USA Inbound Acquisitions & Investments Blog : Inbound Investment Lawyer & Attorney : Sullivan & Worcester Law Firm : Mergers & Acquisitions, Cross Border Investments

Ameek Ponda and Douglas Stransky, partners in Sullivan & Worcester’s Tax Department, co-authored the following article. Mr. Ponda is the director of the Tax Department and a member of the Firm's Management Committee. He concentrates his practice in structuring corporate mergers and acquisitions, advising emerging companies on financing and business issues, designing REIT transactions and financial instruments, and working on cross-border financings and acquisitions. Mr. Stransky concentrates his practice on international tax planning. He has structured numerous tax efficient international mergers, acquisitions, dispositions and reorganizations for a broad spectrum of public and private clients in the financial services, life sciences, manufacturing, private equity, technology and venture capital industries.

United States businesses of all sizes and sectors are more likely than ever to be targeted by buyers from around the globe, including buyers from rapidly emerging economies such as Brazil, China, India, Israel, and Russia. This “inbound” deal flow stems from the convergence of several trends, including globalization, the rise of sovereign wealth funds and a weakened U.S. dollar. In addition, the United States’ comparatively welcoming legal and regulatory environment signals to the rest of the world that “America is open for business.”

In Massachusetts, some notable inbound deals over the last 18 months included the $11.6 billion acquisition of GE Plastics by Saudi Arabian Basic Industries Corporation, the $8.8 billion purchase of Millennium Pharmaceuticals by Japan’s Takeda Pharmaceutical Co., the $3.9 billion acquisition of Putnam Investments by Canada’s Great-West Lifeco, Inc., the $2.6 billion purchase of Sepracor, Inc. by Japan’s Dainippon Sumitomo Pharma Co., and the $1.7 billion acquisition of Samsonite Corporation by United Kingdom-based CVC Capital Partners Ltd. 

Cross-border deals are always more complex than comparable domestic ones. They involve at least two sets of legal and regulatory frameworks, additional currencies, multiple languages and time zones, and potentially significant differences in business culture. Foreign investors and U.S. sellers exploring inbound deals should proceed with informed boldness when developing transaction strategies.

On the sell side, understanding the foreign buyer’s goals and recognizing its possible inexperience with U.S. laws and commercial customs and practices will go a long way toward maximizing value in the deal and ensuring a smoother process. For example, a foreign buyer will likely not be familiar with U.S. employment laws, tort litigation, etc., which are markedly different than those of many other countries.

On the buy side, it is critical for foreign investors to understand U.S. laws and commercial customs and practices. Successful execution is more art than science, and early involvement by experienced U.S. advisors will be important. For example, in contrast to market practice in other parts of the world, there is generally less emphasis on due diligence in the United States, particularly protracted, intrusive due diligence, and instead a reliance on seller representations and associated indemnities. Of course, exceptions to this general rule exist when statutes, cases, and regulations have expanded successor liability into particular areas, and thus more due diligence may be appropriate, for example, with respect to environmental, employment/benefits, money laundering and international trade issues. 

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The regulatory clearance process for inbound acquisitions is playing a central role in the ongoing takeover contest for Terra Industries, Inc. A second buyer has made a higher bid and has cited Terra’s need for regulatory approvals and regulatory delays in the agreed-upon deal in arguing its case to Terra’s shareholders. That and other factors now seems to have won the day for the second buyer. 

Terra is based in Sioux City, Iowa and produces and markets nitrogen and methanol products, predominantly agricultural fertilizers. In February, Norway’s Yara Iternational ASA, the world’s largest fertilizer company, agreed to pay $4.1 billion to acquire Terra in a merger transaction. The merger requires the approval of the stockholder of both companies. According to the Alfidi Capital blog, Yara’s bid for Terra was valued at $41.10 per share. The parties have agreed that the transaction is expressly subject to review by the Committee on Foreign Investment in the United States (CFIUS).

Terra’s merger agreement, as filed with the SEC, illustrates the operation of the U.S. statutes and regulations that apply to an inbound investment. First, the U.S. business that is the target warrants to the buyer – Yara in this case – that the approval of CFIUS is among those governmental consents that are required for the transaction to be completed legally. Second, the U.S. target and the foreign buyer then agree to cooperate to make the necessary filings with CFIUS and to update those filings as necessary. Third, as a condition to completion of the transaction, full regulatory compliance must have been achieved. For a more complete analysis of these and other contractual provisions that are used in acquisitions, please visit the Sullivan & Worcester Web site and review our white paper that discusses contractual provisions.

On March 2, CF Holdings Industries, Inc. of Deerfield, Illinois announced that it was offering $47.40 per share for Terra, or $620 million higher than Yara’s bid. Earlier this year, CF had ended its year-long attempt to acquire Terra. CF’s new bid is $840 million higher than its last bid. Because CF Industries, Inc. is not a foreign buyer, review by CFIUS is not a factor. In its press release, CF says that its offer not only has higher value than Yara’s but is not burdened with the various conditions that apply to Yara’s offer. CF’s letter to Terra’s directors cites “numerous conditions beyond Terra’s control [that] will not be satisfied, including regulatory, legislation and stockholder approvals.” Obviously, CFIUS approval falls under the first of these categories. The Daily Finance blog also handicaps the Yara offer because of CFIUS screening. CF gives Terra the opportunity to make a quick deal.

Going back to the Yara deal, it may be interesting to speculate what factors in its business drove the decision to file with CFIUS. Submitting a notice to CFIUS is optional. If there is no filing and CFIUS later determines that the acquisition adversely affected U.S. national security, CFIUS can attempt to unwind the transaction. The mere prospect that an unwinding might subsequently occur is sufficient to lead parties, their advisors and their financing sources to play the game conservatively and engage in the CFIUS screening process.

Viewed from a less conservative perspective, however, perhaps Terra’s transaction does not affect U.S. national security. Terra’s last annual report did not disclose that it had contracts with the U.S. government or that it was satisfying U.S. defense requirements. Additionally, Norway is a NATO ally and is not a proliferation risk. It is more likely that Terra’s fertilizer products are considered critical resources and material in U.S. agricultural markets. Interestingly, among the risk factors in its annual report is Terra’s disclosure that its fertilizers can be used as explosives and that “governments could impose limitations in the sale, use or distribution of [its products],” so there may well be a general security consideration in the background. On balance, the more conservative position with respect to CFIUS seems warranted.

CF appears to have gained the initiative with its heftier price and its arguments that rely on conditions that apply only to Yara’s deal. Today, Terra announced that its board had notified Yara that CF’s offer constituted a superior offer and that, barring an overbid from Yara within 5 days, Terra would terminate its merger agreement with Yara. Although not the only factor by any means, CFIUS review is tilting the contest toward the domestic buyer. 

We are forced to ask whether that was among the intended results of the legislation that regulates foreign direct investment. 

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The withdrawal of the Chinese acquirer in Firstgold transaction has ignited a debate over whether U.S. investment policy has become more restrictive with respect to China. In fact, Firstgold is unlikely to be a reliable indicator of the policy or regulatory direction of the U.S. government. Firstgold presented an unusual set of facts, did not truly involve U.S. critical infrastructure and has little economic significance. The regulatory outcome was determined well before the blowup between Google and the Chinese government occurred earlier this month. Commentators should be wary before generalizing from the Firstgold outcome, as incorrect observations may reduce offshore investment interest in the U.S.  

The Financial Times reported earlier this month in an article bylined by its Beijing-based reporter Kathrin Hille that Chinese companies are expecting tougher scrutiny in the United States. This change is linked to Google’s announcement that Chinese hackers had accessed its systems and those of 20 other companies. Google’s stand might affect both inbound investors and companies already present in the U.S. The article reported that the failure of the Firstgold investment is an indicator of the Obama administration’s enhanced scrutiny of Chinese investment infrastructure. 

The Firstgold investment was not a conventional inbound investment. The company’s SEC reports contain unusual facts. Firstgold has been an exploration stage company with only minor operations since 1995. Its assets are principally property and equipment for gold prospecting at four sites in Nevada. It is financially distressed. Its audit included a going concern qualification. It must raise capital to survive. Its two hedge fund investors sued it for securities fraud 10 months after making their loans. The Chinese investor, Northwest Non-Ferrous International Investment Company Limited, intended to not merely invest in Firstgold, but to acquire the outstanding senior secured debt from the hedge funds, loan additional funds to Firstgold and invest enough to own 51% of the Company’s equity. The total investment package was valued at $26,500,000 but less than $10,000,000 was an equity investment in the company itself. Firstgold did not file its application with the Committee on Foreign Investment in the United States (CFIUS) until three months after the deal was first announced. Firstgold did have a property located in Fallon, Nevada, 50 miles from a U.S. Naval air facility that tests advanced weapons. It was this proximity that led the staff of CFIUS to conclude that there were national security concerns.

Firstgold’s assets are not critical infrastructure. The regulations promulgated under the Foreign Investment and National Security Act of 2007 define critical infrastructure to be an asset so vital to the United States that the incapacity or destruction of the particular asset would have a debilitating impact on national security. Firstgold’s assets do not satisfy that standard. Critical infrastructure is not an issue in the case.

Firstgold has no economic significance. In its 15-year history, it has produced no material revenues. Because it is not an active mining operation, it is not a factor in the local Nevada economy. Its debt is in default, and it is subject to foreclosure proceedings. The real importance of the transaction was the bailout of its lenders who thought they could offload their position at a favorable price. The value of Firstgold’s stock is questionable, since there are outstanding cheap warrants equal to 26% of the outstanding shares, a significant overhang. In fact, there was a period during 2009 where Firstgold’s stock could not be traded since it had failed to file its reports with the SEC.

On the other hand, it truly is difficult to understand what CFIUS gained from blocking this deal, in which case it may be that its action can only be a signal for a new hawkish outlook. In November 2008 CFIUS published a list of 11 illustrative factors that it will consider in determining whether a covered transaction poses national security risk. The Firstgold deal seems to present none of them. The CFIUS Guidance also discussed transactions that have presented national security considerations because of the nature of the U.S. business over which control is being acquired. Geographic location is not mentioned as a determinative factor. Because Firstgold has no products, it is not able to have products that may have implications for U.S. national security. It is possible that CFIUS determined that the buyer was acting on behalf of the Chinese government. If so, CFIUS never mentioned it. Therefore, if CFIUS intended to send a message, the message may be that a Chinese investor has the burden of proving it is not acting for the PRC government. Given the size of the transaction and the relative obscurity of the parties, however, it is difficult that CFIUS meant for its action to be considered a bellweather for other China-originated transactions. 

It’s appropriate for the media to be alert to policy changes that result from Google’s startling announcement. Reading tea leaves is a tricky business, however, and in the world of commerce, the media should refrain from issuing baseless alarms when the U.S. economy is earnestly seeking foreign direct investment. The rational view is that, all in all, there was little compelling reason once the national security monitors raised doubt as to the real reason for the transaction, for CFIUS to permit the Firstgold deal to go ahead. Had there been some compelling showing that the deal had a rational basis as a business investment, CFIUS would have approved it.

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A relatively small proposed investment in Firstgold Corp. of Lovelock, Nevada, a development stage mining company, has lead to a flurry of press coverage of the refusal by the U.S. Treasury’s Committee on Foreign Investment in the United States (CFIUS) to permit the deal. 

The proposed investor is Northwest Non-Ferrous International Investment Company Limited of Xi’an, China. Firstgold is a small-cap, financially-challenged gold mining business with four tracts in Nevada, but little operating history—in its own words, “a junior mining and exploration company.” The deal size has not been disclosed and may be less than $10 million. The deal structure involves three parts—the acquisition of senior secured debt from a disgruntled private investor, an additional loan to Firstgold and a purchase of a control equity stake, making Northwest both Firstgold’s parent and secured lender. The deal was first announced in July 2009. The parties did not make their CFIUS filing until late September.

After both a review and an investigation, CFIUS is recommending that the President disapprove the transaction. According to CNNMoney’s report, CFIUS apparently based its rejection on the proximity of one of Firstgold’s properties to Fallon Naval Air Station and offered several mitigation possibilities, none of which Firstgold accepted. The company states that the air base is 50 miles away. 

