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

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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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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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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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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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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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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