Recent CFIUS Clearances Are Instructive for Foreign Investments in the U.S.

February.19.2013

The Committee on Foreign Investment in the United States (“CFIUS”) recently cleared two signal acquisitions by parties that are owned by Chinese investors. On February 12, 2013, CFIUS approved China National Offshore Oil Corporation’s (“CNOOC”) $15.1 billion acquisition of the Canadian energy firm Nexen Inc. (“Nexen”), which has oil and gas assets in the U.S. Gulf of Mexico. Previously, on January 29, 2013, CFIUS approved Wanxiang America Corp.’s (“Wanxiang America”) $257 million acquisition of most of A123 Systems Inc. (“A123”), a Massachusetts-based advanced battery manufacturer.

CFIUS has the authority to scrutinize these transactions under the Exon-Florio Amendment to the Defense Production Act of 1950. This statute generally authorizes the President to prevent or restrict a non-U.S.-owned company’s acquisition of a U.S. business if he finds that the transaction threatens U.S. national security.

CNOOC and Nexen

On July 23, 2012, CNOOC, a Chinese state-owned petroleum company, tendered a $15.1 billion cash offer to acquire Nexen in China’s largest-ever outbound acquisition. Nexen is an Alberta, Canada-based petroleum company. Following an extensive review of its foreign investment rules and particularly its policy toward state-owned enterprises, the Canadian government approved the deal on December 7, 2012.

Among its operations outside of Canada, Nexen undertakes oil exploration and production in the U.S. portion of the Gulf of Mexico. Although less than one-tenth of Nexen’s assets are in the United States, these assets are worth well over $1 billion. Nexen’s production and reserves in the Gulf of Mexico are concentrated in six deepwater and four shelf areas. In 2011, facilities in which Nexen has interests produced about 22,000 barrels of oil equivalent per day. The parties submitted the transaction for examination and clearance by CFIUS because the deal encompassed Nexen’s U.S. operations.

A looming backdrop was CNOOC’s failed 2005 effort to acquire the U.S. oil company Unocal Corp. (“Unocal”). Prior to CFIUS’s disposition of that proposed acquisition, CNOOC withdrew its offer for Unocal when threatened congressional action led it to conclude that the transaction would not be permitted. Given the notoriety of the failed Unocal deal, CFIUS’s prospective treatment of the CNOOC-Nexen transaction has drawn broad and acute interest.

Allowing CNOOC to take control of Nexen’s U.S. assets would make CNOOC the first Chinese company to control and operate offshore oil fields in the Gulf of Mexico. Furthermore, one of Nexen’s deepwater fields is less than 50 miles from Naval Air Station Joint Reserve Base at Belle Chasse, Louisiana (the “Belle Chasse Base”) and near subsea telecommunications cables. Nexen’s platforms in West Delta, the closest offshore region to the Belle Chasse Base, are part of its shallower operations in the Gulf’s shelf. The Belle Chasse Base is used for training exercises over land and water for an array of fighter aircraft and is home to a Marine Corps battalion, a Coast Guard air station, Navy training and transport units and fighter squadrons. Several members of Congress expressed opposition to the transaction, with some highlighting Nexen production assets’ proximity to the Belle Chasse Base.

As of late November 2012, the CFIUS proceeding was drawing close to a statutory deadline for completion of the “investigation” of the transaction (75 days following the parties’ notice to CFIUS). CNOOC and Nexen withdrew their notice on November 27, 2012 and immediately resubmitted it. It seems likely that the parties selected the option to withdraw and refile as an alternative to a CFIUS recommendation for adverse action by the President—a dynamic that has sometimes emerged in the history of CFIUS screenings when the Committee needs more time to examine a transaction. Withdrawal and refiling of a CFIUS application can also be an indication of complicated negotiations regarding a mitigation agreement. On February 12, 2013, CFIUS cleared the acquisition.

It is notable that the transaction involved acquisition of a strategic commodity—oil—but no critical infrastructure. In addition, concerns about proximity to a military installation were overcome—which had proved impossible in some recent cases.

At the same time, the breadth and character of “mitigation” commitments by the parties is unknown. Mitigation commitments could range from modest obligations (reporting requirements) to intrusive steps, such as divestment of Nexen assets. An assessment of CNOOC-Nexen mitigation would be needed to reach a meaningful conclusion about the extent to which CFIUS clearance was a success for the parties.