There is other speculation that the investor would use Firstgold’s gold assets—even if undeveloped at this point—to add to China’s hoard of gold, now totaling a staggering estimated $1.95 trillion. China’s gold reserves exceed Switzerland’s. 

Other news reports and blogs covering the development include:

• Reuters
• Northern Miner
  
• Exec Digital
• As well as Firstgold’s own release

This blog, in its October 1 post, alerted readers to the possibility of an unfavorable CFIUS outcome. We noted that management did not seem to approach the CFIUS filing with seriousness and as recently as October had predicted that its CFIUS filing would not be problematic.

The furor surrounding this development has an interesting footnote. The California Gold Rush of 1848-52 began with the discovery on gold on Mexican soil, specifically on land owned by a Swiss farmer, John Sutter—and ultimately led to the annexation of California by the United States. So there may well be historical precedent for the concerns of CFIUS. 

Updated  On December 22, Northwest withdrew from the transaction, Reuters announced.  Therefore, President Obama will not have to take direct action to disapprove the deal. 

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Foreign direct investment has often created dismay and resistance in the investee nation. Self-appointed pundits may try to gain populist following by decrying the sale of local assets to foreign buyers with no regard to the historic contribution foreign ownership has made to the growth of their own economies.

Governmental regulation of foreign direct investment is implemented in part to allay these emotions by screening out those investments judged harmful according to legislated standards. It therefore is counterintuitive when the exercise of regulatory power to screen foreign direct investment also inspires equally ill-tempered reactions. Often, the sound and fury of those reactions do not withstand factual analysis, especially when journalists seek to stir the pot of public emotions. 

Take, for example, “US inquiry into sale of Virgin Galactic stake to Arab investor” which appeared in the online version of The Times of London earlier this week, written by Abu Dhabi based-reporter David Robertson. The Rocketeers and ParabolicArc blogs posted the same story. The story questions why the U.S. has elected to subject the proposed sale of a 32% stake in Sir Richard Branson’s privately-held space travel venture to Abu Dhabi-based Aabar Investments for $280 million to “a national security investigation” and whether the investigation genuinely serves the legitimate interests of the United States. 

Virgin Galactic and Aabar Investments had originally announced their deal in July 2009. The deal includes not only the equity investment but also Aabar’s commitment to fund a small satellite launch capability. 

Timesonline does not point out that the Committee on Foreign Investment in the United States (CFIUS), has reviewed over 300 transactions during the three years ended December 31, 2008 or that filings with CFIUS that seek its review are optional. However, CFIUS may initiate its own review of inbound transactions and, if it finds that a transaction may adversely affect U.S. national security, it can take remedial steps, including rescission. As a result, a prudent inbound investor and its investee will seek CFIUS review to insure that the transaction is permanently settled. Review is the first level of the regulatory process. Investigation is the second level. If review of a filing finds that the transaction could result in control of a U.S. business by an entity that is controlled by a foreign government, then FINSA and its regulations require an investigation unless CFIUS otherwise determines. Given this legal framework, CFIUS could have had sound reasons for subjecting Virgin’s deal to the second level of investigation. The fact that there is an investigation does not, however, suggest that the outcome will be adverse to Aabar.

The Timesonline report suggests that investors in the Arab Middle East will become concerned that their investments in the U.S. are subject to CFIUS review. According to the public version of the CFIUS annual report released last month, during 2006, 2007 and 2008, 11 transactions involving UAE investors or acquirers were filed for CFIUS review. During the same period, 14 transactions from Bahrain, Kuwait, Lebanon, Qatar and Saudi Arabia were filed. Deals originating in Saudi Arabia alone comprised 7% of the total value of completed transactions. Without regard to this body of facts, the writer drags up the divestiture outcome that followed Dubai World’s acquisition of P&O, a deal that CFIUS found did not impair national security and that did close. 

It certainly is legitimate to argue that the statute that CFIUS enforces has an incorrect premise with regard to government-controlled entities. It also is legitimate to argue that the term “national security” is not sufficient well-defined and gives CFIUS too much discretion and the overwhelmingly powerful argument is that Sir Richard Branson is not very likely to have transferred control of Virgin Galactic, despite the size of Aabar’s investment. But, in a government where the legislative branch makes the laws and the executive branch is charged with carrying out those laws, CFIUS is performing as it must. Moreover, CFIUS has taken steps to make the public aware of its views by publishing guidance regarding the types of transactions that it has reviewed and that have presented national security implications.

There is an additional fact that would have put much of this faux fury into perspective. Aabar now owns 4% of U.S.-based Tesla Motors, the electric car company that is a contender to lead the United States into the age of the electric car. In July 2009, Aabar acquired its investment stake in Tesla from Daimler. Because of the confidentiality of the proceedings of CFIUS, there is no way to know whether CFIUS reviewed the transactions that led to Aabar’s stockholding in Tesla. At a minimum, Aabar and its controlling family are not strangers to CFIUS. They have been welcomed into the U.S. in the past and no doubt they will be welcomed here again.

The New York Times coverage of the Virgin Galactic deal, published today, is infinitely more balanced and informative. Reporter Eric Lipton went into the subtleties and difficulties that underlie regulatory judgments regarding FDI. Factual reportage supports constructive public debate that can lead to public policies that enable FDI to produce its best results. 

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Foreign direct investment has often created dismay and resistance in the investee nation. Self-appointed pundits may try to gain populist following by decrying the sale of local assets to foreign buyers with no regard to the historic contribution foreign ownership has made to the growth of their own economies.

Governmental regulation of foreign direct investment is implemented in part to allay these emotions by screening out those investments judged harmful according to legislated standards. It therefore is counterintuitive when the exercise of regulatory power to screen foreign direct investment also inspires equally ill-tempered reactions. Often, the sound and fury of those reactions do not withstand factual analysis, especially when journalists seek to stir the pot of public emotions. 

Take, for example, “US inquiry into sale of Virgin Galactic stake to Arab investor” which appeared in the online version of The Times of London earlier this week, written by Abu Dhabi based-reporter David Robertson. The Rocketeers and ParabolicArc blogs posted the same story. The story questions why the U.S. has elected to subject the proposed sale of a 32% stake in Sir Richard Branson’s privately-held space travel venture to Abu Dhabi-based Aabar Investments for $280 million to “a national security investigation” and whether the investigation genuinely serves the legitimate interests of the United States. 

Virgin Galactic and Aabar Investments had originally announced their deal in July 2009. The deal includes not only the equity investment but also Aabar’s commitment to fund a small satellite launch capability. 

Timesonline does not point out that the Committee on Foreign Investment in the United States (CFIUS), has reviewed over 300 transactions during the three years ended December 31, 2008 or that filings with CFIUS that seek its review are optional. However, CFIUS may initiate its own review of inbound transactions and, if it finds that a transaction may adversely affect U.S. national security, it can take remedial steps, including rescission. As a result, a prudent inbound investor and its investee will seek CFIUS review to insure that the transaction is permanently settled. Review is the first level of the regulatory process. Investigation is the second level. If review of a filing finds that the transaction could result in control of a U.S. business by an entity that is controlled by a foreign government, then FINSA and its regulations require an investigation unless CFIUS otherwise determines. Given this legal framework, CFIUS could have had sound reasons for subjecting Virgin’s deal to the second level of investigation. The fact that there is an investigation does not, however, suggest that the outcome will be adverse to Aabar.

The Timesonline report suggests that investors in the Arab Middle East will become concerned that their investments in the U.S. are subject to CFIUS review. According to the public version of the CFIUS annual report released last month, during 2006, 2007 and 2008, 11 transactions involving UAE investors or acquirers were filed for CFIUS review. During the same period, 14 transactions from Bahrain, Kuwait, Lebanon, Qatar and Saudi Arabia were filed. Deals originating in Saudi Arabia alone comprised 7% of the total value of completed transactions. Without regard to this body of facts, the writer drags up the divestiture outcome that followed Dubai World’s acquisition of P&O, a deal that CFIUS found did not impair national security and that did close. 

It certainly is legitimate to argue that the statute that CFIUS enforces has an incorrect premise with regard to government-controlled entities. It also is legitimate to argue that the term “national security” is not sufficient well-defined and gives CFIUS too much discretion and the overwhelmingly powerful argument is that Sir Richard Branson is not very likely to have transferred control of Virgin Galactic, despite the size of Aabar’s investment. But, in a government where the legislative branch makes the laws and the executive branch is charged with carrying out those laws, CFIUS is performing as it must. Moreover, CFIUS has taken steps to make the public aware of its views by publishing guidance regarding the types of transactions that it has reviewed and that have presented national security implications.

There is an additional fact that would have put much of this faux fury into perspective. Aabar now owns 4% of U.S.-based Tesla Motors, the electric car company that is a contender to lead the United States into the age of the electric car. In July 2009, Aabar acquired its investment stake in Tesla from Daimler. Because of the confidentiality of the proceedings of CFIUS, there is no way to know whether CFIUS reviewed the transactions that led to Aabar’s stockholding in Tesla. At a minimum, Aabar and its controlling family are not strangers to CFIUS. They have been welcomed into the U.S. in the past and no doubt they will be welcomed here again.

The New York Times coverage of the Virgin Galactic deal, published today, is infinitely more balanced and informative. Reporter Eric Lipton went into the subtleties and difficulties that underlie regulatory judgments regarding FDI. Factual reportage supports constructive public debate that can lead to public policies that enable FDI to produce its best results. 

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In the U.S. press, almost all mention of Huawei Technologies recites like a mantra the 2008 refusal by the Committee on Foreign Investment in the United States (CFIUS) to permit it to participate with Bain Capital’s in Bain's proposed acquisition of 3Com Corporation. The consensus line is that CFIUS determined that Huawei’s connections with the government of the People’s Republic of China might have been too strong and therefore refused to approve the deal. The failed transaction is often cited as evidence that the U.S. government will not permit Chinese investment in or acquisition of U.S. high technology businesses. Experts contend that the outcome continues to dissuade Chinese investors from acquisitions of U.S. businesses. 

According to an article by Kevin J. O’Brien in the New York Times on November 30, however, Huawei has in a remarkably short timeframe become a communications equipment powerhouse without the 3Com acquisition and now wields significant market power both with China's mobile networks and around the globe.  

According to the article, Huawei now is established as a serious competitor, winning contracts from major phone networks in Europe and elsewhere on the globe, beating the likes of Ericsson and Nokia Siemens Networks. Huawei has a 20.1% market share of the global equipment market. It ranks as the number 2 supplier of mobile phone systems in the world. Its quarterly sales now are greater than Alcatel-Lucent and Nokia Siemens. It supplies 36 of the top 50 mobile operators, including Cox Communications, Leap and Clearwire in the U.S. The article reports that customers have investigated the ownership of Huwaei, said to be a private company, and concluded that its ownership would not be a factor.

It seems likely that U.S. companies will increasingly become customers of Huawei because of its versatile products and their low cost of operation. Huawei has obviously found a way to prosper here and elsewhere–even if the U.S. government did not think it a suitable owner for a U.S. business. It’s not clear whether the CFIUS decision produced any long-term benefit here at all. And it’s certainly not clear from what national security risk CFIUS protected the U.S.

The ascension of Huawei to prime global competitor status illustrates that a robust multinational high technology enterprise does not need a U.S. base, whether bought or built. Regrettably, it also demonstrates that as a result of the CFIUS decision, the U.S. has lost out on direct contributions to its economy through jobs, purchases from local U.S. vendors and the use of U.S-created R&D. 

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Late last week reports surfaced that the China National Offshore Oil Corporation (Cnooc), China’s state-owned energy company, was in unconfirmed discussions with Norway’s StatoilHydro ASA to acquire oil lease interests in the Gulf of Mexico. A completed transaction would open up oil reserves in the U.S. Gulf to China for the first time. The fact that a Chinese company is involved has led to speculation whether the U.S. will resist this particular foreign direct investment, recalling the political furor that resulted in Cnooc’s unsuccessful 2005 bid to acquire Unocal Corp. 

Environmental Capital blog linked to a Wall Street Journal’s report that StatoilHydro had put five prospects up for sale, a small portion of its Gulf of Mexico assets. The Financial Times wrote that the transaction would have a value of approximately $100 million and that the proceeds would be used to cover the costs of drilling wells rather than to obtain acreage. According to Energy-pedia, StatoilHydro will remain majority owner of any projects for which it brings in partners, noting that oil companies typically offer partnerships in large exploration projects to help pay for drilling and spread risk. 

