The U.S. Department of the Treasury Office of Investment Security ("Treasury") published a final rule on September 15, 2020, significantly changing the mandatory filings administered by the Committee on Foreign Investment in the United States ("CFIUS"). The Foreign Investment Risk Review Modernization Act of 2018 ("FIRRMA") expanded CFIUS's jurisdiction to review and take action to address national security concerns arising from certain investments and real estate transactions involving foreign persons. As a result, mandatory filings apply to certain controlling and non-controlling foreign investments in U.S. businesses that produce, design, test, manufacture, fabricate, or develop one or more critical technologies. Please see our previous article for a detailed analysis of Treasury's proposed rule issued on May 21, 2020.
This final rule is very similar to the provisions included in the proposed rule. Notably, the mandatory filing analysis will move away from the current industry test1 and instead focuses on export control licensing requirements. In other words, the analysis will now be premised on whether the products and technology manufactured/produced by the U.S. business would require a license/regulatory authorization to export to certain persons in the ownership chain. Additionally, the final rule also clarifies the definition of the term "substantial interest" and a related provision and makes one technical revision to example 2 included in the definition of "covered transaction" found at § 800.213(e).2 Below is a summary of the key takeaways from the final rule, which will go into effect 30 days after the final rule is published, or on around October 15, 2020.
1. Applicability of Final Rule. The above-mentioned mandatory filing changes take effect 30 days after the final rule is published. For certain transactions between February 13, 2020 and until October 15, 2020, the previous industry test based on NAICS codes would continue to apply.
2. Substantial Interest (§ 800.244). The "substantial interest" definition revisions remain the same as in the proposed rule. A mandatory filing may be required for certain covered transactions where a foreign government has a substantial interest in a foreign person that will in turn acquire a substantial interest in certain types of U.S. businesses. Responding to comments, Treasury clarified that the substantial interest analysis is appropriately focused on the interest held in the general partner/managing member when such individual primarily directs, controls, or coordinates the entity's activities. The involvement of a third party acting on behalf of the general partner does not remove the transaction from the substantial interest analysis.
3. Modified Criteria for Mandatory Filings (§ 800.401(c)). The new criteria stipulated in § 800.401(c)(1) is now based on whether certain "U.S. government authorization" would be required to export, re-export, transfer (in country), or retransfer one or more critical technologies produced, designed, tested, manufactured, fabricated, or developed by the U.S. business to certain persons in the ownership chain.
The final rule makes it clear that for purposes of the mandatory filing evaluation, both direct and indirect ownership interests (as set out in § 800.401(c)(1)(i)-(v)) should be reviewed. The final rule revisions also clarify that a "group of foreign persons," who are related or have a formal or informal arrangement, 3 would be reviewed as holding voting interests in the aggregate.
4. Timeframe to assess "critical technology" in a covered transaction.
Covered transaction under § 800.401(c) and "substantial interest" transaction under § 800.248(a).
In the final rule Treasury clarifies that a "critical technology" assessment should be conducted as of the earliest date of the transaction activities, including the execution of a binding agreement by the parties, or when changes to investors' rights result in a covered transaction or covered investment.4
5. Export Administration Regulations ("EAR") License Exceptions (§ 800.401(e)(6)). Importantly, when conducting a mandatory filing analysis if an EAR license exception enumerated at § 800.401(e)(6) is deemed applicable, a mandatory CFIUS filing would not be triggered. But the same "persons" that triggered the mandatory filing, must also be eligible to use the EAR license exceptions.
The revisions also clarify that "eligibility" for an EAR license exception refers to having satisfied any requirements imposed by the EAR that must be satisfied prior to export (even if no export is to occur). Notably, CFIUS provides the example of how the export classification requirements (including submission of commodity classification requests) and procedures in EAR license exception § 740.17(b)5 must be met for the exception to apply, and consequently be able to use the CFIUS exception. Otherwise, the CFIUS exception to the mandatory filing requirement would not apply. CFIUS also explains that the following requirements under the relevant EAR license exceptions are not conditions of eligibility to avail parties of the CFIUS exception. These include the:
- reporting requirements (e.g., semiannual reporting) enumerated in EAR license exception for encryption commodities, software, and technology;6
- recordkeeping requirements under EAR license exception for technology and software-unrestricted;7 and
- requirements to furnish certain commodity classifications to third parties under EAR license exception for strategic trade authorization.8
End-users and EAR licenses and exceptions. The final rule also clarifies that special attention should be paid to certain end-users, including entities listed in the Bureau of Industry and Security Entity List (Supplement No. 4 to Part 744), because these parties may not be eligible for license exceptions and they have more stringent license application review policies.
In sum, the final revisions published by Treasury formally set forth the new test for mandatory filings involving critical technologies, which is now focused on export control licensing requirements. Additionally, Treasury also clarified the definition of "substantial interest" and provided insight on using EAR license exceptions to qualify for an exception to the mandatory CFIUS filing requirements. The new test will significantly impact companies and will shed some light on the importance of export control regimes. If a mandatory filing is triggered and not filed, a company can be subject to substantial penalties to include $250,000 or the value of the transaction, whichever is greater. Companies and foreign investors should improve their export compliance programs to ensure accurate product and technology export classifications are readily available to determine licensing or EAR exception applicability.
1 The current industry test is premised on whether U.S. businesses with critical technologies have a connection to the 27 industries identified by the North American Industry Classification System ("NAICS").
2 Section 800.213(e)(2) is amended in the second to last sentence after the word "provides" by removing "Corporation X" and replacing it with "Corporation A." Now the sentence reads, "Corporation X later expands its board of directors and provides Corporation A with the right to appoint a director."
3 31 C.F.R. § 800.256(d) (2020).
4 All the qualifying transaction conditions are set forth in § 800.104(b)(1)-(4).
5 15 C.F.R. § 740.17(b) (2020).
6 15 C.F.R. § 740.17(e) (2020).
7 15 C.F.R. § 740.13(h) (2020).
8 15 C.F.R. § 740.20(d) (2020).
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