Law360, New York (September 27, 2016, 12:57 PM EDT) -- Foreign investors in US companies often must consider multiple regulatory issues. Among those is whether to seek clearance from the Committee on Foreign Investment in the United States, or CFIUS. A related question is when to file with CFIUS. Comparatively little guidance is available on the latter question. After summarizing the answer to the “whether” question, below we’ve provided several possible answers to the “when” question.
Where Does CFIUS Get Its Authority?
CFIUS is a multi-agency US government committee, chartered by statute to conduct national security reviews of foreign investments. Chaired by the US Treasury Department, its members include the US Department of Defense, US Department of Justice, US Department of Homeland Security, US Department of State, and US Department of Commerce, among others. The committee can require conditions on a deal, and in extreme circumstances CFIUS effectively can block a deal or cause it to be unwound. Having a deal unwound can be catastrophic for the parties, so CFIUS risks — often underestimated — should not be taken lightly.
Which Transactions Cause CFIUS to Exercise Its Authority?
“Covered Transactions” and “Control”
CFIUS does not review all foreign investments in the United States; rather, it only reviews “covered transactions.” A covered transaction is one that might result in foreign “control” over a US business.
It’s sometimes tricky to determine whether the transaction could yield foreign “control.” There are detailed regulations on this topic, but essentially the test is a broad functional one — after deal consummation, could the foreign investor cause the US company to take action or prevent it from taking action? For example, veto rights by the foreign investor might constitute control even if it holds only a very small equity stake. On the other hand, minimalist minority stakeholder protections generally do not constitute control. But the only transactions for which there is a clear safe harbor are those in which the foreign investor will acquire a purely passive stake of 10 percent or less. Anything more puts the transaction in a gray area, where it often is better to be safe than sorry when determining whether to file.
Even if a deal is a “covered transaction,” CFIUS is interested only in those related to “national security.” But the committee’s concept of “national security” is as broad and amorphous as its concept of “control.” Investments in US companies involved in information and communications technology, transportation, chemical production, biotechnology and medicine, and energy, among other areas, have been construed by the committee as relevant to national security. Even real estate transactions may be of interest to the committee when the real estate is close to a US defense or security facility or may be frequented by US government personnel. If the transaction is a covered transaction involving a US company plausibly related to national security, then it is wise to submit a filing — a “notice” — to CFIUS.
Foreign Investor “Threat” Levels
Filing is particularly advisable when the foreign investor might be viewed as a “threat.” The country in which the foreign investor is chartered or has its headquarters often can be viewed as a proxy for the concept of “threat.” Companies from Russia and China, for example, are likely to be viewed as a threat, and because China is the largest US trading partner that is not a strategic ally, Chinese investments often receive CFIUS scrutiny. But companies from Europe or the Middle East or elsewhere may receive similar attention — it is a mistake to ignore CFIUS simply because the investor is from a traditional US ally.
Assuming there is a covered transaction relevant to national security, deal parties should file a notice with CFIUS. Filing is nominally voluntary — parties are generally not legal required to obtain CFIUS approval. But there are significant risks when parties do not file, as explained further below.
So ... When to File?
CFIUS generally expects to receive a notice after a deal has been signed but prior to closing — typically, CFIUS clearance is a condition to closing. But this arrangement, while standard, is not the only one permissible, and there are pros and cons to filing at different stages. Below we discuss four scenarios.
1. The parties have a letter of intent or similar nonbinding document.
The committee’s guiding principle is that it will not review speculative deals. There is good reason for this: The CFIUS review process is resource-intensive, and those resources should be spent only on deals that are highly likely to be consummated. But CFIUS often will begin its review process with the submission of a document reflecting a provisional commitment to a deal by both parties, as long as the committee is able to review the material terms of that deal. For example, US-based Company A plans to auction its assets to bidder Companies B, C and D. If foreign Company C files a notice based on its proposed bid for Company A’s assets, CFIUS is unlikely to review that filing. However, if Company A provisionally accepts Company C’s bid — thus giving Company C exclusive rights to acquire Company A’s assets — CFIUS may begin its review process based on their exclusive provisional agreement, even if the agreement is not fully binding.
• Pro: If the provisional agreement or letter of intent (or similar document) is sufficiently specific and certain — i.e., unlikely to materially change — parties may elect to file a notice based on a nonbinding document; getting an early start in this way may be helpful if time is of the essence for closing the deal.
• Con: One potential downside to starting the process prior to deal-signing is that, if the terms of the deal change materially during the review process, then CFIUS may require refiling (starting the process from the beginning), which can be time and resource-intensive for the parties.
2. The parties have a signed agreement, with CFIUS clearance as a condition of closing, or an understanding that they will not close prior to CFIUS clearance.
