2023 CFIUS Mid-Year Update

What Happened

As we pass the half-way point of 2023, it is worthwhile to note several developments relating to the Committee on Foreign Investment in the United States (CFIUS or the Committee) from the very end of 2022 through June 2023.  Several of these actions illustrate how CFIUS has increased its focus on clean energy, biotechnology, and supply chain issues following the issuance of Executive Order 14083 (EO 14083).  Others reflect an expansion of CFIUS inquiries into private equity investors and a refusal of CFIUS to attempt to assert broader authority in some cases.

The Bottom Line

CFIUS is an important consideration in transactions involving foreign investment, and there is increasing need to conduct CFIUS-related pre-transaction diligence to inform appropriate calibration of regulatory risks.  Parties contemplating a transaction involving foreign investment in a US business, particularly within critical sectors of the US economy (in particular, businesses that produce, design, or test certain critical technologies, that own or manage certain types of critical infrastructure, or that possess certain amounts of sensitive personal data (collectively, TID US businesses)), should be aware of the shifting landscape of CFIUS’s reviews and carefully consider what national security concerns, if any, CFIUS may have in light of recent actions.

The Full Story

CFIUS is an interagency committee authorized under Section 721 of the Defense Production Act to review covered transactions (transactions involving acquisition of control of US businesses by foreign persons and certain non-controlling foreign investments in US businesses) in order to determine the effect of such transactions on the national security of the United States.  Since January 13, 2020, CFIUS reviews have been guided by the factors enumerated in the Foreign Investment Risk Review Modernization Act of 2018 (FIRRMA) and the implementing regulations.

On September 15, 2022, President Biden issued EO 14083, which directed CFIUS to evaluate certain factors reflecting modern foreign investment concerns, which factors fall within the statutory framework established by Section 721 of the Defense Production Act.  Among other directives to CFIUS, EO 14083 identified certain priority technologies, including clean energy technology, microelectronics, semiconductors, quantum technologies, biotechnology, climate adaptation technologies, and artificial intelligence, and sectors, including critical minerals and agricultural/food systems, as particularly sensitive to national security, focusing CFIUS’s attention on these areas.  EO 14083 also directed CFIUS to consider in its reviews a covered transaction’s effect on supply chain resilience.  Finally, EO 14083 directed CFIUS to consider in its reviews that national security risks may arise from foreign investors from countries with a “demonstrated or declared strategic goal of acquiring a type of critical technology or critical infrastructure that would affect United States leadership in areas related to national security,” understood by many in the current investment climate to direct CFIUS’s attention to investors from “adversary” countries such as Russia or China.  Our earlier coverage of EO 14083 is available here.

Several of the events and developments in the past six months highlighted below give shape to how EO 14803 is being implemented by the Committee.  Others, though not directly related to EO 14083, reflect tweaks to practice before CFIUS that are nevertheless worthy of note.

1. Borqs Required by CFIUS to Divest from Energy Storage System Company

On December 19, 2022, Borqs Technologies Inc. (Borqs), a China-based corporation, announced that it had received a letter from CFIUS requesting that Borqs negotiate mitigation of the national security risks posed by Borq’s investment in Holu Hou Energy LLC (HHE), a US based producer of energy storage systems.  The letter from CFIUS came more than a year after Borqs acquired 51% ownership of HHE in October 2021.  According to public disclosures from Borqs, CFIUS determined that Borqs’ investment in HHE raises national security issues:  namely, the Chinese government’s potential access through Borqs to HHE’s energy storage and related technology for multi-dwelling residential units, which CFIUS considered a “critical technology” under its post-FIRRMA regulations.  To address the national security concerns cited by CFIUS, Borqs stated its intention to cooperate with CFIUS to complete a divestiture of HHE.  In March 2023, Borqs, HHE, the Department of Defense, and the Department of the Treasury entered into a national security agreement setting forth the terms of Borqs’ divestment.

