Definition of Foreign Person and Application to Investment Entities
Both definitions of covered transactions turn on the involvement of a “foreign person,” which includes any foreign national, foreign government, or foreign entity. For private equity transactions, key questions include whether the fund is a “foreign entity,” and what how to assess the role of limited partners in the fund. This analysis requires consideration of the domicile of the fund, the location of its general partner(s) or investment manager(s), and the nationalities, investment stakes, and governance and information access rights of the fund’s investors.
Under the Final Regulations, a “foreign entity” generally includes any entity organized outside of the United States that either has its “principal place of business” outside of the United States or has equity securities traded on non-U.S. exchanges. The Final Regulations clarify that an entity’s “principal place of business” is defined as the primary location where management directs, controls or coordinates an entity’s activities, or, in the case of an investment fund, where the fund’s activities and investments are primarily directed, controlled or coordinated by or on behalf of the general partner, managing member or equivalent. These clarifications are helpful in assessing when an investment by a fund might be subject to CFIUS review for both “covered control transactions” and “covered investments”.
A. Covered Control Transaction
For a “covered control transaction,” an investment fund would not be considered a “foreign person” – and its transactions would not be subject to CFIUS review – if the general partner or fund manager is in the U.S., has all discretionary authority regarding the fund’s investment decisions, and exercises all voting rights associated with shares acquired by the fund. This is the case even if the fund is domiciled outside the United States and has foreign persons as limited partners (assuming that the foreign LPs do not hold rights that result in the ability to “control” the fund from a CFIUS perspective). In addition, the analysis does not turn on whether the general partner or fund manager is a U.S. person – due to the “principal place of business” test, the most important factor is the location from which a fund’s activities are controlled.
Two examples from the Final Regulations are instructive in this regard:
Example 7. Limited Partnership A comprises two limited partners, each of which holds 49 percent of the interest in the partnership, and a general partner, which holds two percent of the interest. The general partner has sole authority to determine, direct, and decide all important matters affecting the partnership and a fund operated by the partnership. The general partner alone controls Limited Partnership A and the fund.
Example 8. Same facts as [Example 7], except that each of the limited partners has the authority to veto major investments proposed by the general partner and to choose the fund’s representatives on the boards of the fund’s portfolio companies. The general partner and the limited partners each have control over Limited Partnership A and the fund.
Accordingly, investments to acquire control of a U.S. business by a fund whose principal place of business is the United States would not be considered a “covered control transaction” subject to CFIUS jurisdiction.
B. Covered Investment
In addition to having jurisdiction over “covered control transactions,” CFIUS also now has jurisdiction over “covered investments” in certain TID U.S. Businesses. We emphasize that “covered investments” only encompass certain foreign investments in TID U.S. Businesses. Foreign investments in other U.S. businesses that are passive, non-controlling investments and thus are not considered “covered control transactions” are not subject to CFIUS review. In certain cases, a “covered control investment” might require the submission of a mandatory filing to CFIUS – particularly for investments involving certain U.S. businesses that deal in critical technologies or non-U.S. investors who are partially- or wholly-owned by non-U.S. governments.
For “covered investments,” it is not sufficient to rely solely on the fund’s principal place of business to avoid being considered a “foreign entity” and avoid potential CFIUS jurisdiction. One also must consider whether any foreign LPs might have the type of access, participation, or decision making rights that could trigger CFIUS jurisdiction. The Final Regulations clarify that an indirect investment in a TID U.S. Business by a non-U.S. person through an investment fund in which the non-U.S. investor is a limited partner generally is not a “covered investment” as long as certain requirements are met, including that:
- the fund is managed by a U.S. general partner (or equivalent),
- the fund board or committee on which the non-U.S. limited partner sits does not have control over the U.S. fund’s management or investment decisions, and
- the non-U.S. limited partner does not have access to material non-public technical information of the target company, and other potential requirements.
Investments in TID U.S. Businesses by a fund in which one or more non-U.S. limited partners hold an indirect, non-controlling interest also will not be subject to CFIUS jurisdiction simply because the non-U.S. limited partner (or a designee) is given membership or observer rights regarding advisory boards or committees of the fund – as long as the fund otherwise meets the above criteria. However, a fund investment may be subject to CFIUS jurisdiction if the non-U.S. limited partner has access to certain information (e.g., material non-public information) of the target TID U.S. Business or is granted certain control or decision-making rights regarding the actions taken by the fund or the target TID U.S. Business.
Again, an example from the Final Regulations provides some clarity about the scope of potential CFIUS jurisdiction:
Limited Partner A, a foreign person, is a limited partner in an investment fund that invests in Corporation B, an unaffiliated TID U.S. business. The investment fund is managed exclusively by a general partner, who is not a foreign person. The investment affords Limited Partner A membership on an advisory board of the investment fund. The advisory board provides industry expertise, but it does not control investment decisions of the fund or decisions made by the general partner related to entities in which the fund is invested. Limited Partner A does not otherwise have the ability to control the fund. Limited Partner A’s investment in Corporation B does not afford it access to any material nonpublic technical information in the possession of Corporation B, the right to be a member or observer, or to nominate a member or observer, to the board of Corporation B, nor any involvement in the substantive decision-making of Corporation B. Assuming no other facts, the indirect investment by Limited Partner A is not a covered investment.
Accordingly, even if an investment fund has its principal place of business in the United States and is not considered a “foreign entity” or “foreign person” under the Final Regulations, it still would be important to ensure that investments by the fund in a TID U.S. Business are not considered “covered investments” due to the governance and/or access rights provided to foreign LPs of the fund.
