Authors: Prajakt Samant Simone Goligorsky Michael J. Lowell Nicole Cheung Noah Jaffe
A number of economies have reformed their foreign investment review frameworks over the last few years to allow governments more leeway to block deals or impose conditions on their completion. The trend towards increased scrutiny of foreign investment has been primarily focused on national security concerns – for example, the UK government’s intervention in the proposed deal between Advent International and Cobham plc last year, which we considered in this client alert.
However, many countries have now implemented emergency legislation, using foreign investment controls as a means to protect wider economic and social concerns triggered by COVID-19. Companies interested in acquiring businesses in these sectors should be aware of these new measures.
European Commission guidance on foreign direct investment
The European Commission (EC) has singled out the issue of foreign direct investment (FDI) screening as part of the EU’s overall response to COVID-19, and issued guidance to Member States1 on 25 March 2020 to protect critical European assets and technology.
The EC’s guidance is issued within the context of the EU FDI Screening Regulation2 (the Regulation), which will apply fully in all Member States from 11 October 2020. The Regulation empowers Member States to review investments within its scope on the grounds of security or public order, and to take measures to address specific risks. The Regulation applies to all sectors of the economy and is not subject to any thresholds.
On the basis of “an increased risk of attempts to acquire healthcare capacities (for example for the production of medical or protective equipment) or related industries such as research establishments (for instance developing vaccines) via foreign direct investment”, the EC has asked:
- Member States with existing FDI screening mechanisms (currently 14 Member States and the UK),3 to take into account the risks to critical health infrastructures, supply of critical inputs, and other critical sectors as envisaged in the EU legal framework;
- Member States that do not currently have a screening mechanism, or whose screening mechanisms do not cover all relevant transactions, to enact a fully-fledged screening mechanism. Meanwhile, those Member States are called upon to consider other available options to address cases where a foreign investor’s acquisition or control of a particular business, infrastructure or technology would create a risk to security or public order in the EU. Options include imposing controls on capital flows and granting the government a ‘golden share’ in the company. The use of both measures is ordinarily restricted by the EC.
The Regulation sets out a non-exhaustive list of factors that could trigger a screening. “Critical infrastructure” includes energy, transport, water, health, communications, media, data processing or storage, aerospace, defence, electoral or financial infrastructure and sensitive facilities, whether physical or virtual. “Critical inputs” include energy, raw materials and food security.4
Non-EU investors should also bear in mind that under article 7 of the Regulation, even where a foreign investment does not undergo a national screening process, Member States and the EC may provide comments and opinions within 15 months after the foreign investment has been completed, and potentially impose mitigating measures. Article 7 applies to foreign direct investments completed on or after 10 April 2019. For example, a foreign investment completed in March 2020 could be subject to ex post comments by Member States or the EC from 11 October 2020 (when the Regulation applies), and until June 2021.
National Security and Investment Bill announced in the UK
The National Security and Investment Bill was announced in the Queen’s Speech on 19 December 2019. The proposed legislation follows the adoption of the Regulation in the EU, and will replace the UK government’s limited powers to intervene in takeovers and mergers under the Enterprise Act 2002.
The UK government will have enhanced power to “scrutinise investments and consider the risks that can arise from hostile parties acquiring ownership of, or control over, businesses or other entities and assets that have national security implications.” The new power applies to transactions in any sector, regardless of the parties’ turnover or market share.5
The UK government’s proposals currently lack detail, but appear to build on those set out in its 2018 White Paper,6 which we considered in our alert on the Advent/Cobham deal. The three main elements of the proposed legislation are:
- A notification system allowing businesses to flag transactions with potential security concerns to the government for quick, efficient screening.
- Powers to mitigate risks to national security – by adding conditions to a transaction or blocking as a last resort, plus sanctions for non-compliance with the regime.
- A safeguarding mechanism for parties to appeal where necessary.
CFIUS remains unchanged to date, but foreign lenders should be on notice
The United States government has not announced, in response to COVID-19, additional restrictions related to foreign investment in U.S. businesses or any changes to the jurisdiction of the Committee on Foreign Investment in the United States (CFIUS), the inter-agency government committee authorised to review certain transactions involving foreign persons. Nonetheless, as a result of defaults on loans, debt restructuring and investment opportunities, the pandemic may thrust certain types of lending transactions into the spotlight of CFIUS review that would otherwise ordinarily escape scrutiny. In addition, foreign investors seeking to seize opportunities in this climate should be mindful that investments made under the auspices of lending or financing transactions can nonetheless be covered transactions or covered investments subject to CFIUS review.