Generating alarmism, Business Insider first claims that China’s overseas acquisition program is approaching the U.S. and then becomes somewhat more balanced: 

[T]he political tides have changed. In 2005, it was easy to block investments on political grounds, because there was no shortage of cash. Plus, this is just a few leases -- putting their toe in the water, it looks like -- not an $18.5 billion bid for a U.S. company.

Still expect all kinds of howls before this goes through.

Assume that the media has accurately outlined the transaction. Will the transaction between StatoilHydro and Cnooc be a “covered transaction” under the Foreign Investment and National Security Act of 2007 (FINSA)? If so, will the parties then make a voluntary filing with the Committee on Foreign Investment in the United States (CFIUS)?

Not every transaction involving a non-U.S. investor and a U.S. business is subject to FINSA. Only a transaction that “could result in control of a U.S. business by a foreign person” is. A transaction that satisfies this transfer of control test is a “covered transaction.” But not every “covered transaction” is subject to FINSA. The general structure of FINSA is that parties to a covered transaction may file a notice with CFIUS for its review and, possibly, further investigation or Presidential action. If the parties do not file a notice, then CFIUS can block the transaction or later unwind it. The purpose of the CFIUS review and investigation is to determine whether the proposed transaction might impair U.S. national security. 

CFIUS has published regulations that detail the coverage of FINSA, the review process and the contents of the voluntary filing. Applying the facts of the Cnooc discussions to the regulations produces some interesting results:

Does the fact that a Norwegian entity owns the oil leases save the deal from regulatory review? No. A U.S. business is subject to the regulations and to FINSA regardless of the nationality of the person that controls it.^[1]

Are the oil leases a U.S. business? To be a U.S. business, the leases must be an entity engaged in interstate commerce in the United States.^[2] Are they? The regulations define “entity” to include “assets (whether or not organized as a separate legal entity) operated by any [other entity] as a business undertaking in a particular location or for particular products or services.”^[3] Therefore, the leases could be an “entity.”

If the leases are an entity, is the entity engaged in interstate commerce in the United States? The wells are offshore, and not located within the boundaries of any state of the United States, as can be seen from the map published by Energy-pedia. The media coverage says that the leases are located in the “U.S. Gulf.” Is that a state or is it not?

Also, since the wells appear to not yet be operating, are the assets engaged in any commerce at all?

Under the regulations, certain transactions are not covered transactions, including the “acquisition of any part of an entity or of assets, if such part of an entity or assets do not constitute a U.S. business.”^[4] There is an example in the regulation of a foreign person acquiring individual discrete assets -- including land -- from a U.S. business. The example concludes that the acquisition is not a covered transaction. 

If its purpose is to finance drilling, rather than to obtain acreage, then the proposed transaction is an investment, not an acquisition. FINSA, however, applies to investments if control is tranferred. The structure of the deal may be that Cnooc will obtain lease interests. If these interests do not have rights to vote for directors or vote on other matters affecting the entity, then the interests are not voting interests and there may be no “control” aspect to the transaction at all.^[5]

Lastly, if Cnooc is acquiring interests from StatoilHydro without any intent to exercise control, then Cnooc may be acquiring the interests or the leases “solely for the purpose of passive investment,” and the investment may be exempt from FINSA on that basis.^[6] The observation that StatoilHydro intends to remain in operating control supports this view. 

Overall, there could be several bases for the legal conclusion that the proposed deal would not be a covered transaction under FINSA. Cnooc and StatoilHydro will no doubt take their own business assessment of their situation. It will be interesting to see if the views coalesce or diverge. 

All references are to Sections of the CFIUS regulations: 

^[1] Section 226

^[2] Section 226

^[3] Section 211

^[4] Section 302(c)

^[5] Section 228

^[6] Section 302(b)

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If imitation is the sincerest form of flattery, then the architects of the Foreign Investment and National Security Act of 2007 (FINSA) and its regulatory agency CFIUS can be proud. The Canadian government is revising its Investment Canada regulatory scheme. The result resembles the regulatory system here south of the Canadian border.

Recent Canadian statutory enactments and proposed regulations introduced a new national security review mechanism into the screening process. In 2007, FINSA amended the then-existing U.S. statute, known as Exon-Florio, to specify that national security was to be the sole focus of U.S. regulation. The new Canadian structure authorizes the government to review, block or limit inbound investments by non-Canadians based on national security concerns. One commentator has noted that although the legislation does not define “national security,” it remains to be seen whether the regulators will also consider issues of economic security under the national security umbrella.

Under the new regime, Canada’s national security process starts with a preliminary review of the transaction. If the initial review indicates that there are national security concerns arising from the proposed deal, then the Cabinet reviews and determines whether a full review is required. The review applies the standard, “injurious to national security.” If the transaction fails that standard, then the government may order the transaction blocked, restricted or, if closed, unwound. The maximum length of the review is approximately 3 ½ months. Once the time for review has expired, the Canadian regulators cannot challenge a reviewable foreign investment on national security grounds.

Under the legislation the government retains the authority to initiate a review of non-reviewable transactions, including minority investments, at any time within 45 days after completion.

Recent statutory changes will significantly modify the monetary thresholds for review of inbound transactions. If and when the proposed regulatory changes are made, the threshold will be applied to the enterprise value of the target, not the book value of its assets as is currently the case. The threshold itself is set at enterprise value of Cdn $600 million and will increase to Cdn $1 billion over the next four years.

FINSA and CFIUS are, of course, not the only national security-based regulatory schemes in place today. China, France, Germany, Japan, Poland, Russia and the United Kingdom, among others, based their regulatory reviews of inbound deals on national security grounds.

Canada is frequently mentioned together with Australia as the leading developed, resource-rich nations that are targeted for foreign investment by China and others aggressively looking to source commodities. Australia, by contrast, recently revamped its FDI regulatory scheme to limit the range of deals subject to review. Like Canada, it raised the threshold for review. That change and others are reviewed by our recent August 13 posting in this blog.

Unlike Canada, Australia did not adopt a regulatory scheme that specifically vets national security issues.

For a discussion of the role of national security in the CFIUS review process, please access the white paper located on our firm’s Web site.

Howard Burshtein of Torkin Manes LLP, Toronto, Ontario, contributed to this post.

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In a headline-grabbing inbound acquisition deal, General Motors Corp. and Sichuan Tengzhong Heavy Industrial Machinery have reportedly reached definite agreement on the terms of the sale of GM’s Hummer Brand by early 2010 for approximately $150 million. According to a Reuters report appearing in The New York Times, Tengzhong has begun to seek Chinese regulatory approval for its purchase of the Hummer brand, Hummer trademark and manufacturing expertise. The report surmises that three Chinese regulatory bodies – the Ministry of Commerce, the National Development and Reform Commission and the Ministry of Industry and Information Technology. In our post of last June 15, we noted that Chinese regulators could have a significant role in the purchase.

There also are questions as to what U.S. regulatory approvals may be required. Reuters reports that approvals from U.S. regulators are required, but doesn’t specify which regulators. Although far reduced in size from the original $500 million estimate, the $150 million price exceeds the minimum size for filing with the antitrust regulators in the Department of Justice and the Federal Trade Commission. There seem to be few tangible assets changing hands – no plants, no real estate, no equipment. The reports suggest that only intangibles are being bought and sold. Therefore, the key question becomes whether the parties have obligated themselves to make a voluntary filing with CFIUS. In posts earlier this year, we raised the question of whether sales of U.S.-based automotive businesses to offshore buyers would trigger review under the Foreign Investment and National Security Act of 2007 (FINSA). Review under that statute could interpose a 30-day review period plus an additional 45-day period if an investigation is warranted. The descriptions of the deal, structured as the purchase and sale of intellectual property whose value lies in the marketing of the product and certain manufacturing rights, suggests that the parties have taken reasonable steps to minimize those factors that could lead to an adverse regulatory outcome.

It even is possible that GM, Tengzhong and their advisors are so confident of their structure that they will elect not to make the filing with CFIUS which, after all, is voluntary. The deal apparently has provisions that will save 3,000 U.S. jobs through 2011. It may be unlikely that a U.S. regulatory body will risk adding those workers to the already sizeable portion of the workforce that is unemployed. Although there could be regulatory risk, it may not be high for GM. CFIUS could, however, have an interest in fully analyzing the ownership and business relationships of Tengzhong and its 20% partner, Suolang Duoji, to determine whether there could be control by the PRC government.

GM has not yet filed the definitive agreement with the Securities and Exchange Commission. Under SEC rules it has until later the week to file the agreement if it is “material” agreement. Once filed, a review of the agreement should disclose whether the parties will make their voluntary CFIUS filing. 

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September produced two transactions worthy of comments because of CFIUS’ role.

Last July gold mining company Firstgold Corp. of Lovelock, Nevada, announced that it had entered into a binding agreement with a new investor, Northwest Non-Ferrous International Investment Company Limited of Xi’an, China, located in Shanxi province (northern central China). Firstgold is a development stage company with total assets of $19.8 million and a net worth of $5.0 million according to its last annual report filed with the SEC for its year ended January 31, 2009. Its financials are subject to a going concern qualification. Firstgold has been caught up in litigation with two holders of senior secured promissory notes. Northwest agreed to acquire those notes, lend an additional $5.5 million to Firstgold and buy shares representing 51% of the company’s equity, making Northwest both the parent and senior lender to Firstgold. The July announcement stated that the proposed transaction was subject to obtaining all required governmental and regulatory approvals. The deal documentation did not specify Committee on Foreign Investment in the United States (CFIUS) approval, only “regulatory approvals” generally.

Flash forward to September 21, when Firstgold announces that it and Northwest have agreed to extend the time to close their transactions until December 1, 2009. Firstgold’s September 21 press release suggests that Northwest had determined in the interim that it was advisable or necessary for it to file a voluntary notice with CFIUS. In the release, Firstgold takes the position that the CFIUS notice “will not prove to be an obstacle to our closing the transactions we have previously announced.” No doubt it would have been even less of an obstacle if filed in July or August. 

The filing could prove to be more complex than Firstgold believes. CFIUS review of Chinese purchasers tends to be quite exhaustive, particularly on the point of any connections between the purchaser, its board of directors and its principal shareholders and the PRC government. Chinese language submissions are not allowed.

There is a larger question that the Firstgold/Northwest deal raises. Does the U.S. really need CFIUS review for a company that is relatively small and financially weak? Why did Congress not provide a small reporting company-type exemption from FINSA’s notice scheme? Given the scarcity of risk capital in current markets for development stage companies, wouldn’t the U.S. be better served if there were thresholds for U.S. targets before FINSA review is required? 

Updated October 12, 2009--  On October 7 Firstgold updated investors on the status of its proposed refinancing transaction.  Firstgold has made filings with the Ontario Securities Commission so that trading of its stock could resume.  With respect to CFIUS review, the company said that it expects by late October or early November to receive notice from CFIUS that the ongoing review under FINSA is complete and that no further action will be taken.

The New York Times Dealbook blog commented on the September 16 announcement by Chemring Group PLC that it had agreed to acquire aerospace company Hi-Shear Technology for $132,000,000. Hi-Shear is a defense business based in Torrance, California, while Chemring is an English company. The Dealbook blog voices a concern that the parties to the deal have not committed outright to pursue CFIUS and other regulatory approvals. The post points to language in the merger agreement for the proposed deal that requires the parties only to use “reasonable best efforts” to close. But in the following sentence, the agreement requires the parties “to make appropriate filings” under what it refers to as Exxon-Florio. The Foreign Investment and National Security Act of 2007 (FINSA) replaced Exxon-Florio in late 2007. There is a specific provision in the merger agreement that elaborates on the allocation of responsibilities for the parties to file their notice with CFIUS and also sets a timetable. The agreement also specifies a process for the required submission to be made under the International Traffic in Arms Regulations. Receipt of a notice from CFIUS stating that there are no national security concerns or that the CFIUS service has been completed without further investigation is an express condition to completion of the deal. The commentary in Dealbook seems misplaced. Compared with similar language in other merger agreements, the language in the Chemring deal is quite clear and well-drafted.

