December 4, 2018
Stroock Commentary
By: Erin Bruce Iacobucci, Chris Griner, Gregory Jaeger, Shannon Reaves
November 10, 2018 was the effective date for a new pilot program administered by the Committee on Foreign Investment in the United States (“CFIUS”), the inter-agency committee that assesses the national security implications of foreign investment. The pilot program mandates reviews for foreign investments in certain U.S. businesses involved in critical technologies. This is the first time that filings have been mandated; historically, all filings were voluntary. Under the pilot program, parties must either submit a short form declaration or a full written for covered transactions. Failure to file can carry civil penalties as high as the value of the transaction. To avoid costly surprises, U.S. companies, foreign investors, and foreign and domestic investment funds must address several open issues and compliance targets in the near and medium term.
Is your company or fund involved with “critical technology”?
The pilot program is the product of the Foreign Investment Risk Review Modernization Act (“FIRRMA”), enacted in August. The program reaches foreign investment in any U.S. business that “produces, designs, tests, manufactures, fabricates, or develops” a “critical technology” that is used in, or designed for, any of 27 covered industries.
“Critical technology” includes (i) defense articles or services controlled under the International Traffic in Arms Regulations (“ITAR”), (ii) certain dual-use items on the Commerce Control List (“CCL”) of the Export Administration Regulations (“EAR”), (iii) certain nuclear and atomic energy related items and technology, (iv) select agents and toxins, and (v) certain “emerging and foundational technologies.” There are several compliance implications from the broad scope of the critical technology definition, including:
Is your company or customer a “pilot program U.S. business”?
The Federal Register notice announcing the pilot program identified 27 covered industries that define the perimeters of the pilot program. Foreign investment in U. S. businesses that are involved in critical technologies – and that have customers or end-users in those industries – may be subject to mandatory filing under the pilot program. Therefore, U.S. companies and foreign investors must:
Identifying covered non-controlling investments
The pilot program requires a CFIUS filing not only for controlling but also (for the first time) certain non-controlling investments in covered industries. Buyers and investors intending to make passive investments in covered industries risk being unintentionally swept up by the mandatory filing requirement by virtue (for example) of their access to material non-public information or their material involvement in substantive decision-making (e.g., regarding licensing, pricing, and strategic partnerships) involving a covered U.S. business. Avoiding CFIUS review for non-controlling investments may require giving up access to certain information or foregoing certain governance rights in or affecting the target company.
Complying with the investment fund exemption
Foreign indirect investments through hedge funds, venture capital funds, private equity funds, and other investment funds that afford a foreign person membership as a limited partner (or equivalent) on an advisory board or committee of the fund may be exempt from the mandatory filing requirement – but only if certain qualifications are met. The exemption conditions have implications not only for the fund’s structure, governance and operation, but also for investment decisions made at the fund and at the underlying portfolio company level. This is not an easy calculation, and the regulations are often unclear. The comment period (recently concluded) highlighted numerous questions concerning the intended scope of the investment funds exemption. These questions may or may not be answered in the coming weeks.
Fund sponsors must assess their foreign investor base for possible CFIUS exposure under the pilot program. The pilot program does not categorically exempt any type of foreign person from its reach, and includes sovereign wealth funds with ties to allied foreign governments as well as those associated with “countries of concern,” and reaches funds that have no ties to any foreign government whatsoever. Importantly, foreign investors in U.S. funds may also trigger the pilot program requirements, depending upon the specific rights and access they have in the fund.
To assess possible implications of an investment into a pilot program U.S. business, fund sponsors and investors must also conduct a review of the fund’s structure (e.g., fund-of-one, master-feeder, etc.), organizational documents (e.g., LPAs, bylaws), sub-docs (e.g., subscription documents, side letters), policies (e.g., co-investment, conflicts of interest), and practices (delegation, conflicts waiver, and investor reporting), including for compliance with the exemption conditions.
Incremental Acquisitions Rule
Parties required to file with CFIUS have the option of submitting a short form declaration or the traditional, full written notice. Typically, once CFIUS has concluded action on a particular transaction, an additional investment in the same target by the same acquirer is not considered to be a reviewable covered transaction (the so-called “incremental acquisitions rule”). Under the pilot program, however, the incremental acquisitions rule only applies to covered transactions that (1) could result in foreign control of a covered U.S. business and (2) are filed with a full written notice. Importantly, the incremental acquisitions rule is not available for (i) any pilot program covered transaction filed by declaration, or (ii) any declaration or full written notice filed with CFIUS with respect to a “pilot program covered investment” (i.e., the acquisition of equity interest that could not result in control by a foreign person of a pilot program U.S. business and that affords the foreign person any of the access, rights or involvement discussed above). To take advantage of the incremental acquisitions rule, parties may file the full written notice (instead of the short form declaration).
Risk Allocation
In light of the uncertainty surrounding the pilot program, contractual allocation of risk, coupled with adequate due diligence, should be part of an overall strategy. Parties may want to negotiate representations, warranties, and indemnification clauses pertaining to determinations on, for example, (1) critical technology, (2) “covered U.S. business” status, (3) the NAICS codes of customers and end-users, (4) a fund’s foreign investor base, and (5) facts that will support compliance with the investment fund exemption conditions. In the event CFIUS disagrees with a non-filing decision, whether good faith reliance on such contractual provisions will protect a party or fund from civil penalties remains unclear.
This article is for general information purposes only. It is not intended as legal advice, and you should not consider it as such.
