On August 13, 2018, President Donald Trump signed into law the Foreign Investment Risk Review Modernization Act of 2018 (FIRRMA) as part of the John S. McCain National Defense Authorization Act for Fiscal Year 2019. FIRRMA amends section 721 of the Defense Production Act of 1950, the statute that governs the operations and powers of the Committee on Foreign Investment in the United States (CFIUS, or the Committee).
Prior to FIRRMA, CFIUS had jurisdiction to review a transaction by or with any foreign person that could result in control of a U.S. business by a foreign person. Although “control” for purposes of CFIUS jurisdiction is a flexible concept that can reach a large number of minority investments, the legislative sponsors of FIRRMA were concerned that there were a number of foreign investment transactions that did not qualify as involving the acquisition of “control,” or did not involve an investment in a U.S. business, but that still presented threats to national security that needed to be addressed. One of the central concerns of the sponsors was that foreign government-sponsored investment could be used as part of a strategy to neutralize or surpass the United States’ advantages in technology by gaining access to technologies with potential military applications such as robotics, artificial intelligence and automation through non-control investments. In addition to expanding CFIUS’s jurisdiction, FIRRMA also reforms certain elements of the CFIUS review process that will have impacts on all transactions that are subject to CFIUS jurisdiction.
FIRRMA will have a significant impact on structuring considerations and the parties’ assessment of deal risk where foreign parties are involved in a transaction, and especially foreign governments or foreign government-controlled parties. As a result of the jurisdictional expansions pursuant to FIRRMA (although not yet effective, pending regulations to be issued by CFIUS), transactions involving foreign parties are significantly more likely to be subject to CFIUS review than they have been in the past.
New Categories of “Covered Transactions”
FIRRMA expands CFIUS’s jurisdiction to include as “covered transactions” subject to CFIUS review four new types of transactions that would not result in control of a U.S. business by a foreign person:
- Real Estate Transactions. The purchase or lease by a foreign person of, or a concession offered to a foreign person with respect to, real estate located in the United States that is a part of an air or maritime port or is in “close proximity” to a U.S. military installation or another United States Government facility or property that is sensitive for reasons relating to national security, could reasonably provide the foreign person with the ability to collect intelligence on activities at such a installation, facility or property, or otherwise could expose national security activities at such an installation, facility or property to the risk of foreign surveillance has been made subject to CFIUS jurisdiction, even if the purchase, lease or concession does not relate to a U.S. business. Real estate transactions involving a single “housing unit” or real estate in “urbanized areas” are excepted, subject to regulations that CFIUS may adopt in consultation with the Department of Defense that may reduce the scope of these exceptions.
- Non-controlling Investments in Companies that Deal in Critical Technology, Critical Infrastructure and Personal Data of U.S. Citizens. FIRRMA provides CFIUS with jurisdiction to review any “other investment” by a foreign person in any unaffiliated U.S. business that (i) owns, operates, manufacturers, supplies or services critical infrastructure, (ii) produces, designs, tests, manufactures, fabricates or develops one or more critical technologies, or (iii) maintains or collects sensitive personal data of U.S. citizens that may be exploited in a manner that threatens national security.
For purposes of FIRRMA, “other investment” means any non-controlling investment (meaning an acquisition of equity interest, including contingent equity interests), direct or indirect and regardless of size, that affords the foreign person (1) access to any material nonpublic technical information relating to critical infrastructure or critical technologies in the possession of the U.S. business; (2) membership or observer rights on the board or equivalent governing body of the U.S. business or the right to nominate an individual to a position on the board of directors or equivalent governing body; or (3) any involvement (other than through voting of shares) in substantive decision-making regarding critical infrastructure, critical technologies or sensitive personal data of U.S. citizens. CFIUS will prescribe regulations providing guidance on the types of transactions that the Committee considers to be “other investments.”