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Forget about Dubai Ports, forget about Huawei Technologies. There is a new crisis boiling over in foreign direct investment. A Russian billionaire may become the owner of a dearly beloved, U.S. professional basketball team and acquire a controlling interest in the team’s proposed arena in New York City.

On Wednesday of this week, the New Jersey Nets announced that, pending approval from the owners of other National Basketball Association teams and subject to a favorable outcome of litigation surrounding the construction of its new arena, Mikhail Prokhorov’s Onexim Group has agreed in principle to invest $200 million to acquire an 80% interest in the team, a 45% interest in the team’s unbuilt sports arena and the right to acquire a 20% stake in Atlantic Yards, the adjacent real estate project being developed by the team’s current owner, Forest City Ratner Companies. According to the release, the deal will ensure the completion of the proposed Brooklyn, NY-based arena, the relocation of the Nets to Brooklyn and the completion of Atlantic Yards. The tentative date for closing the deal is the first quarter of 2010. 

Mikhail Prokhorev is a high-profile, self-made Russian investor. Many blogs, including Keith Gessen of The New Yorker and Ethan Trex of Mental Floss, catalogue his controversial history. His six-foot-seven height and the fact that he has played basketball make Mr. Prokhorev one of those figures that invite focused interest, even if past media coverage wasn’t enough. And there is the matter of his reported $9.5 billion net worth, making him Russia’s richest man. In his statement, Mr. Prokhorev said, “I have a long-standing passion for basketball and pursuing interests that forward the development of the sport in Russia.”

Forest City’s Bruce Ratner added his own rationale for the deal, stating that he was thrilled that ”[S]mart global investors appreciate the exciting economic potential of Brooklyn. We are one step closer to achieving our goals of creating much needed jobs and economic development for Brooklyn and the city.”

Notwithstanding the promised benefits of the agreement, critics were quick to attack. NoLandGrab, a local opposition group, argues that there must be shady side deals that were undisclosed. Develop Don’t Destroy Brooklyn is adamantly opposed as well, asking

Putting aside legal questions, what are the ethics and policy principles of subsidizing the 40th richest man in the world with city, local and federal financial gifts, as well as a highly controversial use of eminent domain?

The New York Observer reports that Congressman Bill Pascrell Jr., who represents a district that is adjacent to the Arena where the Nets now play, has asked the NBA Commissioner to investigate the deal. Mr. Pascrell has raised questions about a foreign corporation’s benefiting from tax incentives being employed to support the arena. 

So all the elements now are in place for another epic battle over FDI. What will play out here—in the cosmopolitan metropolis of New York, in the legendary Borough of Brooklyn—is the same drama that unfolds in many American towns and villages when the concept of FDI materializes into the real-life acquisition of a local treasure. The forced migration of a sports team is almost always a deep and searing wound. Thousands of fans still mourn the losses of the New York Giants and the Brooklyn Dodgers to California, even though they happened 50 years ago.

The questions proliferate. Will the players or coaches be Russian? If they buy this franchise, will they buy others? Will Americans lose their jobs, even though they are high-paying jobs that most Americans can only dream of? Will foreign ownership change basketball, even though the team in question has never achieved a spectacular record? Will America lose control over one of its institutions, now treasured more in the anticipation of loss than ever before? Arguing that foreigners will benefit somehow from U.S. tax benefits is usually a start to a “we/they” analysis of the situation. Ultimately, someone will ask whether there can be some adverse affect on our national security? 

It’s a good bet that somewhere someone is toiling away, trying to figure out how review by the Committee on Foreign Investment in the United States (CFIUS) can be invoked. Forest City’s hometown paper, The Cleveland Leader, is already advocating that CFIUS must review the deal. 

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Developments in corporate restructurings suggest that the Foreign Investment and National Security Act of 2007 (FINSA) may soon become a factor in debt/equity swaps. As U.S. companies in the telecommunications, defense and other national security-related businesses encounter difficulty in refinancing their debt and seek out-of-court workouts with foreign bank lenders or offshore hedge funds, FINSA’s regulations may apply and could impede those settlements.

The Wall Street Journal reported on September 19 that as a result of the credit crisis, lenders are taking sizable equity stakes of companies that borrowed from them and now must restructure their debt. These lenders are confronting the issues raised by Federal limits on ownership of media businesses in conjunction with equity-for-debt swaps transacted with radio, TV and newspaper companies in distress. The FCC rules have made restructurings more complex. The FCC must approve changes in ownership for a broad range of media businesses. FCC rules limit ownership of multiple media outlets in different markets and apply to all persons, regardless of nationality. But for foreign hedge funds and other foreign lenders, there is an additional set of issues. Federal law also fixes caps on equity ownership of broadcasters by foreign entities. The application of these rules has made restructuring far more difficult to achieve because it limits the amount of equity that can be swapped for debt.

There is a parallel to FINSA and its rules. FINSA applies to transactions between U.S. businesses and foreign entities that acquire control of the U.S. entity. In that case, the parties may file a voluntary notice with the Committee on Foreign Investment in the United States (CFIUS). To determine whether U.S. national security might be impaired as a result of the change in control of the U.S. business, the filing leads to a review process and, in some cases, an investigation and, even more remotely, Presidential review. If CFIUS does not object to the transaction or require that the parties enter into a mitigation agreement with it, then the transaction can proceed and further review is precluded. If the parties do not file a notice and comply with requests for information from CFIUS, then CFIUS can later unilaterally review and investigate the transaction and, in an admittedly extreme case, order divestment. 

Where might these issues arise? The fact pattern would involve:

• A U.S.-based company operating in an industry which is relevant to U.S. national security -- examples include, mineral extraction, energy, defense, telecommunications and certain manufacturers of highly engineered products
• A foreign lender -- traditional or otherwise, including hedge funds -- that now finds that it has little choice other than to take an equity stake
• The equity stake issued in exchange for the debt exceeds 10% of the voting equity of the business on an after-issued basis or has other rights, such as board membership, that give the lender a role in the management or operation of the business

The presence of other factors would exacerbate CFIUS concerns:

• One or more of the lenders is controlled by a foreign government -- as a result of the financial turmoil of the last several years, these categories include all of those bank lenders which, although formerly private, have since been nationalized
• The foreign lenders or offshore funds taking the equity enter into agreements with each other for the operation or management of the U.S. business

Under the FINSA statute, CFIUS has an unlimited period of time to look back and order reviews of previously completed transactions. Therefore, if an offshore lender’s strategy is to restructure today with a debt-for-equity swap and then sell the equity to a buyer -- U.S.-based or foreign -- in a year or two, a background legal issue may appear: Do the sellers have full, indefeasible legal title to the shares they are seeking to sell? Will their buyer in turn become sensitive to the possibility -- however remote -- that a CFIUS investigation may materialize in the future if a competitor brings the absence of a filed notice to the attention of CFIUS? Or if a voter brings the issue to the attention of a Congressperson who in turn will pressure CFIUS?

This chain of events may be far-fetched. But the provisions of FINSA and its regulations make this outcome possible, whether or not likely. Foreign lenders and their advisors may well have no choice but to consider the applicability of these requirements.

L. Elise Dieterich, a partner in the Washington, D.C. office of Sullivan & Worcester LLP, contributed to this post.

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China’s outbound foreign investment strategy continues to make news. TheStreet.com and other business media reported today reported yesterday that China Investment Corp. (CIC), China’s sovereign wealth fund with approximately $300 billion in assets, may be discussing an investment into, or joint venture with, The AES Corporation of Arlington, Virginia. AES operates electrical generating facilities and distribution systems across the globe, has more 25,000 employees and a market capitalization of $9.8 billion. Reuters has reported that last week a senior CIC official said that CIC is seeking minority investments in infrastructure projects as well as green energy projects. 

To view these media reports in proper context, it may be well to review a few basic facts about China’s current outbound foreign direct investment (OFDI) program, as reported by Xinhuanet on September 8. Xinhuanet based its story on a report jointly issued by China’s Ministry of Commerce, the National Bureau of Statistics and the State Administration of Foreign Exchange that same day.

• China’s OFDI added up to US$183.97 billion by the end of 2008. 
• The source of China’s OFDI is more than 8,500 domestic investors, whose overseas corporate assets in 2008 exceeded US$1 trillion. 
• Chinese overseas enterprises employed about 1.03 million people, including 455,000 overseas employees.
• China’s net OFDI in 2008 was US$55.91 billion, an increase of 111% from 2007.
• Chinese investors have established approximately 12,000 enterprises overseas in 174 countries or regions. Approximately 71% of these enterprises were in Asia and Europe.
• Among Chinese outbound investors, 50.2% were limited companies, 16.1% were state-owned enterprises and 9.4% were private companies. 
• Investment by state-owned companies declined 3.6% from 2007.

Australia is a key target for China’s OFDI, because of that continent’s abundant raw materials and other material resources. Xinhuanet also reported that Australia is seeking to attract increased amounts of Chinese investment and deepen their bilateral economic cooperation, especially in the energy and natural resource sectors. The senior trade commissioner of the Australian Trade Commission confirmed Australia’s intentions at a international trade forum held in coastal Xiamen, Fujian Province, on September 8. 

Data from Australia’s foreign review board show that Chinese investment interest in Australia is on a strong upward trend. Even so, at the end of 2008, China’s total investment stock in Australia was only $6.83 billion, and represented an increase of 26.7% from the position at the end of 2007. With this significant increase, China ranked as Australia’s 13^th largest foreign investor.

China’s surge in OFDI may be rooted in its internal $585 billion recession-fighting stimulus package. That package represented 13.2% of China’s gross domestic product for 2008. During Q1 of 2009, Chinese state-owned banks increased their lending by more than one trillion dollars, or more than half of the national GDP on an annualized basis. According to published reports, over half of the new loans went into China’s stock and property markets, generating speculation-driven increases in prices. The remainder went into the Chinese economy and is likely to be doubt a substantial factor driving China’s OFDI. Recognizing that increased China OFDI may be more than desirable for generating and maintaining its economic recovery, Australia’s recently revised foreign investment rules raised the dollar threshold for investments that require regulatory review. The change is expected to result in an increase in the number of Chinese investments in smaller Australian natural resource and energy companies. According to the Australian trade official referenced above, Chinese investment has not harmed Australia’s economic security and has enhanced the reputations of the investors. 

The U.S. is on a slower path with China. It is possible that if the AES discussions mature into a deal and if CFIUS and other regulatory review supports the deal, the pace of China’s OFDI into the United States will accelerate. Adverse regulatory responses will likely have a dampening effect when this country can least needs it. 

Updated: On September 16, in a follow-up article, Xinhuanet reported that, according to China’s Ministry of Commerce, OFDI by China's 136 centrally-administered state-owned enterprises (SOEs) in 2008 was $35.74 billion.  The investment accounted for 64% of China's total OFDI for the year.   This appears to be a significantly larger share than had been previously reported.

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 A new publication by Theodore Moran of the Peterson Institute for International Economics addresses what it considers to be the two most important questions relating to the screening of inbound investment. Entitled “Three Threats: An Analytical Framework for the CFIUS Process,” Moran’s work responds to

• Under what circumstances might the foreign acquisition of a U.S. company constitute a genuine national security threat to the U.S.?
• How should CFIUS assess the risks and threats so as to separate what is serious from what is not?

According to a policy brief that summarizes the publication, as a platform for his analytical model, Moran sets out three categories of threats that might arise from inbound acquisitions:

1. that a foreign-controlled supplier will deny goods or services to U.S. consumers
2. that a foreign-controlled entity will access U.S. technology or expertise previously not available to it
3. that the acquisition will be a means for infiltration, surveillance or sabotage in the U.S.

To analyze these threats properly, argues Moran, CFIUS must understand the “criticality” of the goods or services that the target provides, combined with a second-level assessment of whether alternative suppliers are available and how easily consumers can switch from one supplier to another. 

Moran reviews several of the most high-profile CFIUS involvements of the past 8 years and concludes that most inbound acquisitions pose no credible threat to national security. 

For professionals whose work involves inbound M&A, this publication is essential reading.

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A comment to this blog received last month questioned whether regulatory screening of inbound mergers and acquisitions by the United States conflicts with U.S. bilateral investment treaties (BITs).