The usual practice for the CFIUS process is that the parties file the notice after there is a signed agreement, with the understanding that closing will not occur until CFIUS clearance. With a signed agreement, there is no question as to whether the matter is ripe for review. It is worth noting that parties sometimes decide, if they believe the agreement does not constitute a “covered transaction” (i.e., if they think it is not a transaction over which CFIUS has jurisdiction), to request CFIUS concurrence that the agreement is not a covered transaction. That is, they might file the notice “out an abundance of caution” but with a prefatory argument that the agreement does not constitute a covered transaction. For example, in September 2015, a subsidiary of Chinese-owned Unisplendour Corp. announced that it would invest in US data storage manufacturer Western Digital. Western Digital publicly stated that it did not expect to be subject to CFIUS review because the ownership stake was noncontrolling and it did not view the intellectual property rights or technologies subject to the deal as “sensitive.”
• Pro: If CFIUS agrees with the parties that the deal does not constitute a covered transaction, then the committee will inform the parties that it will not exercise jurisdiction over the transaction.
• Con: If CFIUS concludes that it has jurisdiction, it will proceed to make a decision on the merits. In the Unisplendour/Western Digital case, CFIUS decided that it did have jurisdiction, notwithstanding the arguments made by the parties, and the parties then abandoned the deal.
3. The parties file with CFIUS before closing, but intending to close prior to CFIUS clearance.
In some circumstances, it may be sensible to file a notice with CFIUS before closing but to close the transaction prior to CFIUS clearance. In general, CFIUS reacts negatively, sometimes extremely negatively, to a pre-clearance closing. But CFIUS clearance can take a long time — in hard cases the process generally takes 75 days or more from the time CFIUS accepts a filing — and sometimes commercial circumstances require closing before the end of the process. For example, a foreign private equity firm specializing in corporate turnarounds may seek to invest in an embattled US company when its stock is cheap and then use its newly acquired shareholder and management authority to take prompt action to change the US company’s outlook. However, if the US company is teetering on the edge of bankruptcy or a loan default, time is of the essence for the foreign private equity firm to be able to close the transaction and provide the US company with much-needed capital and strategic guidance.
• Pro: In these cases, the path of least risk may be to file as soon as possible and to explain to CFIUS the circumstances (including the anticipated closing date) that necessitate pre-clearance closing. The upside of submitting the notice to CFIUS, even while intending to close before the end of the CFIUS process, is that the parties may be able to persuade CFIUS that they are not attempting to evade the committee’s jurisdiction. The difficulty of such persuasion escalates dramatically if the parties instead choose not to file at all. So the pre-clearance closing path may be the least worst path, particularly if the parties are confident that CFIUS will not require any risk mitigation measures.
• Con: Parties should be aware, however, that CFIUS generally will not give the parties any comfort about their intent to close prior to the end of the process: The stock response from the committee is that the parties are accepting the risks, including the risk that divestiture may be required or that CFIUS may require a degree of separation between the parties that may be hard to accomplish once integration of the parties has begun. Further, in extreme circumstances, CFIUS (or the President) may issue an order directing the parties not to close the transaction.
4. The parties file post-closing.
Filing with CFIUS post-closing almost always is an acknowledgment of a mistake. Often these post-closing filings are made in response to a communication from the committee that it wants to review the transaction. Since CFIUS can initiate a review of a transaction without a notice from the parties, and that review almost certainly would yield a less favorable outcome, the parties virtually always file a notice when CFIUS makes such a request. In the infamous Ralls v. CFIUS case — the only case resulting in a lawsuit against CFIUS — the Chinese-owned Ralls Corp. did not file with CFIUS, and the committee requested a filing after the transaction closed. Ultimately, CFIUS required divestment of a group of windfarms that Ralls Corp had purchased. But not all post-closing filings make such a splash.
• Pro: A post-closing filing might instead indicate that the parties are simply, of their own accord, correcting an oversight by filing a notice that should have been filed some time ago. Since there is no limitations period for CFIUS review of a closed transaction, and CFIUS has conducted reviews of transactions closed for over a year, it is sometimes sensible to correct oversights, particularly if there is a significant risk that CFIUS will request a review of a closed transaction. In the latter case, the committee often starts a review with a presumption that the parties were trying to evade the committee’s jurisdiction (as seemingly occurred in the Ralls case); that problem can be mitigated if the parties file before CFIUS makes a request.
• Con: As discussed above, CFIUS strongly prefers that parties file before closing and do not close until after CFIUS has reviewed a transaction. If the parties do not file until after closing, CFIUS may take more time to review the transaction and may be more likely to impose harsher mitigation measures or, in the extreme, to require divestment.
As indicated above, decisions about whether and when to file with CFIUS are intertwined. It is conventional wisdom, and correct, that there often is no easy answer about whether to file; it is less commonly understood that the decision about when to file is not always simple, either.
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