If you think only a totalitarian government could undo your closed merger, takeover or acquisition transaction, it is time to think again. The President of the United States has the authority to unwind your merger, acquisition or takeover deal even after the transaction is closed. The Committee on Foreign Investment in the United States (CFIUS) caught the attention of very few for almost two decades, but has been of significant interest to many in the past two years. The scope of CFIUS reviews was significantly expanded by the Foreign Investment and National Security Act (FINSA) at the end of 2007 and as a result more transactions than ever are being submitted for voluntary review by CFIUS.
CFIUS was created in 1975 by an executive order, in reaction to Middle East investments, to monitor the impact of foreign investments in the United States. The Exon-Florio Amendment of 1988 to the Defense Production Act of 1950 provided the President the authority to suspend, prohibit or take other action with respect to foreign acquisitions, mergers, and takeovers of U.S. businesses that threaten to impair U.S. national security. The passage of FINSA in late 2007 further broadened the scope of this authority to include transactions that would result in foreign control of U.S. critical infrastructure including but not limited to "critical technology" and "major energy assets."
The review process under Exon-Florio is delegated to CFIUS, currently a committee of nine prominent U.S. government agencies. It is chaired by the secretary of the Treasury, and the U.S. departments of Defense, Homeland Security, Commerce and Justice generally take the most active roles in the process. As a result of FINSA, the Office of the Director of National Intelligence must now evaluate a transaction’s national security implications. The review authority of CFIUS covers any inbound M&A transaction involving any foreign person that could result in foreign control of a U.S. business. CFIUS primarily reviews transactions that (i) threaten to impair U.S. national security, (ii) would involve control by a foreign government, or (iii) would result in foreign control of U.S. critical infrastructure, if such control threatens to impair national security.
Most transactions are voluntarily submitted to CFIUS for review by filing a notice to CFIUS. The benefit of submitting a transaction for voluntary review is that once CFIUS has concluded its review or investigation and determined that there are no unresolved national security concerns the transaction qualifies for a "safe harbor" and, subject to the terms of any safe harbor, mitigation agreement or other conditions imposed by CFIUS, the transaction can proceed without the possibility of suspension or prohibition. A transaction that has not successfully completed CFIUS review and qualified for the safe harbor can unilaterally be reviewed by CFIUS even after the transaction has been concluded, which can result in the transaction being unwound if national security considerations cannot be resolved.
Today more than ever, Exon-Florio has become particularly relevant to Indian companies investing in the United States for the following reasons:
Although Exon-Florio and CFIUS have been around for more than three decades, this regulatory landscape has evolved considerably in the past two years as a result of FINSA’s expansion of the scope of CFIUS reviews beyond areas traditionally viewed as "national security" (e.g., defense, and nuclear matters, etc.) to the area of "critical infrastructure," which in some cases could include technology and telecommunications. Almost half of the transactions subject to CFIUS review from 2006 to 2008 involved the manufacturing sector and approximately one-third involved the information sector. This is important to Indian buyers because information technology (IT) and IT-enabled services companies have been and will continue to be of significant interest to Indian buyers, as the growth of the Indian economy to a large extent is dependent on the growth of its IT industry. Close to 50 percent of the acquisitions by Indian companies in the United States between 2006 and 2009 and 65 percent in the first half of 2010 were in the information technology sector. The manufacturing and the energy sectors are also a significant and growing part of Indian acquisitions in the United States.
We have seen a dramatic increase in the number of cases subject to CFIUS review (a 250 percent increase in transaction reviews by CFIUS over the last five years) and investigation (transactions subject to CFIUS investigation in 2008 and 2009 were more than three times the number of investigation in 2006 and 2007). During this four-year period more than 10 percent of the transactions were withdrawn by the parties during the 30-day review period and 25 percent were withdrawn during the follow-on 45-day investigation period. In the vast majority of these transaction the parties were able to make necessary changes to the transactions to mitigate and address CFIUS concerns and successfully resubmitted the transactions for CFIUS review and approval. For example, of 23 notices withdrawn in 2008, 20 were resubmitted and only three were abandoned.
Acquisitions by Indian companies in the United States have grown considerably over the past few years (aggregating approximately $3.8 billion in the first half of 2010 alone), and are expected to continue to grow. Transaction sizes have also been growing, with the first half of 2010 witnessing mega-deals like Reliance’s acquisition of Atlas Energy and Pioneer Natural Resources valued at $2.8 billion and Essar Group’s acquisition of Trinity Coal for $600 million. The stories of big Indian corporate houses taking over major international companies in the past few years has put India Inc. in the headlines of leading U.S. newspapers and certainly on the minds of CFIUS members.
