Deals are generally approved, but a new law increases the number and types of deals reviewed.
As governments in various countries tighten their grip on national security reviews of foreign direct investment, the need for better assessment and calibration of the associated regulatory risk in cross-border transactions is greater than ever before
Nowhere is this trend more evident than in the United States, with the August passage of the Foreign Investment Risk Review Modernization Act (FIRRMA), which expanded the range of transactions that are subject to review by the Committee on Foreign Investment in the United States (CFIUS), and the more recent release of a pilot program under FIRRMA that instituted mandatory declarations for a broad range of transactions and put in place penalties—up to the full value of the transaction—for failure to comply. With CFIUS set to clamp down still further in coming months, CFIUS compliance is rapidly moving to the very top of the due diligence list for cross-border transactions involving US businesses.
The US is far from alone. As you will read in the pages that follow, the European Union, United Kingdom, Germany, France, China and other nations are also incrementally ratcheting up their reviews. In the UK, for instance, the government is proposing radical new legislation to allow it to intervene in cases that raise potential national security concerns. The UK government itself estimates that, under the new law, approximately 50 cases a year may end up with some form of remedy to address such concerns. In France, the new PACTE law is likely to strengthen the sanctions mechanism, extend the list of sectors subject to review and introduce some transparency into the process through annual reporting on a no-name basis of reviewed cases.
The pages that follow offer a common-sense guide to investing in major jurisdictions, a snapshot of recent regulatory changes in each, and guidance on making sound investment decisions in a time fraught with regulatory uncertainty.
Deals are generally approved, but a new law increases the number and types of deals reviewed.
While few deals are challenged in Canada, national security reviews are becoming more common and complex
Proposed European foreign direct investment regulation— a first step toward harmonized European investment controls
Deals are generally not blocked in Finland.
New legislation has been proposed to expand the scope of French national security reviews, especially in the technology sector, and to strengthen the powers of French authorities to impose sanctions
Federal Ministry for Economic Affairs and Energy is enforcing a stricter regime for foreign direct investment reviews
Deals are generally not blocked by the Italian government. However, in connection with the clearance process, conditions may be imposed that can have a significant impact on the investment
New amendments potentially require foreign investors to disclose information about beneficiaries, beneficial owners and controlling persons as part of pre-clearance
National security interventions have, with one exception, involved defense considerations
Australia requires a wide variety of investments by foreign businesses to be reviewed and approved before completion
China is attempting to implement a more structured and comprehensive system to keep a closer eye on economic deals that might have security implications
Japan’s implementation of the 2017 amendments to FEFTA must be watched closely to see whether Japan will adopt a more aggressive stance
Deals are generally approved, but a new law increases the number and types of deals reviewed
The Committee on Foreign Investment in the United States (CFIUS), which is led by the US Department of the Treasury and made up of US national security and economic agencies, including Defense, State, Justice, Commerce, Energy and Homeland Security, reviews acquisitions of, and investments in, US businesses by foreign persons or businesses.
In August 2018, Congress passed, and President Trump signed, the Foreign Investment Risk Review Modernization Act (FIRRMA), which significantly overhauled the CFIUS process. Although most substantive provisions of FIRRMA will not take effect until new implementing regulations are in place, the key provisions and implications of FIRRMA are discussed where applicable below. CFIUS has also introduced a pilot program mandating short-form notifications for certain transactions involving US companies involved with critical technologies in specified industries.
The parties to the transaction file a joint voluntary notice that addresses specific information about the investor, the US business and the transaction, and includes attachments such as annual reports, the deal document and information about the target's US government contracts (if any). In most cases, a CFIUS review is ostensibly a voluntary process, but even in some "voluntary" cases it is effectively mandatory; e.g., acquisitions of cleared defense contractors. Moreover, under FIRRMA, the CFIUS process will no longer be voluntary for transactions involving an investment that results in the acquisition, directly or indirectly, of a "substantial interest" (a term that will be defined in the updated CFIUS regulations) in a US business involved in critical infrastructure, critical technology, or sensitive personal data by a foreign person in which a foreign government has, directly or indirectly, a "substantial interest." FIRRMA also authorizes CFIUS to identify additional transactions that would require mandatory notification, such as those involving critical technology companies. The pilot program has mandated declarations for both controlling and qualifying non-controlling foreign investments in businesses that are involved with critical technologies in certain specified industries. Parties may be subject to penalties up to the value of the transaction if they fail to submit a mandatory declaration.
