The Foreign Investment Risk Review Modernization Act of 2018 (“FIRRMA”) was enacted 18 months ago, expanding the jurisdiction of the Committee on Foreign Investment in the United States (“CFIUS”) and mandating CFIUS filings for certain transactions. When reviewing the new legislation, countries and investors around the world seized on language in FIRRMA authorizing the to limit the application of some of these new provisions to “investments of certain categories of foreign persons.”
On January 13, 2020, CFIUS released final regulations implementing FIRRMA, including the awaited exemptions, which will be applicable to certain investors from CFIUS-approved countries. These regulations will take effect on February 13, 2020. This note explains which investors will qualify as “excepted investors” and “excepted real estate investors” under the new regulations and the benefits and limitations of receiving those designations.
The “sense of Congress” section of FIRRMA urges international outreach by the United States to help “allies and partners” establish national security review processes like those of CFIUS and to “facilitate coordination.” The FIRRMA regulations build on this language, establishing a two-pronged test for countries to qualify as “excepted foreign states” or “excepted real estate foreign states” from which investors may qualify for certain exemptions from CFIUS jurisdiction or mandatory filings:
- Eligible foreign state. To be “excepted,” a country must first be determined by CFIUS to be “eligible.” As this term is undefined by the FIRRMA regulations, CFIUS has full discretion to decide whether a foreign state qualifies. Presumably, in keeping with Congress’s intent, eligible countries will be limited to “allies and partners.”
- Robust process for foreign investment review and coordination. Effective February 13, 2022, an eligible country must also have been determined by CFIUS to have a “robust process to analyze foreign investments for national security risks and to facilitate coordination with the United States on matters relating to investment security.”
- Prior to FIRRMA, CFIUS confidentiality rules precluded coordination between the United States and other countries on national security reviews. Both Congress and CFIUS clearly recognized that this was not an ideal approach, particularly when faced with acquisitions of multinational companies subject to multijurisdictional foreign investment reviews.
Notably, the final regulations eliminate language in the draft rules that would have permitted the designation of “excepted foreign states” and “excepted real estate foreign states” to be made with the assent of only two thirds of CFIUS’s voting members; the draft language would have prevented dissenting votes by as many as three CFIUS members from blocking a country’s designation. Removal of the two-thirds provision implies that like other CFIUS decisions, designation of a country as “excepted” will require consensus of the entire committee.
CFIUS has initially designated Australia, Canada, and the United Kingdom as “eligible” countries that will also be deemed “excepted” under both the corporate and real estate investment rules unless they have not satisfied the “robust process” prong in the next two years. All three countries already have foreign investment review processes; Australia and Canada have foreign investment review processes initiated through notices by the parties, and the United Kingdom proposes to add a notice-based process to the current process initiated unilaterally by the government. In addition, all three countries are members (along with the United States and New Zealand) of the “Five Eyes” intelligence sharing alliance.
CFIUS is authorized to establish separate lists of “excepted foreign states” for purposes of corporate investments and “excepted real estate foreign states” for purposes of other real estate transactions subject to CFIUS jurisdiction. Whether this happens over time may reflect how differently CFIUS comes to view the national security risks posed by corporate investments and real estate transactions.
To benefit from the exemptions under the FIRRMA regulations, an investor must qualify as “excepted” by demonstrating that it is owned and controlled by the government or “nationals” of excepted countries. Except for certain disqualifying factors described below, an investor that is itself an excepted country’s government qualifies, as does an individual investor who is a national of an excepted country and does not hold dual nationality with another country other than the United States or another excepted country.
For investors that are entities, the determination is considerably more complicated. To qualify as an excepted investor or excepted real estate investor, the investor and each of its intermediate and ultimate parents, if any, must meet each of the following tests:
- Place of organization. The entity must be organized under the laws of an excepted country or the United States.
- Principal place of business. The entity’s principal place of business must be in an excepted country or the United States.
- Board of directors. At least 75 percent of the voting members and 75 percent of any observers on the board of directors or similar governing body of the entity must be U.S. nationals or nationals of excepted countries, excluding dual nationals with countries other than the United States or another excepted country.
