The U.S. Department of the Treasury (“Treasury”), in its capacity as chair of the Committee on Foreign Investment in the United States (“CFIUS” or the “Committee”), recently posted two new frequently asked questions (“FAQs”) to CFIUS’s website that have important implications for parties planning transactions subject to the Committee’s jurisdiction.
First, CFIUS confirmed its recent practice of requiring detailed information on all direct or indirect foreign ownership involved in a transaction, including disclosure of all limited partners (or “LPs”) of an investment fund, without regard to any pre-existing agreements between the fund sponsor and investor regarding disclosure.
Second, CFIUS offered guidance regarding the meaning of “completion date” for purposes of when a mandatory filing must be submitted for a multi-stage transaction. The guidance could have broad implications, especially for some venture financing transactions, as it introduces uncertainty regarding the ability of investors to use a staged transaction to acquire an initial, passive equity interest prior to submitting a mandatory CFIUS filing with respect to a subsequent acquisition of control or certain non-passive rights. The new guidance seems at odds with language that appears in the preamble to the regulations implementing the Foreign Investment Risk Review Modernization Act of 2018 (“FIRRMA”), and the practice of transaction parties for the last several years. CFIUS did not provide any explanation for this change, which raises questions as to why the Committee has issued the guidance now.
Each of these developments is discussed in more detail below.
1. CFIUS may require detailed information regarding all foreign persons involved directly or indirectly in a transaction, including limited partners in an investment fund.
Treasury published the following FAQ on May 11:
Does CFIUS require information on all foreign persons, such as limited partners in an investment fund, that would hold an interest in a U.S. business, whether directly or indirectly, as part of the transaction?
“In addition to the information required for submission of a complete filing with CFIUS, to facilitate its review, CFIUS through the Staff Chairperson may request follow-up information with respect to all foreign investors that are involved, directly or indirectly, in a transaction, including limited partners in an investment fund. Like other aspects of the CFIUS process, the scope of such a request depends on the facts and circumstances of each transaction. For example, CFIUS often requests identifying information for indirect foreign person investors, including limited partners, their jurisdiction(s) of organization, and ultimate ownership, among other information, regardless of any arrangements that may otherwise limit the disclosure of such foreign person’s identity. CFIUS may also request information with respect to any governance rights and other contractual rights that investors collectively or individually may have in an indirect or direct acquirer or the U.S. business to facilitate the Committee’s review regarding jurisdictional or national security risk-related considerations. Such information, as with all information filed with CFIUS pursuant to 50 USC 4565, is subject to the confidentiality protections afforded by 50 USC 4565(c).”
The new FAQ reflects an evolution in the Committee’s approach to disclosure of information about LPs. Historically, there were some circumstances—largely involving fund transactions from China—in which the Committee would insist on receiving information on all LPs, regardless of how small (from a percentage standpoint) and passive a particular LP interest was. However, by and large, well-known fund sponsors from allied countries have not generally been required to provide detailed information on all LPs in a fund. Instead, if the fund could demonstrate control by the general partner and that the LPs were geographically diverse and entirely passive, it often was the case that the Committee would accept summary information on the composition of the LP base, or at least not require specific information on any LP that held less than a 5 percent indirect interest in the ultimate U.S. business. That approach has shifted, as reflected in this FAQ, and the purpose of the FAQ is to put fund sponsors on notice regarding the breadth and specificity of the information that CFIUS will now seek.
As set forth in the FAQ, CFIUS may now insist on detailed information regarding all LPs and other co-investors in a fund or other investment vehicle involved in a covered transaction, regardless of the fact that such LPs may be passive, financial investors. This will include, among other things:
- the identity of the LP;
- the LP’s relative contribution of committed capital to the fund and transaction at issue (and therefore the relative ownership percentage);
- information regarding LPs’ principal places of business and places of legal organization, as well as whether any LP is owned or controlled by a foreign government; and
- all documentation with the LP, including all side letters entered into with LPs, as well as all organizational and governance documents for the fund, regardless of whether any such documents are protected by confidentiality provisions negotiated between the fund sponsor and the LPs.
