discretion of the President or the Committee, if such transactions could pose a risk to U.S. national security. For CFIUS review purposes, the concept of “national security” is purposefully not defined but interpreted broadly to include issues relating to homeland security and its application to critical technologies and infrastructure to give CFIUS maximum flexibility in determining the outcome of a transaction, which imposes another layer of uncertainties to cross-border transactions.
What “Covered Transactions” Are Subject to CFIUS Jurisdiction?
In response to the evolving national security landscape, including China’s growing investment in the U.S., Congress adopted the Foreign Investment Risk Review Modernization Act of 2018 (“FIRRMA”), effective November 11, 2018. Regulations issued by the Treasury Department implementing the FIRRMA took effect on February 13, 2020. FIRRMA and associated regulations expanded the scope of “covered transactions” subject to CFIUS jurisdiction. Primary covered transactions are as follows:
Controlling Foreign Investments
CFIUS is authorized to review any merger, acquisition, or takeover by or with any foreign person that could result in foreign control of any person engaged in interstate commerce in the United States.
Foreign transactions involving U.S. businesses are subject to CFIUS jurisdiction. Such U.S. businesses also extend to U.S. subsidiaries, operations, and/or assets of non-U.S. companies. In 2016, President Obama blocked a Chinese company’s acquisition of Aixtron, a German semiconductor company, because the acquisition would include Aixtron’s U.S. subsidiary and assets in California.
The term “control” is interpreted broadly for CFIUS review purposes. According to CFIUS, control is defined as the power, direct or indirect, whether or not exercised, through the ownership of a majority or a dominant minority of voting interests, board representation, proxy voting, a special share, contractual arrangements, or other means to determine, direct, or decide important matters affecting an entity. Even a lending transaction can give a foreign person control if the foreign lender acquires governance rights of the entity through lending terms, or a default could give the foreign lender actual control of the U.S. business. As a practical matter, except for certain non-controlling investments discussed below, one “safe harbor” outside CFIUS’s review is an investment resulting in a foreign person having an ownership interest of no more than 10% of voting shares of the U.S. business. Such foreign investments are held solely for the purpose of passive investment.
Certain Non-controlling Foreign Investments
FIRRMA expanded CFIUS’s authority to review investment transactions even though a foreign transaction does not end up with foreign control if (i) the acquired U.S. business is involved in critical technologies, critical infrastructure, or sensitive personal data (TID businesses) and (ii) the minority foreign investment is allowed (a) access to material nonpublic technical information, (b) membership or observer rights on the board of directors or equivalent governing body of the U.S. business, or (c) substantial involvement in the U.S. business decision making.
As the world moves into a data economy, the U.S.’s “sensitive personal data” is guarded by CFIUS against foreign investors. Businesses that engage with “sensitive personal data” are those that maintain or collect, directly or indirectly, the sensitive personal data of U.S. citizens, including but not limited to businesses that target or tailor products or services to sensitive populations, such as U.S. government personnel; or maintain or collect data on more than one million individuals, etc. Other protected “sensitive personal data” also includes financial, geolocation, and health data. In 2019, Beijing Kunlun Tech. Co., Ltd. attempted to acquire Grindr LLC, an online dating service company. However, the Chinese acquirer eventually divested itself of Grindr over CFIUS’s concerns about foreign access to personally identifiable information of U.S. citizens. Besides personal data managed by the dating service business, genetic information is also included in the definition of “sensitive personal data.” As such, foreign investments in biotechnology and life science companies may be subject to CFIUS review.
Real Estate
FIRRMA also expanded CFIUS’s jurisdiction to review certain real estate transactions, including a foreign person’s purchase or lease of real estate near certain airports, maritime ports, military facilities, and other facilities and properties of the U.S. government that are sensitive for national security reasons. In 2012, President Obama ordered Ralls Corp., a Chinese company, to divest its investments on national security grounds following a CFIUS review of Ralls’ purchase of a wind farm near a naval base.
Foreign Person
An investor is a foreign person for CFIUS purposes if it is an entity over which a foreign national, foreign government, or foreign entity can exercise some degree of control. However, it is worth knowing that a U.S.-based entity may become a “foreign person” if such a U.S. company has taken investments from non-U.S. sources so that such foreign sources may exercise control over the U.S. entity, in which case the CFIUS will have jurisdiction over such entity’s transactions in the U.S. As such, private equity funds are advised to pay attention to the control power given to their foreign partners.
CFIUS Review Process
Except for transactions that require mandatory notifications by FIRRMA, parties are voluntary to notify CFIUS of a covered transaction. Generally, once CFIUS clears a transaction, it is cleared forever. However, suppose a voluntary filing is not made. In that case, a covered transaction will indefinitely remain subject to CFIUS review, which may result in divestment or other mitigation requirements imposed by CFIUS even after the transaction is closed. As such, parties are advised to file a voluntary notification with CFIUS if the covered transaction involves sufficient national security concerns. FIRRMA and associated regulations also require parties to mandatorily notify CFIUS of certain covered transactions, such as certain investments by foreign governments, certain investments in TID businesses, and investments in certain critical technologies covered by the CFIUS Pilot Program.
Suppose the parties decide to notify CFIUS before filing a formal notification. In that case, they are encouraged to initiate an informal consultation with CFIUS, enabling CFIUS staff to identify potential issues before the review process formally begins. This informal review may give the parties additional time to negotiate with CFIUS mitigation arrangements, if any.
CFIUS will start its formal review upon the parties filing either a short-form declaration or a full notice of the covered transaction. CFIUS has 45 days (30 days if a declaration is filed) to assess the national security impact of the covered transaction. If, after the review, CFIUS determines that the transaction threatens to impair national security and such threat has not been mitigated during the review period, or the foreign person is controlled by a foreign government, CFIUS is required to conduct a national security investigation for an additional 45 days. After investigation, CFIUS has the authority to recommend to the President that a transaction be blocked. If so, the President has 15 days to make a decision. Parties may withdraw their filings during the process to avoid negative publicity of a potential adverse decision.
CFIUS is notorious for its non-transparent review process. Parties may challenge CFIUS decisions through judicial review. However, a decision made by the President is not subject to judicial review.
Mitigation Agreements
During the review process, CFIUS may negotiate, impose, or enforce any agreement or condition with the parties in order to mitigate any threat to national security, such as restricting foreign person’s access to sensitive information. CFIUS will keep track of those mitigation actions and may reopen a review of a transaction and overturn its approval at any time if CFIUS believes that the parties materially fail to comply with the mitigation agreement.
In conclusion, CFIUS plays a critical role in safeguarding U.S. national security interests in an increasingly complex global investment landscape. As its scope and authority have expanded, particularly with the implementation of FIRRMA, foreign investors and U.S. businesses alike must carefully navigate the CFIUS review process. While the committee’s broad discretion and non-transparent nature can introduce uncertainty into cross-border deals, understanding the types of transactions subject to review, the evolving definition of national security concerns and the potential for mitigation agreements is crucial. Parties involved in covered transactions should consider early engagement with CFIUS through informal consultations and weigh the benefits of voluntary filings against the risks of post-closing scrutiny. As geopolitical tensions and technological advancements continue to shape the international business environment, CFIUS will likely remain a critical factor in cross-border investment strategies and due diligence processes.