CFIUS actively looks for transactions of interest that were not notified and will request parties to submit a filing regarding transactions it would like to review. In recent years, CFIUS has reviewed transactions in a wide array of industries.
In 2018, the Foreign Investment Risk Review Modernization Act (FIRRMA) was enacted, marking the first overhaul of the Committee on Foreign Investment in the United States (CFIUS) statute in more than a decade. FIRRMA was designed to modernize the CFIUS process and close a number of key gaps under the prior law, particularly with respect to Chinese acquisitions.
FIRRMA expands CFIUS's jurisdiction in several ways, most significantly to include purchases or leases of real estate in close proximity to sensitive US government facilities (regardless of whether there is an investment in a US business), as well as non-passive, yet non-controlling acquisitions in US businesses whose activities involve critical technologies, critical infrastructure or sensitive personal data of US citizens. FIRRMA also introduces a "declaration" process for abbreviated notifications that may allow for expedited reviews of certain transactions. FIRRMA also makes declarations mandatory in certain cases—a substantial shift from the current regime, in which CFIUS review is typically a voluntary process. Finally, FIRRMA extends the formal CFIUS timeline by increasing the initial review period to 45 calendar days and authorizing a potential 15-day extension of the 45-day investigation period.
Most of the new law's major changes will not take effect until new implementing regulations are promulgated, which may take as long as 18 months. That said, CFIUS has introduced a pilot program mandating "declaration" filings for certain foreign investments—including non-controlling investments—in companies involved with critical technologies in certain industries.
TYPES OF DEALS REVIEWED
CFIUS currently has jurisdiction to review any transaction that could result in control of a US business by a foreign person, changes in rights that a foreign person has with respect to a US business if that change could result in foreign control of the US business, and any other transaction structured to circumvent the CFIUS process. "Control" is defined—and interpreted by CFIUS— broadly and can include many minority investments. The types of transactions that CFIUS can review are quite varied, including deals structured as stock or asset purchases, debt-to-equity conversions, foreign-foreign transactions where the target has US assets, private equity investments (in some cases even from US-based companies) and joint ventures where the foreign partner is investing in an acquired or contributed US business.
Under FIRRMA, once new regulations are in effect, CFIUS will also have jurisdiction to review certain real estate transactions (regardless of whether the transaction involves an investment in a US business), and certain non-passive, non-controlling investments involving critical infrastructure, critical technologies, or sensitive personal data (regardless of whether the investment results in control by the foreign investor). As indicated above, CFIUS already has jurisdiction to review non-passive, non-controlling investments in certain cases under the FIRRMA pilot program.
The CFIUS statute does not directly specify what types of industries are relevant to national security. This has given CFIUS substantial leeway to review transactions covering a wide variety of areas, including semiconductors and other technology areas, identity authentication, biometrics, information technology, energy, telecommunications, food safety, financial services, real estate, cybersecurity and healthcare, as well as industries with a more direct link to national security such as aerospace and defense. External issues unrelated to the structure of the transaction, such as the US business's location in close proximity to sensitive US government assets, can also pose substantial national security concerns.
Accordingly, it is important to consider CFIUS issues in connection with any transaction involving foreign investment (direct or indirect) in a US business or US real estate with a potential link to national security.
SCOPE OF THE REVIEW
The CFIUS review process is designed to assess the risk profile of the deal from a US national security perspective. CFIUS analyzes the threat posed by the foreign buyer, the vulnerability exposed by the target, and the consequences exposed by the combination of the threat and vulnerability. Based on that risk profile, CFIUS decides if the deal can proceed (with or without mitigation) or whether it needs to be stopped.
Often the analysis is done based on the filing as well as follow-up Q&A. In some cases, the parties will also meet with CFIUS per the parties' or CFIUS's request.
TRENDS IN THE REVIEW PROCESS
In recent years, there has been a significant broadening of the foreign investor base represented in CFIUS reviews, with greater activity from emerging markets, such as China, Japan, India and the Middle East.
Notably, there has been rising sensitivity to China-based transactions, which have continued to increase under President Trump's administration. In response, Congress passed FIRRMA, which is intended to close gaps between the transactions that CFIUS is currently able to review and transactions it currently cannot review but that present potential national security concerns. FIRRMA's provisions are particularly aimed at gaps that have been exploited by certain Chinese investment trends. These trends include real estate acquisitions in sensitive areas, minority investments (particularly through private-equity-type structures) that might not be controlling but that nonetheless provide access to sensitive information or technology of the target US business, the increasing use of Chinese joint ventures into which US-origin technology is transferred, and concerns that Chinese deals are being structured to circumvent CFIUS.
