In the fourth quarter of 2020, the major CFIUS development was the significant revision of one of CFIUS’s two mandatory filing programs. Specifically, on 15 September 15 2020, the Department of Treasury (the Treasury) issued a Final Rule revising CFIUS’s critical technologies mandatory filing program and making certain other clarifying amendments to the other mandatory filing program. The most significant changes in the Final Rule can be summarized as follows:
- Replacing certain industry-related criteria in the CFIUS critical technologies mandatory filing program with certain export authorization criteria.
- Defining the scope of foreign persons to be considered when assessing whether the export authorization criteria are satisfied (to include the direct acquirer/investor, as well as persons with a 25 percent or greater voting interest, direct or indirect, in such direct acquirer/investor).
- Expanding the export license exceptions that exclude a transaction from the CFIUS critical technologies mandatory filing program (while also clarifying that to be “eligible” for the use of the license exception the specific requirements of the license exception must be satisfied).
- Clarifying the application of the “substantial interest” definition when assessing foreign government interests in certain entities under the CFIUS foreign government-backed mandatory filing program.
The effective date for the final rule was 15 October 2020.
Replacing the Industry Prong with an Export Licensing Prong
Under the previous version of the CFIUS regulations, pursuant to the critical technologies mandatory filing program, a foreign investor and a U.S. business were legally obligated to submit a filing to CFIUS if:
- The investment would have afforded the foreign person control over the U.S. business or one of three foreign investor rights (the Foreign Investor Rights Prong).
- The investment was in a U.S. business that produced, designed, tested, manufactured, or developed a critical technology (the Critical Technologies Prong).
- The critical technology was used in the Company’s business activities in, or specifically designed for, one of 27 identified industries (the Industry Prong).
The Final Rule replaces the Industry Prong with a test as to whether the Company’s critical technologies would require an export authorization for the hypothetical export, re-export, transfer, or retransfer to certain foreign persons involved in the transaction (the Export Licensing Prong). Under the Final Rule, an export authorization includes: (i) a license or other approval issued by the Department of State under the International Traffic in Arms Regulations; (ii) a license from the Department of Commerce under the Export Administration Regulations (the EAR); (iii) specific or certain general authorizations issued by the Department of Energy pursuant to 10 C.F.R. part 810; or (iv) a specific license issued by the Nuclear Regulatory Commission pursuant to 10 C.F.R. part 110.
The Export Licensing Prong is likely to exclude from the CFIUS critical technologies mandatory filing program many investments by allied country investors that otherwise would have been subject to the program under the former Industry Prong. Nonetheless, in some cases, the due diligence required to confirm whether the Export Licensing Prong is satisfied will require more time and effort than the Industry Prong required, particularly if one or more persons hold a 25 percent voting interest, direct or indirect, in the foreign investor.
Defining the scope of foreign persons to which the Export Licensing Prong must be applied
In assessing the Export Licensing Prong, the Final Rule clarifies that, in the context of the underlying transaction, the U.S. business must assess whether an export authorization would be required for the hypothetical export, re-export, transfer, or retransfer of the U.S. business’s critical technologies to: (i) any foreign person who could gain direct control over the U.S. business; (ii) any foreign person who will directly obtain one or more of three foreign investor rights specified in the CFIUS regulations (e.g., board/board observer rights); (iii) any foreign person who has a direct investment in the U.S. business and whose investor rights are changing pursuant to the transaction, such that either (i) or (ii) could occur; and (iv) any person who has, directly or indirectly, a 25 percent or greater voting interest in the persons described in (i)-(iii). The Export Licensing Prong, therefore, requires an examination of the hypothetical export licensing requirements for exports not just to the foreign acquirer/investor, but also entities or individuals in its ownership chain.
Expansion of license exceptions
The previous version of the CFIUS regulations provided a particular exclusion from the CFIUS critical technologies mandatory filing program on the basis of license exception ENC, which relates to encryption hardware, software, and technology. The Final Rule expands the scope of potentially applicable license exceptions to include not only (i) provisions of license exception ENC (15 C.F.R. § 740.17(b)), but also (ii) license exception TSU (technology and software unrestricted 15 C.F.R. § 740.13) and (iii) provisions of license exception STA (strategic trade authorization – 15 C.F.R. § 740.20(c)(1)) applicable to destinations in or nationals of country group A:5 under the EAR (Supp. 1 to 15 C.F.R. § 740)).
In identifying these additional license exceptions as exclusions from the CFIUS critical technologies mandatory filing program, the Final Rule also clarifies that in order for one of the license exceptions to exclude a transaction from CFIUS’s critical technologies mandatory filing program, the U.S. business must have satisfied all the requirements for the use of the license exception in the context of the hypothetical export, re-export, transfer, or retransfer to the relevant foreign persons in the transaction (even if no such export, re-export, transfer, or retransfer is in fact anticipated in connection with the transaction). For example, in the context of a U.S. business that develops proprietary encryption source code, which is a critical technology and is described in 740.17(b)(2) of license exception ENC, the U.S. business must have met all the regulatory requirements of 740.17(b)(2) (assuming the source code has not otherwise been made publicly available), which includes submission of a commodity classification to the Commerce Department’s Bureau of Industry and Security and, in some cases, a 30-day waiting period, in order to utilize license exception ENC in excluding the transaction from CFIUS’s critical technologies mandatory filing program.
Substantial interest modification
The Final Rule also amends the definition of “substantial interest” which is relevant in considering the applicability of the CFIUS foreign government-backed mandatory filing program. In particular, the rule clarifies that with regard to entities whose activities are primarily directed, controlled, or coordinated by or on behalf of a general partner, managing member, or equivalent, the “substantial interest” considerations only apply if the national or subnational governments of a single foreign state hold 49 percent or more of the interest in the general partner, managing member, or equivalent.
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Authored by Brian Curran, Anne Salladin and Josh Gelula