This text is based on presentations on this subject made recently by Mr. Burke to the American Chamber of Commerce in Beijing, the American Chamber of Commece in Shanghai, and the CCH/Wolters Kluwer conference for in-house legal counsel in Beijing.
Some Chinese Mistakenly Think They Are Unwelcome
Chinese direct investment in the United States is increasing. Last year Chinese companies doubled the amount of money they invested in the United States compared to 2009.
There are many reasons why Chinese companies would want to acquire or set up operations in the United States. Most costs of doing business in the United States, other than labor, are now cheaper than in areas of China with the advanced infrastructure that modern industrial operations need. Production in the United States often provides better access to customers; allows companies to take advantage of Buy American provisions when selling to government agencies; and enables companies to avoid trade barriers, such as antidumping or countervailing duties assessed on imports from China.
Notwithstanding these reasons for investing in the United States, many Chinese companies are hesitant to do so because of media reports on national security reviews of foreign investment that have given the impression the United States is hostile to foreign investment, or at least investment from China. The media have created the impression that Chinese companies are forced to abandon acquisitions in the United States because of political opposition and national security reviews by the Committee on Foreign Investment in the United States (“CFIUS”).
The reality is that the United States welcomes most Chinese investment. The United States has no restrictions on greenfield investment by foreigners, except for some state (non-federal) laws that limit the ability of foreign persons to purchase farmland. Thus, foreigners may create new U.S. businesses on the same basis as Americans. Recent examples of Chinese greenfield investments in the United States include Tianjin Pipe’s steel pipe mill in Texas; Suntech Power’s solar panel assembly plant in Arizona; and American Yuncheng’s gravure cylinder plant in South Carolina.
CFIUS national security reviews apply only to the acquisition of existing U.S. businesses. Even in those circumstances, only three to seven percent of foreign acquisitions each year go through the CFIUS process. Blocked acquisitions are rare; projects blocked presented unique challenges.
Chinese Transactional Failures Have Been Exceptions
A handful of Chinese acquisitions have been abandoned as a result of CFIUS review, or political opposition. However, circumstances unique to each transaction, not general hostility to Chinese investment, caused those deals to fail.
One failure was Northwest Non Ferrous International Investment Co. Ltd.’s attempted acquisition of Firstgold Corp., a gold mining company in Nevada. That acquisition was abandoned just before the end of a CFIUS review due to the expectation of an unfavorable CFIUS recommendation. Questions had been raised because of sensitive military and intelligence installations adjacent to the mines. Had those mines been located elsewhere, the acquisition likely would have sailed through the national security review.
The failed acquisitions receiving the most press attention recently include Huawei Technologies Co. Ltd.’s attempt to acquire 3Com and, more recently, assets from 3Leaf Systems. Huawei bought intellectual property rights from 3Leaf Systems, a developer of cloud computing, without filing a notification with CFIUS. CFIUS learned about the transaction and self-initiated a national security review that resulted in a recommendation that Huawei be ordered to divest.
There were several reasons why the 3Leaf transaction ended badly for Huawei. The Pentagon had serious concerns about the technology that were magnified by a lingering mistrust of Huawei following the 3Com transaction and its mishandling of the CFIUS process in the 3Leaf case. The more important reason, however, was a more general mistrust of Huawei in the U.S. Government due to allegations of close corporate connections to the People’s Liberation Army, espionage, intellectual property theft, and support for terrorist regimes (Iran, Iraq and the Taliban). These circumstances were peculiar to Huawei. The Huawei transactional failure does not indicate any general hostility to Chinese investment.
The Legal Framework And Its Operation: CFIUS And FINSA
Congress enacted the Foreign Investment National Security Act Of 2007 (“FINSA”) on July 26, 2007 in reaction to Dubai Ports World and other controversies to improve accountability and transparency in the CFIUS process. FINSA provides that the President may “suspend or prohibit any covered transaction” whenever the President finds credible evidence “that the foreign interest exercising control might take action that threatens to impair the national security.” However, the purpose of FINSA set out in the preamble to the legislation is “[t]o ensure national security while promoting foreign investment ....” Thus, FINSA reinforces that, notwithstanding the need to protect national security, promoting foreign investment in the United States remains the policy of the U.S. Government. The following statistics on CFIUS reviews in the three years (2008 to 2010) since FINSA became law demonstrates that this law is not an impediment to the vast majority of foreign acquisitions of U.S. business:
- National security reviews 313
- Extended investigations 83
- Voluntary withdrawals (most re-filed and subsequently cleared) 42
- Cases submitted to the President 0
To be governed by FINSA a transaction must be a covered transaction, which means that the transaction must involve a foreign person obtaining control over an existing US business. A covered transaction can be blocked only if it would impair national security and that impairment cannot be remedied through some other means.
