U.S. national security concerns about direct and indirect Chinese investment continue to grow. Kirkland & Ellis attorneys summarize recent developments at the Committee on Foreign Investment in the United States and other key takeaways for M&A professionals.
Despite the passage of the sweeping Foreign Investment Risk Review Modernization Act of 2018 (FIRRMA) and the precipitous decline of Chinese investment over CY 2018, U.S. national security concerns about direct and indirect Chinese investment continue to grow.
We summarize below certain recent developments and things to watch in the months ahead, and offer related takeaways for M&A professionals.
CFIUS Pilot Program
The Committee on Foreign Investment in the United States (CFIUS) implemented a mandatory “declaration” requirement for certain transactions, under penalty of law.
CFIUS initiated a “Pilot Program” in November 2018 that creates a new mandatory obligation to provide a 45-day pre-closing declaration to CFIUS for foreign acquisitions of, or non-passive investments in, U.S. businesses with a nexus to one or more identified key industries that produce, design, test, manufacture, fabricate, or develop a “critical technology.”
Historically, CFIUS reviews have always been voluntary and involved no mandatory pre-closing waiting periods. CFIUS may apply draconian penalties of up to the value of the transaction for non-compliance.
Increased CFIUS Caseload
CFIUS’ CY 2018 caseload generally remained at elevated CY 2017 levels, and there is reason to believe that its CY 2019 caseload will increase further.
CFIUS’ total caseload in 2018 likely remained static from 2017, when it reviewed approximately 250 notified transactions. Less than 10 percent of the 2018 reviews likely involved mandatory declarations because the Pilot Program only became effective in mid-November and CFIUS stopped accepting new filings during the government shutdown at year-end.
More Resources for CFIUS Reviews
CFIUS member agencies are increasing resources for CFIUS reviews—including for monitoring non-notified transactions.
Many CFIUS member agencies are increasing their CFIUS teams in response to the current workload and in anticipation of FIRRMA’s full implementation. Notably, FIRRMA mandates that CFIUS promulgate a streamlined inter-agency process for identifying and reviewing transactions that were not affirmatively notified to CFIUS, but could potentially pose national security concerns.
What to Watch
Evolving Perceptions of What Is Considered Sensitive for National Security Purposes.
The U.S. Department of Commerce (Commerce) expects to issue an Advanced Notice of Proposed Rulemaking (ANPRM) for the criteria it will use to identify “foundational technologies” within the next few months. This likely will be similar in scope and form to the ANPRM it released in November that covered “emerging technologies.” Commerce expects to issue a Notice of Proposed Rulemaking (NPRM) for emerging technologies sometime this summer.
More Declarations From Lower-Risk Buyers
CFIUS will review more declarations from lower-risk buyers for transactions that likely would not have been filed under the voluntary regime. Notably, certain non-U.S. pension plan investors cited this increase in declarations and resultant strain on CFIUS’ resources as grounds for excluding “trusted” investors from CFIUS’ jurisdictional scope in certain cases in their public comments on the Pilot Program.
Increasing Coordination With Non-U.S. CFIUS Analogues
CFIUS is likely to substantially increase its international coordination with a goal of exporting its best practices to its international counterparts in U.S. allied countries. We further anticipate that the forthcoming EU-wide national security review process may draw on CFIUS’ best practices as well.
Regulatory Uncertainty Will Prevail for Months
While FIRRMA made sweeping changes to CFIUS’ jurisdictional ambit, it gave CFIUS the task of defining through regulations certain key terms that are needed to fully implement the statute, including terms such as “critical infrastructure,” “sensitive personal data,” and “substantial interest.” By law, CFIUS must implement all of FIRRMA by February 2020.
M&A Practice Points
Dig Deep, Early
Early and deep due diligence is critical for buyers and sellers alike. With stiff penalties for non-compliance, parties to transactions involving a U.S. business that has any potential nexus to critical technologies in Pilot Program industries must engage in, for example, a sufficiently detailed technical analysis of the U.S. business’ export control profile to determine if the transaction requires submission of a mandatory declaration.
While legal penalties for failure to file a declaration fall jointly on both parties, the target company will generally be better positioned to engage in this analysis.
Build in Sufficient Time for CFIUS Reviews
If a transaction requires a mandatory declaration or warrants a voluntary filing, parties must ensure that transaction and financing documents appropriately allocate risk and are sufficiently flexible to accommodate the potential timing impacts of the CFIUS process.
Account for New and Emerging National Security Concerns
CFIUS’ notions of national security are evolving—quickly. The national security sensitivity of a target is often non-obvious (and, sometimes, counter-intuitive), and expert advice should be sought before reaching a definitive judgment about whether a prospective transaction requires or warrants a submission to CFIUS.
Moreover, receipt by a non-US buyer of CFIUS clearance on a prior transaction does not insulate a foreign buyer from a future adverse result. Overreliance on historical precedents—even relatively similar or recent ones—can have dire consequence if emerging concerns are missed.
Mario Mancuso leads Kirkland’s International Trade and National Security practice. A former senior member of the President’s national security team, he specializes in counselling clients on international trade and national security matters, guiding clients through the CFIUS process, and resolving crises involving economic sanctions and export control-related investigations by the U.S. government.
Shawn Cooley, a partner in Kirkland’s Washington office, focuses on managing national security reviews and all foreign investment regulatory aspects of clients’ cross-border transactions. He served nine years as the Director of Foreign Investment Risk Management at the U.S. Department of Homeland Security and counseled on all matters pertaining to foreign investment in the United States.
Lucille Hague, an associate in Kirkland’s Washington office, advises private equity sponsors and companies on CFIUS matters across transactional and investment scenarios, including fund formation, M&A, syndication, co-investments, and exit.