Key Takeaways

• On May 21, 2020, the U.S. Treasury Department, as chair of the Committee on Foreign Investment in the United States (“CFIUS” or the “Committee”), published a proposed rule that would modify the mandatory declaration provision for covered transactions involving critical technology and clarifies the “substantial interest” test used for determining mandatory declaration requirements for certain investments by non-U.S. governments (the “Proposed Rule”).
• The Proposed Rule is significant in two respects:
  • It removes the North American Industry Classification System (“NAICS”) code criteria for determining whether a transaction involving critical technology requires a mandatory declaration and replaces it with an analysis focused on export control licensing requirements, which should narrow the scope of covered transactions subject to the mandatory declaration requirement; and
  • It clarifies the breadth of the mandatory declaration requirement for certain covered transactions involving non-U.S. government investors.
• There is not yet an effective date for the Proposed Rule. Interested parties have until June 22, 2020 to submit comments.

Background

President Trump signed into law the Foreign Investment Risk Review Modernization Act of 2018 (“FIRRMA”) on August 13, 2018, which made several substantial changes to the CFIUS process and expanded the scope of the Committee’s jurisdiction. FIRRMA’s implementation has since been rolled out in phases. In November 2018, CFIUS established a pilot program to expand jurisdiction to certain non-controlling investments and mandate notifications to CFIUS in certain circumstances (our coverage of which is available here). In September 2019, CFIUS issued proposed rules pertaining to critical technology, critical infrastructure, and sensitive personal data (“TID”) U.S. businesses and certain real estate transactions (our coverage of which is available here and here, respectively). In January 2020, CFIUS released the accompanying final regulations (“TID Final Regulations”) and (“Real Estate Final Regulations”). Our coverage of final regulations is available here and here. In March 2020, CFIUS issued a proposed rule to establish filing fees for CFIUS review of notices of transactions (“Proposed Filing Fee Rule”) and, in April 2020, published an interim rule to begin collecting filing fees for transaction notices filed after May 1, 2020 (“Interim Filing Fee Rule”). Our coverage of the Proposed Filing Fee Rule and Interim Filing Fee Rule is available here and here.

One of the key changes under FIRRMA authorized CFIUS to mandate short form notifications for certain covered transactions involving critical technologies¹ (previously, CFIUS did not require mandatory filings for any transactions). These mandatory declarations typically are no longer than five pages and must be filed at least 45 days prior to the expected completion date of the transaction. Required information includes, but is not limited to, the size, timing, and governance rights implicated by the transaction, statements about the non-U.S. acquirer and the U.S. target, and information related to the critical technologies involved.

Following the filing of a mandatory declaration, CFIUS may request that parties file a formal full notice, inform the parties that it cannot complete its action and invite them to file a notice seeking written notification of the completion of the review process, initiate a unilateral review of the transaction, or notify parties that it completed its review of the transaction.

Mandatory Declarations for Transactions Involving Critical Technology

Currently, the TID Regulations implement a mandatory declaration process for covered transactions that involve critical technologies and industries covered by 27 NAICS codes. The NAICS codes covered a wide range of industries, including manufacture of missiles, tanks and space vehicles as well as industries whose products and technologies might have broader application, such as semiconductors, batteries, aviation and petrochemicals. As described in more detail in the subsequent section, CFIUS also has implemented a mandatory declaration process for certain covered transactions involving non-U.S. government investors. This resulted in an avalanche of mandatory declarations filed with CFIUS.

The Proposed Rule will narrow the scope of covered transactions requiring a mandatory declaration by eliminating the NAICS code criteria and instead basing the requirement on whether a U.S. government export authorization would be required to transfer the target company’s critical technology to any foreign investor party. It would require a mandatory declaration if the critical technology the TID U.S. business produces, designs, tests, manufactures, fabricates, or develops requires a “U.S. regulatory authorization” to export, re-export, transfer (in-country), or retransfer it to the foreign person involved in the proposed transaction. The Proposed Rule also clarifies which persons in the proposed ownership chain should be analyzed for export licensing requirements, to include any foreign person who individually holds, or is a part of a group of foreign persons that, in the aggregate, holds, a “voting interest for purposes of critical technology mandatory declarations.”