- 10 percent and controlling owners. Each foreign person that (i) holds a voting or economic interest of at least 10 percent of an entity, (ii) is a member of a group that together holds a voting or economic interest of at least 10 percent of an entity, or (iii) could otherwise exercise control over an entity must be:
- A national of an excepted country who does not hold dual nationality with another country other than the United States or another excepted country;
- The government of an excepted country; or
- An entity organized under the laws of an excepted country with its principal place of business in an excepted country or the United States.
- Minimum excepted ownership. The “minimum excepted ownership” of the entity (defined below) must be held, individually or in the aggregate, by one or more individuals or entities who are:
- Not foreign persons;
- Nationals of excepted countries who do not hold dual nationality with countries other than the United States or other excepted countries;
- Governments excepted countries; or
- Entities organized under the laws of excepted countries with their respective principal places of business in excepted countries or the United States.
Five key definitions apply to these tests:
- National. A “national” is an individual who is a citizen of, or otherwise owes permanent allegiance to, a country. U.S. nationals include individuals born in certain U.S. possessions, but do not include permanent residents of the United States.
- Parent. A “parent” is anyone who owns a 50 percent voting or economic interest in an entity or is the entity’s general partner, managing member, or equivalent. Parentage extends through multiple layers of an organization; for example, if Company X is a parent of Company Y, which in turn is a parent of Company Z, Company X is also treated as a parent of Company Z.
- Principal place of business. The FIRRMA regulations include an interim rule defining the “principal place of business” of an entity as the primary place where (i) an entity’s management directs, controls, or coordinates the entity’s activities, or (ii) in the case of an investment fund, the activities and investments of the fund are primarily directed, controlled, or coordinated by or on behalf of the fund’s general partner, managing member, or equivalent.
- Group. A “group” includes persons and entities that are related, have formal or informal arrangements to act in concert, or are each part of or controlled by the national or subnational governments of a single foreign state.
- Minimum excepted ownership. For an entity whose shares are primarily traded on an exchange in the United States or an excepted country, “minimum excepted ownership” is defined as a majority of the entity’s voting interests, the right to a majority of its profits, and the right in the event of dissolution to a majority of its assets. For other entities (i.e., privately held entities or public entities whose shares are primarily traded outside the United States or an excepted country), “minimum excepted ownership" is defined as at least 80 percent of these rights.
Disqualification of Excepted Investors
Even if an investor meets the qualifications above, it can still be disqualified as an “excepted investor” or “excepted real estate investor” if, during the five years prior to closing, the investor, any of its parents, or any of its parents has:
- Made a material misstatement or omission to CFIUS or submitted a false certification to CFIUS;
- Violated a material mitigation condition agreed to, imposed, or ordered by CFIUS;
- Had a transaction blocked by the President as the result of a CFIUS proceeding;
- Violated (or settled claims of violations of) U.S. sanctions administered by the Office of Foreign Assets Control of the U.S. Department of the Treasury;
- Been debarred by the Directorate of Defense Trade Controls of the U.S. State Department for violations of the International Traffic in Arms Regulations;
- Violated (or settled claims of violations of) U.S. export control laws administered by the Bureau of Industry and Security (“BIS”) of the U.S. Department of Commerce;
- Violated Atomic Energy Act provisions relating to non-U.S. production or development of special nuclear materials; or
- Was convicted of, or entered into a deferred prosecution or non-prosecution agreement with the U.S. Department of Justice, any felony in any national or subnational jurisdiction of the United States.
An investor is also disqualified if it, any of its parents, or any entity of which it is a parent, was on the BIS Unverified List or Entity List at the time the transaction agreement was signed.
For up to three years after closing, a previously excepted investor may be disqualified retroactively if it:
- Is no longer a national of an excepted country who does not hold dual nationality with another country other than the United States or another excepted country;
- Is no longer the government of an excepted country;
- No longer meets the place of ownership, principal place of business, or board of directors tests for entities; or
- Makes a material misstatement or omission to CFIUS, violates CFIUS mitigation conditions, or has a transaction blocked by the President at the conclusion of a CFIUS proceeding.
The first three post-closing disqualifications do not apply if the applicable excepted investor standard was not met because CFIUS revoked its previous determination that a relevant country was excepted.