FINSA defines “covered transaction” to mean “mergers, acquisitions, or takeovers . . . by or with foreign persons which could result in foreign control of persons engaged in interstate commerce in the United States.” It only covers transactions involving an existing US business. As noted previously, greenfield investments, such as the Tianjin Pipe project in Texas, are not covered. It covers an acquisition of one foreign company by another if control of a U.S. business were to change.
The regulations implementing FINSA, which the Treasury Department published for CFIUS, define “control” as:
"the power, direct or indirect, whether or not exercised, through the ownership of a majority or a dominant minority of the total outstanding voting interest in an entity, board representation, proxy voting, a special share, contractual arrangements, formal or informal arrangements to act in concert, or other means, to determine, direct, or decide important matters affecting an entity . . . .
A ten percent passive investment in a U.S. company generally would not be enough to meet this definition of control. However, contractual arrangements that give a foreigner control of important matters can cause a transaction in which the foreign entity does not obtain any equity to be a “covered transaction.”
CFIUS’s implementing regulations define “foreign person” to be “(a) Any foreign national, foreign government, or foreign entity; or (b) Any entity over which control is exercised or exercisable by a foreign national, foreign government, or foreign entity.” This definition includes US subsidiaries of foreign companies.
Neither FINSA, nor the implementing regulations, defines “national security.” Consequently CFIUS has broad discretion to define national security on a case-by-case basis. Other provisions in FINSA, the implementing regulations, the legislative history and CFIUS’s subsequent actions indicate the following key areas in which national security concerns are likely to arise:
- Defense industries, which would include companies that provide “defense articles” or “defense services” that are subject to heightened export controls under the International Traffic in Arms Regulations (“ITAR”) and the defense industrial base, which provides products needed for making military items;
- Proximity to critical government facilities, as shown in the Firstgold case;
- Critical infrastructure, defined in the implementing regulations as “a system or asset, whether physical or virtual, so vital to the United States that the incapacity or destruction of the particular system or asset . . . would have a debilitating impact on national security.” The company’s system or assets have to be big enough to make a difference under this definition.
- Critical technologies, which would include (a) items controlled under the ITAR, (b) items controlled under Export Administration Regulations for national security, chemical and biological weapons proliferation, nuclear proliferation or missile proliferation reasons (probably only if the item needed a license to be exported to the acquiring company’s home country), (c) items controlled under the Export and Import of Nuclear Equipment and Materials Regulations, and (d) items controlled under the Export and Import of Select Agents and Toxins Regulations (threats to plant, animal or human health);
- Energy and other critical resources, including essential raw materials for defense industries and critical infrastructure.
FINSA requires heightened review of proposed transactions in which a foreign government would obtain control of a U.S. business. There is a presumption that transactions by foreign governments or entities controlled by foreign governments receive an additional 45-day extended investigation beyond the initial 30-day review under which CFIUS clears most transactions. This presumption can be waived if the Treasury Secretary and the head of the other agency designated as the lead for the particular CFIUS review “jointly determine . . . that the transaction will not impair the national security of the United States.”
When a transaction is considered to be foreign government-controlled, FINSA requires CFIUS to consider the adherence of the country to non-proliferation control regimes, the U.S. relationship with the country, specifically on cooperation with counter-terrorism efforts, and the potential for diversion of technologies with military applications.
The United States is open to investment, but potential investors do need to pay attention to legitimate national security concerns. For the vast majority of foreign investors, including investors from China, the CFIUS review process is not an impediment. Greenfield investments do not require a CFIUS review. Most cross-border mergers and acquisitions do not require a CFIUS review. Most CFIUS reviews clear the transaction within 30 days. Only a handful of transactions have been abandoned as a result of national security concerns.