December 4, 2018
Stroock Commentary
By: Erin Bruce Iacobucci, Chris Griner, Gregory Jaeger, Shannon Reaves
November 10, 2018 was the effective date for a new pilot program administered by the Committee on Foreign Investment in the United States (“CFIUS”), the inter-agency committee that assesses the national security implications of foreign investment. The pilot program mandates reviews for foreign investments in certain U.S. businesses involved in critical technologies. This is the first time that filings have been mandated; historically, all filings were voluntary. Under the pilot program, parties must either submit a short form declaration or a full written for covered transactions. Failure to file can carry civil penalties as high as the value of the transaction. To avoid costly surprises, U.S. companies, foreign investors, and foreign and domestic investment funds must address several open issues and compliance targets in the near and medium term.
Is your company or fund involved with “critical technology”?
The pilot program is the product of the Foreign Investment Risk Review Modernization Act (“FIRRMA”), enacted in August. The program reaches foreign investment in any U.S. business that “produces, designs, tests, manufactures, fabricates, or develops” a “critical technology” that is used in, or designed for, any of 27 covered industries.
“Critical technology” includes (i) defense articles or services controlled under the International Traffic in Arms Regulations (“ITAR”), (ii) certain dual-use items on the Commerce Control List (“CCL”) of the Export Administration Regulations (“EAR”), (iii) certain nuclear and atomic energy related items and technology, (iv) select agents and toxins, and (v) certain “emerging and foundational technologies.” There are several compliance implications from the broad scope of the critical technology definition, including:
Is your company or customer a “pilot program U.S. business”?
The Federal Register notice announcing the pilot program identified 27 covered industries that define the perimeters of the pilot program. Foreign investment in U. S. businesses that are involved in critical technologies – and that have customers or end-users in those industries – may be subject to mandatory filing under the pilot program. Therefore, U.S. companies and foreign investors must:
Identifying covered non-controlling investments
The pilot program requires a CFIUS filing not only for controlling but also (for the first time) certain non-controlling investments in covered industries. Buyers and investors intending to make passive investments in covered industries risk being unintentionally swept up by the mandatory filing requirement by virtue (for example) of their access to material non-public information or their material involvement in substantive decision-making (e.g., regarding licensing, pricing, and strategic partnerships) involving a covered U.S. business. Avoiding CFIUS review for non-controlling investments may require giving up access to certain information or foregoing certain governance rights in or affecting the target company.
Complying with the investment fund exemption
Foreign indirect investments through hedge funds, venture capital funds, private equity funds, and other investment funds that afford a foreign person membership as a limited partner (or equivalent) on an advisory board or committee of the fund may be exempt from the mandatory filing requirement – but only if certain qualifications are met. The exemption conditions have implications not only for the fund’s structure, governance and operation, but also for investment decisions made at the fund and at the underlying portfolio company level. This is not an easy calculation, and the regulations are often unclear. The comment period (recently concluded) highlighted numerous questions concerning the intended scope of the investment funds exemption. These questions may or may not be answered in the coming weeks.
Fund sponsors must assess their foreign investor base for possible CFIUS exposure under the pilot program. The pilot program does not categorically exempt any type of foreign person from its reach, and includes sovereign wealth funds with ties to allied foreign governments as well as those associated with “countries of concern,” and reaches funds that have no ties to any foreign government whatsoever. Importantly, foreign investors in U.S. funds may also trigger the pilot program requirements, depending upon the specific rights and access they have in the fund.
To assess possible implications of an investment into a pilot program U.S. business, fund sponsors and investors must also conduct a review of the fund’s structure (e.g., fund-of-one, master-feeder, etc.), organizational documents (e.g., LPAs, bylaws), sub-docs (e.g., subscription documents, side letters), policies (e.g., co-investment, conflicts of interest), and practices (delegation, conflicts waiver, and investor reporting), including for compliance with the exemption conditions.
Incremental Acquisitions Rule
Parties required to file with CFIUS have the option of submitting a short form declaration or the traditional, full written notice. Typically, once CFIUS has concluded action on a particular transaction, an additional investment in the same target by the same acquirer is not considered to be a reviewable covered transaction (the so-called “incremental acquisitions rule”). Under the pilot program, however, the incremental acquisitions rule only applies to covered transactions that (1) could result in foreign control of a covered U.S. business and (2) are filed with a full written notice. Importantly, the incremental acquisitions rule is not available for (i) any pilot program covered transaction filed by declaration, or (ii) any declaration or full written notice filed with CFIUS with respect to a “pilot program covered investment” (i.e., the acquisition of equity interest that could not result in control by a foreign person of a pilot program U.S. business and that affords the foreign person any of the access, rights or involvement discussed above). To take advantage of the incremental acquisitions rule, parties may file the full written notice (instead of the short form declaration).
Risk Allocation
In light of the uncertainty surrounding the pilot program, contractual allocation of risk, coupled with adequate due diligence, should be part of an overall strategy. Parties may want to negotiate representations, warranties, and indemnification clauses pertaining to determinations on, for example, (1) critical technology, (2) “covered U.S. business” status, (3) the NAICS codes of customers and end-users, (4) a fund’s foreign investor base, and (5) facts that will support compliance with the investment fund exemption conditions. In the event CFIUS disagrees with a non-filing decision, whether good faith reliance on such contractual provisions will protect a party or fund from civil penalties remains unclear.
This article is for general information purposes only. It is not intended as legal advice, and you should not consider it as such.