A large number of attempted foreign acquisitions of US businesses ran into CFIUS trouble in 2012. That is the most striking fact revealed in the annual report by the Committee on Foreign Investment in the United States (CFIUS), which in late December 2013 issued a report on its activities during the 2012 calendar year. The Committee conducts national security reviews of inbound foreign investments, and 2012 was a very active year. (Steptoe attorneys have been involved in hundreds of CFIUS cases over the years, including some of the most prominent in the last several years.)
The report indicates that 10 of the 114 deals that CFIUS reviewed in 2012 failed to garner approval. Others required extensive negotiations with CFIUS before the Committee cleared the deals. While the report also indicates that Chinese investors filed far more cases than ever before, the rejected cases and other problem cases involved investors from several countries. CFIUS' annual reports do not identify the nationality of the foreign investors whose deals ran aground, but historically the countries besides China that have encountered CFIUS problems have included France, Israel, Russia, and India, among others.
Several CFIUS problems involved "non-notified" or "non-filed" deals – instances in which the parties notified CFIUS only after their transactions closed. As we have written previously, the Committee has pursued these non-notified transactions with increasing frequency and aggressiveness, compelling filings from the parties and then dealing with them harshly. Thus occasional CFIUS rejections – mostly of non-notified transactions for which CFIUS then compels filings – are to be expected. Even so, it is surprising for 10 cases to be unable to clear CFIUS in 2012. That number is at least twice the high-water mark from any previous year.
Parties involved in inbound foreign investments need to consider filing with CFIUS. They should do so if: (i) the transaction results in foreign "control" of a US business, with "control" defined broadly; and (ii) the transaction touches on national security, with security also defined broadly. Parties should err, if at all, on the side of filing. If they do not, there is a good chance they will end up as an unfortunate statistic in CFIUS' future annual reports.
What follows is a summary of key points from the most recent report.
A Continuing "Investigation" Trend, and a Large Increase in Problem Cases
In 2012, CFIUS reviewed 114 "covered transactions" – deals that would result in foreign "control" of a US business. The Committee clears many cases after 30 days, but of the 114 filed in 2012, CFIUS proceeded to "investigate" 45 of them – or about 40%. An investigation takes up to another 45 days. The fact that CFIUS investigated nearly 40% of cases in 2012, just a tick up from previous years, is a reminder that companies need to plan for a long CFIUS process.
Not all of these 45 investigated cases ran into significant problems, but a good number of them did. The report states that CFIUS required "mitigation measures" for eight cases. Mitigation measures are conditions on a deal that generally are negotiated between CFIUS and the foreign investor and that are memorialized in a written agreement. The Committee requires them when it has national security concerns that prevent it from clearing the deal without mitigation of those concerns. A broad array of mitigation measures can be used, such as limitations on who can access technology, requirements to provide the US government with access to books and records, and obligations to make reports to the US government. The eight mitigation agreements that CFIUS required in 2012 is a number roughly consistent with previous years.
What is not consistent with previous years, however, is the number of deals withdrawn from CFIUS review in 2012, and particularly the subset of those deals that were not refiled. A bit of explanation is warranted regarding the CFIUS withdrawal process. If CFIUS does not clear a case after the first 30 days, it must act by the end of 75 days (30 days for the initial review plus 45 days for the investigation). At the end of 75 days, CFIUS can clear the case without mitigation measures, clear the case with mitigation measures, or refer the case to the President. If CFIUS concludes that the national security risks cannot be mitigated then the Committee will refer the case to the President and recommend that the President block the deal. In such a case, the parties almost always withdraw the case from CFIUS review and walk away from the deal (or they agree to divest if the deal has closed), rather than inviting the President to issue a blocking or divestment order. That is one situation – walking away from the deal rather than facing adverse action by the President – that results in withdrawal.
