Treasury Department Issues Final Regulations on CFIUS and Further
Defines “Covered Transaction” and Other Terms

Recently, the U.S. Treasury Department issued final regulations governing the Committee on Foreign Investment in the United States, or CFIUS. These regulations, which became effective on December 22, 2008, clarify the Foreign Investment and National Security Act of 2007¹ (FINSA) and the review process employed by CFIUS. Additionally, the Treasury Department offered clarification on the following terms:

I. Covered Transaction

The regulations state that any transaction proposed or pending after August 23, 1988, by or with any foreign person, which could result in foreign control of a U.S. business constitutes a “covered transaction”. A U.S. business is further defined to include any entity, irrespective of the nationality of the persons who control it, engaged in interstate commerce in the United States, but only to the extent of its activities in interstate commerce. For example, where a corporation, organized under the laws of a foreign nation and wholly owned and controlled by a foreign national, engages in interstate commerce in the United States through a branch or subsidiary, the branch or subsidiary qualify as a U.S. business, but the corporation does not. Therefore, where another foreign entity wishes to acquire a part of the subsidiary or branch, this qualifies as a covered transaction. All three entities, however, qualify as a foreign person, should any attempt to acquire a part of another U.S. business.

Furthermore, the Treasury Department states that the following are not covered transactions:

• a start-up investment;
• an acquisition of assets which do not constitute a “U.S. business”; and
• a long-term lease or lending transaction in which the acquisition does not vest actual control in the foreign entity, does not allow the foreign entity to make “substantially all business decisions”, or does not acquire financial or governance rights.

In addition, where CFIUS has cleared an earlier covered transaction, and the same entity acquires additional interest in the U.S. business, this incremental acquisition is not considered a new covered transaction, and therefore will not warrant review by CFIUS.

II. Foreign Control
The regulations reiterate that rather than employ a bright-line test, whether or not the covered transaction indicates foreign control will be determined on a case-by-case basis. Generally, “control” is defined as the ability to “determine, direct, or decide important matters affecting an entity”. More specifically, the final regulations state that CFIUS will evaluate the question of control by assessing a variety of areas, including:

• the level of ownership interest,
• the rights that flow from such ownership,
• the restrictions on the exercise of such rights, and
• other relevant facts and circumstances particular to the covered transaction under review.

No transaction is classified as forbidden merely due to the size of the acquisition. Ultimately, the regulations focus on whether or not the foreign person or entity will gain decision-making powers.

Additionally, the regulations eliminate the previous automatic-safe-harbor for transactions involving a ten-percent-or-less acquisition of a U.S. business. This safe harbor rule is only applicable where the ten-percent or less investor takes a passive interest, intends to remain passively involved, and takes no later action to the contrary. The final regulations state that, for example, where a foreign business acquires only seven percent of a U.S. company’s voting shares, but also acquires the right to veto the dismissal of senior executives, the foreign company does indeed exert control over the U.S. corporation, even though only seven percent of the voting shares are now in the hands of the foreign company. In addition, CFIUS may consider situations where apparently benign minority-interest holders are closely related, controlled by the same foreign entity, or have otherwise agreed to formal or informal arrangements to act in concert and therefore have the potential to exert forbidden control over the U.S. entity.

III. Critical Infrastructure and Critical Technology
While CFIUS is charged with reviewing acquisitions involving foreign control over a covered transaction, the regulations reiterate that transactions concerning “critical infrastructure” or “critical technologies” require more intense scrutiny since such critical areas have the potential to affect national security. In most cases, this means an additional 45-day investigation will necessarily follow the initial 30-day review.

The regulations provide only one example of what constitutes critical infrastructure: major energy assets. CFIUS will likely conduct a review of a proposed acquisition involving a foreign entity acquiring a major U.S. energy asset(s) or wanting to purchase a U.S. company holding such assets. As previously clarified, the foreign acquirer should be careful that a covered transaction, especially one involving major energy assets, does not evidence a transfer of control into the hands of a foreign entity or individual. If such control is indeed present, CFIUS will be more likely to disapprove the transaction. However, even if no control is found, CFIUS may still call for the disapproval of the transaction if it concludes that it poses a threat to national security. Determining what exactly is a threat to national security is not clear, but CFIUS has broad discretion in this area, and a transaction involving major energy assets clearly appears as one that has a higher likelihood of not being approved.

