International Trade & Compliance Alert | May.22.2020
The Committee on Foreign Investment in the United States (“CFIUS”) issued a proposed rule on May 21, 2020 that would: (a) modify the scope of the mandatory filing regime for certain “critical technology” transactions by replacing the industries-based trigger (as per North American Industry Classification System (“NAICS”) codes) with a test based on the applicability of U.S. export control licensing requirements, and (b) clarify the definition of “substantial interest,” a term used in CFIUS’s regulations in connection with certain investments by foreign investors with specified levels of foreign government ownership.
The Foreign Investment Risk Review Modernization Act of 2018 (“FIRRMA”) authorizes CFIUS, through the issuance of regulations, to mandate filings for covered transactions involving certain U.S. businesses that produce, design, test, manufacture, fabricate, or develop one or more critical technologies. Critical technologies comprise hardware, software, and technical information that is export controlled in specified ways or subject to other security-related restrictions.
Additionally, FIRRMA requires a filing for certain covered transactions if a foreign government has a “substantial interest” in a foreign entity that will acquire a substantial interest in a “TID U.S. business,” principally focused on critical technologies, certain critical infrastructure, or sensitive personal data. Please see our prior client alert for additional information on CFIUS’s regulations implementing FIRRMA that became effective on February 13, 2020.
Public comments on the proposed rule are due by June 22, 2020.
Removal of the prior NAICS code-based industry test
Under CFIUS’s existing regulations, transaction parties must determine whether the acquired U.S. business produces, designs, tests, manufactures, fabricates, or develops a critical technology utilized in connection with the U.S. business’s activity in, or designed by the U.S. business specifically for use in, one or more of 27 industries (identified by their NAICS codes). This test would be removed and replaced by the export control test discussed below.
Basing the mandatory filing requirement for certain critical technology transactions on U.S. export control authorizations
The proposed rule would narrow the pool of critical technology mandatory filings in certain respects by requiring a filing for a particular transaction only if an export authorization would be required for the export of the relevant critical technology to the foreign investor (or certain parties holding interests in the foreign investor).
Under the proposed rule, “U.S. regulatory authorization” would be defined to include four major U.S. export control regimes:
The proposed rule adds the term “voting interest for purposes of critical technology mandatory declarations” to determine which persons in the ownership chain of foreign persons must be considered in assessing whether an export license would be required for a transfer in order to establish whether a particular transaction may trigger a mandatory declaration.
The proposed rule provides that, except for certain EAR license exceptions, a U.S. regulatory authorization is considered to be required even though a license exception or exemption may be available under the EAR or ITAR, respectively. It also provides that where the applicable regulatory authorization is tied to the “end user” status of the person receiving the critical technology, the relevant foreign person(s) that are a party to the covered transaction should be considered the end user(s).
Under CFIUS’s regulations, a filing is mandatory for any transaction that would result in an acquisition, directly or indirectly, by a foreign person of a “substantial interest” (defined as a 25 percent or greater direct or indirect voting interest) in a TID U.S. business by a foreign person in which a certain foreign government has, directly or indirectly, a “substantial interest” (defined as a 49 percent or greater direct or indirect voting interest). The regulations include special treatment of non-corporate entities, currently providing that if the foreign person has a general partner, managing member, or equivalent, a foreign state will be considered to have a substantial interest in the entity only if the government holds 49 percent or more of the interest in the general partner, managing member, or equivalent. (Limited partnership interests do not count.)
CFIUS previewed the proposed changes to the critical technologies mandatory filing requirements when it issued its new 31 C.F.R. part 800 regulations in January 2020. The proposed rule specifically focuses on export control requirements for critical technologies, as CFIUS notes that it “leverages the national security foundations of the established export control regimes, which require licensing or authorization in certain cases based on an analysis of the particular item and end user, and the particular foreign country for export. . . .” Basing the mandatory filing requirement on whether U.S. export control licensing requirements would be applicable to the foreign investor and certain of its affiliates in a particular transaction would mean that foreign investors from countries such as China and Russia that are subject to far-reaching U.S. export control restrictions would likely be required to submit declarations or notices with CFIUS for a broader scope of transactions than is the case under the current regulations. Conversely, investors from countries subject to less stringent U.S. export control licensing requirements could see fewer mandatory filings.
31 C.F.R. §800.235 defines parent to mean: with respect to an entity: (1) a person who or which directly or indirectly: (i) holds or will hold at least 50 percent of the outstanding voting interest in the entity; or (ii) holds or will hold the right to at least 50 percent of the profits of the entity, or has or will have the right in the event of dissolution to at least 50 percent of the assets of the entity; or (2) the general partner, managing member, or equivalent of the entity.
The license exceptions that would apply are 15 C.F.R. §740.13 (Technology and Software – Unrestricted (TSU)), 15 C.F.R. § 740.17(b) (sub-part (b) of Encryption Commodities, Software, and Technology (ENC)), and 15 C.F.R. § 740.20(c)(1) (Strategic Trade Authorization – (STA)).
The proposed rule would also make certain edits to 31 C.F.R. § 800.244(c) to clarify how to calculate interests held by one entity indirectly in another entity.