As Indian companies continue to aggressively expand their operations outside India and their acquisitions in the United States, they further diversify their investments in the United States beyond the traditional technology sector to the telecommunication, transportation, coal, oil and gas and other energy sectors of the U.S. economy, which are more traditionally the subject of CFIUS scrutiny. Recent transactions such as Reliance’s deal with Atlas to pick up a 40 percent stake in Marcellus Shale, a gas project, or Coal India’s proposal to buy equity in Peabody Energy Corp., and MphasiS’s acquisition of Fortify Infrastructure Services are only indicative of the future trends. It is expected therefore that as the diversification continues, more transactions will be subject to CFIUS scrutiny.
Finally, although India’s disinvestment program in the last two decades has significantly reduced the Indian government’s control of many Indian businesses, several Indian businesses are still owned in part by the government of India. CFIUS will keep its eyes wide open for investments by Indian businesses to ensure that the Indian government does not indirectly have any control over U.S. business that could hamper U.S. interests.
This is not to say that all acquisitions by Indian companies are expected to be subject to Exon-Florio and CFIUS review. However, becoming knowledgeable about the statute and its scope and learning to navigate the CFIUS review process effectively should become a mainstay for Indian companies looking at doing acquisitions in the United States, especially in light of the following:
The statute is intentionally broad to provide latitude to the President in the protection of U.S. national security interests. The term "national security" has a flexible and evolving meaning under the statute and the regulation, which allows the U.S. authorities to interpret the term broadly. In practice, CFIUS reviews each covered transaction on a case-by-case basis to evaluate whether any national security concern may be presented by a transaction, based on factors such as whether the transaction involves "critical infrastructure" or activities affecting national defense or homeland security. It is expected that CFIUS will continue to interpret this term in a broad manner. It is therefore not easy for foreign buyers without the assistance of regulatory experts to determine if the acquisition of a U.S. business could be subject to CFIUS scrutiny.
The addition of "critical infrastructure" in the CFIUS review is of practical importance because of the reach of this concept and its applications. The statute requires additional investigation in cases in which the transaction results in foreign control over critical infrastructure that, in the determination of CFIUS, could impair national security. "Critical infrastructure" is defined as "a system or asset, whether physical or virtual, so vital to the United States that the incapacity or destruction of the particular system or asset of the entity over which control is acquired pursuant to that covered transaction would have a debilitating impact on national security." This definition allows CFIUS to consider many inbound transactions to be within the scope of their investigation. Critical infrastructure would include industries such as telecommunications, energy, electrical power systems, oil and gas, transportation, banking and finance, water supplies and emergency services. Technology, however, is a grey area, as certain technologies could be instrumental in national defense. Acquisitions of U.S. technology by a foreign buyer is therefore becoming of growing interest to CFIUS.
CFIUS is required to advise Congress if it finds a coordinated effort by a foreign government or foreign companies to acquire U.S. companies producing "critical technologies." "Critical technologies" are critical technology, critical components, or critical technology items essential to national defense, identified under the statute, subject to regulations issued at the direction of the President. The meaning of "essential to national defense" is again an evolving concept based on several factors, including government policies. India ranked fourth among the countries acquiring "critical technologies" in the United States in 2008, with 11 acquisitions.
Despite the ambiguity, there are some indicators that may help a foreign buyer understand the landscape. For example, in certain technology transactions, it is common for CFIUS to require information "regarding whether the U.S. business provides cyber systems, products or services (including business systems used to support common business processes and operations, such as enterprise resource planning, e-commerce, e-mail, and database systems; telecommunications or Internet systems; control systems used to monitor, assess, and control sensitive processes and physical functions, such as supervisory control, data acquisition, and process and distributed control systems; or safety, security, support, and other specialty systems, such as fire, intrusion detection, access control, people mover, and heating, ventilation, and air conditioning systems)."
Notification of a transaction to CFIUS is voluntary, and parties who are comfortable that their transaction does not implicate national security issues can elect not to notify CFIUS of their plans. However, failure to notify is no guarantee that the transaction is in compliance with Exon-Florio and leaves the transaction subject to unilateral CFIUS review and Presidential action indefinitely.
Following notification, CFIUS has a 30-day period to conduct a review of the transaction. Following this initial review period, CFIUS has an additional 45-day period to conduct an investigation of the transaction if it chooses to do so. This 45-day period can be extended as required by the investigation. At the end of the process, if national security considerations have not been resolved, the President can decide to suspend, prohibit or take other actions, including unwinding the transaction. Out of 469 transactions that were subject to CFIUS review between 2006 and 2009, 61 were subject to investigations and only two were subject to presidential determination. In both of these cases, the President decided not to suspend in light of agreements that mitigated U.S. government concerns.
Conducting a preliminary CFIUS analysis in connection with the review of potential acquisition targets in the United States should become a mainstay for all Indian companies doing business in the United States. And in certain cases, filing a voluntary notification under Exon-Florio may be advisable because of the potentially severe consequences, as well as the uncertainties caused by not filing.
Valérie Demont, Bipul K. Mainali and Stanley R. Soya