- Changes in Rights of a Foreign Person with Respect to its Investment in a U.S. Business. Any change in the rights that a foreign person has with respect to a U.S. business in which the foreign person has an investment, if that change could result in foreign control of the U.S. business or an “other investment.”
- Transactions Structured To Evade CFIUS Review. Any other transaction, transfer, agreement or arrangement the structure of which is designed or intended to evade or circumvent the application of the covered transaction definition, subject to regulations prescribed by the Committee.
Potential Expansion of Target Businesses Subject to CFIUS Jurisdiction
Another potentially significant jurisdictional expansion relates to the definition of “U.S. business.” FIRRMA defines “U.S. business” to mean “a person engaged in interstate commerce in the United States.” In contrast, the current definition in CFIUS regulations includes a limiting clause “but only to the extent of its activities in interstate commerce.” Without this limiting clause from the current CFIUS regulations, FIRRMA appears to have the potential to provide CFIUS with jurisdiction to review elements of a transaction affecting an entity that provides goods or services in the United States without limiting that review to the entity’s U.S.-based activities. Depending on the regulations that are promulgated by the Committee under FIRRMA, this definition of “U.S. business” could entail oversight over transactions with much less of a U.S. nexus than is currently the case.
Clarification of “Other Investment” for Investment Fund Investments
FIRRMA clarifies and limits CFIUS’s jurisdiction over investments by U.S.-controlled investment funds that may receive capital contributions from foreign limited partners or the equivalent. Subject to regulations prescribed by the Committee, FIRRMA provides that an indirect investment by a foreign person through an investment fund in a U.S. critical infrastructure, critical technology or personal data business that affords the foreign person (or a designee of the foreign person) membership as a limited partner or equivalent on an advisory board or committee of the fund will not be considered an “other investment” as long as (i) the fund is managed exclusively by a general partner or equivalent that is not a foreign person; (ii) the advisory board does not have the ability to approve, disapprove or otherwise control investment decisions of the fund or decisions made by the general partner or equivalent related to entities in which the fund is invested; (iii) the foreign investor does not otherwise have the ability to control the fund, including the authority to approve, disapprove or otherwise control investment decisions of the fund or decisions made by the general partner or equivalent related to entities in which the fund is invested, or to unilaterally dismiss, prevent the dismissal of, select or determine the compensation of the general partner or equivalent; and (iv) the foreign person does not have access to material nonpublic technical information relating to critical infrastructure or critical technologies in the possession of the U.S. business as a result of its participation on the advisory board or committee.
Accordingly, investments in the types of sensitive businesses identified by FIRRMA by U.S.-controlled investment funds with foreign limited partners will not necessarily be subject to CFIUS review. These provisions will have potentially significant implications for U.S.-controlled investment funds that receive investments from foreign investors, and both U.S.-controlled funds and foreign investors already invested or who are seeking to invest in such funds will need to understand and consider the implications of these rules with respect to fund governance and other limited partner rights afforded to foreign investors.
Although the clarification of how to treat indirect investment through U.S. investment funds was included to clarify the circumstances in which a limited partner’s governance or other rights in a U.S.-controlled fund could give rise to jurisdiction as an “other investment,” it is not unreasonable to expect that CFIUS may use such indicia by analogy in considering whether investment by a foreign-controlled investment fund whose general partner is located in one foreign country poses a greater threat because of foreign limited partners from one or more other foreign countries than if such limited partners had no such rights. For example, in assessing the potential threat posed by an investment by an investment fund with a general partner located in the United Kingdom or Canada (which would be jurisdictionally covered as a transaction that gives a foreign person control of a U.S. business), CFIUS might apply the four criteria in assessing the significance and potential threats posed by Chinese limited partners in that fund.
