Government Contracts Monitor

Regulatory Change Pertaining to Mergers, Acquisitions, and Takeovers by Foreign Persons

December 20, 2008

Effective December 22, 2008, Regulations Pertaining to Mergers, Acquisitions, and Takeovers by Foreign Persons, 31 C.F.R. 800.101-801, will change.

Under the new rules, the President and an Executive Committee may review Mergers, Acquisitions, and Takeovers that could result in foreign control over people and entities engaged in interstate commerce in the United States.

Background

The Foreign Investment and National Security Act ("FINSA") became effective on October 24, 2007. FINSA requires the issuance of regulations implementing its provisions, and pursuant to its authority, Regulations Pertaining to Mergers, Acquisitions, and Takeovers by Foreign Persons will be amended. Under the new regulations, the President has the authority to review "covered transactions." A covered transaction is any merger, acquisition, and takeover by or with any foreign person or entity that could result in foreign control of a person or entity engaged in interstate commerce in the United States. FINSA established the Committee on Foreign Investment in the United States ("CFIUS"), which will review "covered transactions" in cases where:

the transaction threatens to impair U.S. national security and that threat has not been mitigated;
the transaction is a foreign government-controlled transaction;
the transaction results in foreign control over critical infrastructure that could impair national security; or
a lead executive agency recommends, and CFIUS concurs, that an investigation should be undertaken.

Questions and Answers Regarding the Rule

Will these changes result in significantly greater reviews of mergers and acquisitions involving foreign entities?

CFIUS does not expect the change to materially affect the number of transactions that it reviews. CFIUS states that it will focus on genuine national security concerns and not economic or other national interests. From 2005 through 2007, CFIUS reviewed less than ten percent of foreign acquisitions in the United States.

Will reporting to CFIUS now be mandatory?

While reporting to CFIUS continues to be based on voluntary notices by parties engaging in "covered transactions," the new regulations give CFIUS the authority to review a transaction that has not been voluntarily reported. The new regulations encourage parties to contact CFIUS before making a formal filing.

What information should be contained in a voluntary notice?

At a minimum, CFIUS requires a summary describing: the essentials and nature of the transaction; contact information on the foreign entity that is entering into the transaction, contact information on the entity that will ultimately control the entity; contact information on the entity that is the subject of the transaction; the expected date of consummation for the transaction; the name of any financial institutions involved; and finally, a good faith approximation of the net value of the interest acquired. Please see 31 C.F.R. 800.402 for more detail.

Is submission of a voluntary notice an admission that a transaction is a "covered transaction"?

No. Parties filing a voluntary notice are required to state their opinion as to whether the transaction is a covered transaction.

Are there any exceptions to "covered transactions"?

Yes. A foreign person or entity will not be deemed to "control" an entity engaged in interstate commerce if the foreign entity (1) holds ten percent or less of the voting interest in the entity; and (2) the foreign entity?s interest is held solely for the purpose of passive investment. In addition, because the regulation only applies to mergers, acquisitions, and takeovers, start-up entities and "greenfield" investments are exempt from the regulations. "Control" is a guiding principal for CFIUS when determining whether a transaction is "covered."

How is "control" defined?

"Control" will be considered in functional terms, such as the ability to exercise powers over important matters affecting an entity. If a foreign entity obtains ownership of a majority of outstanding voting interests, or even a dominant minority of outstanding voting interests, it will likely be deemed to "control" the entity. However, there is no bright line. CFIUS will analyze control issues on a case-by-case basis, considering the ownership interest held, the rights afforded by such ownership interest, restrictions on the exercise of other's rights, and any other facts and circumstances deemed relevant.

What is a "foreign government-controlled transaction"?

A foreign government-controlled transaction is a covered transaction that has the potential to result in the control of an U.S. business by a foreign government or person acting on behalf of a foreign government.

What types of infrastructure will be deemed "critical"?

Infrastructure will be deemed critical if its incapacity or destruction would have a debilitating national security impact. However, CFIUS will not designate certain classes of assets as critical infrastructure.

Companies engaging in mergers and acquisitions that may involve a covered transaction, as defined by the regulations, have always considered whether to provide a voluntary notice to CFIUS. Prior to this regulatory change, however, there was no chance that the President would review the transaction if a company did not voluntarily notify CFIUS. Under the new rule, contractors are subject to review regardless of whether they intend to notify CFIUS. Contractors should therefore assess whether their transaction constitutes a "covered transaction" and prepare accordingly.