BITs generally promise that the host country will treat all inbound investors equally with investors from the host country. The rationale is clear -- based on the treaty provisions FDI will flow into the host country and will be protected. BITs promise investors fair and equitable treatment for their investments, equal treatment with the host’s own nationals and “most favored nation” treatment, as well as a guarantee of full compensation should appropriation occur. BITs also establish an agreed-on tribunal for resolving disputes under the treaty.

The objective of BITs is to generate FDI. The general model of BIT currently used by the U.S. extends equal treatment with U.S. investors not only to businesses once established but also to the period prior to the actual creation of the investment, that is, while there is an agreement to acquire or invest. On the other hand, the purpose of a regulatory screening regime, such as the Committee on Foreign Investment in the United States (CFIUS), is to filter inbound mergers and investments so that foreign ownership does not impair the ability of the U.S. to defend itself. The policy is rooted in national security, not economic security or the protection of U.S.-based businesses against external competition. CFIUS implements its policy during the pre-investment phase.

The resolution to this apparent conflict between policies and the answer to our commenter’s question is found in the BIT itself. The current U.S. model form has the following provision, entitled “Essential Security,” that describes certain “Non-Precluded Measures” that the treaty permits the U.S. or the other treaty party to take:

Nothing in this Treaty shall be construed . . . to preclude a Party from applying measures that it considers necessary for the fulfillment of its obligations with respect to the maintenance or restoration of international peace or security, or the protection of its own essential security interests.

In laymen’s terms, as long as the CFIUS review is undertaken to protect essential security interests, it trumps the BIT’s provisions.

A few interesting facts about BITs, all extracted from a comprehensive and detailed overview of the topic authored by Lisa E. Sachs and Karl P. Sauvant of the Vale Columbia Center on Sustainable International Investment:

• the number of BITs worldwide have literally exploded over the past half century from one in 1959 to 2,573 in 2006, with more than 2,000 of these having been signed since 1989
• by the end of 2006, 177 countries had entered into one or more BITs
•  the economies with the most BITs are Germany (135), China (119) and Switzerland (114)
• the U.S. is not listed among the 10 countries who are parties to the greatest number of BITs, although it is the country that has entered into the greatest number (148) of double taxation treaties

The Sachs/Sauvant overview is essential and interesting reading for anyone seeking an informed perspective on the interplay BITs and FDI.

Thanks to my partner Jim Silkenat for his assistance in preparing this post.

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Observers of the FDI scene might have come to believe that China’s outbound foreign direct investment (OFDI) program would be unequivocally welcome for its global stimulus effect.  A recent editorial in the Financial Times initially concedes that China’s investment strategy will benefit both Europe and the investing companies. It then asserts a contradictory view.

In a piece decidedly protectionist, two Dutch researchers assert that Europe needs to screen Chinese investment. 

The main issue is not the Chinese taking over European companies of great strategic importance; it is how to respond to the longer-term accumulation of economic power in Europe by a country such as China. 

The writers suggest that the EU emulate the U.S. and establish a regulatory body similar to CFIUS with jurisdiction over all of its member nations. The union-wide solution is necessary to prevent Chinese investors from playing one country against another, say the authors. The editorial then raises the Trojan Horse rationale for regulation:

What has already caused anxiety in some European countries, particularly Germany and France, is the fact that the leading Chinese companies, banks and investment funds are state-controlled. Because Europeans regard China’s autocratic political system as incompatible with their own democratic norms, the growth of Chinese influence in European companies is a highly sensitive issue.

An effective, non-politicized regulatory body that screens solely for issues of national security, and not broader issues of economic security, may or may not be beneficial to the EU. Conjuring up threats of stealth investment by Chinese state-owned enterprises is not likely to lead to a dispassionate, reasoned evaluation of the proposal. There is also the equally important question of how to insure that a regulatory screening body chartered to protect national security does not morph into a Trojan Horse for wider nationalist or protectionist agendas. 

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The Committee on Foreign Investment in the United States (CFIUS) figured prominently in the high level discussions held last week in Washington between representatives of the People’s Republic of China and the U.S. government.

According to the “The First U.S.-China Strategic and Economic Dialogue Economic Track Joint Fact Sheet,” the U.S. committed unequivocally that the CFIUS screening process would be non-discriminatory:

In addition, the United States confirms that the Committee on Foreign Investment in the United States (CFIUS) process ensures the consistent and fair treatment of all foreign investment without prejudice to the place of origin. The U.S. reaffirms its commitment to the open and non-discriminatory principles for recipients of sovereign wealth fund investment as identified by the Organization for Economic Cooperation and Development.

Two days of meetings were held among U.S. Secretary of State Hilary Rodham Clinton and U.S. Secretary of the Treasury Tim Geithner, as special representatives of President Obama, and Chinese Vice Premier Wang Qishan and State Councilor Dai Bingguo, as special representatives of President Hu Jintao.

Underscoring the importance of the meetings to the U.S. economy, President Obama addressed the opening session of the Dialogue. Twelve U.S. cabinet secretaries and heads of executive agencies also attended. The Fool’s Mountain blog carries an extended excerpt from the President’s address. There is no question but that the White House is taking substantive steps to acknowledge the importance of China’s investor status to the improvement of the U.S. economy.

Secretary Geithner’s closing statement, released on July 28, reflected the high profile that CFIUS has in these discussions. He reaffirmed U.S. commitments “to open and rules-based trade and investment” and to avoiding protectionist measures. In return, China agreed to increase its thresholds for “foreign direct investments that must obtain central government approval.” The accompanying release clarifies that China’s commitment means less regulation of inbound investment into China, particularly by its opening service markets to private investment.

The Administration seems determined to confront and allay the misgivings that Chinese investors and businesses have about the U.S. regulatory screening process. The prior experiences of Huawei Technologies and CNOOC are often cited to substantiate doubts, without equal time given to those transactions that proceeded without incident. In the conventional view of Chinese investors and businesses, any overall effort to increase investment from China requires clarity from CFIUS as to what U.S. industries, if any, are off limits. Congress has given CFIUS the gatekeeper role for inbound FDI. To keep CFIUS as far away from politics as possible, CFIUS must keep its profile low, remain nimble in its dealings and maintain intact its process for dealing with filed notices on a case-by-case basis. Pronouncements that characterize specific industries as in bounds or out of bounds will only attract the degree of attention that has been hostile to FDI in the past. Although foreign investors may genuinely desire more definitive guidance, that guidance may be better obtained from experienced U.S. advisors rather than backing CFIUS into unwelcome positions.

The net result of the meeting and the dialogue may well be that offshore buyers and investors — Chinese and other — see their way clear to proceeding with U.S.-targeted deals. This will be welcome news for private equity, venture and buyout funds with portfolio companies in need of cash. It will also be welcome news for M&A advisory firms, especially those who have built relationships in the developing world.

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The Foreign Investment and National Security Act of 2007 (FINSA) and its regulations are intended to strike a balance between the opportunities and threats associated with inbound investment into the United States. The regulatory structure for addressing the conflicts often created by inbound investments is review by the Committee on Foreign Investment in the United States (CFIUS), and its approval or disapproval of acquisitions and investments that might harm genuine U.S. interests.

For example, if a foreign nation with intent inimical to the United States were to acquire a high-tech business whose products were, or had the potential to be, essential for the critical functioning of large portions of the U.S. economy, the regulators would scrutinize the risks arising from the transaction. If necessary, the regulators would impose conditions to mitigate those risks or perhaps even block the transaction. Because it is based on national security grounds rather than economic security grounds, the system is designed to be less susceptible to undue political influence. 

A reasonably designed system would also designate a class of transactions between a foreign buyer and a U.S. target that need not be scrutinized. One reason for doing so would be that certain transactions as a class present low risks to U.S. national security. Therefore the costs of review far outweigh possible benefits. Similarly, the efficient and timely functioning of the regulator may require that fewer than all transactions be reviewed. In defining the class of transactions that is except from the system, legislators often use quantitative, rather than principle-based, measures. So, for example, review by CFIUS does not reach investments of less than 10% of outstanding voting stock of a U.S. business if the investment is passively held. The exemptive rule applies both to an initial investment in a U.S. business and to subsequent transfers that the investor may make to foreign persons. The rule applies to transfers made by the transferee and by any subsequent transferee as well.

The exemption, however reasonable, can lead to questionable results. For example, after a recent transaction Aabar Investment PJSC of Abu Dhabi has now come to own approximately 4% of Tesla Motors Inc. of San Carlos, California. Tesla is perhaps the most advanced developer of commercial all-electric cars in the United States. Aabar is an investment company whose largest stakeholder is the International Petroleum Investment Company, which in turn is wholly-owned by the Government of the Emirate of Abu Dhabi. Aabar’s shares also trade on the Abu Dhabu Securities Exchange. Aabar acquired its interest in Tesla from Daimler, AG, based in Stuttgart, Germany. Daimler had acquired an interest of slightly less than 10% in March of this year in exchange for an infusion of $50 million into Tesla. Aabar holds 9.1% of Daimler, making it Daimler’s largest shareholder. According to the blog earth2tech, Daimler never intended to keep the full investment for long. Daimler and Tesla apparently tried to make the original investment jointly, but terms could not be fully worked out between them in March.

There is no indication that either Daimler’s original investment or its resale to Aabar underwent CFIUS scrutiny, even though Aabar is a government-controlled entity. Both seem to have relied on the exemption for acquisitions of less than 10% of shares. 

Now to engage in a law school-styled hypothetical. What if the participants were other than Daimler or Aabar? Suppose the shares wound up in the hands of a nefarious investor who intended to use its position to retard Tesla’s technology or to put it in the hands of an ill-willed competitor. As noted above, reasonable standards for exemption may be necessary to prevent bureaucratic overreach. Reasonable standards can, however, morph into a pathway for circumvention. 

Tesla has presumably protected its own interests. It may have retained the ability to approve or limit transfers and subsequent transfers of its shares. It may have restricted by contract its obligation to share its technology with stockholders. It may have imposed legal limitations on the ability for any investor who has access to its technology to use or transfer it. These protections are normal and sound, as long that the company has the bargaining power to obtain them while negotiating the deal with its prospective investors.

As a final note, there must be something about the name Tesla that attracts the possibility of bad acts. Nikola Tesla was a Serb-American physicist and electrical engineer, inventor of the radio and the electric motor and generator. He is regarded as one of the major forces in the development of commercial electricity. Although famous in his day, Tesla became embroiled in disputes with Marconi others about his intellectual property. No doubt the responsible executives at Tesla Motors are aware of the burden of history.   

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Earlier this month the U.S. State Department clarified its position on the importance of inbound foreign direct investment (FDI) to the U.S. economy. State released a fact sheet on July 1 entitled "The State Department, Open Investment, and American Jobs."  The fact sheet underscores the importance of FDI to economic growth and job creation in the U.S.

The fact sheet credits the Committee on Foreign Investment in the United States (CFIUS) with concluding action on over 150 transactions in 2008. This represents an increase of at least 9% over the 138 transactions that CFIUS reviewed in 2007. Of the 2008 transactions, 92% were mergers and acquisitions of U.S. businesses. The balance was likely to have been joint ventures or loan transactions. The State Department points out that, as a result of its membership on CFIUS, it has a direct role in the rulings that the panel makes.

Without doubt, inbound acquisitions and investments are quantitatively significant. In 2006, U.S. inbound FDI totaled $236.7 billion, or 1.8% of GDP. U.S. affiliates of foreign firms spent $395.8 billion on U.S. payrolls and $34.3 billion on U.S. R&D.

Because of these direct economic effects, the State Department wants its message to be crystal clear:

The United States has a significant stake, as both the world’s largest source and recipient of foreign direct investment, in working with our economic partners both multilaterally and bilaterally to implement policies that facilitate global investment flows.

State’s pronouncements and their forceful delivery add to the expectation that inbound FDI will assist in pulling the U.S. economy out of its current slump.

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A lawsuit that could have determined whether a filing made with CFIUS can be considered customary has ended. In May 2009, husband and wife Joseph and Judy Ehrenreich sued 3Com Corporation for damages they allegedly suffered from the loss in value of their 3Com shares. The case was brought under the provision of the federal securities laws that enables purchasers of stock to recover losses arising out of incorrect or incomplete statements made by the issuer of the shares. 3Com is a Massachusetts-based enterprise networking solutions provider.

