CFIUS reviews will become more common as Chinese companies invest more in the United States, but careful preparation can help companies navigate a complex process.
With levels of Chinese FDI in the United States soaring, compliance with the Committee on Foreign Investment in the United States (CFIUS) review process has become particularly important for Chinese companies investing in the United States. Scrutiny of Chinese companies in all industries has increased dramatically in recent years. So have the number of notices filed with CFIUS, which regulates foreign investment in the United States for national security and other risks. The most recent CFIUS Annual Report notes that “investors from China accounted for seven percent of the notices for the 2009-11 period (20 notices), up from five percent for 2008-10, with the number of notices filed by Chinese acquirers growing each year.”
The CFIUS review process is technical and complicated. This article will familiarize both potential Chinese investors and their US partners with some of the technicalities and complications that can arise during the CFIUS review process.
Commencement of CFIUS review
A CFIUS review can be triggered in two ways. Transactional parties can take the initiative to notify CFIUS of the contemplated deal by jointly filing a voluntary notice with the Treasury Department, which oversees CFIUS. Or a CFIUS member agency (like the Department of Homeland Security) can unilaterally compel a review of a transaction that is not voluntarily filed. Most reviews are initiated by voluntary notification. This gives the parties a safe harbor against later unwinding—or reversing—the transaction.
If parties do not file a voluntary notice, CFIUS can independently initiate the review process, even after a deal has closed. If findings are unfavorable, the US government can then retroactively require that the transaction be unwound. For example, President George H.W. Bush in 1990 ordered the China National Aero-Technology Import and Export Corporation to divest its control of a US aircraft parts manufacturer. And in February 2011, CFIUS ordered Huawei Technologies Inc., China’s largest telecom equipment manufacturer, to divest $2 million worth of intellectual property rights it had acquired from an insolvent California startup company. Huawei had initially closed the transaction without seeking CFIUS preapproval, possibly due to a prior experience. In 2008, the company failed to get CFIUS approval for its proposed investment in 3Com, a US network security firm. In 2010, Huawei again failed to get approval for a proposed investment in home networking through transactions with 2Wire Inc. and Motorola Inc. The failure of these deals to obtain CFIUS approval was linked to Huawei’s supposed ties to China’s military and intelligence agencies.
To avoid the risk of having a closed transaction unwound, transacting parties—particularly when the acquirer is owned by a Chinese company—should file a voluntary notice and get clearance from CFIUS prior to closing. One case in point took place in February 2013, when Chinese oil and gas producer CNOOC Ltd. obtained clearance from CFIUS to acquire Nexen Inc., a Canadian oil and gas company. This happened despite the fact that Nexen owned oil-drilling platforms in the Gulf of Mexico within 50 miles of a large US military base.
Instrumental in the Nexen closing were several factors. First, the parties jointly submitted a voluntary notification. Second, they cooperated with CFIUS during the review process. Finally, they conditioned the closing of the deal upon CFIUS approval. While the basis for the CFIUS clearance was not disclosed, it appears that CNOOC’s agreement to give up operating control of oil drilling platforms was a critical factor in the decision. The approval is also significant in light of the failure of CNOOC’s 2005 $18.5 billion bid for Unocal Corp. due to US national security concerns.
Once the review process begins, CFIUS conducts a 30-day review of the proposed transaction. During this stage, the Treasury Department distributes the parties’ filings to other CFIUS agency members and may request additional information from transacting parties. If all national security issues are resolved within the 30 days, CFIUS approves the deal. But if CFIUS still has unresolved issues on day 30, then the review process proceeds to a 45-day investigation.
Three types of transactions can proceed to a 45-day investigation. The first is any transaction that involves a foreign-government controlled entity, like a sovereign wealth fund. The second is any transaction that could result in foreign control of critical US infrastructure, like major energy assets. In these two instances, an investigation can still be avoided if the Treasury Department and the head of the lead CFIUS agency jointly declare that the transaction will not breach national security. Finally, all transactions that have not been approved within the 30-day review process are subject to a mandatory 45-day investigation.
At the end of the investigation, CFIUS has three options. It can allow the transaction to move forward, order the parties to abandon the deal, or send a report to the US president, requesting that he or she make the ultimate decision within 15 days.
15-day presidential ruling
If the transaction is sent to the president, he or she must permit, block, or modify the transaction within 15 days of the 45-day investigation. In September 2012, President Barack Obama blocked a transaction under CFIUS for the first time in 22 years. Obama ordered Ralls Corporation, which is owned by Chinese nationals, to divest its interests in wind farms that it had purchased earlier that year because the farms were located near a US Navy base in Oregon. CFIUS sent the matter to the president after it determined that the national security risks posed by the purchase could not be resolved.
Which deals are covered by CFIUS?
