23 March 2020

CFIUS: A Deal Makers Reference List

The final CFIUS regulations were effective on February 13, 2020. Like many regulations, they contain a long list of defined terms, and many of the definitions are intricately nested. Deal-makers sometimes face a challenge quickly identifying whether the type of buyer or target, or the type of transaction in front of them presents a CFIUS question or not.

This is a list of quick answers to the question whether CFIUS applies to a transaction, sorted by the characteristics of transactions that deal -makers always identify first. Of course, this list only focuses the inquiry; whether CFIUS actually applies and if so, what to do about it, is a matter that should be referred to a specialist.

Types of targets

Tech companies

Any investment into or acquisition of a US business is potentially subject to the CFIUS voluntary filing regime. Technology companies, however, may be captured by the definition of “TID US business” and transactions with those companies may be subject to mandatory filings. The deal maker should find out early in the process if the target is involved with any “critical technology” as defined in the CFIUS regulations.

Companies near national-security sensitive locations

A target can raise national security concerns simply by being physically near a national security sensitive installation or location, even if the target itself has no sensitive operations or technology.

Companies involved with critical infrastructure

Targets involved with “critical infrastructure” as listed in the regulations will attract special scrutiny, and transactions with them may be subject to a mandatory filing.

Companies that collect personal data

Targets that collect certain types of personal data on US citizens will attract special scrutiny, and transactions with them may be subject to a mandatory filing. Find out early what type of data is collected or could be collected given the company’s product offering. Even apparently non-sensitive companies (automobile manufacturers, grocery stores and pharmacies, etc.) may collect data on customers that CFIUS would find sensitive.

Companies with government contracts

A transaction with a company that has government contracts will raise national security concerns ranging from issues of classified information to supply chain considerations, and will be more difficult to clear. This is even more true if the company is involved in classified contracts or its employees have security clearances.

Branch offices

If a foreign company is engaged in interstate commerce in the US through a branch, that branch will be included in the definition of “US business.” Any transaction with the foreign company therefore could be subject to CFIUS review. Of course any acquisition of the branch would be subject to CFIUS review as well, since the branch constitutes a “US business.

Foreign target with US operations

A transaction with a foreign target—such as the acquisition of a German company—will nevertheless be subject to CFIUS if the target has a US subsidiary, branch, or on-the-ground operations in the US.

Foreign target with US sales or customers

A foreign target with sales into the US, but no assets or personnel in the US, is presumptively not be a US business. An acquisition of or investment into the foreign entity would not be covered by CFIUS.

Foreign-owned US operations

The US branch or subsidiary of a foreign company is a US business. Any investment into or acquisition of the subsidiary will be covered, even though the target is already foreign-owned.

Public companies and other companies with large boards

A foreign investor that has the right to appoint one out of a significant number of board members, where it appears the other board members are independent and not easily influenced, could attempt to rebut the presumption of control implied by the board rights.

Companies with no business

A US start-up can still be a US business even if it has not commenced operations, depending on the extent of its pre-operational activities. Therefore a transaction with a brand-new startup may trigger CFIUS even if the target has not yet commenced operations, has no revenue, no customers, etc.

Companies that have ceased operations

Depending on how recently operations have ceased, a dormant company can still be a US business, especially if its assets are still in working order.

Companies in bankruptcy

A company in bankruptcy is still a US business if it is engaged in interstate commerce, and a transaction with it would be subject to CFIUS. Any transaction that would otherwise be covered is still covered even if it arises out of a bankruptcy transaction.

Types of buyers/investors

State-owned or government-related parties

Any transaction which could result in the acquisition of control of a US business by any foreign government or agency of a foreign government, or any person controlled by or acting on behalf of a foreign government, are not specifically disfavored, but any review of such a transaction must proceed to the second, “investigation” phase.

VC and PE funds

Investment funds that are controlled by foreign persons are treated like any other foreign person for CFIUS purposes. However, an investment fund controlled by a US general partner, and whose principal place of business is in the US, may not be a “foreign person” for purposes of CFIUS, if foreign limited partners cannot control the GP or investment decisions, and have no access to material nonpublic technical information in the possession of the fund or any portfolio companies that are US businesses.

