Written by Adam Kalbfleisch and Alysha Pannu
The U.S. Treasury Department, on behalf of the Committee on Foreign Investment in the United States (CFIUS) issued two final regulations implementing the Foreign Investment Risk Review Modernization Act of 2018 (FIRRMA), which have the effect of expanding CFIUS' ability to review transactions for national security threats. These rules, which will come into effect on February 13, expand CFIUS' jurisdiction to review: (i) non-controlling investments, whether direct or indirect, by foreign persons in U.S. businesses that involve critical technologies, critical infrastructure or sensitive personal data (TID business) of U.S. persons; and (ii) real estate transactions that do not involve the acquisition of a U.S. business.
Notably, Canadian investors may be exempt from CFIUS' expanded jurisdiction over these non-controlling and real estate investments owing to the new "excepted investor" exemption provided they can demonstrate a substantial connection to Canada.
However, investors should note that the new rules do not alter or affect CFIUS' existing ability to review transactions that do result in foreign control of a U.S. business.
Effective February 13th, CFIUS will have jurisdiction to review non-controlling investments by foreign persons in TID businesses that provide the foreign person with access to or influence over the U.S. business or its products, technologies, critical infrastructure or sensitive personal data (referred to as covered investments).1
The CFIUS review process will continue to remain largely voluntary once the rules come into effect, except that parties must file a declaration in two scenarios. First, the rules require filings where a foreign investor acquires a substantial interest in a TID business. A "substantial interest" means 25% or more of the voting interests in the TID business where a single foreign government holds 49% or more in the foreign investor.2 Second, the rules require filings for investments in U.S. critical technology businesses in one or more of 27 industries specified in the rules. CFIUS did indicate that it intends to issue a revised rule replacing the 27 industries rule with one that is based on export control license requirements.
A failure to make a mandatory filing could result in a fine of up to $250,000 for an investor or the value of the transaction at issue, whichever is greater.
Real Estate Transactions
The rules also expand CFIUS' existing jurisdiction to cover the purchase, lease by, or concession to a foreign person of certain covered real estate (i.e., real estate located near sensitive, national security sites) or changes to the rights a foreign person has with respect to covered real estate. In order for a transaction to be considered a "covered real estate transaction" under the rules, it must provide foreign persons with three or more of the following property rights: (i) to physically access, (ii) to exclude, (iii) to improve or develop or (iv) to affix structures or objects. To assist investors in understanding the geographic coverage of its real estate rules, CFIUS will be developing a web-based tool.
There is no mandatory filing requirement for covered real estate transactions. Parties involved in covered real estate transactions may submit a voluntary declaration or a full notification to CFIUS.3
The new rules do not affect CFIUS' existing jurisdiction over transactions resulting in foreign control or certain non-controlling investments by a foreign person in an entity engaged in interstate commerce that also owns or leases real estate.
Exemptions to CFIUS' Expanded Jurisdiction
The rules exempt the following transactions from CFIUS' expanded jurisdiction:
- Transactions in which the foreign investors qualify as "excepted investors";
- Transactions in which the U.S. business' sole "critical technology" is encryption commodities, software and technology eligible for an export license exception under the U.S. Export Administration Regulations; and
- Investments by funds managed and controlled exclusively by U.S. nationals.
Under the new rules, investors with a substantial connection to Canada, the United Kingdom or Australia (the excepted foreign states) are exempt from scrutiny under CFIUS' expanded jurisdiction (excepted investors).
Investors from excepted foreign states qualify as an excepted investor if they are (a) a national of an excepted foreign state (and for dual nationals, no non-excepted states); (b) a government of an excepted foreign state; and (c) foreign entities that meet five conditions for itself and its parent entities. The five conditions that foreign entities must meet in order to be considered excepted investors are:
- The entity is organized under the laws of an "excepted foreign state" or the United States;
- The entity's principal place of business is in an "excepted foreign state" or the United States;
- 75% of the directors of the board or equivalent body are citizens of the excepted foreign states or U.S. citizens;
- Shareholders holding a 10% or greater shareholding interest or other significant rights are from an excepted foreign state; and
- The "minimum excepted ownership" of the foreign entity must be held by shareholders from an "excepted foreign state" or the United States. For publicly traded entities, the "minimum excepted ownership" is a majority of the voting interests, right to profits, and assets in the event of a dissolution. For private entities, the "minimum excepted ownership" is 80% of the voting interests, right to profits and assets in the event of a dissolution.
While excepted investors are exempt from CFIUS' expanded jurisdiction for non-controlling investments and covered real estate transactions as well as from the new mandatory filing requirements, they are not exempt from CFIUS' traditional jurisdiction for transactions resulting in foreign control of a U.S. business. As such, excepted investors acquiring control of a U.S. business, including Canadian excepted investors, will want to consider whether to make a voluntary filing, particularly if the transaction may give rise to national security concerns.
What Canadian Investors Need to Know
- CFIUS' jurisdiction to review foreign investments in U.S. businesses will expand as of February 13th to include non-controlling investments by foreign persons in U.S. businesses involving critical technologies, critical infrastructure or sensitive personal data and real estate transactions that do not involve the acquisition of a U.S. business.
- Under the new rules, mandatory pre-closing filings are required to be made to CFIUS if a foreign person acquires a substantial interest in a U.S. business involved in critical technology, critical infrastructure or sensitive personal data or if a foreign person acquires a non-controlling interest in a U.S. business that produces, designs, tests, manufactures, fabricates or develops certain critical technologies.
- A failure to make a mandatory filing will result in a fine of up to $250,000 or the value of the transaction at issue, whichever is greater.
- Canadian companies may be exempt from CFIUS' expanded jurisdiction provided they meet the five criteria set out in the rules to demonstrate a substantial connection with Canada, the United Kingdom, Australia or the United States.
- Specifically, the investment must provide the foreign person:
- access to any material nonpublic technical information in the possession of the U.S. business;
- membership or observer rights on, or the right to nominate an individual to a position on, the board of directors or equivalent governing body of the U.S. business; or
- any involvement, other than through voting of shares, in substantive decision-making of the U.S. business regarding: (i) the use, development, acquisition, safekeeping, or release of sensitive personal data of U.S. citizens maintained or collected by the U.S. business; (ii) the use, development, acquisition, or release of critical technologies; or (iii) the management, operation, manufacture, or supply of critical infrastructure.
- If the non-U.S. investor is a limited partnership, the 49% foreign government interest threshold applies to the general partner's ownership. The limited partnership interests will not be counted.
- Please note that certain real estate transactions are excluded from CFIUS' jurisdiction.