International Trade & Compliance Alert | 12.08.16
On December 2, President Obama, acting under the Exon-Florio law, blocked the planned acquisition by China's Fujian Grand Chip Investment Fund LP ("Fujian Grand Chip"), a Chinese investment fund, of the U.S. operations of German technology company Aixtron SE ("Aixtron") as part of Fujian Grand Chip's overall acquisition of Aixtron due to findings of national security concerns relating to Aixtron's U.S. operations.
Exon-Florio Law and CFIUS
CFIUS comprises the heads of major U.S. government executive departments and agencies and is chaired by the Secretary of the Treasury. The Exon-Florio Amendment to the Defense Production Act of 1950 ("Exon-Florio") generally authorizes the president to disrupt or block a transaction if it has resulted or could result in a foreign person gaining control of a U.S. business and the president finds that the transaction threatens the national security.
The president's authority to act under Exon-Florio applies to any "covered transaction" – an "acquisition, merger, or takeover" of a U.S. person "by or with foreign persons." In assessing whether a transaction is covered, the key question is whether the transaction could result in a foreign person having, directly or indirectly, control in fact over a U.S. business. CFIUS takes a broad view of what constitutes "control."
Parties have the option of subjecting covered transactions to screening by CFIUS by submitting a notice of the transaction to the committee. Notice of a transaction to CFIUS is never mandatory. But the absence of clearance by CFIUS leaves a covered transaction indefinitely susceptible to adverse action under Exon-Florio. Clearance by CFIUS generally insulates a transaction from adverse action under the statute.
If CFIUS identifies security concerns, CFIUS and the transaction parties often negotiate commitments on the basis of which the transaction is cleared. These commitments can include, for example, changes to the transaction structure and safeguards to address perceived security concerns. The U.S. Defense Department is ordinarily the ultimate arbiter of national security assessments within CFIUS, and this is particularly true as regards transactions that involve microelectronics.
Planned Aixtron Acquisition
Aixtron of Germany is a leading provider of deposition equipment that is used to build advanced components for electronic and optoelectronic applications based on compound, silicon or organic semiconductor materials. Aixtron has global operations, but is currently based around three leading technology hubs in Herzogenrath (Germany), Cambridge (UK) and Sunnyvale, CA (United States). Roughly 20 percent of Aixtron's revenues are derived from its U.S. operations.
Fujian Grand Chip is wholly owned by Fujian Grand Chip Investment Fund LP, which in turn is 51 percent-held by Zhendong Liu (a Chinese national) and 49 percent-held by Xiamen Bohao Investment Co., Ltd. ("Bohao") – a company financed by the Xiamen municipal government. There reportedly is no Chinese government ownership of Bohao.
On May 23, 2016, Fujian Grand Chip made a tender offer to acquire Aixtron for €670 million. Fujian Grand Chip and Aixtron filed a notice of the transaction with CFIUS on July 1, 2016. CFIUS conducted both a 30-day "review" of the transaction and then a 45-day "investigation" of the transaction. The parties proposed mitigation options, but CFIUS told the parties that it does not believe that its national security concerns could be resolved by mitigation proposals.
Learning From Attempted Aixtron Acquisition and Possible Exon-Florio Policy Developments
First Official Transaction Block Under Exon-Florio: This is the first time in history that a U.S. president has, under Exon-Florio, officially forbidden parties to close a foreign acquisition of U.S. business operations. In a handful of instances, transaction parties have terminated transactions based on warnings from CFIUS that the committee would recommend that the president block the transaction. And in two instances, Presidents have ordered divestment to reverse completed transactions – most recently, in the 2012 case of Ralls Corporation's acquisition of a wind energy project in Oregon. But never before had any president officially exercised Exon-Florio authority to prohibit parties to complete a transaction.
Importance of Understanding Target Company Technology in United States: Aixtron and U.S. government treatment of prior transactions show that, to engage with CFIUS effectively, parties to covered transactions need to understand precisely what sensitive technologies U.S. target operations have, how that technology is embedded in the target company and what U.S. defense and security officials' views are on those technologies.
The President's blocking order appears to be driven by Aixtron U.S. operations' leadership in a particular semiconductor production technology that has military utility – use of gallium nitride ("GaN") rather than silicon as the basis or substrate to manufacture an integrated circuit. Semiconductor companies that develop products using GaN – so-called "compound semiconductors" – have been scrutinized in the past by CFIUS. Most notably, in January 2016 CFIUS's opposition to the acquisition of Royal Philips NV's LED business, Lumileds, by a Chinese consortium led by GO Scale Capital caused the parties to abandon the transaction instead of proceeding with a presidential review. Lumileds reportedly possesses GaN-focused compound semiconductor technology.
Exon-Florio Extending Beyond Acquisitions of U.S. Companies: Aixtron's operations are predominately outside the United States. That the Aixtron transaction involved an attempted acquisition of a German company reinforces in a concrete way that CFIUS has jurisdiction over and the president is authorized to act against acquisitions of control of non-U.S. companies to the extent they control U.S. operations. This case also demonstrates that a target company need not generate the majority of its revenues from the United States for its acquisition in practice to be subject to CFIUS jurisdiction and potential presidential review; all that is required is for the target to, directly or indirectly, engage in interstate commerce in the United States.
Mitigation Often Critical but Sometimes Inadequate: In an effort to forestall the President's action, the parties to the attempted Aixtron acquisition allegedly offered to establish an arrangement that would completely insulate U.S. Aixtron operations from Fujian Grand Chip's control. It is understood that they proposed a trust arrangement under which control of U.S. Aixtron operations would reside with a U.S. trust with U.S. citizen trustees. This would have made the investment, in essence, a passive, financial undertaking. With some justification, the parties could have argued that this arrangement would have eliminated CFIUS's and the President's jurisdiction to act under Exon-Florio on the grounds that a foreign person would not gain control over a U.S. business. Evidently, neither CFIUS nor the President accepted this argument.
United States Not Closed to Chinese Investment: Recent CFIUS clearance of other Chinese investment transactions shows that the United States is not, under current policy, closed to Chinese acquisitions – even by Chinese government-controlled entities. To cite just a few examples:
U.S. Policy on Foreign Investment in Flux: In its last years, the Obama Administration has devoted considerable attention to the strategic importance of the U.S. semiconductor industry. Separately, statements by persons associated with President-Elect Trump's transition and other commentary highlight the possibility of important CFIUS-related policy developments in 2017. Also, a 2016 report of the U.S.-China Economic and Security Review Commission ("US-CESRC") recommended that the Congress amend Exon-Florio to bar Chinese state-owned enterprises from acquiring or otherwise gaining effective control of U.S. companies. The US-CESRC found that "both private and public Chinese entities present significant risks to U.S. economic and national security, as the degree of state ownership does not necessarily reflect a business' strategic importance."
Members of Congress have announced that they will propose legislation in the new Congress to make treatment of investment transactions under Exon-Florio more restrictive. The Government Accountability Office ("GAO") announced an investigation related to the sufficiency of Exon-Florio authority earlier this year, which is expected to result in a GAO report on that topic.
A broad reversal of the U.S. open investment policy seems unlikely, and it is not expected that CFIUS will become what is normally an insurmountable obstacle to Chinese investment in the United States. But relevant policy debates and legislative action in 2017 merit careful attention.