As discussed in the initial article on the new CFIUS regulations, there are two important exceptions from coverage that need to be evaluated in determining what, if any, steps need to be taken to ensure compliance with the new CFIUS regulations. Exceptions for investors from Australia, Canada, and the United Kingdom apply to investors that qualify with the applicable requirements. There is also an exemption for U.S.-managed investment funds that have foreign limited partners or investors. Both of these exemptions have numerous requirements and potential events of disqualification. Careful analysis is needed to ensure that parties that avail themselves of these exceptions qualify and maintain adequate controls to ensure they do not become disqualified by allowing investors from non-excepted countries to exceed maximum allowable ownership interests or rights of access to non-public information.
Excepted Foreign States and Excepted Foreign Investors
The term “excepted foreign states” and “excepted investors,” as defined by the regulations, describe nationals and entities of the excepted foreign states, and include excepted foreign state entities. CFIUS has announced that the three initial excepted foreign states are: Australia, Canada, and the United Kingdom, including Northern Ireland. (The FIRRMA regulation creates a process for other countries to qualify as excepted foreign states. CFIUS will issue guidelines for other countries to seek “excepted foreign state” status.) This excepted status is set to expire in two years unless these excepted countries meet specified requirements to ensure that their national security-based foreign investment review processes and bilateral cooperation with the United States support the goals of this new CFIUS regime.
It is important to restate that these exemptions do not apply to investments that are deemed to provide the foreign investor control of a U.S. business—they only apply to non-controlling investments and to purchases of “covered” real estate under the regulations that became effective on February 13, 2020. An excepted foreign investor may need to file a traditional CFIUS disclosure if the transaction, when completed, will result in control of a U.S. business, including TID (Technology, Infrastructure or Data) U.S. businesses.
Foreign entities from exempted states must meet the following criteria to qualify as “Excepted Foreign Investors” and “Excepted Real Estate Investors”:
- The foreign entity must be organized under the laws of the excepted foreign state;
- The foreign entity must have its principal place of business in an excepted foreign state or in the United States;
- 75% or more of the members of its board of directors and 75% or more of the observers on the board of directors of the foreign entity must be nationals of one or more excepted foreign states or the United States.
There is also a limitation on the maximum allowable ownership of the foreign excepted investor by a non-excepted individual, entity or a group of foreign persons who act in concert that are not nationals of an excepted foreign state—these investors may not hold 10% or more voting interest, not have a right to 10% or more of the profits or not have the right, in dissolution, to 10% or more of the assets. Non-excepted foreign national entities or individuals will be aggregated if they have a formal or informal arrangement to act in concert or are agencies or instrumentalities of or controlled by, the national or subnational governments of a single non-excepted foreign state.
Even if a foreign excepted investor meets these foregoing criteria, such investor may be disqualified from the CFIUS exemptions if, in the five years prior to the transaction for which qualification as an excepted investor is evaluated, the foreign person or any entity of which it is a parent has violated U.S. laws related to national security. Careful analysis of any enforcement action the potential foreign investor has been a party to is needed to determine whether they qualify as an excepted foreign investor.
Investment Fund Exemption
The new regulations exclude investments by an investment fund if:
- the fund is managed exclusively by a U.S. general partner, managing member, or an equivalent (collectively referred to herein as “general partner”);
- no foreign non-excepted investors in the fund have the ability to control the investment fund, including the power to approve, disapprove or otherwise control decisions made by the general partner or to unilaterally dismiss, prevent the dismissal of, select, or determine the compensation of the general partner;
- no foreign non-excepted investors are provided advisory board or committee membership have the ability to approve, disapprove or otherwise control investment decisions or decisions made by the general partner related to entities in which the investment fund is invested; and
- no foreign non-excepted investors have access or rights to material, nonpublic technical information in the possession of a TID U.S. business that the fund invests in.
A detailed review of these exceptions to coverage is needed to insure that a foreign investor can avail themselves of these exemptions. Additionally, exempted parties need to make sure they have adequate controls in place to prevent disqualification as a result of allowing non-exempted foreign investors from exceeding the ownership limits.