2. Sino Biopharm Permitted to Proceed with Acquisition of Biotechnology following Negotiation of a National Security Agreement with CFIUS

On December 29, 2022, CFIUS issued an interim order to F-star Therapeutics, Inc. (F-star) and subsidiaries of Sino Biopharmaceutical Limited (Sino Biopharm), a China-based company, to halt the implementation of a merger agreement that would result in Sino Biopharm’s acquisition of F-star’s antibody platform.  The purpose of CFIUS’s order was to provide the Committee with an adequate opportunity to review the transaction and evaluate whether mitigating steps can be taken to close the transaction.  In early March 2023, the parties announced that an agreement had been reached with CFIUS regarding the terms of a national security agreement.  The transaction with Sino Biopharm closed on March 8, 2023. 

This transaction is significant because it indicates that – even in the highly important biotech­no­logy sector and even where the buyer is viewed as an adversarial state – it is possible to get at least some deals through the CFIUS clearance process using a national security agreement to mitigate CFIUS concerns.

3. CFIUS Reiterates Its Lack of Authority with respect to “Green Field” Projects

The Committee determined in two recent transactions that it lacks jurisdiction to review matters where the buyer was building from scratch (not buying) a business and where the real property involved did not constitute covered real estate under the post-FIRRMA rules relating to real estate-only transactions.  In the earlier of the two, on December 12, 2022, CFIUS notified Fufeng USA, a subsidiary of Fufeng Group, a China-based company (Fufeng), that it had concluded that the Committee did not have jurisdiction over Fufeng’s planned construction of a wet-corn milling and bio-fermentation facility to be located near Grand Forks, North Dakota.  Fufeng planned to purchase approximately 370 acres of vacant land to build and operate the facility.  This location was approximately 12 miles from Grand Forks Air Force Base.  Although CFIUS has jurisdiction over transactions involving real estate within a specified distance of certain sensitive military installations and other sensitive infrastructure (i.e., covered real estate) listed in the post-FIRRMA real estate rules (31 CFR Part 802 (Part 802)), Grand Forks Air Force Base was not on any of those lists.  It appears that the parties to the transaction were confident of their view that the real estate was not covered real estate and did not seek CFIUS’s concurrence under Part 802. 

However, Fufeng did seek CFIUS clearance for the acquisition of a business under the main post-FIRRMA rule set (31 CFR Part 800 (Part 800)).  Although the CFIUS filing is confidential, under the facts we suspect that Fufeng argued to CFIUS in its filing that the transaction was not an acquisition of a US business and sought clearance under Part 800 in case CFIUS disagreed.  According to news reports, CFIUS’s closing letter to Fufeng stated that “CFIUS has concluded that the Transaction is not a covered transaction and therefore CFIUS does not have jurisdiction under” Part 800.  Although the basis for CFIUS’s determination is not publicly available, it seems likely that CFIUS concluded it lacked authority under Part 800 because Fufeng’s purchase of undeveloped land was not an acquisition of a US business, but rather was a greenfield investment.  There is no CFIUS authority under the Part 800 rules for greenfield investment because the rules require as an essential element the acquisition of an existing business.

Ultimately, the Fufeng transaction foundered.  The US Air Force protested loudly against the creation of a Chinese-run enterprise so close to the Grand Forks base and the state and local governments withdrew support.  CFIUS has proposed to add the Grand Forks base and a number of others to the listing of sensitive military installations that constitute covered real estate in the Part 802 rules.

A somewhat similar transaction involving a greenfield project in Michigan appears to have received the same treatment from CFIUS but seems to be headed toward a different outcome at the state and local level.  Reports indicate that CFIUS declined to disturb an acquisition of land in Michigan by Gotion, Inc., a Chinese-owned company that produces electrical vehicle batteries. Gotion plans to build a $2.4 billion plant on the land.  Gotion representatives have indicated CFIUS found that the acquisition did not involve covered real estate and was not a covered transaction within CFIUS’s jurisdiction.  The covered real estate determination is not surprising; there are a handful of military installations between 50 and 100 miles from Mecosta County (where Gotion’s land purchase was to occur) and none of those facilities appear on CFIUS’s sensitive installations lists.  Insofar as the covered transaction determination is concerned, published reports do not explain CFIUS’s approach.  However, we suspect that – as was the case for Fufeng’s proposed investment in Grand Forks – CFIUS determined the transaction is a greenfield investment and not the purchase of an existing US business.

