While lending transactions generally do not fall within the scope of CFIUS jurisdiction, loans by foreign lenders that could result in the lender obtaining “control” of a U.S. business or in the lender’s acquisition of even a non-controlling investment in certain types of U.S. businesses may. This risk is heightened by the specter of many U.S. businesses defaulting on their loan obligations in the wake of the COVID-19 crisis. Foreign lenders therefore should pay particular attention to the consequences of a condition of default in their lending agreements. If a default could result in a change in control of the U.S. business, placing the foreign lender at the helm, or if the lender could acquire an ownership interest (or an increased ownership interest) in the U.S. business, such as through the conversion of debt to equity, the resulting transaction could fall within the scope of CFIUS review.
CFIUS, the Committee on Foreign Investment in the United States, is an interagency committee of the U.S. government that reviews the national security implications of foreign investments in U.S. companies or operations. Chaired by the Secretary of the Treasury, CFIUS includes representatives from 16 U.S. departments and agencies, including the Defense, State and Commerce departments, as well as (most recently) the Department of Homeland Security.
On February 13, 2020, a sweeping set of regulations took effect to implement the Foreign Investment Risk Review Modernization Act (FIRRMA). Among other significant changes, the new regulations vastly expanded CFIUS’s jurisdiction from those transactions that could result in the foreign “control” of a U.S. business to those that could result in a foreign person obtaining a non-passive, non-controlling investment in certain types of U.S. businesses—called TID U.S. businesses—that are involved in “critical technologies,” “critical infrastructure,” or in the collection or maintenance of “sensitive personal data of U.S. citizens.”
Specifically, FIRRMA expanded the scope of CFIUS jurisdiction to “covered investments” in TID U.S. businesses that afford a foreign person: (1) “[a]ccess to any material non public information in the possession of the TID U.S. business”; (2) “[m]embership or observer rights on, or the right to nominate an individual to a position on, the board of directors or equivalent governing body of the TID U.S. business”; or (3) “[a]ny involvement, other than through voting of shares, in substantive decisionmaking of the TID U.S. business regarding: (i) [t]he use, development, acquisition, safekeeping, or release of sensitive personal data of U.S. citizens maintained or collected by the TID U.S. business; (ii) [t]he use, development, acquisition, or release of critical technologies; or (iii) [t]he management, operation, manufacture, or supply of covered investment critical infrastructure.” 31 C.F.R. §800.211.
What does this mean for foreign lenders whose U.S. borrowers enter into default? CFIUS jurisdiction may be implicated if, as a consequence of a default:
(1) the foreign lender could (or does) acquire “control”1 of any U.S. business; or
(2) a foreign lender could (or does) acquire a non-passive, non-controlling investment in a TID U.S. business that affords the lender (or investor) (1) board member or observer rights, (2) access to material nonpublic technical information in the possession of the TID U.S. business, or (3) involvement in substantive decision-making of the TID U.S. business regarding (i) the sensitive personal data of U.S. citizens, (ii) “critical technologies,” or (iii) “covered investment critical infrastructure.”
In either case, the foreign lender should consult its CFIUS legal counsel to determine whether the circumstances warrant filing a notice or declaration with CFIUS seeking clearance for the transaction. The consequences of failing to file a notice or declaration with CFIUS of a covered transaction potentially could result in its modification or, in the exceptional case, the unwinding of the transaction by the President. And in the case of certain mandatory filings, the failure to file could result in a significant civil monetary penalty. For example, if the TID U.S. business produces, designs, tests, manufactures, fabricates, or develops one or more “critical technologies” in certain highly sensitive industries identified by CFIUS, filing with CFIUS would be mandatory. 31 C.F.R. §800.401. Similarly, if a foreign government has a “substantial interest” in the foreign lender or investor, such that the consequences of default would result in the foreign government acquiring a substantial interest in a TID U.S. business, a CFIUS filing also would be mandatory.
Why it matters
While the COVID-19 crisis may offer significant opportunities to lend to distressed U.S. businesses or acquire their debt, the regulatory risks associated with CFIUS’s expanded jurisdiction over certain foreign investments remain. A foreign lender that seeks to exercise its remedies in the event of a default by a U.S. business should consider whether doing so could implicate CFIUS jurisdiction. Convertible debt instruments that confer equity-like rights upon conversion may trigger CFIUS jurisdiction depending upon certain factors, such as when conversion is imminent or within the control of the foreign lender. 31 C.F.R. §800.308. Foreign lenders therefore should seek CFIUS counsel before drafting, acquiring, or exercising such rights to manage and mitigate these risks.
1 The term “control” is defined broadly by CFIUS to include the direct or indirect power “to determine, direct, or decide important matters affecting an entity.” 31 C.F.R. §800.208. Notably, a foreign person’s acquisition of “control” over a U.S. business has been a basis for CFIUS jurisdiction predating FIRRMA.