What Outbound Investment Reviews Would Mean For US Cos.

In this article for Law360, partners Mario Mancuso and Luci Hague discuss the potential impacts for investors and companies related to the forthcoming implementation of outbound investment controls in the United States.

The other shoe has fallen. A new proposed version of the National Critical Capabilities Defense Act was quietly released on June 13.

The proposed legislation would establish, for the first time, an outbound investment screening mechanism overseen by a new committee on national critical capabilities that would regulate U.S. outbound investment in certain U.S. and non-U.S. companies on national security grounds.

The committee would effectively operate as a reverse version of the Committee on Foreign Investment in the United States. The concept of a "reverse CFIUS" is not new. Initial iterations of CFIUS reform legislation in 2017 contained provisions that would have regulated certain outbound investment transactions, including some ex-U.S. joint ventures.

Although those prior attempts at regulating outbound investment went nowhere — reportedly due to significant opposition from industry — there has been increasing bipartisan policy and political support in recent years for a formal regime that would oversee U.S. capital flows to countries and companies deemed to be adverse to U.S. national security and foreign policy interests.

U.S. investments in Chinese companies have been the particular focus of policy and political scrutiny, and while the draft legislation would on its face apply to investments in other countries deemed to be "of concern," there's no question that U.S. investments in Chinese-owned companies and China-based companies are the target of these new potential investment controls.

The proposal has been positioned as a compromise between the original proposal for outbound investment controls in the America Competes Act, which the U.S. Senate passed in March 2022, and a draft proposal from the U.S. Department of the Treasury that would have set up a time-limited pilot program to regulate outbound investment pertaining to certain sensitive technologies.

However, the proposed legislation appears, in many ways, more sweeping than its predecessors. If enacted, the effects on U.S. investors and companies engaging in ex-U.S. transactions — particularly those with a geographic or other nexus to China — may be significant, affecting deal timing, feasibility and certainty.

Here are a few highlights and related takeaways for investors and companies.

Mandatory Notification Requirement

The proposed legislation would establish a mandatory notification requirement for a variety of transactions and other noncommercial arrangements involving "countries of concern" or "entities of concern."

Timing

The proposed legislation would require that U.S. persons and companies — including foreign portfolio companies of U.S. private equity sponsors — or foreign entities that plan to or engage in identified covered activities submit written notifications of the activity to the committee no fewer than 45 days prior to closing.

Scope

The term "covered activities" includes — but is not limited to — investment transactions. An activity is covered if it, among other things:

• Builds, develops, produces, expands, shifts, services, manages, operates, utilizes, sells or relocates a national critical capability to or in a country of concern;
• Shares, discloses, contributes, transfers or licenses to an entity of concern any design, technology, intellectual property or know-how that supports, contributes to or enables a national critical capability by an entity of concern or in a country of concern; or
• Invests in, provides capital to, consults for, or gives any guidance relating to enhancing the capabilities or facilitating access to financial resources for a national critical capability for an entity of concern or a country of concern.

Disposition of Cases

While the process for disposition of filings is not wholly fleshed out in the draft legislation, the committee may, if it determines that a covered activity poses an unacceptable risk to U.S. national security, enter into a mitigation agreement to address the national security concerns identified by the covered activity, and/or make recommendations to the president regarding actions to address the identified risk — including under existing national security legal authorities.

Definition of "Entity of Concern"

The draft legislation defines "entity of concern" very broadly to cover companies located anywhere in the world with shareholders or key personnel from a country of concern, or that the committee determines to be influenced by a country of concern.

The draft legislation's definition of "country of concern" is straightforward. It mirrors the list of countries that are defined as "foreign adversaries" in the Secure and Trusted Communications Networks Act, and currently comprises China, Russia, Iran, North Korea, Cuba and Venezuela.

By contrast, the definition of "entity of concern" is potentially much broader: An entity qualifies as such if it is "influenced by a country of concern," or "directly or indirectly affiliated with a country of concern."

The draft legislation does not define what would constitute sufficient influence over an entity to make it an entity of concern. Notably, the definition of "affiliated with a country of concern" is much broader than the definition of "affiliate" in the traditional corporate context.

An entity is affiliated with a country of concern if, among other things: (1) a country of concern or an entity influenced by a country of concern holds 5% or more of the outstanding voting stock of the entity; (2) the entity is headquartered in the country of concern or a subsidiary of an entity headquartered in the country of concern; (3) the entity is a variable interest entity; or (4) the entity is influenced by a national of the country of concern.

Definition of "National Critical Capabilities"

The draft legislation narrows the definition of "national critical capabilities" from its definition in the America Competes Act, and also makes several important changes.

Given the policy history of support for outbound investment controls, it's no surprise that the term "national critical capabilities" is defined to include critical supply chains — e.g., semiconductor manufacturing and advanced packaging, large-capacity batteries, critical minerals and materials, pharmaceuticals and active pharmaceutical ingredients.

With that said, the draft legislation also specifies that national critical capabilities shall include technologies identified by the director of national intelligence as critical and emerging technologies, including artificial intelligence, bioeconomy, and quantum information science and technology.

This is notable for two reasons. First, the regulatory classification of dual-use technologies has traditionally been within the purview of the U.S. Department of Commerce, not the intelligence community.

Second, the draft names artificial intelligence as a critical and emerging technology, without differentiating between types and capabilities of AI. As a result, the legislation could potentially apply to companies that use AI for more benign commercial purposes — e.g., automatic vacuums — as well as those that use AI for military or defense applications.  

Takeaways

Evaluate potential governance and operational impacts.

If enacted in anything similar to its current form, the draft legislation would have profound implications for the governance and operations of companies deemed to be associated with national critical capabilities.

If such companies have one or more board members that are nationals of countries of concern, or subsidiaries or joint ventures located in countries of concern, they may need to modify governance or the ways in which ex-U.S. and U.S.-based entities interact with each other, in order to avoid triggering the legislation's notification requirement.

Consider beginning to incorporate outbound investment screening considerations in strategic assessments of potential transactions as well as in transactional due diligence.

Given the current policy and political environment, we assess that the likelihood of an outbound investment screening mechanism becoming reality in the near term is quite high.

Investors and companies should ensure that assumed exit scenarios for proposed investments are plausible, and that due diligence for a merger, acquisition, joint venture, licensing agreement or similar activity accounts for the factors outlined in the draft legislation, as well as in the legislation's national security policy goals.

Assess your company's shareholder base.

Could your company be deemed an entity of concern, such that a U.S. investment in your company may trigger a mandatory notification to the committee? If so, what, if any, measures may be warranted to mitigate this risk — e.g., forced redemptions, etc.?

Given the U.S. policy and political consensus in support of outbound investment controls, this will be a topic with which U.S. sponsors and companies will have to contend sooner rather than later. Any transaction that may implicate a national critical capability with a nexus to China, or another country of concern, should be carefully assessed in light of the potential new legal requirements, as well as U.S. policy objectives.