Foreign Investment. What Is It and What Rules Apply? – Due Diligence for Sellers In M&A Transactions
Since 2020, more stringent rules have been in effect relating to transactions involving foreign nationals, which may need to be reported to the Committee on Foreign Investment in the United States (“CFIUS”) in M&A transactions.[i] These new rules cover a much wider range of transactions, which may not initially seem like foreign investment. CFIUS has jurisdiction to review almost any transaction in the United States which “could result in foreign control of any person engaged in interstate commerce in the United States.”[ii] A seller needs to fully understand if there is any foreign control or access because not complying with the mandatory filing procedures could result in a civil penalty of up to $250,000 or the value of the transaction, whichever is greater. A penalty the size of the transaction itself cannot be ignored, so it should be a regular part of M&A due diligence.
A “foreign person” includes foreign nationals, foreign governments, foreign entities, and even domestic entities where foreign national, foreign entity, or foreign government can exert control of the business or access critical technologies.[iii] Canada, Australia, and the United Kingdom are excepted foreign states, meaning nationals of those countries are not treated as a foreign person.
Foreign Investment Risk Review Modernization Act (“FIRRMA”)
The Foreign Investment Risk Review Modernization Act (“FIRRMA”) was passed in 2018 and took effect in February 2020. FIRRMA revised the guidelines for what kinds of transactions would be covered by CFIUS. These revisions broaden what is considered a covered foreign investment triggering review and making disclosure of that transaction to CFIUS mandatory.
A “covered” foreign investment transaction refers to any merger, acquisition or takeover which results in foreign control of any person engaged in interstate commerce in the United States, as well as “TID” businesses (Technology, Infrastructure, Data) with any non-controlling acquisitions that meet certain requirements relating to control, voting, or access to non-public technology.
A non-controlling transaction is now subject to CFIUS review and a mandatory reporting if the transaction affords the foreign person:
- access to any material nonpublic technical information in the possession of the TID U.S. business;
- membership or observer rights on the board of directors or equivalent governing body of the TID U.S. business; or
- any involvement in substantive decision making of the TID U.S. business regarding critical technologies, critical infrastructure, or sensitive personal data of U.S. citizens.
Depending on the industry, even non-controlling transactions with a foreign person could be subject to mandatory CFIUS reporting and review.
Private Equity Concerns
Private equity funds based in the United States, but with foreign limited partners are not considered a foreign person or entity so long as four requirements are met.
- There must be no foreign person involved in the management of the fund.
- The fund advisory board on which any foreign person sits must not have any control over the investment decisions of the firm.
- The foreign person must not have any ability to control the fund or to approve or disapprove decisions made by the fund manager or determine the compensation of the partners in the fund.
- The foreign person must not have access to any material, nonpublic technical information.
If each of these four requirements are met, then a U.S.-based private equity fund with a foreign partner is not subject to review by CFIUS or mandatory filings.[iv]
Questions for Sellers to Ask Buyers
Some questions that every seller should consider asking a potential buyer of their business:
- Are any of the owners of the acquiring entity not U.S. citizens or not U.S. based business entities?
- Is there any direct or indirect ownership of buyer by a foreign person or company?
- Does any part of the investment funds for the transaction have a foreign source?
- Does any of buyer’s other financing have a foreign source?
- Would a foreign person gain any voting rights or control over the company by way of this purchase?
- Does buyer have any kind of reporting or disclosure obligations to a foreign person?
- Does buyer grant access to technical or confidential information to any foreign person or would any foreign person gain access to the company’s technical or confidential information?
If the answer to any of these is yes, you should work with counsel to investigate further.
Issues relating to foreign investment, even indirect foreign investment, can be serious and costly to get wrong. Sellers especially should consider these issues carefully and work with counsel to try to avoid unnecessary risks. Buyers and Sellers alike should be mindful of the fact that recent changes may bring a wider range of transactions under review.
[i] CFIUS is an Executive Branch committee created by the Defense Production Act of 1950 (DPA), codified as amended at 50 U.S.C. app. § 2170, and chaired by the Secretary of the U.S. Treasury Department (Treasury Secretary), see 50 U.S.C. app. § 2170(k).
[ii] See 50 U.S.C. § 2170(a)(3).
[iii] See 50 U.S.C. § 4565
[iv] See 30 C.F.R Part 800.401.