Post-closing disqualification of a previously excepted investor reopens the transaction to CFIUS jurisdiction, possibly leading to a CFIUS-initiated review if a CFIUS member agency is sufficiently interested to submit an “agency notice.” Post-closing disqualification does not, however, trigger a mandatory filing by the parties for the acquisition of a substantial interest by a foreign government in a U.S. business involved in critical technology, critical infrastructure, or the personal data of U.S. citizens even if one would have been applicable prior to closing, as described below.
Scope of Exemptions
Qualification as an “excepted foreign state” or “excepted investor” as described above can, in certain circumstances, exempt an investor from the two categories of mandatory CFIUS filings established under the FIRRMA regulations (described in greater detail in our earlier client alert):
- Acquisition of a substantial interest by a foreign government. Investors acquiring interests of at least 25 percent in certain businesses involved in critical Technology, critical Infrastructure, or sensitive personal Data of U.S. citizens (together, “TID Businesses”) are generally required to submit pre-closing filings to CFIUS if a foreign government holds an interest of at least 49 percent in the investor. If, however, the foreign government holding the 49 percent interest is an “excepted foreign state,” a CFIUS filing is not required. Note that this exemption applies even if the investor does not meet the other qualifications of an "excepted investor.”
- Investments in certain critical technology businesses. A CFIUS filing is generally required for foreign investment—even a non-controlling investment—in a U.S. business engaged in producing or developing certain “critical technologies,” if the investment would afford the foreign investor material governance or information access rights with respect to the U.S. business or its technology. If the investor is an “excepted investor,” however, a CFIUS filing is not required.
“Excepted” status also exempts the foreign party from CFIUS jurisdiction over two other types of transactions covered by FIRRMA and its regulations:
- Non-controlling investments in TID Businesses. Under the FIRRMA regulations, CFIUS will normally have jurisdiction over a non-controlling foreign investment in a TID Business if the investment would afford the investor (i) access to material nonpublic technical information of the TID Business; (ii) membership or observer rights (including appointment rights) with respect to the board of directors or similar body of the TID Business; or (iii) other involvement, other than through voting of shares, in substantive decision making with regard to the TID Business’s use, development, acquisition, or release of critical technology, the management, operation, manufacture, or supply of critical infrastructure, or the use, development, acquisition, safekeeping, or release of sensitive personal data of U.S. citizens. CFIUS will not have jurisdiction over this investment, however, if the foreign investor is an excepted investor.
- Real estate transactions. As detailed in our previous alert, CFIUS will have jurisdiction under the FIRRMA regulations over real estate purchases, leases, and port concessions within or near sensitive government facilities and activities. “Excepted real estate investors” meeting the qualifications described above will not, however, be subject to this extension of CFIUS’s jurisdiction.
Excepted investors will be exempt from mandatory CFIUS filings and FIRRMA’s expansion of CFIUS jurisdiction as described above, but CFIUS will retain jurisdiction (including post-closing jurisdiction) over investments by excepted and other foreign investors that could result in control of a U.S. business—the same transactions that CFIUS reviewed prior to the enactment of FIRRMA. Such transactions can therefore still be the subject of voluntary CFIUS filings by the parties or, in extremely rare instances, “agency notices” submitted by a member of CFIUS.
CFIUS is expected to expand the number of countries over time, resulting in an expansion of the number of parties that will be able to avail themselves of the exceptions described above.
Separately, FIRRMA contemplates CFIUS waivers of mandatory filings by investors in which a foreign government holds a substantial interest (described above) if the investor (i) can demonstrate that its investment decisions are not directed by a foreign government and (ii) has a history of cooperation with CFIUS. The FIRRMA regulations issued in January 2020 did not provide for such waivers, but in its introductory comments, CFIUS indicated that it will consider procedures for granting such waivers in the future after it has gained more experience with mandatory filings under this new set of regulations.
FIRRMA’s expansion of CFIUS jurisdiction and new filing requirements are particularly complex; understanding these new rules and the application of the exemptions described in this note will require transaction-specific analysis. We strongly recommend that prospective parties consult with experienced counsel to better understand changes to the CFIUS regulatory regime.