The Committee on Foreign Investment in the United States (CFIUS) recently issued a new Frequently Asked Question (FAQ) that updates CFIUS's interpretation of the "completion date" for a transaction, which represents a significant change for transaction parties that have for years relied upon "springing rights" for minority investments subject to CFIUS jurisdiction. Specifically, this FAQ promulgates CFIUS's new position that the completion date is the date on which the foreign person obtains any equity interest in the US business, regardless of when jurisdiction-triggering rights vest. Most notably, this affects the date by which a mandatory filing must be submitted to CFIUS—effectively precluding parties from utilizing springing rights that have previously enabled foreign investors to quickly provide capital to US businesses while respecting the 30-day waiting period required for mandatory CFIUS filings. This may present substantial challenges for certain venture capital investments and other funding transactions where timing is often critical. Further, this new CFIUS position does not recognize any distinction between initial passive equity interests and delayed governance rights. Accordingly, it also confirms that an investor using springing rights assumes the risk that CFIUS could seek divestment of its purely passive equity interests if CFIUS determines the transaction presents national-security risks that cannot be mitigated.
Background
Pursuant to regulations issued under the Foreign Investment Risk Review Modernization Act of 2018 (FIRRMA), CFIUS has jurisdiction to review any transaction that could result in foreign control of a US business (which can include an array of minority investments) as well as certain non-controlling, yet non-passive investments in businesses that qualify as "TID US businesses" and that afford the foreign investor certain "covered investment rights" (a board seat or observer, certain information/access rights, or certain decision-making rights) (covered investment rights and control rights are referred to collectively as "CFIUS triggering rights"). TID US businesses are certain US businesses involved with critical technologies (i.e., certain items or technology subject to US export controls), certain critical infrastructure, or sensitive personal data of US citizens.
While CFIUS review is generally a voluntary process, FIRRMA introduced mandatory filing requirements for certain transactions subject to CFIUS jurisdiction involving TID US businesses. Please see our prior alerts here and here for additional details regarding CFIUS's jurisdiction and mandatory filing requirements under FIRRMA, as well as our CFIUS FIRRMA Tool 2.0. Failure to make a mandatory CFIUS filing at least 30 days before the transaction's completion date could result in penalties up to the value of the transaction.
Since mandatory filing requirements first took effect in 2018, parties to certain minority investments requiring more immediate funding (e.g., venture-capital investments in startups) have commonly utilized constructs that would allow the investor to provide the capital for the investment but not obtain any CFIUS triggering rights until the mandatory-filing waiting period expired or CFIUS cleared the transaction. Parties have similarly often used springing rights—including multi-investment-tranche—structures to fund minority investments and delay CFIUS triggering rights while voluntary CFIUS reviews were pending.
These springing-rights structures have sought to address CFIUS requirements and considerations while pragmatically managing transaction timing needs. In practice, for the nearly five years in which mandatory filings have applied, CFIUS has generally permitted springing rights—and to our knowledge, CFIUS has never penalized parties that utilized springing rights for mandatory filings. Accordingly, while the new FAQ references the language of the existing regulatory definition of "completion date," it represents a significant change in CFIUS practice that will impact a range of foreign investors and US businesses.
What's new?
Though CFIUS has not made a formal announcement of this change in practice, the FAQs on the CFIUS website were recently updated to add the question, "How does CFIUS determine the 'completion date,' in assessing whether a mandatory filing should be submitted, where the foreign person first acquires equity interest but will not receive CFIUS triggering rights until after CFIUS's review?"
The FAQ response states, "In a transaction where the ownership interest is conveyed before the foreign person receives the corresponding rights, the 'completion date' is the earliest date upon which the foreign person acquired any of the equity interest." (Emphasis added.) The response further provides the following example:
If Company A acquired a 25 percent ownership interest in Company B on July 1, but its right to control Company B was deferred until after CFIUS reviews the transaction, the "completion date" for the transaction is July 1. If the transaction is subject to the mandatory declaration requirement . . . , the latest date that the parties can file the transaction with CFIUS is June 1.
What does this mean for transaction parties?
Most significantly, this will impact the timeline for minority investments that trigger mandatory filing requirements. Specifically, foreign investors in transactions triggering a mandatory filing will not be able to acquire equity interests—even on an initially purely passive basis—in US businesses until at least 30 days after the filing is made with CFIUS. This may cause delays in certain venture capital investments and other funding transactions where timing is often critical, presenting substantial challenges to deal completion.