In some cases, however, CFIUS and the parties may believe that the security risks can be mitigated, but they might run out of time to conclude mitigation negotiations before the 75 days have expired. In these circumstances, the parties may withdraw the case and refile it. This withdrawal/refiling starts the CFIUS clock anew, at the beginning of the 30 day review (which may be followed by another 45 day investigation).
Of the 114 filed cases in 2012, CFIUS has reported that 22 were withdrawn – suggesting that these 22 deals encountered significant problems. The report indicates that 12 of the 22 were refiled and eventually cleared by CFIUS. But 10 of them were never cleared. In contrast, 2011 saw only 6 withdrawals, and of those withdrawn cases 4 were refiled and eventually cleared. So in 2011, companies failed to obtain clearance in only 2 cases. It is particularly striking that in 2012, 10 of the 22 withdrawals failed to get clearance.
A Formal Presidential Blocking of a Deal in Proximity to a Sensitive Area
There is another development discussed in the new CFIUS report that is also significant, but has been widely reported for over a year. In 2012, the President formally blocked a CFIUS-reviewed transaction for the first time since 1990. In that case, the Chinese-controlled Ralls company acquired a wind farm that sat in close proximity to a US defense facility without notifying CFIUS. CFIUS compelled a filing from Ralls and recommended that the President order divestment. As discussed above, parties generally walk away from deals when there is a likely prospect of adverse presidential action, particularly because presidential action is public, whereas CFIUS actions are confidential. But Ralls did not walk away, and the President ultimately ordered divestment. This is one of several cases in which CFIUS has refused to clear Chinese acquisitions of assets located near defense facilities. That trend continued into 2013, and we commented on one of the most recent "proximity" cases here.
Increasing CFIUS Review of Purchases by Chinese Companies
As noted above, the problem cases in 2012 involved foreign investors from an array of countries. But CFIUS reviews of Chinese investments warrant special mention. In 2012, CFIUS reviewed 23 notices from Chinese companies, more than doubling 2011's total (10 notices), and nearly quadrupling 2010's (6 notices). This made 2012 the first year in which CFIUS received more notices from Chinese companies than from any other country in the world.
On some level this increase was expected. As Chinese investment in the United States increases, there are more transactions that fall within CFIUS' jurisdiction. The increase might also suggest that Chinese companies are becoming more familiar with the CFIUS process and confident that they will be treated fairly.
However, Chinese companies also should be aware that the US government often perceives significant national security risks in these deals, particularly when the deals relate to information and telecommunications technologies. Ultimately, CFIUS generally approves most Chinese investments (just as CFIUS approves most investments from companies of other nationalities), at least when the deals are filed with CFIUS before closing. But the level of scrutiny in these Chinese cases is often high, and mitigation measures are common. Accordingly, planning for the CFIUS review process is a particularly critical component for many China-US deals.
CFIUS Reverses Position on Whether Foreign Companies and Governments are Seeking to Acquire Critical US Technology Companies
A final fact worth noting from CFIUS' recent report is an interesting tidbit from the US Intelligence Community (USIC), which participates in CFIUS. The USIC concluded it is unlikely there exists a coordinated effort by foreign countries or governments to acquire US companies producing critical technologies. This is interesting because it is a reversal of the position from the previous year, in which the USIC concluded that it was likely such a coordinated strategy exists.
It is impossible to account for this change with confidence. The information on which the USIC bases its conclusions is classified, and the CFIUS report does not otherwise explore the reasons why it no longer believes such a coordinated effort is underway. Nevertheless, given that many viewed the USIC's previous conclusion as directed at China and Chinese companies, we can speculate that the reversal in the current report may indicate CFIUS is becoming more familiar with Chinese investment and less suspicious than in previous years, even as CFIUS continues to play a robust role in policing transactions between Chinese and US companies.
CFIUS' report on calendar year 2012 documents a continued aggressiveness in reviewing transactions between foreign and US companies that implicate national security concerns. The report provides ample evidence that failure to plan for CFIUS review can be highly disruptive and, in some cases, fatal to a deal.
We will continue to monitor developments relating to CFIUS reviews.
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