Section 721 of the Defence Production Act of 1950, as amended (commonly referred to as 'Exon-Florio'), gives the president broad authority to review mergers, acquisitions and takeovers that "could result in foreign control of any person engaged in interstate commerce in the United States" and to suspend or prohibit transactions deemed a threat to national security that cannot otherwise be addressed under law. The statute is administered and reviews are conducted by the Committee on Foreign Investment in the United States (CFIUS).
Since notification under Exon-Florio is voluntary and 'national security' is deliberately not clearly defined, transaction parties in questionable cases are often presented with a potentially difficult decision as to whether to submit a notification. However, avoiding CFIUS review can carry significant risks. While a transaction which clears CFIUS may not be reinvestigated unless the initial review was based on false or misleading information or material omissions, acquisitions for which CFIUS receives no notice remain forever open to executive branch scrutiny and potential forced divestment. Accordingly, it may be prudent to vet even arguably exempt transactions with CFIUS.
Merger, stock purchase and other forms of acquisition transactions involving Exon-Florio review will typically contain provisions relating to:
the need to obtain CFIUS approval;
the process for doing so; and
the ramifications if CFIUS clearance is not received within a specified period.
These provisions can have a significant impact on deal certainty and should be carefully drafted and negotiated.
The CFIUS review process is generally initiated by the filing of a joint notification of a proposed transaction by the buyer and the target (or the seller). If the parties agree to file a CFIUS notice, the acquisition agreement will usually contain an express requirement to prepare, pre-file(1) and then file a joint notice with CFIUS as promptly as practicable following the date of the agreement. It may be desirable to include an outside date by which the parties agree to make the formal filing, especially in cases where CFIUS clearance is likely to be a significant factor in determining the timing of consummation of the transaction.
In most cases the acquisition agreement will make satisfactory CFIUS review an express closing condition, because a general government approval condition addressing legally required approvals will not cover CFIUS approval, since notification is voluntary. However, in reliance on the voluntary nature of the Exon-Florio notification, in some cases the parties may decide not to include such a condition, allowing the transaction to close without CFIUS clearance, with the buyer assuming the risks noted above.
Outside termination date
The selection of the outside date after which either party may freely terminate the agreement if the conditions to closing have not been met may also be affected by the CFIUS process. The initial CFIUS review period is 30 days from formal filing, after which CFIUS can initiate a 45-day investigation. A full 45-day investigation is mandatory for foreign government-controlled transactions in the absence of a waiver at secretary or deputy secretary level by the Treasury Department and the lead agency conducting the review. Depending on the outcome of the investigation, there could also be a 15-day presidential review period. The selection of the outside termination date should take into account these potential timing considerations in the context of the expected level of CFIUS scrutiny for the particular transaction.
Cooperation and covenants
Virtually without exception, the acquisition agreement will include a mutual covenant that the parties will agree to use some level of effort (eg, 'commercially reasonable efforts', 'reasonable best efforts' or 'best efforts') to obtain CFIUS approval. While there is uncertainty as to the exact distinction among the various effort formulations customarily utilized, and the interpretation of the standard may vary depending on the contract law chosen to govern the agreement, it is generally understood that 'best efforts' is an elevated standard that could result in enhanced and potentially unexpected obligations. As discussed below, this is especially true for transactions involving companies holding US facility security clearances (known as 'cleared companies').
While the parties are required to respond to CFIUS requests for additional information within three business days, the agreement may also expand on the general cooperation covenant to require specifically that the parties promptly comply with such requests. In addition, the cooperation covenant may specifically require that the parties provide each other with copies of all filings and correspondence provided to the agencies and an opportunity to review and comment, as well as with the ability to participate in all meetings with the agencies.
An additional consideration is whether the parties should expressly address the possibility that CFIUS will request them to 'pull and refile' the CFIUS notification, an action sometimes taken (and generally without prejudice) when CFIUS requires more time to evaluate a transaction.
While both parties will likely have an interest in avoiding presidential review (the alternative to 'pull and refile' when the deadline runs out), they may want to address this possibility expressly.
If the acquisition target holds security clearances, the CFIUS process will occur concurrently with review by the Defence Security Service of the Department of Defence, or its counterpart at the Department of Energy, to determine the conditions under which the company's security clearances can be retained following the change in ownership. US law prohibits foreign-controlled companies from holding security clearances unless the buyer accepts procedures designed to mitigate its foreign ownership, control or influence in accordance with the relevant national industrial security regulations, including the National Industrial Security Programme Operating Manual. Under these circumstances, as a practical matter CFIUS approval is unlikely to be received until the terms of the mitigation have been agreed in principle.
With these considerations in mind, and as an outgrowth of similar concerns arising under antitrust reviews, potential buyers often insist that the efforts obligations expressly not include any obligation to divest or hold separate any of the buyer's or the target company's assets, or otherwise limit their ability to engage in any of their existing business activities. With the potential need for foreign ownership, control or influence mitigation, which could take the form of a restrictive proxy agreement, these provisions should be considered carefully by each of the parties to ensure that their expectations regarding foreign ownership, control or influence mitigation are both realistic and clearly reflected. In some cases parties have provided that the buyer must accept a special security agreement if requested for foreign ownership, control or influence mitigation. The special security agreement constrains the foreign buyer's management of the cleared company, but allows the foreign shareholder representation on the board. In other cases more ambiguous obligations, including terms such as 'reasonable' or 'not having a material adverse effect' are used to qualify mitigation obligations. The question may arise as to how these terms will be construed in context - for example, it could be argued that a restrictive proxy agreement does not have an adverse effect on the underlying business. The answer is unclear and suggests a need for a thoughtful negotiation strategy and careful drafting.
Where security clearances affect a significant part of the target business, the agreement will typically include a closing condition requiring Defence Security Service approval in principle for the buyer to operate the business following the closing. If highly classified information is involved, the agreement may also require assurances, acceptable to the buyer, that favourable national interest determinations will be granted authorizing access to proscribed information after closing. In such case a definition of 'acceptable assurances' or further qualifying language should be discussed. These conditions should also be considered in selecting an outside termination date.
When acquisitions involve potential national security concerns and/or security clearance issues, the parties should address them in drafting and negotiating:
the conditions to closing;
the covenants relating to necessary (or desirable) approvals; and
the termination date provisions.
Concerns may be heightened in cases where the target maintains security clearances. The way to address these items in a particular agreement will likely depend on a variety of factors, including:
the identity and background of the parties (ie, nationality, level of government ownership, prior transactions by the parties involving such issues, existence of special security arrangements or other foreign ownership, control or influence mitigation by the buyer);
the amount of proscribed information involved (if any); and
the businesses of the buyer and the target.
The ability to craft appropriate provisions in a particular case, and to navigate the regulatory processes successfully and efficiently and determine the likelihood of a successful continuation of a target business following its acquisition, is often a function of understanding agency practice and policy, as well as familiarity with statutory requirements. These factors must be taken into account in negotiating acquisition agreements and evaluating acquisitions.
For further information on this topic please contact Christopher G Griner, Farhad Jalinous, Nancy E Fuchs or Thomas Yadlon at Kaye Scholer LLP by telephone (+1 202 682 3500), fax (+1 202 682 3580) or email (email@example.com, firstname.lastname@example.org, email@example.com or firstname.lastname@example.org).
(1) Pre-filing is recommended at least five business days prior to the formal filing in order to give CFIUS advance informal notice and an opportunity to raise questions. These questions can inform the formal filing and help avoid problems.