Beyond clarifying timing requirements for mandatory filings, this new FAQ also provides insight into how CFIUS could assess the national-security risks arising from transactions involving springing rights more broadly (regardless of whether such filings are mandatory or voluntary). CFIUS is now not distinguishing between an initial passive equity investment and future CFIUS triggering rights that take effect after CFIUS clearance. Accordingly, in cases where CFIUS determines a transaction presents national-security risks that cannot be mitigated, the Committee may recommend that the president order divestment if the parties do not voluntarily agree for the investor to divest its entire interest. Significantly, this would be the case even if the CFIUS triggering rights can effectively never spring—i.e., if under the transaction terms the rights could not spring due to the lack of CFIUS clearance, the transaction would nonetheless not be insulated from divestment risk even if it would not have been subject to CFIUS jurisdiction as a permanently passive investment.
The FAQ represents the most pointed guidance from CFIUS yet that it will not distinguish between an equity investment and the CFIUS triggering rights negotiated pending CFIUS clearance. Accordingly, while CFIUS risks and deal considerations need to be assessed on a case-by-case basis, investors should be aware that springing-rights structures do not insulate them from CFIUS divestiture risk.
Will this interpretation apply retroactively?
Although the FAQ provides new guidance about CFIUS's interpretation of its current regulatory requirements rather than conducting a regulatory update (thereby suggesting that the regulations have always barred springing rights to satisfy mandatory filing timing requirements), CFIUS is unlikely to retroactively apply this interpretation to penalize parties who previously used springing rights in transactions subject to CFIUS's mandatory jurisdiction. To date, CFIUS has not announced any enforcement actions relating to mandatory filing requirements.
Has CFIUS made any other recent changes?
New FAQ on Requests for Limited Partner Information
In addition to the springing-rights FAQ described above, CFIUS also recently issued a new FAQ: “Does CFIUS require information on all foreign persons, such as limited partners in an investment fund, that would hold an interest in a U.S. business, whether directly or indirectly, as part of a transaction?” The FAQ answer states:
In addition to the information required for submission of a complete filing with CFIUS, to facilitate its review, CFIUS through the Staff Chairperson may request follow-up information with respect to all foreign investors that are involved, directly or indirectly, in a transaction, including limited partners in an investment fund. Like other aspects of the CFIUS process, the scope of such a request depends on the facts and circumstances of each transaction. For example, CFIUS often requests identifying information for indirect foreign person investors, including limited partners, their jurisdiction(s) of organization, and ultimate ownership, among other information, regardless of any arrangements that may otherwise limit the disclosure of such foreign person’s identity. CFIUS may also request information with respect to any governance rights and other contractual rights that investors collectively or individually may have in an indirect or direct acquirer or the U.S. business to facilitate the Committee’s review regarding jurisdictional or national security risk-related considerations. Such information, as with all information filed with CFIUS pursuant to 50 USC 4565, is subject to the confidentiality protections afforded by 50 USC 4565(c).
This new FAQ does not reflect a change in practice or policy by CFIUS, but it does make clear that as part of its broad authorities CFIUS may request information—including details on passive limited partners in an investor’s funds and related documentation—as part of its review process. Investors utilizing fund structures should be prepared for such requests in connection with CFIUS reviews.
Proposed Expansion of Real Estate Jurisdiction
CFIUS recently issued a notice of proposed rulemaking to expand its real-estate jurisdiction to add eight military installations to its list of US Government sites around which CFIUS has jurisdiction to review real-estate transactions. These eight military installations would be added to the list that makes certain real-estate transactions involving property within 100 miles of those installations potentially subject to CFIUS jurisdiction. The eight military installations are located in Palmdale, California; Abilene, Texas; San Antonio, Texas; Del Rio, Texas; Grand Forks, North Dakota; Box Elder, South Dakota; Des Moines, Iowa; and Glendale, Arizona. Though jurisdictionally this addition only applies to real-estate transactions, the military installations and the related real-estate jurisdictional rules are also informative of potential proximity concerns for foreign investment transactions.
This notice of proposed rulemaking likely is a reaction to recent cases where foreign persons purchased real estate near sensitive military sites that were not identified in the CFIUS real-estate regulations.
Final Thoughts
The new FAQs and the proposed expansion of CFIUS’s real estate authority emphasize that CFIUS review is a continuously evolving regulatory regime. Through formal rulemakings, informal guidance such as FAQs, and CFIUS activities relative to specific transactions, there are a wide array of means by which CFIUS considerations, authorities and approaches can change. Transaction parties should carefully assess CFIUS issues and risks in each transaction that could be subject to CFIUS review.
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This article is prepared for the general information of interested persons. It is not, and does not attempt to be, comprehensive in nature. Due to the general nature of its content, it should not be regarded as legal advice.
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