That is, if a fund sponsor has made a commitment to keep confidential the identity of an LP or other information regarding the investment, CFIUS may insist on knowing that identity regardless of that contractual commitment. CFIUS will, however, keep that information confidential in the CFIUS process (i.e., not make it publicly available), as required by statute.
Going forward, investors should anticipate these requests and be prepared to provide CFIUS with the requested information and documentation. Investors also should assume that CFIUS will press for such information and documentation regardless of any privately negotiated confidentiality provisions. To the extent possible, investors may wish to inform their LPs that such information and documentation may be required to be disclosed to CFIUS, and that a delay in or failure to disclose it to CFIUS could prejudice CFIUS’s view of the investor. The best time to have these conversations with LPs is before a CFIUS filing is made, because once the transaction is under review, the parties will have only three days (or two, in the case of a declaration) to respond to a question set from CFIUS requesting information on the investor’s LPs.
2. The Committee’s newly issued guidance creates uncertainty regarding the timing for mandatory filings in multi-stage transactions.
Treasury also published the following FAQ on May 11:
How does CFIUS determine the “completion date,” in assessing when a mandatory filing should be submitted, where the foreign person first acquires equity interest but will not receive control or covered investment rights until after CFIUS’s review?
“The ‘completion date’ is the earliest date upon which any ownership interest is conveyed, assigned, delivered, or otherwise transferred to a person [31 C.F.R. § 800.206]. In a transaction where the ownership interest is conveyed before the foreign person receives the corresponding rights, the ‘completion date’ is the earliest date upon which the foreign person acquired any of the equity interest. For example, if Company A acquired a 25 percent ownership interest in Company B on July 1, but its right to control Company B was deferred until after CFIUS reviews the transaction, the ‘completion date’ for the transaction is July 1. If the transaction is subject to the mandatory declaration requirement pursuant to 31 C.F.R. § 800.401, the latest date that the parties can file the transaction with CFIUS is June 1. Note that contingent equity interests are assessed separately under 31 C.F.R. § 800.207.”
This new informal guidance is significant because it appears to suggest that parties cannot structure transactions such that the foreign investor provides a U.S. business with an injection of capital in exchange for a strictly passive and non-controlling equity interest, while agreeing that any subsequent receipt of equity or rights that would constitute a covered transaction and trigger a mandatory CFIUS filing will be subject to prior CFIUS approval. If that interpretation of the FAQ is accurate, then the FAQ would seem to be at odds with Treasury’s own explanatory comments that accompanied the publication of the regulations that implemented FIRRMA and the Committee’s practices in recent years.
FIRRMA, enacted in 2018, required for the first time certain transactions to be filed with CFIUS prior to consummation. Under the implementing regulations, in the event that a transaction would trigger a mandatory filing, the parties must submit a declaration or a notice to CFIUS “[t]hirty days before the completion date of the transaction.” 31 C.F.R. § 800.401(g)(2). 31 C.F.R. § 800.206 in turn defines “completion date” as “the earliest date upon which any ownership interest, including a contingent equity interest, is conveyed, assigned, delivered, or otherwise transferred to a person, or a change in rights that could result in a covered control transaction or covered investment occurs.”
When these rules were published in 2020, Treasury explained in its accompanying comments that the rules included a definition of “completion date” “to clarify that, in the event that a covered transaction will be effectuated through multiple or staged closing, the completion date is the earliest date on which any transfer of interest or change in rights that constitutes a covered transaction occurs.” 85 Fed. Reg. 3112, 3114 (Jan. 17, 2020). Transaction parties have generally interpreted this to mean that the filing must be submitted 30 days prior to the “transfer of interest or change in rights that constitutes a covered transaction.” (Emphasis added.) In other words, the filing must be submitted 30 days before the date on which the foreign investor acquires either “control” of the U.S. business or any of the “covered investment” rights that would trigger a mandatory filing. However, the acquisition of a strictly passive, non-controlling interest would not trigger a mandatory filing—even if documented as part of a broader transaction—because it is not a “transfer of interest or change in rights that constitutes a covered transaction.”
