Key Takeaways

• On September 25, 2023, the U.S. Department of Commerce (“Commerce”) issued the final rule (the “Final Rule”) regarding the use of funds offered under the CHIPS and Science Act (the “CHIPS Act”).
• The Final Rule incorporates many changes to the proposed rule published in March 2023, including the possibility of mitigation measures imposed at the time of entry into a required agreement and/or if there are violations of a required agreement.
• Below we provide a brief summary of the CHIPS Act and highlight important things to know before the Final Rule becomes effective on November 24, 2023.

Background

The CHIPS Act provides incentives for the domestic manufacture of semiconductors and the conduct of related research & development. Through a mix of funding and loans, the CHIPS Act will allocate $280 billion^[1] over the next ten years. Multiple individuals and entities have begun applying for funding already; Commerce has received more than 500 statements of interest and more than 100 pre-applications and full applications since it began accepting them in March 2023.

As an initial step in establishing the CHIPS Act program, in March 2023, Commerce’s National Institute of Standards and Technology (“NIST”) published a proposed rule in respect of the CHIPS Act (which we wrote about here). On September 25, 2023, Commerce published the Final Rule, which incorporates changes reflecting comments received during the comment period. Ultimately, the Final Rule establishes the various mechanisms at Commerce’s disposal to prevent the improper use of CHIPS Act funding, namely setting forth the clawback mechanisms that may be imposed if funding recipients engage in certain prohibited transactions, research or licensing activities.

By way of background, the CHIPS Act offers funding incentives for those who are selected by Commerce, but the funds come with strings attached. Each funding recipient must enter into a “required agreement” with Commerce that governs the use of the CHIPS funding, setting forth relevant restrictions on certain activities. Commerce will customize each required agreement to a funding recipient (and members of its affiliate group^[2]) regarding certain prohibited significant transactions^[3] involving the material expansion of semiconductor manufacturing capacity in a “foreign country of concern” (e.g., China, Russia, Iran, or North Korea) for 10 years (the “Transaction Prohibition”). If a funding recipient or member of the affiliate group does plan a significant transaction, then that funding recipient must notify Commerce of the planned significant transaction so Commerce may confirm there are no national security risks. Should a funding recipient or one of its members of the affiliate group violate the Transaction Prohibition, Commerce may claw back the funds up to the full award amount and/or impose a mitigation agreement on the funding recipient.^[4]

At the same time, a funding recipient is prohibited from engaging in certain joint research or technology licensing efforts with a “foreign entity of concern” related to a technology or product that raises national security concerns (the “Technology Prohibition”). Unlike planned significant transactions, funding recipients are not permitted to plan any such joint research or technology licensing efforts in connection with CHIPS funding. If Commerce identifies an instance in which a funding recipient violates the Technology Prohibition, then Commerce will claw back the full amount of the award.^[5]

We highlight key aspects of the Final Rule below, including potential compliance concerns and points for funding recipients to consider when negotiating a required agreement with Commerce.

Broader Export Restrictions

Notwithstanding suggestions from commenters that Commerce harmonize the current export controls with the Final Rule’s list of covered semiconductor products,^[6] the Final Rule is intentionally broader in reach than the Export Administration Regulations (the “EAR”). According to Commerce, broader coverage is necessary to meet the national security objectives of the CHIPS Act. Commerce appears to take the view that funding recipients should not engage in certain activity that is inconsistent with the spirit of the CHIPS Act, even if such activity is not restricted by the EAR.

Commerce seeks to prevent irreversible harm that could arise from violations of the Technology Prohibition, but Commerce will allow the continuation of ongoing projects. Specifically, there is a safe harbor for ongoing joint research and technology licensing activities with foreign entities of concern conducted on/before the date of entry into a required agreement. Commerce may grandfather limited activities into funding agreements with funding recipients. There are also exceptions for activities involving standards-related activities (as defined in the EAR) and research and development between and among employees of a funding recipient and a related entity.

Funding recipients should be prepared to update and revise their export compliance programs to account for the broad reach of the CHIPS Act’s restrictions and to avoid violating the Technology Prohibition.

Potential Mitigation Measures and Mitigation Agreements

Commerce may impose mitigation measures on a funding recipient at the time of entry into a required agreement to mitigate potential national security risks. These mitigation measures may be incorporated in respect of the Transaction Prohibition and/or the Technology Prohibition.