The Ehrenreichs claimed that the cause of their loss was 3Com’s failure to specify that CFIUS review of its proposed merger with affiliates of Bain Capital was a significant risk. 3Com had published a press release announcing the proposed merger on September 28, 2007. The press release stated that the merger was subject to “customary regulatory approvals.” CFIUS review was not mentioned. The plaintiffs purchased 13,000 shares of 3Com stock after the announcement of the proposed merger.

The basis of the plaintiff’s case was that the proposed merger did truly raise serious national security concerns and that, as a result, CFIUS review was not customary. The plaintiffs interpreted “customary” to mean perfunctory or ministerial. The aspect of the merger that triggered CFIUS review was that, as part of the transaction, affiliates of China’s largest network equipment company, Huawei Technologies, were to acquire an interest in 3Com. Press reports associated Huawei with China’s military and possible links to Chinese cyber warfare efforts against the U.S. and the U.S. military. Although 3Com disclosed on October 4, 2007 that it intended to make a CFIUS filing, the plaintiffs contended that 3Com’s announcement omitted the reasons for seeking the review and downplayed the risk that CFIUS could block the transaction. Five months later, 3Com withdrew its CFIUS filing. One month later, the parties terminated their merger. The announced reason was that CFIUS intended to prohibit the deal. The price of 3Com stock plummeted from its level at the time of the original announcement.

The complaint claims that the peculiar structure of FINSA – its voluntary and not mandatory filing requirement -- gives parties an incentive not to mention the possibility of CFIUS review. It suggests that parties might try to “fly under the radar screen” and not provoke public reaction to a deal.

We will not know from this case whether 3Com’s initial failure to specify CFIUS review and the basis on which CFIUS could review the transaction was an incorrect or incomplete statement. The plaintiffs voluntarily withdrew on June 30, dismissing their case with prejudice. A settlement may have occurred. Even if abandoned at this stage, the case stands as a warning to parties contemplating a CFIUS filing. When communicating to the markets, it’s best to say more about the likelihood of a CFIUS review rather than less. Parties now are on notice that CFIUS review may be more than perfunctory. It’s safer to make that clear if the review leads to an unexpected end to the deal.

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 June produced a few more noteworthy green shoots for inbound deals.

In a strategic transaction announced at the beginning of the month, Taiwan-based Prime View International is acquiring Cambridge, Massachusetts-based E Ink Corporation for approximately $215 million. Prime View develops, manufactures and sells thin-film transistor liquid crystal display (TFT-LCD) products. Shares of Prime View are traded on the Taiwan stock exchange. E Ink is the leading supplier of electronic paper display (EPD) technologies and is privately-held. The transaction is subject to shareholder and regulatory approval and is expected to close in the fourth quarter of 2009. CFIUS approval is not  specified.  The Pulse 2 blog reports that Prime View and E Ink have been partners since 2006, and that together they have supported about 20 e-book manufacturing companies worldwide. 

On June 16, Calgary-based TransCanada Corporation announced that it had reached an agreement to buy the remaining interest of Houston-based ConocoPhillips in the Keystone Pipeline System. Now under construction, Keystone will be one of the largest oil delivery systems in North America, extending through the upper Midwest to Illinois and Oklahoma. TransCanada will pay approximately $550 million, and assume both $220 million of short-term debt and ConocoPhillips’ obligation to fund its share of the capital investment to complete the project, valued at approximately $1.7 billion. The transaction is expected to close in the third quarter of 2009, subject to regulatory approvals. CFIUS approval is not specified. 

On June 23, Atlanta-based Office Depot sold a significant equity position to funds advised by BC Partners, the London-based international private equity firm, raising $350 million. The equity stake represents a 20% interest in the U.S. company, assuming full conversion of shares. Three executives named by the investors will join the board of Office Depot.

On June 25, Arcadis NV announced that it planned to acquire privately-held Malcolm Pirnie Inc., a water-services company based in White Plains New York, for $222 million in cash and stock. Malcolm Pirnie provides engineering and consulting services to states and cities in the United States. Arcadis, with over 13,500 employees worldwide, is based in Arnheim, Netherlands, and provides consultancy, engineering and management services worldwide. According to Mergers Unleashed, the shares being issued in the transaction were valued based on the closing stock price for shares of Arcadis of $14.981 on June 24. The Dealbook blog reports, “The deal, expected to be completed next month, will improve Arcadis’s position in the United States, and in the water services business worldwide.” Dealbook also reports that the deal will afford Arcadis access to investments in U.S. infrastructure by municipal governments. It is possible that access to infrastructure might lead the parties to seek CFIUS review, but there is no confirmation on that point.

We look forward to reporting what transactions July brings. With better weather, and a little less rain here on the east coast of the U.S., the shoots may become more of a lawn. 

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A Primer for the U.S. Business on the Required Information for the CFIUS Filing

A previous post described what the foreign party needs to disclose in its filing to the Committee on Foreign Investment in the United States, or CFIUS, when it wants to merge with, acquire or otherwise take over a U.S. business. Today’s post summarizes the information required from the U.S. business.

From the perspective of the U.S. business, the filing should provide a thorough presentation of those aspects of its business and operation that could raise what CFIUS deems to be national security considerations. In the case of the acquisition of some, but not all, of the assets of an entity, the U.S. business is to provide the requested information only with respect to those of its assets that have been or are proposed to be acquired. In all events, the notice that the U.S. business files should cover six general areas:

1.         What’s your business? The U.S. business must describe its business activities, including:

•  product and service categories;
• market share estimates;
• a list of direct competitors; and
• the address of facilities manufacturing certain products or services. 

2.         Really, what’s your business? The U.S. business must further respond to detailed questions regarding its business operations and critical technologies (as defined by FINSA) that it owns or licenses. If the U.S. business responds affirmatively to any of those questions, it also must provide additional disclosures. The questions include whether the U.S. business:

• supplies products or services to the U.S. government and whether it is the single qualified source for those products or services;
• manufactures or provides services for other parties that it knows are rebranded by the purchaser or incorporated into the products of another entity;
• produces products or provides services subject to various defense-related statutes or regulations;
• holds other licenses, permits or authorizations from the U.S. government; and
• has any technology with military applications.

3.         Have You Any Government Contracts? The U.S. business must state whether it:

• is or has been a party to contracts with the U.S. government involving classified information or technology or with agencies with responsibility for national defense, homeland security or other aspects of national security; and
• is or has been a party to any priority-rated contracts or orders under the Defense Priorities and Allocations System (DPAS regulations).

These questions require information going back three years in some cases and five years in others.

4.         What’s the CyberPlan? CFIUS requires that the U.S. business indicate whether it has a cyber-security plan. If so, it must attach a copy of the plan.

5.         Attach your Reports. The U.S. business must attach its most recent annual report. If the financial results of the U.S. business that is the target are consolidated with the results of its parent, the report of the parent may, in some cases, be sufficient. If the U.S. business does not prepare an annual report and its results are not included elsewhere, the filing need only include the business’s most recent audited financial statements. If there is none, then the business must attach its most recent unaudited financial statements.

6.         Jointly Presented Information. The CFIUS regulations require that, except for a hostile takeover, the U.S. business and all other parties to the covered transaction must disclose certain information, which is best accomplished when all parties file one notice. The information includes:

• general identifying information about the parties, and their parent entities;
• a description of the transaction in sufficient degree to permit CFIUS to determine whether the transaction’s structure brings it within the definition of “transaction” for purposes of its regulations;
• the anticipated completion date;
• the approximate value of the transaction;
• the identities of all financial advisors, underwriters and financing sources for the transaction; and
• the history of prior dealings between the parties and CFIUS, including whether any party is or has been a party to a prior mitigation agreement with CFIUS.

Of course, the descriptions of the six items above are summaries only. Reference should be made to the CFIUS regulations for the complete and definitive requirements. The assistance of a competent legal advisor in responding to these requirements is recommended.

More complete information about the filing can be found in our white paper, “Complying with the Voluntary Review Process When Investing in or Acquiring a U.S. Business.”

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The Obama administration has formally appointed Mark Jaskowiak, the acting head of the agency since last July, to be the staff chairperson of CFIUS.  According to an article by Roxana Tiron and Silla Brush appearing earlier today in The Hill, Mr. Jaskowiak will become the Treasury Department's Deputy Assistant Secretary for Investment Security.  The Treasury Department is the lead agency in inter-agency CFIUS. 

The Hill gave additional details on Jaskowiak's resume:

Jaskowiak is a former legislative aide to Sen. Charles Schumer (D-N.Y.), a critic of the Dubai Ports deal who also played a role in efforts to reform CFIUS in the wake of the controversy. Jaskowiak also served previously as director of the Office of Multilateral Development Banks.
 

The Hill quoted Nancy McLernon, the president and CEO of the Organization for International Investment, a business association whose members are U.S. subsidiaries of foreign firms.  Ms. McLernon's statement supported Mr. Jaskowiak's appointment. 

The staff chairperson's mandate is to manage the Treasury's role in CFIUS and to provide reports to Congressional leadership and members of Congressional committees on its activities.

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Inbound investments into the United States by sovereign wealth funds (SWF’s) were the subject of a second report issued last month by the Government Accountability Office (GAO). Last September GAO released a report describing data that was available on the size and investments of SWF’s in the United States. Both reports responded to questions that members of the Senate Committee on Banking, Housing and Urban Affairs had raised about the increasing investment activities of SWF's. The May report examines U.S. laws that specifically affect foreign investment and the processes that U.S. agencies use to enforce these laws. The report found that no laws targeted only SWF’s. It’s a important resource for any advisor or principal looking for a survey of the regulation of foreign investment. 

The Harvard Law School Forum on Corporate Governance and Financial Regulation contains a good summary of the report, authored by Jeff Trinklein, in particular that part of the report that catalogues the applicable laws:

Before proposing a transaction involving a U.S. asset, the GAO suggests that foreign investors should be aware of four different areas of focus.

1. CFIUS Review. The Foreign Investment and National Security Act of 2007, an amendment of the Defense Production Act of 1950, provides that any foreign acquisition, merger, or takeover of a U.S. business is subject to a review by the Committee on Foreign Investment in the United States (CFIUS), if the proposed transaction could potentially impair U.S. national security interests. The review is intended to determine if the proposed investment presents serious national security concerns, and if so, CFIUS can enter into an agreement that will impose conditions in order to mitigate those concerns. Following the review, the President is authorized to suspend or prohibit the transaction if there is credible evidence of a national security threat. Furthermore, due to recent changes in CFIUS rules, the normal 30 day review period is extended by an additional 45 days if state-owned entities are deemed to have a controlling interest in a transaction.

2. Emergency Powers. The International Emergency Economic Powers Act gives the President the authority to prohibit certain transactions if the transaction is seen as a threat to national security, foreign policy, or the economy of the United States.

3. Political Risk. General political risk may threaten a proposed investment. For example, the Dubai Ports World investment in U.S. port facilities was first approved by CFIUS but ultimately was abandoned due to the intense political controversy it provoked on Capitol Hill.

4. Public Disclosure. Any company that does business in the United States is subject to general reporting requirements including, but not limited to, confidential disclosure requirements for foreign-owned companies.

The report concludes that staff at certain agencies do not routinely review information from other governmental agencies or private sources to supplement the information that they use to enforce their own rules. GAO reached this conclusion after detailing the various and differing approaches to enforcement that six agencies follow. 

Reading between the lines, there may be a suggestion for a more uniform approach across federal agencies to foreign investment by SWF’s or perhaps even regulation centralized within a single agency.   There's no indication of whether there will be a third report and, if so, whether with wil address itself to the question of whether inter-agency uniformity or centralization would assist foreign investors who may be deterred by the current mutli-facted process.

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A Primer for the Non-U.S. Party on the Required Information for the CFIUS Filing

Mergers, acquisitions and other takeovers of U.S. businesses by non-U.S. parties may require that the parties file a notice with the Committee on Foreign Investment in the United States, or CFIUS. Though much of the information required in the filing by the foreign party and its parent entities is quite detailed and technical, it can be organized into eight general areas.