Wanxiang and A123 Systems

In January 2012, CFIUS cleared Wanxiang America’s acquisition of most of A123, a bankrupt advanced battery manufacturer. Wanxiang America is a U.S. subsidiary of the Wanxiang Group, a Chinese automotive components manufacturer and one of China’s largest nonstate-owned companies. Wanxiang America acquired most of A123’s assets, including its automotive, grid and commercial business assets for about $256.6 million.

A123 supplies, among other things, electric car batteries to about a dozen customers. The company filed for bankruptcy last year after being awarded roughly $249 million in federal grants from the U.S. Department of Energy (“DOE”). Prior to filing for bankruptcy, A123 had drawn down about $130 million of this grant money. This large expenditure by DOE significantly increased the political profile of the transaction. Members of Congress raised concerns about the sale on the grounds that it would entail a transfer to China of technology developed with U.S. government funds. DOE issued a statement that the grant to A123 was used for the construction of battery manufacturing facilities at two Michigan locations rather than for research.

Press reports indicate that the deal was actively opposed by Milwaukee-based Johnson Controls Inc. (“Johnson Controls”), which unsuccessfully bid to acquire A123. Johnson Controls sought to acquire A123’s automotive assets out of bankruptcy for $125 million, but bowed out of the auction after a final bid of $251 million, made jointly with Japan’s NEC, fell short of Wanxiang’s pledge of $256.6 million.

To facilitate government approval, the parties agreed that Wanxiang’s acquisition would not extend to A123’s government-supply business, including its U.S. military contracts. Rather, this part of A123’s business was sold to Woodridge, Illinois-based Navitas Systems LLC for about $2.25 million. This part of A123 encompassed activities relating to portable power solutions, unmanned aerial vehicles, pulsed power weapons as well as small energy cells for remote devices.

The government-supply business likely included activity that is regulated by the International Traffic in Arms Regulations (“ITAR”). United States government practice is to forbid transfer of ITAR-regulated operations to a China-owned company.

CFIUS approved the Wanxiang’s acquisition on January 28, 2013, reportedly without conditions, suggesting that there were no mitigation commitments. Still, DOE issued a statement explaining that the purchase of the plants in Michigan built with the Recovery Act money includes DOE’s requirement that the plants and equipment continue to operate in Michigan.

Instructive Aspects of CNOOC-Nexen and Wanxiang-A123

Uncertainties remain about these CFIUS outcomes. But they merit careful attention as parties evaluate options for transactions that would be CFIUS-reviewable and that would be expected to raise national security concerns.

Although much could depend on the character of CNOOC-Nexen mitigation, at some substantial level these CFIUS clearances confirm that the U.S. government will countenance acquisitions by China-owned firms of U.S. operations that present national security issues. Issues arose after CNOOC’s failed effort to buy Unocal as to whether CFIUS would ever permit a Chinese-government controlled company to secure substantial U.S. petroleum production rights. CNOOC-Nexen appears to show that this type of acquisition is possible. Wanxiang-A123 shows that inclusion of advanced U.S. technology in a China acquisition is not a bar to consummation, even when there is government funding of the target company. Both CFIUS outcomes confirm once again that CFIUS will not necessarily acquiesce to political opposition, even in controversial cases.

Questions remain, however, about CFIUS screening when target assets are close to a U.S. military base. Military installation-proximity has emerged in the last few years as a rarity—a national security factor that has not seemed susceptible to mitigation as a basis for clearance. The most famous example is the 2012 Ralls Corp. acquisition of Oregon wind farm assets, which was reversed by the President. One is tempted to conclude that CNOOC-Nexen establishes that military installation-proximity can be shown to be nonproblematic. For example, perhaps it was established that activities at Belle Chasse Base are insufficiently sensitive for relatively close petroleum production assets to raise concerns. Or perhaps it was shown that the locations were not, in fact, so close as to raise concerns. But might it be that mitigation commitments include divestment obligations that, when implemented, will eliminate the proximity?

Lastly, the Wanxiang-A123 outcome indicates that CFIUS is continuing to resist arguments by third parties against clearance that are essentially economic but are purported to have national security implications. In Wanxiang-A123, as in other cases, some argued that purported Chinese dominance of manufacturing would jeopardize supply sources for the U.S. government and others. CFIUS appears consistently to be rejecting these types of contentions.