“U.S. regulatory authorization” includes licenses or other approvals/authorizations from the Department of State under the International Traffic in Arms Regulations (“ITAR”), the Department of Commerce under the Export Administration Regulations (“EAR”); the Department of Energy under the regulations governing assistance to foreign atomic energy activities at 10 CFR part 810 other than the general authorizations described in 10 CFR § 810.6(a); or a specific license from the Nuclear Regulatory Commission under the regulations governing the export or import of nuclear equipment and material at 10 CFR part 110.5.

Significantly, the Proposed Rule takes into consideration the availability only of certain license exceptions or general licenses (both of which are export authorizations published in regulations and made applicable to any transaction meeting the published criteria) and not others. Whether a “U.S. regulatory authorization” would be required will be assessed:

• Regardless of any license exception available under the ITAR;
• Regardless of any license exception available under the EAR except for the following EAR license exceptions:
  • Part of license exception ENC for encryption items (15 CFR § 740.17(b));
  • License exception TSU for less sensitive technology (15 CFR § 740.13); and
  • Part of license exception STA for exports to close allies (15 CFR § 740.20(c)(1));
• Based on such foreign person’s principal place of business (for entities) or such foreign person’s nationality or nationalities (for individuals) under the relevant U.S. regulations; and
• As if such foreign person is an “end user” under the applicable U.S. regulatory authorization.

The term “voting interest for purpose of critical technology mandatory declarations” has been proposed in order to specify which person in the ownership chain of the foreign acquirer should be analyzed for export licenses and authorization purposes. In general, a foreign person will be considered to have a sufficient “voting interest for purposes of critical technology mandatory declarations” if it holds 25% or more of the voting interest in U.S. business.

For investment funds, a foreign person will be considered to have such a voting interest if it holds 25% or more of the interest in the general partner, managing member, of equivalent of the entity. Additional considerations apply to voting interests held indirectly by parent companies, foreign persons who have formal or informal arrangements to act in concert, or foreign persons that are agents or instrumentalities of foreign governments.

Amendments to Definition of “Substantial Interest”

Under the TID Final Regulations, mandatory filing requirements also apply to transactions in which a “substantial interest” in a TID U.S. business is acquired by a non-U.S. person in which a non-U.S. government holds a “substantial interest.”

The meaning of “substantial interest” differs based on the context. A non-U.S. person is considered to be acquiring a “substantial interest” in a U.S. business if the non-U.S. investor obtains an indirect or direct voting interest of 25% or more in the U.S. business. A non-U.S. government is considered to hold a “substantial interest” in the non-U.S. investor if the government holds a 49% or greater direct/indirect voting interest in the non-U.S. person. In the case of an investment fund, or an entity with a general partner, managing member, or equivalent, the non-U.S. government will be considered to hold a “substantial interest” if it holds 49% or more of the interest in the general partner, managing member, or equivalent of the entity.

The Proposed Rule adds language to clarify that even in the case of an investment fund, for purposes of determining the percentage of interest held indirectly by one entity in another entity, any interest of a parent will be deemed to be a 100% interest in any entity of which it is a parent. For example, if a foreign government holds 75% of the voting interest in a parent of a foreign acquirer, the parent of the foreign acquirer is deemed to have 100% of the voting interest in the foreign acquirer as its parent entity and the foreign government’s indirect voting interest is imputed to the foreign acquirer.

Conclusion

The Proposed Rule codifies a much anticipated change to the definition of critical technologies. Like many of the other regulations that implement the provisions of FIRRMA, the Proposed Rule will add a new level of complexity to the CFIUS review process and highlights the importance of proper export classifications for the products and technologies of a target TID U.S. business. Comments must be submitted by June 22, 2020. After that, investors should stay tuned for the final regulation and changes that might be made in response to submissions received during the public comment period.