New CFIUS Guidance Could Lead to Investment Delays, Challenges, Law Firms Say

New guidance from the Committee on Foreign Investment in the U.S. could significantly curtail the use of “springing rights” deals, leading to “substantial challenges” and delays of certain investments, law firms said this month. Other new CFIUS guidance puts companies “on notice” that the committee will demand information on limited partners involved in a transaction, despite any previously made confidentiality agreements.

Combined, the new set of frequently asked questions issued by CFIUS shows the committee is a “continuously evolving regulatory regime,” White & Case said in a client alert. The firm said the changes represent “a significant change in CFIUS practice that will impact a range of foreign investors and US businesses.”

The most notable change, outlined in a FAQ released earlier this month, describes CFIUS’ “new position” that the completion date of a transaction is the date when the foreign person obtains any equity interest in the U.S. business, White & Case said. This will be a large shift for parties that for years have relied on "springing rights" for minority investments subject to CFIUS, the firm said, which are deals that allow an investor to acquire equity, but not in a way that would make their stake a covered transaction under CFIUS. Under a springing rights agreement, the investor may acquire a small, non-controlling interest in the company, and would only be granted larger governance rights after CFIUS approval.

Springing rights deals have allowed companies to meet CFIUS requirements “while pragmatically managing transaction timing needs,” White & Case said, adding that “to our knowledge, CFIUS has never penalized parties” using the deals for mandatory filings.

But that could change. Foreign investors that trigger a mandatory filing will now no longer be able to acquire equity interests in an American business as part of a springing rights deal, “even on an initially purely passive basis,” until 30 days after the filing is made with CFIUS, the firm said. “This may cause delays in certain venture capital investments and other funding transactions where timing is often critical, presenting substantial challenges to deal completion.”

The FAQ suggests that CFIUS could treat an “initial passive minority investment” that would normally not be subject to CFIUS “as nonetheless subject to CFIUS jurisdiction” if the foreign investor later acquires rights that “separately would constitute a covered transaction,” Covington & Burling said. If “the transaction documents contemplate the foreign person -- at any point in the future -- possibly acquiring rights or interest that would trigger a mandatory filing, the parties would be required to file at least 30 days before the first share transfers,” the firm said, or be subject to civil fines.

Covington said the new FAQ “creates ambiguity in numerous ways,” including whether CFIUS is saying it has jurisdiction to review an initial, passive investment “that does not confer control” if the parties “then subsequently agree to undertake a controlling transaction.” This would “seem to be at odds with CFIUS’s statutory and regulatory authority,” the firm said. It’s also “unclear” how CFIUS will treat a “multi-stage transaction” that features an initial passive investment but is followed by “an acquisition of rights in a second stage when that later second stage is never completed.”

Covington expects “that this shift will make it harder for U.S. businesses, in certain circumstances, to receive crucial (and timely) injections of capital,” especially for early stage businesses involved with critical technologies, which are the focus of the committee. The new position is “a curious one given that these are the exact types of companies that the Biden Administration otherwise has indicated it is paramount to nurture and grow in the United States,” the firm said.

White & Case said it doesn’t expect CFIUS to “retroactively” apply its new position to deals that have previously used springing rights agreements. It also stressed that CFIUS has never “announced any enforcement actions” for violations of mandatory filing requirements.

Another new FAQ from CFIUS clarifies that the committee’s investigation during a review isn’t limited to filing parties, Latham and Watkins said in a client alert. “The FAQ puts parties on notice that CFIUS may request information about indirect foreign investors involved in a transaction, such as limited partners in an investment fund.”

Covington said the committee may now “insist” on “detailed information” about limited partners and any other investors, “regardless of the fact that such LPs may be passive, financial investors.” This could include requests to reveal the identity of the limited partner, their “relative contribution of committed capital to the fund,” their “principal places of business” and “all documentation” with the limited partner, ”regardless of whether any such documents are protected by confidentiality provisions,” the firm said. “That is, if a fund sponsor has made a commitment to keep confidential the identity of an LP or other information regarding the investment, CFIUS may insist on knowing that identity regardless of that contractual commitment.”

Investors using “fund structures” should “be prepared” for these requests, White & Case said. Covington said companies may want to inform their limited partners that they may have to disclose certain information to CFIUS, “and that a delay in or failure to disclose it to CFIUS could prejudice CFIUS’s view of the investor.”