Commerce also may impose mitigation agreements on a funding recipient in response to violations of the Transaction Prohibition and, in limited circumstances, the Technology Prohibition. As part of its notification process and potential identification of violations of the Transaction Prohibition, Commerce may impose a mitigation agreement to overcome national security risks posed by the significant transaction. In contrast, Commerce will not impose a mitigation agreement in response to a funding recipient’s violation of the Technology Prohibition, but it may impose a mitigation agreement on the funding recipient if that funding recipient’s related entity^[7] violates the Technology Prohibition.

Notably, the Final Rule does not identify potential mitigation measures, but, instead, seemingly provides Commerce with expansive legal authority to include “additional terms to mitigate national security risks”. The Final Rule merely states that mitigation of national security risks may include the negotiation of an amendment (i.e., a “mitigation agreement”) to the required agreement in connection with the violating transaction.

Funding recipients should be aware that they may need to negotiate and could become subject to mitigation measures or a mitigation agreement. They should also be aware that the actions of members of their affiliated group or related entities (as applicable) could also result in a mitigation agreement. As Commerce begins entering into required agreements and issuing awards, funding recipients, members of their affiliate groups, and related entities should be prepared with internal compliance procedures and infrastructure to ensure no violations occur.

Existing Facilities and Continuous Growth

In a win for funding recipients with existing facilities, the Final Rule carves out certain transactions involving improvements to existing facilities in countries of concern. The Final Rule revised the definition of “material expansion” so certain improvements to regular equipment and efficiency upgrades can no longer be prohibited. Rather, Commerce will consider as the material expansion metric the building of a new cleanroom space or physical space that increases the existing space by more than five percent of the capacity set forth in the required agreement. Additionally, Commerce will consider carving out any “significant renovations”^[8] that are already in process at the time of entry into a required agreement.

Funding recipients should be cognizant of ongoing projects that could be considered material expansions or significant renovations of existing facilities and account for this in their manufacturing capacity output. They should ensure they negotiate provisions that consider these projects at the time of entry into a required agreement to prevent any accidental violations of the Transaction Prohibition.

Conclusion

Commerce is expected to issue guidance as the implementing regulations for the CHIPS Act mature. Funding recipients should carefully consider potential impacts of entering into required agreements with Commerce and consider group-wide investment strategies to avoid potential foot faults in connection with one or more prohibitions (and related clawbacks) in funding agreements.

Outside of the United States, parties should expect U.S. allies to develop and implement similar incentive programs and rules. In this regard, the United Kingdom, South Korea, Japan, and India have each unveiled their own semiconductor programs (each exceeding at least a billion dollars in incentives) since the passage of the CHIPS Act.

Dechert will continue to monitor this space and report on significant developments as they arise.

[1] The majority of funding incentives (approximately $200 billion) will be allocated to scientific research and development and commercialization.

[2] “Members of the affiliated group” captures a funding recipient’s parents, subsidiaries, and entities with a common parent, in each case, subject to a voting power threshold of 80% (noting that certain entities, like non-profits, are exempt). Members of the affiliated group are subject to the same prohibitions as the funding recipient itself, and violations committed by affiliates may result in consequences for the funding recipient.

[3] The threshold for a significant transaction is important because it will determine when a funding recipient must notify Commerce of certain planned transactions. Based on multiple comments on the proposed rule, Commerce has taken the view that thresholds for significant transactions will be tailored to each funding recipient and eliminated the fixed $100,000 threshold from the proposed rule.

[4] Commerce may waive, in whole or in part, claw back of the CHIPS funds in connection with a violation if a mitigation agreement is entered into and complied with by the funding recipient.

[5] Commenters requested a mitigation process for violations of the Technology Prohibition, but Commerce declined to develop such process because the CHIPS Act compels Commerce to claw back the full amount if a violation occurs.

[6] The Final Rule expressly identifies semiconductors critical to national security in 15 CFR § 231.118. Many of these products are widely used in commercial application.

[7] Funding recipients should take note that Commerce uses the broader term “related entity” instead of making reference to a funding recipient’s member of the affiliated group (as is the case under the Transaction Prohibition) regarding a violation of the Technology Prohibition. A related entity is defined as “any entity that directly, or indirectly through one or more intermediaries, controls or is controlled by, or is under common control with, the covered entity.” See 15 CFR § 231.204(b).

[8] “Significant Renovations” means “building new cleanroom space or adding a production line or other physical space to an existing facility that, in the aggregate during the applicable term of the required agreement, increases semiconductor manufacturing capacity by 10 percent or more of the capacity memorialized in the required agreement.”