Expect Outbound Investment Penalties 'Sooner Rather Than Later,’ Lawyer Says

Companies should expect the Treasury Department to aggressively penalize violators of its upcoming outbound investment prohibitions relatively soon after those rules are finalized, lawyers with Kirkland & Ellis said this week. They also said American chip companies and other technology firms are considering inserting new outbound investment-related warranties in their contracts and may start pulling out of existing investment deals that could soon be captured by the new prohibitions.

The Treasury Department published proposed regulations last month that could introduce new prohibitions and notification requirements on U.S. investments in China, Hong Kong and Macau (see 2406210034) and the Biden administration said it hopes to finalize those rules before 2025 (see 2405080039). Luci Hague, who advises clients on foreign investment reviews, sanctions and export controls, said Treasury has so far signaled that it plans to take enforcement of the investment prohibitions seriously.

“I think they're going to pursue potential issues and violations pretty vigorously, and they may be public,” she said during a webinar hosted by the law firm. She noted that the Committee on Foreign Investment in the U.S., which is also housed in Treasury, had its busiest enforcement year ever in 2023, imposing four penalties for breaches of mitigation agreements (see 2407230017).

“We would expect the same vigorous enforcement approach with respect to these [outbound] regulations,” she said, “and I personally would expect that we'll see enforcement sooner rather than later, after they've been finalized.”

Mario Mancuso, also a Kirkland & Ellis trade and national security lawyer, said it's important for industry lawyers to recognize that the new outbound restrictions are being implemented by the same agency that enforces CFIUS rules and financial sanctions.

“Even though there are open questions as to the scope and as to the application of this draft regulation, we have some sense as to how it might evolve,” said Mancuso, who served as Bureau of Industry and Security undersecretary from 2007 to 2009, where he also worked on CFIUS issues. “And that is a good thing, I think, for practitioners and for principals alike.”

He added that U.S. semiconductor companies in particular are “really going deep into the draft regulations” to analyze how they will be affected and to make sure they can comply. Hague said the rule’s restrictions around investments in China’s chip sector is “an area that is going to be extremely technical” and isn’t as “clear-cut” as the artificial intelligence prohibitions.

“It's going to be really hard in practice to undertake this technical assessment in the context of [an investment] transaction, especially if it's competitive, to assess whether or not you as a U.S. person might trigger one of these potential requirements,” she said.

Law firms and industry associations have asked Treasury to outline clear due-diligence steps that will be required of deal-makers, warning that the new rules risk chilling a broad range of U.S. ventures in China and incentivizing foreign companies to seek funds elsewhere (see 2310050035).

Mancuso said some U.S. and foreign parties are already starting to request specific “comfort” letters from investors to certify that they won't “engage in transactions that are otherwise prohibited under” the new outbound investment predictions. He also expects companies and lawyers to add new language, including ​​reps and warranties, in contracts with possible investment partners. That language could, for example, require a Chinese company to state that they’re not covered by the new restrictions.

“There will be an art that evolves as to that” language, Mancuso said.

Treasury’s proposed rules aren’t designed to capture investments made before Aug. 9, 2023 -- the date President Joe Biden signed an executive order authorizing the new regime (see 2308090066) -- but Hague said some of those older investments could still be affected. Certain new investment activities involving those older deals -- including more funding contributions or an expansion of the existing deal -- could make the investment subject to the Treasury restrictions if those activities took place after Aug. 9.

She said this could cause some companies to withdraw from agreements that have long been in place.

“Even though it may not be required by the regulations to unwind the existing transactions and agreements with counterparties, we do expect that there will be a bit of a chilling effect,” Hague said. “Folks will probably start to pull out of these existing arrangements simply so they don't trip the requirements in the future.”