1. Are You a Foreign Government? The foreign party must state whether a foreign government or a person controlled by or acting on behalf of a foreign government:
   • holds or controls any of the acquirer’s ownership interests;
   • holds the right to appoint any of its principal officers or any members of its board of directors;
   • holds any rights that relate to control; or
   • has any arrangements with other foreign persons that hold any interests in the acquiring foreign person.
2. Are You Planning On Materially Altering the U.S. Business? The notice must include any plans of the foreign party and its parents to materially alter the U.S. business in certain aspects, including any plans to:
   • reduce or sell research and development facilities;
   • change product quality;
   • shut down facilities or remove them from the U.S.;
   • consolidate or sell any product lines;
   • modify or terminate contracts involving classified information or contracts with certain governmental agencies; or
   • eliminate domestic supply.
3. Whose Deal Is This? CFIUS wants to know whether the actual party in interest is the named party to the transaction or a parent of the named party.
4. Who Are Your Directors, Officers and Substantial Shareholders?  Each acquiring foreign party must provide detailed information as to:
   • each member of its board of directors, including non-affiliated directors;
   • each executive officer; and
   • each individual owning more than five percent or more of the foreign party.
5. Who Is Your Parent? Each immediate, intermediate and ultimate parent (defined as an owner of fifty percent or more) is required to provide the same information as to its directors, officers and owners.
6.  What Is Your Name, Rank and Serial Number? The information to be disclosed by individuals is name, address, date and place of birth and national identity number, plus a curriculum vitae or an equivalent. In an effort to determine national security ramifications, individuals must also provide the dates and nature of service with a foreign government and foreign military service. CFIUS permits this information (other than the curriculum vitae) to be contained in a separate appendix.
7. Don’t Forget the Attachments! The completed notice requires the foreign party to submit several attachments:
   • annual reports, in English (with a certified translation), of the acquiring foreign party, unless its results are consolidated with those of a parent;
   • annual reports, in English (also with a certified translation), of the intermediate and ultimate parents of the foreign party;
   • organizational charts that illustrate all of the entities above the foreign party, up to and including the ultimate control person, including ownership percentages;
   •  the opinion of the filer as to whether it is a foreign party or is controlled by a foreign government and whether the transaction could result in foreign control of a U.S. business; and
   • any documents or agreements setting forth any arrangements among foreign parties that hold ownership interests in the foreign party to act in concert on matters affecting the U.S. business.
8. Have There Been Any Critical Changes? While the matter is pending before CFIUS, each filing party must promptly advise of any critical changes in the plans, facts and circumstances addressed in the notice and in the information that was provided. Each filing party must also file amendments to the notice describing those material changes. This requirement presents a significant challenge for a foreign party to “freeze” the affairs of its corporate parents and to be aware of (a) all material changes in ownership, (b) certain changes in the management of businesses over which the filing persons may have no control and no knowledge and (c) any other proceedings before CFIUS in which any other member of the corporate family may be engaged. Therefore, best practices for the filing parties are to involve each of their ultimate parents fully in the preparation of the filing and its processing, to ensure that all relevant changes are properly communicated and advised to CFIUS.   

Of course, the descriptions of these 8 items are summaries only. Reference should be made to the regulations for the complete and definitive requirements. The assistance of a competent legal advisor in responding to these requirements is recommended.  

Later posts to this blog will address the information that a U.S. business who is a party to a covered transaction must provide in its notice filed with CFIUS, as well as other tips for filing. More complete information about the filing can be found in our white paper, “Complying with the Voluntary Review Process When Investing in or Acquiring a U.S. Business.” 

Many thanks to summer associate Michael Litrownik from the Washington University School of Law for his assistance with this post. 

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It’s well to remember that CFIUS is not the only regulator of cross-border deals that affect U.S. businesses. 

The Wall Street Journal’s Deal Journal on June 11 quoted Liu Shanwen, the CTO of Dongfeng Motor Group, who discussed Sichuan Tengzhong Heavy Industrial Machinery’s pending purchase of Hummer.  Mr. Liu estimated the transaction has less than a 30% chance of being approved by China’s Ministry of Commerce.  Hummer’s buyer does not have a high profile in China, and the Hummer product seems to be the opposite of the fuel-efficient automotive technology that the Chinese government is actively promoting.  According to Automotive News, Sichuan Tengzhong is privately owned and manufactures heavy special-use vehicles, structural components for highways and bridges and construction machinery. Hummer’s management is optimistic about an enhanced product line after the deal closes later this year, including changes to current products.

Even if it were predictable that Chinese regulators would be less than enthusiastic with Hummer’s becoming a Chinese product, there may have been another Chinese contender for the purchase of Hummer—Beijing Automotive Industry, Daimler’s China partner. According to several reliable media sources, Beijing Automotive has also expressed interest in acquiring Volvo from Ford, having been unable to capture GM’s Opel unit. Beijing Automotive and Geely Automotive Holdings are reportedly in competition for Volvo. Geely, China’s biggest private automobile maker, had been mentioned as an interested purchaser of some of GM’s models. There is no indication yet whether China’s regulators will weigh in on the Volvo transaction.

Not to be outdone, even if in Chapter 11, GM too is looking to shed its Scandinavian unit, Saab Automotive AB. According to MarketWatch, a Swedish TV station has reported that Saab has agreed to be bought by Koenigsegg Automobile AB, a niche sports-car maker that employs only 45 full-time workers and produces only a few cars a year. The deal apparently has the backing of the Swedish government, which may be prepared to issue a loan guarantee to support Saab going forward. Unlike Beijing, there do not appear to be regulatory hurdles in Stockholm.

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As of yesterday evening, the U.S. Supreme Court allowed the purchase of Chrysler’s business to proceed as part of Chrysler’s Chapter 11 proceedings. The sale now has closed. A consortium that includes Italy’s Fiat SpA will acquire key assets of Chrysler’s international operations, including the core U.S. business, within a matter of days. The deal has been prominent in the news, particularly when the appeal by pension funds and consumer groups generated some uncertainty. The deal also is historic because of the extent of the U.S. government’s direct involvement as a party and as a dealmaker.

The sale of Chrysler provides a case study for applying the Foreign Investment and National Security Act of 2007 (FINSA) and its implementing regulations, administered by the Committee on Foreign Investment in the United States (CFIUS). 

Fiat and its wholly-owned subsidiary--the buyer that will carry on Chrysler’s business--have entered into a “Master Transaction Agreement” with Chrysler and most of its subsidiaries. The U.S. Treasury, the Canada Development Investment Corporation and an independent health care trust have entered into agreements to subscribe for equity membership interests and become Class A members of the buyer. The buyer will apply the proceeds of those subscriptions to pay its $2 billion cash acquisition price to Chrysler. Fiat has agreed to contribute to the buyer certain rights to Fiat technology--including product platforms, powertrains and other key technology, management services, access to international markets and other distribution enhancements--and retains a 20% membership interest. The buyer can increase its 20% interest to 35% in three tranches of 5% each by satisfying certain performance metrics. Fiat also has the option to own a 51% membership interest in the buyer. Fiat and the buyer will be cooperating in the development of joint purchasing programs, the sale of Fiat products in North America and the sale of the buyers products elsewhere through Fiat’s network, R&D activities and branding opportunities. 

According to the White House’s initial announcement of the deal on April 30

• The U.S. Treasury will receive 8% of the equity of the new Chrysler and also has the right to select the initial group of four independent directors of the buyer; and
• The Canadian participant will receive 2% of the buyer’s equity of the buyer and will have the right to select one independent director on the same basis as the four independent directors initially chosen by the U.S.

Analyzing these parties and their relationship to each other under the U.S regime for regulating foreign investment leads to a conclusion that their deal is a “covered transaction.” Covered transactions are subject to the voluntary notice procedures that CFIUS administers and to unilateral CFIUS review if no filing has been made. If a deal is a “transaction” with “foreign person,” and if as a result the foreign person acquires “control” or could acquire “control” of a U.S. business, then the transaction is a covered transaction. The FINSA regulations give the words in quotation marks special meanings. Applying those special meanings to the facts of the deal determines whether the voluntary filing requirement apples. 

• First, since the transaction among Chrysler and the other parties is an acquisition, it is a “transaction.”
• Second because Chrysler is a business entity engaged in U.S. interstate commerce, it is a “U.S. business.”
• Third, is the buyer a “foreign person”? Under the rules, a “foreign person” is any entity over which a foreign person exercises control. Fiat is a foreign person. Before the deal it owns 100% of the buyer. After the deal it owns 20% of the buyer with the right to own 51%. The rules define control to mean the power to “determine, direct or decide important matters affecting an entity.” The basis for the right need not be a majority position; a “dominant minority” is sufficient. Fiat’s business arrangements with the buyer, the board members it presumably will be able to appoint and its ability to achieve 51% ownership satisfy the requirements for control to exist.  The public's perception, expressed by Carcorner, is that Fiat is in control.
• Fourth, the buyer--a foreign person--is conclusively acquiring control of Chrysler.

If the parties have entered into a covered transaction, have they filed with CFIUS? Although their agreement details what antitrust filings the parties will make, it uses general, non-specific language for all other governmental filings. The receipt of governmental approvals was a condition to closing for all parties. Was the condition met or was it waived to close ASAP? The details of what filings were being made are in annexes to the agreement that do not appear to be publicly available. 

It may be interesting to speculate here. In all likelihood, the parties have made their CFIUS filing. If Chrysler and Fiat have not filed, however, it may be because they perceive no national security aspect to their deal and therefore no risk that, because of the absence of a filing, CFIUS will challenge their deal--a risk that few others might take. In its December 2008 Annual Report, CFIUS provided data on filed transactions in the transportation segment of the manufacturing sector. This means that other parties in the industry concluded that there was sufficient connection between the segment and U.S. national security to justify the time, expense and delay of filing a notice with CFIUS. The Report also points out that CFIUS monitors surface transportation and industrial automation as “critical technologies.” 

Since all CFIUS filings are shielded from public access, until CFIUS issues its next annual report the public may not know whether Fiat and Chrysler filed. If they haven’t, could CFIUS challenge the deal when a different administration is elected? 

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The 2008 crisis in financial markets has led to increased government control and nationalization, of many financial institutions, including those based in the UK, Ireland and Europe. The financial institutions affected by these changes include banks that lend to U.S. businesses, directly or through subsidiaries. Among the results of partial or full nationalizations of those lenders could be greater regulation by the Committee on Foreign Investment in the United States, or CFIUS, the watchdog agency that monitors foreign direct investment into the United States. Along with increased regulation may come the unintended consequence that those foreign lenders that have become subject to increased government ownership and control may encounter restrictions or difficulty in enforcing their rights against U.S. borrowers. 

CFIUS administers the Foreign Investment and National Security Act of 2007, or FINSA. In November 2008, CFIUS published its final regulations, including rules that apply to non-U.S. lenders. The purpose of FINSA was to require approval for certain acquisitions and investments by foreign investors – those that could impair U.S. national security. The statute placed certain classes of transactions under a higher level of scrutiny by subjecting them not only to a first level of review by CFIUS but to a second level of investigation, unless CFIUS determines the investigation not to be necessary. One class of transaction requiring the enhanced investigation are those that could result in control of a U.S. business being held by

• a foreign government, or
• an entity that is controlled by a foreign government or that acts on behalf of a foreign government. 

When CFIUS wrote its regulations, it intended to include sovereign wealth funds because of the influence they were projected to have in the international economy. CFIUS may not have intended to include banks that were brought under the control of a foreign government as a result of major interventions as a result of an international fiscal crisis.

Transactions between foreign lenders and U.S. borrowers, whether secured or unsecured, are subject to a bifurcated regulatory approach: 

• Generally, there is no regulatory involvement when the parties enter into a conventional loan agreement; but 
• The regulatory scrutiny moves into place if and when the loan enters default or is about to enter default, since CFIUS considers the foreign lender’s enforcement of its rights to be a “covered transaction,” or a “takeover” of the U.S. borrower. 

Under FINSA, parties to a covered transaction may opt to file an extensively detailed notice with CFIUS. Failure to file the voluntary notice empowers FINSA, if it determines that the change in control will impair the U.S. national security, to block the covered transaction or to unwind it at a later time. For a negotiated merger or acquisitions deal, the risks of being blocked or unwound, if national security is involved, are generally of sufficient severity to transform the voluntary filing into a compulsory filing.