Effectiveness of Jurisdictional Expansions
The jurisdictional expansions discussed above are not immediately effective. According to the U.S. Department of Treasury’s FIRRMA FAQs, CFIUS will provide further guidance as to the timing for the effectiveness of these provisions. FIRRMA also authorizes CFIUS to conduct pilot programs to implement any provisions of FIRRMA that are not immediately effective. The FIRRMA FAQs indicate that the scope and procedures of any such pilot program will be published in the Federal Register. Although FIRRMA’s jurisdictional expansions will take effect only upon the Committee’s issuance of regulations or the implementation of one or more pilot programs, as a matter of prudence, parties should evaluate potential transactions under the expanded jurisdictional provisions.
Additional Time for CFIUS Review
Under the prior version of the statute, the CFIUS review process consisted of a 30-day review period, potentially followed by a 45-day investigation period. Although parties to a transaction may in certain cases withdraw and refile the notice at the end of the investigation period, and thus start a new sequence of review and investigation periods, the core CFIUS review process under the old statute lasted for up to 75 days.
FIRRMA extends the initial review period to 45 days and authorizes CFIUS to extend the subsequent investigation period by an additional 15 days in “extraordinary circumstances,” to be defined by CFIUS regulations. With these modifications, the core CFIUS review process has been extended to 90 days, and the CFIUS review process could take as long as 105 days before taking account for any time related to the pre-filing process and before accounting for any withdrawals and resubmissions of the written notice.
Timing for Review of Draft Filings and Acceptance of Filings
FIRRMA requires that CFIUS provide comments on draft notices submitted by the parties to a transaction in advance of a formal filing within 10 business days, and further requires CFIUS to accept formal filings — and thus start the review period “clock” — within 10 business days following submission. If CFIUS determines that the submission is incomplete, it must explain to the parties why the filing is incomplete. In order for the 10-day deadlines to apply, the parties must stipulate that the transaction is a “covered transaction” subject to CFIUS jurisdiction.
Declarations and Mandatory Declarations
FIRRMA establishes a new form of “light” filing, called a “declaration,” that contains basic information regarding the transaction and generally would not exceed five pages in length. FIRRMA directs CFIUS to prescribe regulations establishing specific requirements for declarations, and the provisions relating to declarations are not yet effective.
FIRRMA provides that, upon receiving a declaration, CFIUS may request that the parties to the transaction file a written notice, initiate a unilateral review of the transaction, notify the parties in writing that the Committee has completed all action with respect to the transaction or inform the parties that the Committee is unable to complete action with respect to the transaction on the basis of the declaration alone and invite the parties to the transaction to file a written notice with complete responses to all the items that CFIUS expects to be included in a filing. FIRRMA requires the Committee to take action in respect of a declaration within 30 days following receipt.
FIRRMA provides that a declaration (or, at the election of the parties, a written notice in lieu of a mandatory declaration) is mandatory in respect of certain transactions that would result in the direct or indirect acquisition of a substantial interest in a United States business by a foreign person in which a foreign government has a direct or indirect substantial interest. The transactions at issue include those that involve investment in a U.S. business that is the target of the “other investment” provision described above – U.S. businesses in critical infrastructure, critical technology or with personal data of U.S. citizens that may be exploited in a manner that threatens national security. FIRRMA authorizes CFIUS to identify through regulations other categories of transactions that involve critical technologies (but not critical infrastructure or sensitive data on U.S. citizens) beyond those that involve a substantial interest in a United States business by a foreign person in which a foreign government has a direct or indirect substantial interest for which declarations will be mandatory.
For purposes of the mandatory declaration, the term “substantial interest” will be defined by CFIUS regulations. In developing those regulations, the Committee is required to consider the means by which a foreign government could influence the actions of the foreign person, including through board membership, ownership interest or shareholder rights. However, FIRRMA specifies that an interest that is excluded from the term “other investment” or that is less than a 10-percent voting interest will not be considered a “substantial interest.” Mandatory declarations also will not be required for investment funds that are structured consistent with the clarification of “other investment” in the investment fund context, as discussed above. FIRRMA also authorizes CFIUS to waive, with respect to a foreign person, the requirement to submit a mandatory declaration if the Committee determines that the foreign person has demonstrated that the investments of the foreign person are not directed by a foreign government and that the foreign person has a history of cooperation with the Committee. This waiver provision could potentially benefit government-sponsored pension funds that have a long history of investment in the United States.