To address these types of investments, FIRRMA expands CFIUS's jurisdiction, allowing it to review the following additional types of transactions:
These provisions are subject to important limitations and caveats. First, the expanded categories of jurisdiction do not go into effect until CFIUS issues new regulations or initiates a pilot program (such as the one already introduced) involving one or more of the categories. Second, FIRRMA requires CFIUS to further limit the term "foreign person" for purposes of the "other investments" and real estate categories, which may exempt certain investors from these expansions. Third, the terms "critical infrastructure" and "critical technologies" must be further defined in forthcoming regulations.
FIRRMA also allows for shorter notifications, called "declarations," which will become a filing option after the FIRRMA implementing regulations take effect. Declarations may enable some transactions to effectively receive CFIUS approval based upon an abbreviated notification and in a condensed timeframe. This will also offer an avenue for parties unsure of whether to file to potentially gain clarity without first having to go through a full notice and review. Significantly, while parties will be permitted to start with a declaration (rather than a full notice) in any case, in certain circumstances declarations will be required—meaning that the CFIUS process will no longer be voluntary for such transactions.
In particular, FIRRMA requires a declaration for transactions involving an investment that results in the acquisition, directly or indirectly, of a "substantial interest" in a US business involved in critical infrastructure, critical technology or sensitive data by a foreign person in which a foreign government has, directly or indirectly, a "substantial interest." The term "substantial interest" will be defined in forthcoming CFIUS regulations, and FIRRMA allows the application of this provision to be both narrowed to certain foreign persons and broadened to other types of transactions. Notably, all transactions covered by the initial pilot program—both controlling and non-controlling—are subject to mandatory declarations.
HOW FOREIGN INVESTORS CAN PROTECT THEMSELVES
It is critical for foreign investors to consider CFIUS issues in planning and negotiating transactions, including with respect to allocation of CFIUS-related risk. The range of mitigation requirements that can be imposed is quite wide (based on the risk profile of the deal), and it is important for buyers in particular to have as clear an understanding as possible with respect to what mitigation requirements would be acceptable to them. As a buyer, you do not want to buy an asset and have CFIUS-imposed mitigation prevent you from achieving your objectives for the deal. It is also advisable for investors in potentially sensitive transactions to try to avoid owing reverse breakup fees should the transaction fail due to CFIUS objections.
REVIEW PROCESS TIMELINE
Typically, the process takes at least four to five months from the time the parties submit the joint voluntary notice and its attachments to CFIUS in draft (called a prefiling) to completion. Concurrent with a recent surge in CFIUS reviews—2017 well exceeded the previous modern-era record for CFIUS cases in a year and 2018 is at a similar pace—the CFIUS process is often taking longer, sometimes significantly so. CFIUS typically takes about two to four weeks to review and comment on the pre-filing, though in some cases this process can take longer. Thereafter, once the parties incorporate CFIUS's comments and formally file, CFIUS typically takes at least one to two weeks to accept the filing and start a 45-calendar-day review process. At the end of the 45 calendar days, the review is either completed or is taken to the investigation phase (which happens in most filed cases annually).
Investigation can take up to 45 calendar days, and may be extended for one 15-day period in "extraordinary circumstances." Most reviews are completed after the investigation phase. On rare occasions, contentious deals are taken to the president for a decision, who has 15 days to decide. More commonly, typically when CFIUS needs more time to assess a sensitive transaction or parties are still negotiating mitigation terms with CFIUS, CFIUS may encourage the parties to withdraw and resubmit the notice to restart the 45-day review period. In the past couple of years, the number of transactions that have been withdrawn and resubmitted for a second review cycle has increased, though the statutory time period for review and potential investigation was extended under FIRRMA, which may reduce the need for additional review cycles.
2018 UPDATE HIGHLIGHTS
- CFIUS's jurisdiction will be increased to include certain real estate transactions and non-controlling, non-passive investments
- For some investors with foreign-government ownership, a CFIUS declaration will be mandatory in certain cases
- Most deals are still approved and are expected to continue to be approved
- Where CFIUS has national security concerns, it can impose mitigation conditions that can have significant implications on the foreign investor's involvement with the US business
- A relatively small but nevertheless notable number of deals are abandoned while going through the process
- Only the US president can formally stop a deal, which has happened five times in the history of CFIUS—twice during the current administration. More typically, in cases where CFIUS determines there are unresolvable national security concerns, CFIUS will suggest that parties abandon a deal or it will recommend a presidential block, at which point parties usually agree to withdraw from the transaction
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