CFIUS does not report its determinations. As a result, it’s difficult to know with any precision what transactions with what U.S. businesses have raised U.S. national security considerations. A review of the last report that CFIUS made available to the public shows that parties to transactions with U.S. businesses in the following business segments filed notices:

• information technology
• telecommunications
• transportation equipment and services
• electric power generation, transmissions and distribution

In December 2008, CFIUS published its Guidance to describe what it believes are those parties whose involvement in covered transactions may raise national security implications. The Guidance also clarifies that the nationality of the foreign buyer and its nexus to the government of its domicile is important. CFIUS also takes into account the conformity of certain policies of the domicile’s government with critical U.S. policies, such as nuclear deterrence. It would not be much of an exaggeration to say that the acquisition of a retail outlet in a strip mall in foreclosure by a North Korean lender would, under the terms of its Guidance, trigger CFIUS review. The conclusion is that, for assessing national security risks, who the lender is matters as much as what the business of the target is.

To be fair, the CFIUS regulations attempt to provide some relief to foreign lenders. If a lender engages U.S. persons to manage the U.S. borrower of the foreclosure, CFIUS must consider that fact in making its determination. If foreign lenders are part of a syndicate controlled by U.S. lenders, and do not control the syndicate, the enforcement or foreclosure is exempt from CFIUS review. But if a lender is not able to comply with these narrow requirements, the foreign lender is left to deal with the CFIUS filing requirement. Since the borrower’s cooperation is required, the lender may well find itself in a surprising situation of asymmetrical power held by the U.S. borrower. For more detailed discussion of this unusual and anticipated outcome, subscribers are encouraged to read our white paper Treatment of Loan Transactions by Foreign Lenders as Regulated Foreign Direct Investments posted on the Sullivan & Worcester LLP Web site.

Foreign lenders now operating under the control or ownership of their governments face a broad array of challenges. The prospect of operating under a U.S. bureaucracy that examines their business dealings with defaulted borrowers is, no doubt, an unintended consequence. It may even be an unintended consequence of little consequence to the bank. To recover from the downturn of the past 18 months, however, the U. S. credit market, however, requires every bit of lender participation it can muster. To have any bank lenders step out of the market—particularly the market for mid-size and small businesses—would retard the recovery just as it seems to be gaining traction. The Obama Administration has spent months of efforts and billions of taxpayer dollars in coaxing the economy into recovery. CFIUS, being part of the Administration, might do to step forward and advise the community of foreign lenders the role it intends to play with regard to loan defaults by U.S. borrowers that result in foreclosures and other enforcement proceedings. 

The illustration above is courtesy of Joseph Rank. 

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This morning's print and online media, including Dealbook, is covering GM's planned sale of its Hummer brand to China-based Sichuan Tengzhong Heavy Industrial Machinery Co., Ltd. for a price that is reported to be less than $500 million.  The business being sold does not include the military vehicle after which the Hummer is designed. Chinese news media also carried stories reporting the memorandum of understanding.

Sources reporting the planned sale included automotive blogs, including Kicking Tires and Autoblog.

This development for GM is an interesting follow up to our blog posted May 25 speculating whether sales of U.S. automotive businesses to non-U.S.buyers will trigger CFIUS review.  The article in today's Wall Street Journal reporting the transaction includes a chart that reviews the regulatory review record for major recent inbound deals originating in China. 

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Analysts and others who follow mergers, acquisitions and other foreign direct investment into the United States can often be frustrated in their attempt to learn what inbound deals are being subjected to U.S. governmental scrutiny.  Other than occasional press releases, little useful information that is transaction-specific seems to be available. There was press coverage of  the proposed merger transaction among affiliates of Bain Capital Partners, 3 Com Corporation and Huawei Technologies of China in 2007 and 2008.  That transaction did not survive govenmental scrutiny.  More recently, in mid-May of this year, Rio Tinto and Chinalco announced that they had obtained U.S. government approval for both the proposed issue of convertible bonds to Chinalco and the indirect minority investment in Kennecott Copper Coporation, as contemplated by their February 2009 strategic transaction. 

The Committee on Foreign Investment in the United States, known by its acronym CFIUS, is the regulator that oversees foreign direct investment, make certain limited information available.  On November 14, 2008, CFIUS, sent its most recent Annual Report to Congress.  CFIUS operates under The Foreign Investment and National Security Act of 2007, or FINSA .  FINSA mandates that CFIUS prepare and send this report.    One month later, CFIUS made available to the public an unclassified version of the report  that presents only aggregate information.  The 2007 Annual Report  covers the years 2005, 2006 and 2007, when there was considerably more inbound M&A and inbound investment activity into the U.S., as well as more cross-border transaction activity generally, than currently.

The unclassified version of the report does not identify the foreign persons or the U.S. businesses involved. The data is segmented by business sector of the U.S. business and by nationality of the foreign person. There is no specification of whether the basis of the national security considerations was the nexus of the U.S. business with U.S. national security or the identity of the acquiring foreign party.

Some of the data in the report, however, is helpful in determining those standards that buyers and sellers are following. CFIUS’ annual report states that, in 2007, parties filed 138 notices of transactions with CFIUS. The unclassified version of the report provides only aggregate data with respect to the filed submissions. To summarize, for 2007:

• of the 138 filed notices, ten notices (7%) were withdrawn during the CFIUS national security review and five (4%) were withdrawn during the CFIUS national security investigation;
• the parties to three of the five transactions that withdrew their filings during investigation subsequently refiled them, and the refilings led to conclusion without action;
• the parties to two other transactions withdrawn during investigation abandoned their transactions; and
• the parties to the remaining withdrawn application restructured the transaction such that the foreign party no longer gained control over the U.S. person.

The report does not indicate whether or how many of the transactions that were withdrawn during the national security review were later resubmitted with or without restructuring. Unlike 2006, when the President acted to suspend two transactions, the President did not suspend or prohibit any transactions during 2007.

In response to FINSA’s mandate that the report provide “[s]pecific, cumulative and, as appropriate, trend information,” the annual report presents aggregate statistics regarding 313 transactions for the period 2005 through 2007. In summary, during those three years, 24 notices (8%) were withdrawn during the CFIUS national security review, 15 notices (5%) resulted in investigations and 2 notices (1%) resulted in a Presidential decision. Although the statistics indicated that the number of notices filed increased year-to-year from 64 to 111 to 138, the data, presented below, show no other clear trends. 

Source:  CFIUS 2008 Annual Report

To put these numbers of filings in to context, the number of transactions in which foreign buyers acquired U.S. business were substantially larger. CFIUS filings were made only in a small fraction of cases. According to Capital IQ, there were 657 completed inbound acquisition transactions in 2005, 889 in 2006 and 1,076 in 2008. The percentage of these transactions as to which the parties filed CFIUS notices were 10% in 2005, 12.5% in 2006 and 12.8% in 2007, or an overall percentage of 11.9% for the three-year period. The trend line is moving upward, although only slightly so.

Pursuant to the mandate in FINSA, the report analyzes the notices that were filed during the three-year period by business sector and the countries originating the transactions. This is the data that may be most useful to determine what parties have chosen to voluntarily submit their notices. The business sectors represented and the most-often reported business segments within those sectors, measured by percentage of the total 313 filings, were:

 Source:  CFIUS 2008 Annual Report

Business sectors of business segments with respect to which parties made filings, but not in statistically significant (i.e., 5% or more) numbers, included:

• Chemical (within Manufacturing)                   –      12 filings
• Primary metal (within Manufacturing)           –         7 filings
• Machinery (within Manufacturing)                  –       16 filings

Within the 51 Computer and Electronic Product segment filings were filings by businesses that manufacture semiconductors and other electronic components (21 filings) and that manufacture navigational, measuring, electromedical and control instruments (13 filings). Within the 52 Professional, Scientific and Technical Services segment filings were businesses that provided architectural, engineering and related services (21 filings) and that provided computer systems designed related services (also 21 filings). 

Because FINSA prohibts CFIUS from presenting transaction-by-transaction data, parties looking for  precedent or practices by others will benefit by keeping these statistics in mind.  Given the business risks for failing to file the voluntary notice, the parties are well-advised to make conservative judgments and build compliance with the filing process into their deal budgets and timelines.  Qualified legal advisors can assist buyers, sellers, investors and investees in complying with U.S. government review efficiently and effectively. 

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Foreign direct investment into the United States has generally grown in the aftermath of prior recessions and economic downturns.  As the U.S. economy was entering the current downturn in mid-2007, however,  the U.S. Congress enacted the Foreign Investment and National Security Act, known as FINSA.  FINSA empowered an existing multi-agency regulatory body in the Executive Branch, the Committee on Foreign Investment in the United States, to regulate inbound acquisitions and investments that might impair U.S. national security.  In the ongoing discussion over the destiny and direction of the U.S. automotive industry, there seems to be little discussion of what the Obama Adminstration's policy is with respect to foreign ownership of or investment in key U.S. industries.  The conversation is dominated by the need to maintain or restructure the businesses, without regard to ownership of the industry's participants.  There is no doubt that a vigorous economic rebound will require full international participation in the form of inbound investment.  It is critical, however, for the Administration to articulate its stance on inbound investment so that foreign buyers and investors know what regulatory hurdles and consequences they may face. So it now seems opportune for CFIUS to address publicly the question of how the welfare of the U.S. automobile industry, in particular, relates to U.S. national security. 

According to The Wall Street Journal of May 7, 2009, international buyers are showing strong interest in purchasing businesses, assets and subsidiaries of both Chrysler and GM.  The interest of Italy's Fiat, France's Renault and China's Geely Automotive suggests that these transactions, if they come to fruition, would be "covered transactions" as defined by FINSA and therefore potentially subject to CFIUS review.  

Daimler's newly-announced investment in Tesla Motors might also be a covered transaction.  Although Daimler is acquiring 10% of Tesla's shares, a board seat has been set aside for a Daimler executive.  Under CFIUS rules, a board seat indicates a control position.  There is a strong suggestion that Daimler is making its investment to gain access to Tesla's highly regarded advanced battery technology, arguably a major U.S. strategic asset.   

Will these purchasers and their U.S. investees make voluntary notice filings with CFIUS?  Will CFIUS review and investigate the filings?  If so, will the review require the full 30 days?  If there is an investigation, will the investigation require the full 45 days?  Will CFIUS pass the application on to President Obama for him to decide?

CFIUS operates under complete confidentiality.  Prospective investors and buyers may not know what regulatory filings may be required and how their filings, if made, will fare.  The Freedom of Information Act is not available as a means for gaining access to those notices that parties have filed with it.  None of the press surrounding the proposed Fiat transaction with Chapter 11- embedded Chrysler has mentioned any role for CFIUS.  Similarly, Barclay's purchase of the brokerage business of Lehman Brothers out of Chapter 11 proceedings may not have been accompanied by a filing with CFIUS. 

The principal question is whether the connection between the U.S. automobile industry and U.S. national security is sufficiently strong for Treasury and Homeland Security policymakers to consider.  One might well begin by assessing what portion of the tanks, armored personnel carriers, other transport vehicles or parts that the Department of Defense purchases are made by Chrysler or GM.  The U.S. automobile industry today is a distant cry in many ways from the Second World War.  But those with long memories will recall that the Roosevelt Administration turned to our domestic automobile manufacturers to produce tanks as well as airplanes during that war.  There are alternative sources for production today, to be sure, including defense contractors whose core business it is to manufacture the equipment that our armed forces rely on.  But, with two ongoing wars and the world far from peaceful, is it prudent to assume no risk of impairment to U.S. national security from the transfer of these assets into foreign hands? 

It would be interesting to know whether CFIUS expects to receive filings for these deals if, as and when they mature. 

Readers who may not be familiar with FINSA, its regulations and the regulatory regime that CFIUS oversees can find resources and informative analysis on these and related topics at the page in the Sullivan & Worcester LLP Web site that describes its U.S. Inbound Investments Group. 

This post is the first on this blog.  It is the mission of this blog to generate discussion on topics relating to inbound acquisitions and investments into the United States economy at all levels and become a forum on this topic.  Readers are encouraged to comment.

The above picture is reproduced from Volume II of American Military History by the U.S. Army.

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