Like the Fufeng transaction in North Dakota, the Gotion plant project has been subject to public outcry over the Chinese ownership.  Following these transactions, bipartisan legislation was introduced in Congress earlier this month that proposes, among other things, to expand CFIUS jurisdiction to cover all land purchases by foreign investors and to bring agricultural sector investments under CFIUS’s jurisdiction.

4. Trends May Suggest an Increasing Use of National Security Agreements

Increasingly, we are seeing – and other practitioners have also reported seeing – CFIUS require national security agreements to mitigate national security concerns in voluntarily-noticed transactions where the parties did not foresee significant national security issues.  In many situations where national security agreements are required by CFIUS, the parties to such transactions recognize well before notices or declarations are filed that the transaction at issue may require mitigation commitments to be made before CFIUS will clear the transaction.  While the need for mitigation is determined on a case-by-case basis, the trend towards more national security agreements, if borne out, may signal a lower threshold at CFIUS for requiring mitigation than prevailed in the past. 

It is worth noting that the perception of a lower threshold for mitigation agreements may cause parties to choose not to make voluntary filings in some circumstances where they might otherwise have voluntarily filed with CFIUS before the national security threshold changed.  That is, for some relatively safe investors acquiring assets that were not particularly sensitive, seeking CFIUS approval was sometimes viewed as a prudent thing to do, with no particular downsides other than time and cost.  If CFIUS and its participating agencies are now imposing mitigation requirements (perhaps as a result of EO 14083) more frequently, such investors may now need to include in their cost-benefit analysis the likelihood of longer review times (and therefore increased transaction timelines) as well as the possibility of being saddled with mitigation that might not be imposed in the absence of a voluntary submission.

5. CFIUS Closes Loophole related to Mandatory Filings

In an FAQ announced in May 2023, the Committee staked out a new position with respect to “springing rights” in transactions otherwise subject to a mandatory filing under Rule 800.401.  Under the post-FIRRMA rules, foreign investor parties to certain transactions involving TID US businesses are required to submit the transaction to CFIUS for clearance at least 30 days prior to closing.  Failure to submit such a transaction to CFIUS prior to closing could result in substantial penalties.

The problem with this mandatory filing requirement is that it made it difficult in certain circumstances for companies in distress to raise capital from foreign investors and buyers.  Some of these transactions were restructured so that elements that gave rise to a mandatory filing – for example, veto rights that gave the investor “control” within the scope defined by the CFIUS rules and/or board or observer rights for non-control investments – were delayed until after CFIUS approval was obtained.  The idea was that, because the rights that gave rise to a covered control transaction or covered investment did not come into effect until CFIUS approval was obtained, it was not a violation of Rule 800.401 to close such transactions before a submission to CFIUS was made.

In its May 2023 FAQ, CFIUS stated:

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. 

(Emphasis added.)  The FAQ thus precludes the issuance of any equity security with delayed, springing rights as a means to postpone the date for filing a transaction that would otherwise be considered subject to Rule 800.401.  Note, however, that this rule appears to leave open the possibility that convertible debt instruments – “contingent equity interests” in CFIUS parlance – may still be permitted as a means to defer the filing date for a mandatory CFIUS filing.

6. CFIUS Announces Greater Scrutiny of Private Equity Capital Structures

In FIRRMA, the private equity industry won a major concession in that indirect foreign invest­ments in US businesses through private equity capital structures would not be deemed to be a covered investment if the structure met certain specified requirements.  The requirements are set forth in Rule 800.307.

In a second FAQ announced in May 2023, CFIUS announced that – notwithstanding Rule 800.307 – it has the authority to make inquiries “with respect to all foreign investors that are involved, directly or indirectly, in a transaction, including limited partners in an investment fund” and “with respect to any governance rights and other contractual rights that investors collectively or individually may have in an indirect or direct acquirer or the US business.”  This more extensive inquiry is likely to lead to longer times to obtain CFIUS clearance at least until private equity sponsors and CFIUS have agreed on the scope and details of any such additional disclosures.

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The national security, mergers and acquisitions and competition practices at Hunton Andrews Kurth LLP will continue to monitor the development of this and other CFIUS and cross-border investment matters. Please contact us if you have any questions or would like further information regarding these developments or CFIUS.