CFIUS has jurisdiction to review only “covered transactions.” Under Treasury regulations, a transaction is covered if it is a “merger, acquisition, or takeover by or with any foreign person which could result in foreign control of any person engaged in interstate commerce in the United States.” CFIUS may only review investments that could result in a foreign entity’s direct control of a US business. Consequently, CFIUS cannot review investments that do not give the foreign acquirer control over the target’s business operations. For example, a transfer of ownership of less than 10 percent of the voting securities of a US target is considered a transaction for investment purposes only. Investments directly made by a bank, mutual fund, or other financial institution “in the ordinary course of business for its own account” are not covered transactions. Foreign greenfield investments or investments in a non-US business are not covered transactions.
Although CFIUS has traditionally focused its scrutiny on deals involving critical sectors like energy and technology, the breadth of its review has expanded in recent years. For example, in September 2013, CFIUS approved a transaction in the food sector—the $4.7 billion acquisition of Smithfield Foods, Inc. by Shuanghui International Holdings, one of China’s largest meat processors. Shuanghui filed for voluntary CFIUS review, but the transaction remained contentious among politicians and the American public. Because Smithfield is one of the United States’ largest food producers, and because Shuanghui has experienced food safety issues in the past, members of Congress raised concerns about whether it was in the United States’ interest for Smithfield to remain a US company. Despite these concerns, CFIUS approved the transaction, finding that the deal did not pose a threat to national security.
In another case in 2012, Beijing-based Dalian Wanda Group voluntarily filed with CFIUS to acquire US movie theater company AMC Entertainment Holdings. While the content of the deal was not likely to pose a threat to US national security, Wanda took the safest possible course by proactively seeking CFIUS review. When the $2.6 billion deal was cleared and later closed in September 2012, it represented the largest takeover of a US company by a Chinese firm and made Wanda the world’s largest movie theater owner.
If your deal is covered by CFIUS, what should you do?
Foreign companies seeking to acquire US companies should conduct CFIUS-related due diligence early in the acquisition process to identify potential impediments before significant time and money has been spent.
The CFIUS review timeline, once started, is rigid. Accordingly, CFIUS encourages transacting parties to engage in informal, pre-filing consultations prior to the commencement of the review process. CFIUS consultations are confidential and provide parties with a good sense of the information that CFIUS may request down the line.
When CFIUS requests additional information, parties have three business days to respond. Therefore, both transacting parties should identify any national security-related issues in the early stages of the review process. The acquirer, for example, should be well aware of matters like the target’s proximity to sensitive US assets and access to sensitive information or trade secrets before CFIUS makes a request.
US firms seeking cross-border acquisitions should first do their own internal reviews to determine if any aspects of their business may generate CFIUS concerns. They can then take steps to attempt to increase their chances of obtaining CFIUS approval, such as divestures of business activities likely to raise CFIUS concerns. For example, in January 2013, a US subsidiary of Chinese automotive components manufacturer Wanxiang Group obtained CFIUS clearance to acquire the assets of A123 Systems, a US lithium ion battery manufacturer that had declared bankruptcy after its original deal with Wanxiang fell apart. Under the original deal, Wanxiang would have invested $450 million in A123. However, the deal was derailed when members of Congress raised concerns about continued government funding of A123. The second transaction, a $256.6 million purchase of A123 assets by Wanxiang, received CFIUS approval, but only after Wanxiang divested $2.25 million worth of government and military contracts held by A123. Similarly, CNOOC’s agreement to give up operating control of oil drilling platforms within 50 miles of a US military base appears to have been instrumental in it receiving CFIUS clearance for its acquisition of Nexen.
The CFIUS review process can be highly politically charged. Transactions that are favored by the public are more resistant to political attack. As a result, a well-planned public relations strategy can be a key aspect of a CFIUS process expected to generate close scrutiny. One good case in point is the March 2013 $117.6 million acquisition of Complete Genomics Inc., a human genomics sequencing company, by BGI-Shenzhen. After one of Complete Genomics competitors raised national security concerns in the press, Complete Genomics’ president responded with a media strategy to dispel the concerns, noting that BGI already was one of the company’s largest customers. CFIUS approved the deal despite continued opposition to the transaction by members of Congress.
In the past, CFIUS was rather lax in its monitoring approach. But since the 2008 enactment of Foreign Investment and National Security Act (FINSA), CFIUS has become more proactive in inspecting cross-border transactions. US acquisitions by Chinese acquirers have been particularly scrutinized. So while obtaining CFIUS approval is now a necessary element of virtually all US acquisitions by Chinese companies, with advanced preparation and the assistance of skilled attorneys, transacting parties can successfully navigate the review process.
[author] Thomas S. Vaughn ([email protected]) is a senior member of the law firm of Dykema Gossett PLLC, and heads the firm’s China Business Team. His practice focuses on representing both US and international companies in mergers, acquisitions, and joint venture transactions. Shang Kong will join Dykema Gossett PLLC as an associate in the spring of 2014, after graduating from the University of Michigan Law School. Mr. Kong assisted on this article while serving as an intern with the firm. [/author]