Offshore funds

An investment fund organized offshore, but with its principal place of business (the place where investment decisions are made) in the United States, if controlled by a US general partner, and if any foreign LPs lack the ability to control the GP and investment decisions and do not have access to material nonpublic technical information in the possession of the fund or any portfolio companies that are US businesses, will not be considered a “foreign person”

Sovereign wealth and state-owned LPs

If a venture capital or private equity fund is controlled by a general partner or equivalent who is a US person, if its principal place of business is in the United States, and if foreign government-related limited partners cannot control the GP or investment decisions, the fund may qualify as a US-controlled investment fund. Such funds are specifically exempted from the mandatory declaration filing requirement for control transactions and non-control investments in US TID businesses. They may also make an argument they are not foreign persons in the context of voluntary filing situations.

Foreign-foreign deals

Even if both buyer and seller are foreign, the regulations provide that acquisition of the seller’s US business is a covered control transaction. Logically, the same would apply to the acquisition of non-control rights.

Underwriters

The acquisition of securities by a person acting as a securities underwriter, in the ordinary course of business and in the process of underwriting, is not a covered transaction.

Insurers

The acquisition pursuant to a condition in a contract of insurance relating to fidelity, surety, or casualty obligations if the contract was made by an insurer in the ordinary course of business.

Minority investments, convertible debt, warrants and options

<10% investments

Investments of less than 10% by vote, which also carry no board rights, may qualify for the safe harbor for “purely passive investments.” This is true for private transactions as well as open market transactions in public companies.

<10% investments with “non-control” rights

Board rights (board seat or observer), right to access material nonpublic technical information, or involvement in substantive decision-making regarding critical technology, make a transaction a “covered investment” regardless of the voting percentage acquired, §800.211 and discussion at ¶1.14.

Minority position on board

A right to even one board seat out of ten means the investment is not “solely for the purpose of passive investment” and renders the safe harbor unavailable. However, the investor can still rebut the presumption of control.

Minority protection rights

Certain “customary” minority rights are listed as non-problematical in the regulations, such as a separate vote on the sale of the company, or rights of first refusal and anti-dilution rights.

Anti-dilution rights

The acquisition of anti-dilution rights that do not change the rights of the foreign stockholder with regard to the other stockholders does not constitute a covered control transaction.

Incremental acquisitions (increases in stakes)

If, in a prior transaction that was cleared by CFIUS, a foreign person (or downstream affiliate) obtained control over a U.S. business, then an increase in that investor’s stake or control rights is excluded from the definition of a “covered transaction.” However, if the transaction was not previously cleared, the transaction would be covered, and if the subsequent transaction gives a person control who did not have control when the deal was earlier cleared, it might be.

Contingent equity interests

Contingent equity interests are instruments that are not currently equity, but can be converted into equity, or afford the right to acquire equity, in the future. Examples include convertible debt, warrants and options. CFIUS will take the associated rights into account if the conversion or exercise is within the control of the foreign person, or is imminent; and may defer consideration of the rights if those factors are not present. Formerly, contingent equity rights were automatically taken into account in sensitive transactions (the former “pilot program”), but that provision has been eliminated in the final regulations.

Asset deals

Asset acquisitions generally

Acquisition of any part of an entity or of assets, if such part of an entity or assets do not constitute a US business, is not a covered transaction. If the assets do constitute a US business—for example, if they are being operated by the target as a business—then the transaction would be covered.

Intellectual property

Acquisition of intellectual property alone generally will not constitute the acquisition of a US business. If the intangible intellectual property is combined with tangible property, customer lists, advertising and promotional material, branding, trademarks, domain names, internet presence or other assets, and the entire package is being “operated as a business,” the transaction might be covered.

Physical facilities

The acquisition of a physical facility (such as a warehouse), without more, is not the acquisition of a US business. However, if the deal included inventory, personnel, customer lists, etc., it might be. The acquisition of rental property, especially if occupied, would likely be the acquisition of a US business.

Acquisitions out of bankruptcy

Any transaction that would otherwise be covered is still covered even if it arises out of a bankruptcy transaction.

