The Committee on Foreign Investment in the United States (CFIUS, or the Committee) recently issued a clarification (through updated FAQs, available here) that certain “springing rights” arrangements are not permissible when a transaction would require a mandatory filing. This Sidley client alert explains the CFIUS clarification and its impact on certain “springing rights” investment arrangements.

Overview of CFIUS Mandatory Filing Procedures

CFIUS has jurisdiction to review certain kinds of “covered transactions” involving an investment by a foreign person in a U.S. business. In most cases, filings before CFIUS in connection with covered transactions are voluntary. However, certain transactions that afford a foreign investor certain governance or information rights in “TID U.S. businesses” could trigger a mandatory CFIUS filing. TID U.S. businesses include businesses involved in “critical technology,” “critical infrastructure,” or the collection or maintenance of sensitive personal data.

For example, a CFIUS filing would likely be mandatory if a foreign investor acquires the right to appoint a director or observer to the board of a U.S. company that develops, designs, tests, manufactures, produces, or fabricates “critical technology,” for instance, technology subject to certain export control restrictions.

See previous Sidley client alerts here and here for a more complete explanation of situations in which a CFIUS filing may be mandatory.

If a CFIUS filing is mandatory, the filing must be made at least 30 days prior to the “completion date,” that is, 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.” Failure to submit a CFIUS filing by the deadline could result in monetary penalties up to the value of the transaction, and other potential consequences.

CFIUS Clarification That Certain “Springing Rights” Are Not Permissible in the Context of a Mandatory CFIUS Filing

In many cases, parties have a commercial need to close a transaction as soon as possible. This situation might arise, for example, if the U.S. business is in urgent need of funding, such that waiting 30 days may place the U.S. business in difficult financial circumstances. In such situations, parties have sought ways to expedite financing without triggering an immediate mandatory filing while still giving CFIUS the opportunity to review the transaction before the foreign investor acquired the governance and information rights that would result in a covered transaction. One solution often used in these circumstances was a “springing rights” arrangement.

In a typical springing rights arrangement, the investor would immediately acquire equity interests that would not in themselves result in a covered transaction (e.g., nonvoting equity or a small, noncontrolling equity interest) but would hold its governance/information rights in abeyance until CFIUS approval, at which time the investor’s governance or information rights would “spring.”

Through a recent FAQ, CFIUS clarified that such springing rights arrangements are not permissible in a mandatory filing context. The FAQ stated:

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.

The Clarification Does Not Require Parties to Wait Until CFIUS Approval to Close

The CFIUS clarification and CFIUS regulations do not require that parties wait until CFIUS clearance before closing a transaction. As the CFIUS clarification states, in a mandatory filing situation, the parties must file with CFIUS at least 30 days before closing on any equity interest. However, they may close on the equity interest 31 days after filing with CFIUS, even if CFIUS has not yet approved the transaction. They could also choose to close on the investor’s information and governance rights at that same time or continue to hold those rights in abeyance until CFIUS clearance.

The Clarification Applies to Deals That Have Already Closed or Are Pending

The new CFIUS FAQ does not amend the CFIUS regulations but rather clarifies them. This means that the clarification applies not only to future transactions but also to transactions that have already closed or are pending. Consequently, CFIUS could find that parties to springing rights deals involving a mandatory filing that have closed or were pending prior to the issuance of the CFIUS clarification did not comply with CFIUS regulations.

The Clarification Does Not Limit Use of Springing Rights in Voluntary Filing Situations

The CFIUS clarification does not apply to situations in which a CFIUS filing is voluntary. Therefore, if the rights that the foreign investor would acquire would result in a “covered transaction” but would not trigger a mandatory filing, then springing rights are permissible. The parties may still choose to close on the initial equity interests immediately but hold the relevant governance and information rights in abeyance until CFIUS approval. In some cases, parties may choose this arrangement so as not to appear to “prejudge” the result of any CFIUS process.

Implications for Acquisitions of Contingent Equity Interests

There may be situations in which a foreign investor does not immediately acquire equity but instead acquires a contingent equity interest (such as a convertible note), with conversion contingent on CFIUS approval.

As the CFIUS clarification notes, “contingent equity interests are assessed separately under 31 C.F.R. § 800.207.”1 However, the CFIUS clarification does not address whether the acquisition of such a stand-alone equity interest is a covered transaction prior to conversion. This question would need to be resolved in accordance with other provisions in the CFIUS regulations.