Thus, the preamble to the regulations seemed to communicate that parties could structure a transaction such that the foreign investor could first acquire a strictly passive and non-controlling equity interest in a U.S. business without a CFIUS filing. In turn, parties have routinely undertaken transactions where they have agreed that if the investor subsequently could acquire “control” of the U.S. business or non-passive rights enumerated in 31 C.F.R. § 800.211(b) (such as the right to appoint a member of the board), prior CFIUS approval would be contractually required if such subsequent transaction would trigger a mandatory filing. To our knowledge, CFIUS has not questioned parties’ practices in structuring transactions in that manner until recently. The ability to undertake an initial, passive equity investment without triggering a CFIUS filing allowed foreign investors to provide U.S. businesses with immediate capital at critical junctures. At the same time, this approach also delayed a covered transaction until the parties had time to assemble a fulsome CFIUS filing, thereby ensuring that CFIUS would have the ability to review the transaction before the foreign person acquired any non-passive rights.
The FAQ, on the other hand, suggests that CFIUS may treat an initial passive minority investment that on its own would not be subject to CFIUS jurisdiction as nonetheless subject to CFIUS jurisdiction (and triggering a mandatory filing) if the foreign investor later also would—or could—acquire rights or interests that separately would constitute a covered transaction. If this is accurate, then even if an investment is “solely for purpose of passive investment” within the meaning of the regulations and outside of CFIUS’s jurisdiction, if the transaction documents contemplate the foreign person—at any point in the future—possibly acquiring rights or interest that would trigger a mandatory filing, the parties would be required to file at least 30 days before the first share transfers, or risk civil penalties up to $250,000 or the value of the transaction. See 31 C.F.R. §§ 800.401(g)(2), 800.901(b).
It is not clear, however, how CFIUS will interpret this new FAQ in practice, and it creates ambiguity in numerous ways. For example:
- Is CFIUS now asserting it has jurisdiction to review an initial, strictly passive investment that does not confer control, if the parties then subsequently agree to undertake a controlling transaction? That would seem to be at odds with CFIUS’s statutory and regulatory authority, but the only difference between that example and the example in the FAQ is whether the transaction is structured as one multi-stage transaction or two separate transactions. For example, if transaction A provides the foreign investor with a strictly passive and non-controlling stake in a business that produces a critical technology and, two years later, transaction B occurs, with transaction B conferring additional equity and a board seat (or other covered investment right), it is not clear, even under this FAQ, if CFIUS would retrospectively conclude that transaction A triggered a mandatory filing.
- It equally is unclear how CFIUS would treat a multi-stage transaction that contemplates an initially passive investment, followed by an acquisition of rights in a second stage when that later second stage is never completed. Consider, for example, a multi-stage transaction in which a foreign person agrees to acquire initially a strictly passive, non-controlling equity interest of 4.9 percent of the outstanding voting interest in a TID U.S. business that produces a critical technology that requires a U.S. government license to be exported to the foreign person. The foreign person also agrees that, if the U.S. business meets certain performance thresholds in the future, the foreign person will invest another 4.9 percent and acquire the right to appoint a board member. This second stage of the transaction (i.e., the additional 4.9 percent and the board appointment right), however, is subject to prior receipt of CFIUS approval. The U.S. business never meets the performance criteria to trigger the second stage of the investment, and the foreign person never acquires the board appointment right or the additional 4.9 percent interest. Under the FAQ, CFIUS appears to suggest that this transaction would need to be filed 30 days before any equity interest transfers (i.e., 30 days before the first stage), even if the second stage of the transaction never occurs and the foreign person never acquires the board appointment right—even though at no point under this example is the foreign person actually “afforded” a board right.
- The FAQ notes that contingent equity interests are addressed separately, but the FAQ raises the question of whether CFIUS will see the acquisition of a contingent equity interest that contemplates later acquisition of board or other covered investment rights (subject to prior CFIUS approval) as requiring a filing 30 days before acquisition of the contingent equity interest.
It is not clear why Treasury has now decided to issue this new FAQ on multi-stage transactions—particularly without reconciling it with the prior commentary issued in connection with the regulations—but we expect that this shift will make it harder for U.S. businesses, in certain circumstances, to receive crucial (and timely) injections of capital. This may be especially so for early stage companies that are involved with critical technologies, and therefore CFIUS’s position is a curious one given that these are the exact types of companies that the Biden Administration otherwise has indicated it is paramount to nurture and grow in the United States.