The regulations hesitate to otherwise conclusively include or exclude other areas from critical infrastructure, and merely restate the statutory definition. Critical infrastructure involves “systems and assets, whether physical or virtual, so vital to the United States that the[ir] incapacity or destruction . . . would have a debilitating impact on national security”. With such a broad definition, it is not surprising that the review process must be done on a case-by-case basis, and much like determining whether or not the foreign entity’s acquisition will manifest control over the U.S. business, no bright-line test is available.

Like critical infrastructure, the final regulations allow CFIUS a wide range of flexibility to determine whether the transaction involves assets which have the potential to affect critical national technologies. The final regulations define “critical technologies” as those which are monitored or regulated by certain current laws and regulations, including the International Traffic in Arms Regulations and the Export Administration Regulations, as well as nuclear-related equipment and select agents and toxins. Like critical infrastructure, a transaction that involves critical technology has a high likelihood of coming under close scrutiny by CFIUS. Parties involved should be aware that the review process will be longer and more intense than a regular foreign acquisition of a United States business.

Awareness and Early Participation Are Key
A foreign entity or individual involved in the acquisition of a U.S. company or assets should consider making a voluntary and pre-transaction notification indicating their intent. Doing so allows the parties to participate in the federal government review process from the beginning, instead of risking early government review without valuable input from the very parties involved. The final regulations clarify that there is no bright-line test with which to quickly determine whether or not a covered transaction results in foreign control. Without a clear-cut test, multiple factors must be divulged to CFIUS; this information can then be investigated by the federal government and per the strict timeline reinforced by the final regulations, the ultimate decision will rest in the President’s hands. Where a foreign entity provides early participation and a willingness to fully cooperate with the process, there is a higher likelihood that the transaction, in some form agreeable to both sides, can be approved.

Those contemplating transactions which involve the U.S. energy industry should be aware, though, that the review process for such protected critical infrastructure will likely be more stringent. Transactions connected to the energy industry area were singled out as a clear example of protected critical infrastructure, and they will more than likely receive a more stringent vetting, and they have a higher likelihood of falling under the additional 45-day review due to implications of national security. Clearly, the U.S. energy industry is on the radar of CFIUS, and careful preparation and anticipation of CFIUS procedures and sticking points is of great importance. Any serious considerations of a foreign acquisition of a company involved in U.S. energy assets should realize from the beginning that careful compliance with FINSA and acquiring a depth of knowledge on the overall review process is essential to ensuring the transaction has the best of chance of overall success.

About CFIUS
For several decades CFIUS has been charged with the duty to determine whether or not a covered transaction has the potential for foreign persons or entities to control either U.S. companies or matters of importance to the United States. Should CFIUS, or the President of the United States through his ultimate review of the transaction, determine that control will be vested in a foreign person or entity, the President, normally acting on CFIUS’ recommendations, has the express ability to withhold approval and ultimately disallow the covered transaction.

Foreign entities may choose to voluntarily submit notification to CFIUS of their intent to acquire a U.S. company, shares thereof, or a number of other transactions involving a U.S. company which qualify as a covered transaction, explained more fully above. Only those acquisitions which qualify as a covered transaction are subject to review by CFIUS and may potentially be forbidden or divested. While the process is voluntary, CFIUS may nonetheless initiate an investigation on its own accord. Thus it is the foreign entity or person’s best interest to voluntarily submit notification to be part of the review process from the moment it begins. After the process has been initiated, CFIUS has 30 days to determine whether or not the covered transaction clearly evidences control of the U.S. company, poses a threat to national security, or otherwise merits further investigation.

The final regulations clarify what does or does not qualify as a covered transaction, and further define control and how the committee determines whether or not the transaction will so evidence control. If after the 30 days CFIUS determines the covered transaction does not evidence control or pose a threat to national security, the process is complete and the transaction is free to commence. If further examination is merited, CFIUS is granted an additional 45 days to complete an investigation so as to determine if it will permit the transaction, enter into a mitigation agreement with the parties involved, or recommend to the President that the transaction be halted or divested.

Prepared by Andrew A. Pidgirsky and Kristine Dittmeier

¹The Foreign Investment and National Security Act was signed into law on July 26, 2007.  Adams and Reese prepared a summary of the Act.  To view the summary, please click here.