Intention to move all operations offshore

The acquisition of a US business is still a covered transaction even if the buyer intends to move all operations offshore after closing.

Intention to use assets offshore

The acquisition of assets being used as a business (e.g., intellectual property) is still the acquisition of a US business even if the buyer intends to use the assets outside the US.

Changes and transfers in rights

Change in rights

If a transaction involves a change in the rights, and if the change could result in control by a foreign person, the transaction will be covered.

Transfers of interests

Transfers of control from one foreign person to another are covered control transactions. This can even be the case if for intra-group transfers, see discussion of “corporate reorganizations, below.

Stock splits and pro rata stock dividends

Stock splits and pro rata stock dividends that do not involve a change in control are not covered control transactions, and if they do not afford “non-control” rights, they are not covered investments, either. Presumably the same should be true of rights offerings, unless a change in the distribution of rights is involved.

Joint ventures

Joint ventures are specifically called out as one type of covered transaction, but the examples clarify that joint ventures will only be covered transactions if “one or more of the parties contributes a US business and a foreign person could control that US business by means of the joint venture.”

Sales, licensing and other commercial transactions

Companies with sales to or purchase from the US.  A foreign company with sales into the US, or that licenses technology to US customers and provides remote technical support to those customers, is not a US business unless it has assets or personnel in the US. Thus the acquisition of such a company would not be a covered transaction.

Purchases, sales and other commercial transactions. Sales into the US, and purchases from the US, are not “covered transactions” unless the terms of the arrangement give a foreign person control over the US counterparty (“control” means the “power, direct or indirect, whether or not exercised, through … contractual arrangements, formal or informal.

OEM and ODM arrangements.  Unless the terms of the arrangement give a foreign person control over a US business, these do not constitute covered control transactions.

Licensing transactions. Unless the terms of the arrangement give a foreign person control over a US business, these do not constitute covered control transactions.

Lending transactions (debt):  commercial lending transactions that do not involve equity-like rights are not covered transactions.

Venture capital and private equity.

Deals that have already closed.  Any covered transaction that has not been cleared by CFIUS remains subject to the Committee’s jurisdiction to initiate a review or to request the parties to make a filing, and if national security concerns cannot be resolved, the foreign party can be required to divest.

Corporate reorganizations

Inversions

An inversion of a US company with foreign equity holders is a transaction with a foreign person (the offshore target of the inversion) that will result in control of a US business by foreign persons—the same foreign persons. Therefore the transaction is presumptively covered. There is no explicit guidance on this issue, but corporate reorganizations are somewhat analogous.

Corporate reorganizations

Treasury Department guidance indicates some corporate reorganizations may raise national security concerns, especially where a new foreign person that raises national security concerns gains control of a US business. These types of transactions must be examined on a case-by-case basis.

Greenfield investments

These are not covered transactions (because they involve the creation of a US business, but not the acquisition of a US business). However, they may implicate the rules relating to real estate transactions.

Mechanisms to avoid or delay appearance of “control”

Agreement not to exert control

An investment that is purely passive, without any of the “non-control” board, access and involvement rights specified in the regulations, is not a covered transaction. However, if the investor has the right to exercise control, an agreement not to do so does not change the result: it is still a covered control transaction.

Agreement to delay exercise of control.  If a foreign investor has rights that would add up to control (board rights, more than 10% by vote, etc.) but agrees not to exercise those rights for a period of time—even as much as 10 years—the transaction will still be covered.

Structures designed to avoid or circumvent

Generally

The basic definition of “covered transaction” includes a transaction designed to evade or circumvent the requirements of CFIUS. Deal-makers must be cautious of structures that are not driven by independent business or economic considerations, but rather appear to be constructed to avoid CFIUS.

“Fronting” 

A transaction in which a foreign person provides funds to a US person to purchase or make an investment in a US business, pursuant to informal arrangements between them, would be a “transaction designed to evade or circumvent.”

Key contacts

A Guide to Doing Business in China

We explore the key issues being considered by clients looking to unlock investment opportunities in the People’s Republic of China.

Doing Business in China
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