CFIUS is authorised to review any transaction that could result in foreign control of a U.S. business, as well as certain non-controlling investments in U.S. businesses that afford a foreign person access to information, rights or involvement in specified U.S. technology, infrastructure or data. Ordinarily, the extension of a loan or a similar financing arrangement by a foreign person to a U.S. business does not, by itself, constitute a covered transaction subject to CFIUS review, even if the loan creates a secured interest over the securities or assets of the U.S. business in favour of the foreign person. However, CFIUS will review such loans or financing arrangements when imminent or actual default or other condition creates a significant possibility that the foreign person may obtain control of a U.S. business or may acquire a non-controlling equity interest. Accordingly, foreign lenders facing imminent defaults by U.S. borrowers in the wake of COVID-19 may soon find themselves subject to CFIUS jurisdiction if control of the U.S. business or certain equity rights are transferred to the foreign lender as a result of the default.
For example, CFIUS regulations contemplate a scenario where a U.S. business seeks bankruptcy protection after it defaults on its loan from a foreign lender, and the foreign lender has the only secured claim on the U.S. business’s assets, creating a high probability that the lender will receive title to assets that would constitute a U.S. business. The impending bankruptcy court adjudication transferring control of the U.S. business’s assets to the foreign lender may be subject to CFIUS review as it could constitute a covered control transaction.
Relatedly, new foreign investors seeking to inject financing into U.S. businesses during the COVID-19 economic climate should be aware that a loan or similar financing arrangement may be subject to CFIUS jurisdiction if the arrangement more closely resembles an equity investment rather than a loan. For example, CFIUS may have jurisdiction to review a new financing transaction where a foreign person acquires an interest in the profits of the U.S. business or other comparable financial or governance rights characteristic of an equity investment but not of a typical loan.
Foreign lenders confronted with the potential acquisition of control or equity interests in a U.S. borrower should immediately assess the U.S. borrower’s business activities, as certain activities trigger mandatory CFIUS filing requirements. CFIUS declarations are required for some foreign acquisitions and investments in U.S. critical technologies, as well as for certain transactions where a foreign government will obtain a substantial interest in specified U.S. technology, infrastructure or data. The failure to comply with mandatory filing requirements may result in a civil penalty in the amount of the value of the transaction.
Temporary changes to foreign investment review in Australia
The Australian government has announced temporary changes to its foreign investment review framework in light of the economic implications arising from COVID-19. From 29 March 2020, all proposed foreign investments into Australia subject to the Foreign Acquisitions and Takeover Act 1975 (FATA) will require approval from the Foreign Investment Review Board (FIRB), regardless of value or the nature of the foreign investor.7
In ordinary circumstances, a private foreign investor would only require approval if it plans to acquire a “substantial interest” (20 per cent or more) in an Australian corporation where the target is valued above certain monetary thresholds. Foreign government investors are already subject to a lower threshold of A$0 for proposals to acquire all “direct interests” (an interest of 10 per cent or more) in an Australian entity or business, or to start a new Australian business.8 Acquisitions of interests in “critical infrastructure assets”, such as ports, electricity, water and gas assets, by foreign investors are also subject to review by FIRB.
The Treasurer has power under FATA to block foreign investment proposals that are considered “contrary to Australia’s national interest”. Relevant factors include national security, competition, other Australian government policies (including tax), impact on the economy and community, and character of the investor.
The temporary measures will remain in place for the “duration of the coronavirus crisis”,9 and will apply to all new overseas investment proposals as well as those currently in the process. FIRB has also extended the timeframes for reviewing applications from 30 days to up to six months.
Concluding thoughts
As COVID-19 continues to spread, it is possible that more countries will take a similar stance to protect their own national interests and economies.
These developments highlight the need for investors to carefully consider foreign investment review risks in respect of transactions that are currently underway and those that are contemplated.
Our Reed Smith Coronavirus team includes multidisciplinary lawyers from Asia, EME and the United States who stand ready to advise you on the issues above or others you may face related to COVID-19.
For more information on the legal and business implications of COVID-19, visit the Reed Smith Coronavirus (COVID-19) Resource Center or contact us at COVID-19@reedsmith.com.
- Available at trade.ec.europa.eu.
- Regulation (EU) 2019/452, Available at eur-lex.europa.eu.
- Denmark, Germany, Spain, France, Italy, Latvia, Lithuania, Hungary, the Netherlands, Austria, Poland, Portugal, Romania, Finland and the United Kingdom. Available at trade.ec.europa.eu.
- Article 4(1), Regulation (EU) 2019/452.
- Queen’s Speech Government background paper, 19 December 2019, available at assets.publishing.service.gov.uk.
- Department for Business, Energy and Industrial Strategy, “National Security and Investment: A consultation on proposed legislative reforms” (July 2018), available at assets.publishing.service.gov.uk.
- Available at ministers.treasury.gov.au.
- Available at firb.gov.au.
- Available at firb.gov.au.