Under FIRRMA, CFIUS may not require mandatory declarations to be submitted more than 45 days before the completion of the transaction, and FIRRMA provides CFIUS with authority to impose civil penalties on any party that fails to comply with a mandatory declaration requirement. CFIUS may not request or recommend that a mandatory declaration be withdrawn and refiled, except to permit the parties to correct material errors or omissions. This means that CFIUS will have to make the decision to do one of the following: (1) request that the parties to the transaction file a written notice; (2) initiate a unilateral review of the transaction; (3) notify the parties in writing that the Committee has completed all action with respect to the transaction; or (4) inform the parties that the Committee is unable to complete action with respect to the transaction on the basis of the declaration alone and invite the parties to the transaction to file a written notice with complete responses to all of the items that CFIUS expects to be included in a filing. CFIUS is required to make such decision within 30 days after it receives a mandatory declaration, but if CFIUS decides that a written notice is necessary, then a full review and investigation period could be required.
Under the prior version of the statute, there was no filing fee associated with any notification to CFIUS. FIRRMA authorizes CFIUS to impose a fee of no more than one percent of the value of the transaction or $300,000 (adjusted annually for inflation pursuant to regulations prescribed by the Committee), whichever is less. CFIUS has not yet taken steps to impose this fee, and will do so by regulation at a later date.
In addition, FIRRMA establishes a fund to be administered by the CFIUS chairperson and authorizes $20 million in appropriations to this fund for each of fiscal years 2019 through 2023 to enable the Committee to perform its functions.
Parties will need to consider carefully both the statutory and regulatory definitions and examples of key terms such as “critical technology,” “critical infrastructure,” “sensitive personal data” and “U.S. business” to determine whether the nature of the U.S. business brings any particular transaction within CFIUS’s purview. Real estate transactions that previously were not subject to CFIUS review because they did not involve a U.S. business will potentially be subject to CFIUS jurisdiction. Parties to transactions will need to analyze whether a foreign government has a “substantial interest” in any foreign party to the transaction, as well as whether that foreign party is acquiring a substantial interest in a U.S. business involved in one of the specified categories, to determine whether a declaration of the transaction to CFIUS is mandatory.
Investment fund managers will need to consider carefully the implications of the structure of their funds and the rights given to foreign limited partners. U.S.-based investment fund managers that provide governance and informational rights to foreign limited partners will need to be aware that those rights may give rise to CFIUS jurisdiction in respect of the fund’s investments, so that any acquisition by that fund of U.S. businesses involved in critical infrastructure, critical technology or personal data of U.S. citizens could potentially be subject to CFIUS jurisdiction. Foreign-based investment fund managers will also need to consider the rights they give to limited partners located in foreign countries that are generally deemed to present greater national security threats, such as China, because those rights could affect how CFIUS views the potential threat posed by a proposed acquisition by that investment fund.
Certain provisions, such as the introduction of declarations as a form of “light” filing or the specification of a time period during which CFIUS must comment on draft notices or accept certain formal notices, may serve to reduce the length of the CFIUS review process for parties to certain transactions. However, FIRRMA’s extension of the initial review period to 45 days and introduction of the possibility that parties’ submission of a declaration may be followed by a request from the Committee for a full notice filing means that in other cases parties will certainly face a longer review process than they would have under prior law.
In addition, since FIRRMA leaves many details to be prescribed by Committee regulations, the full implications of the CFIUS reform affected by FIRRMA will not be known for many months. However, parties will have substantial opportunities to engage with the Committee throughout the rulemaking process and to provide the Committee with valuable insight into essential aspects of transactions involving foreign investment in the United States.