On August 1, 2018, U.S. Congress passed the Foreign Investment Risk Review Modernization Act (“FIRRMA”), which reformed the Committee on Foreign Investment in the United States (“CFIUS”) review process and significantly expanded CFIUS jurisdiction over foreign investments. On October 10, the U.S. Department of the Treasury issued an interim rule for a pilot program implementing certain provisions relating to critical technologies of FIRRMA that were not immediately effective upon enactment. The interim rule expands CFIUS jurisdiction over certain non-controlling foreign investments in critical technology companies in 27 pilot program industries, and requires mandatory declarations for such investments. Foreign investors will face a more stringent review process in the U.S.
However, FIRRMA provides an exemption for the foreign investments by or through an “investment fund”, which are not subject to the covered transactions if certain conditions are satisfied. The interim rule for the pilot program and the updated FAQs clarify the application of the FIRRMA “investment fund” exception to the pilot program, and reconfirm that the pilot program applies to the indirect investment of limited partners through investment funds.
First of all, FIRRMA limits the application of CFIUS authority over certain types of investments. An explicit exception is for investment involving air carriers. It is regulated that no investment involving an air carrier with an issued certificate shall be a pilot program covered transaction. The second exception clarifies that certain investment fund invested indirectly by foreign persons as a limited partner or equivalent on an advisory board or a committee of the fund shall not be covered for the purpose of FIRMMA if they satisfy the requirements at 31 CFR 801.304(a):
- The fund is managed exclusively by a general partner, a managing member, or an equivalent;
- The foreign person is not the general partner, managing member, or equivalent;
- The advisory board or committee does not have the ability to approve, disapprove, or otherwise control:
- (i) Investment decisions of the investment fund; or
- (ii) Decisions made by the general partner, managing member, or equivalent related to entities in which the investment fund is invested;
- The foreign person does not otherwise have the ability to control the investment fund, including the authority:
- (i) To approve, disapprove, or otherwise control investment decisions of the investment fund;
- (ii) To approve, disapprove, or otherwise control decisions made by the general partner, managing member, or equivalent related to entities in which the investment fund is invested; or
- (iii) To unilaterally dismiss, prevent the dismissal of, select, or determine the compensation of the general partner, managing member, or equivalent;
- The foreign person does not have access to material nonpublic technical information as a result of its participation on the advisory board or committee; and
- The investment otherwise meets the requirements of paragraph (4)(D) of subsection (a) of section 721 made effective by part 801.
That is to say, only when the foreign limited partner does not have the ability to make decisions and control the investment in a direct or indirect way, their investments shall not be considered a pilot covered transaction. In addition, if there are no extraordinary circumstances, a waiver of a potential conflict of interest, a waiver of an allocation limitation, or a similar activity, applicable to a transaction pursuant to the terms of an agreement governing an investment fund shall not be considered to constitute control of investment decisions of the investment fund or decisions relating to entities in which the investment fund is invested.
As it is clarified in FAQs on FIRMMA Critical Technology Pilot Program, if a foreign limited partner does not meet all of the criteria in 31 CFR 801.304(a), it is not necessarily subject to the pilot program. If a foreign limited partner is a member of the advisory board or committee of a fund, but all of the criteria set forth in 31 CFR 801.304(a) are not met, an analysis of the particular facts and circumstances will be required to determine if the indirect investment by the foreign person in a pilot program U.S. business through an investment fund is a pilot program covered transaction. The analysis would consider whether the investment could result in foreign control of a pilot program U.S. business or affords the foreign person any of the following:
- access to any material nonpublic technical information in the possession of the pilot program U.S. business;
- membership or observer rights on the board of directors or equivalent governing body of the pilot program U.S. business or the right to nominate an individual to a position on the board of directors or equivalent governing body of the pilot program U.S. business; or
- any involvement, other than through voting of shares, in substantive decision making of the pilot program U.S. business regarding the use, development, acquisition, or release of critical technology.
The pilot program requires the submission of mandatory declarations, but FIRRMA includes an exception to the mandatory declaration requirement for investments by investment funds meeting certain criteria. FAQs points out that FIRRMA’s exception to the mandatory declaration requirement applies in the context of the pilot program. FIRRMA includes an exception to the mandatory declaration requirement for investments by an investment fund if：
- the fund is managed exclusively by a general partner, a managing member, or an equivalent;
- the general partner, managing member, or equivalent is not a foreign person; and
- the investment fund satisfies, with respect to any foreign person with membership as a limited partner on an advisory board or a committee of the fund, the criteria specified in FIRRMA’s general clarification for investment funds (sections 721(a)(4)(D)(iv)(cc) and (dd) of the DPA).
If the same foreign person is making both an indirect investment in a pilot program U.S. business through an investment fund, as well as a direct investment in the pilot program U.S. business, CFIUS will consider the totality of the particular facts and circumstances of the transaction in determining whether a transaction is subject to its jurisdiction.
Accordingly, if a foreign investor wants to invest in the U.S. business by investing though an “investment fund” as a limited partner or equivalent on an advisory board or committee of the fund, the criteria of the exceptions in the interim rule should be satisfied. The foreign limited partner should participate in the investment fund passively to avoid triggering the CFIUS jurisdiction. In addition, in the FAQs, CFIUS further clarified that if a foreign limited partner does not meet all of the criteria in the interim rule of the pilot program, CFIUS will consider the totality of the particular facts and circumstances to determine whether the investment could result in foreign control and subject to CFIUS review. This exception provides a potential channel for foreign investors to invest in the U.S. business.
Under the background of the trade war between China and the U.S., FIRRMA and the implementation of the pilot program have increased the difficulty and uncertainty of foreign investors investing in the U.S. The foreign investments related to critical technologies may face more complicated procedures and stricter review process. Chinese investors need to conduct a compliance assessment of the investment in advance, and prepare themselves to encounter a more rigorous and time-consuming review process. On the other hand, FIRRMA did not overly extend CFIUS jurisdiction over non-control investments through “investment fund”. Chinese investors can reasonably take advantage of the exception clause of CFIUS to legally and effectively plan and promote transactions under the framework set by FIRRMA and the interim rule of the pilot program. If the investors want to invest through “investment fund” as a limited partner or equivalent on an advisory board or committee, they should plan the transaction structure and strategy as early as possible, and fully assess the relevant terms of the agreement, so as to ensure the compliance with the above provisions of the pilot program and avoid control of the investment fund decisions or access of any material nonpublic technical information. Therefore, the risks of CFIUS review and unnecessary burdens on costs and time can be reduced and the success rate of the investment can be improved.
