CFIUS in the Time of COVID-19: Opportunities (and Risks) in Debt Financing Transactions

This article was originally published by Law360 on March 26, 2020.

The sudden economic effects of the COVID-19 pandemic have been dramatic in recent weeks, as businesses around the world have been required to suspend—or significantly curb—their commercial operations. While much remains uncertain, there will likely be an uptick in debt restructuring transactions by U.S. businesses, along with opportunities to invest in distressed assets. It is critical that both non-U.S. investors and non-U.S. lenders assessing when, and to what extent, to exercise their remedies in an event of a default of a U.S. business—which may include equity conversion rights—should consider whether such action may inadvertently trigger the jurisdiction of the Committee on Foreign Investment in the United States (“CFIUS” or the “Committee”).

CFIUS Overview

CFIUS is an interagency committee of the U.S. government with authority to review certain foreign investments in U.S. businesses (defined to include any entity engaged in interstate commerce in the United States). Historically, CFIUS had authority to review a relatively narrow subset of foreign investments in U.S. businesses—specifically, investments that could result in foreign control of a U.S. business (“covered control transactions”). However, new regulations, effective February 13, 2020, expanded CFIUS’s jurisdiction to review non-passive, non-controlling investments (“covered investments”) in three categories of U.S. businesses (collectively, “TID U.S. businesses”):

• Businesses that produce, design, test, manufacture, fabricate, or develop one or more critical technologies;
• Businesses that own, operate, manufacture, supply or service any of 28 identified categories of critical infrastructure; and
• Businesses that collect or maintain sensitive personal data of U.S. citizens.

Application to Lending Transactions

In general, lending transactions are not within the scope of CFIUS’s jurisdiction, provided that they do not grant the foreign person economic or governance rights more characteristic of an equity investment. If a financing or lending transaction, for example, grants a foreign party (1) an interest in profits of a U.S. business; (2) the right to appoint members of the board of directors of the U.S. business; or (3) other comparable financial or governance rights characteristic of an equity investment, CFIUS could have jurisdiction over the transaction.

Where a non-U.S. lender acquires a convertible debt instrument that will confer equity-like rights upon conversion, the CFIUS jurisdictional analysis becomes fact-specific. The CFIUS regulations define “contingent equity interest” as “a financial instrument that currently does not constitute an equity interest but is convertible into, or provides the right to acquire, an equity interest upon the occurrence of a contingency or defined event.”¹  

The acquisition of a contingent equity interest has the potential to trigger CFIUS jurisdiction, either (1) at the time of acquisition or (2) upon conversion, depending on the circumstances. In particular, if the contingency is sufficiently imminent—or within the control of the lender—CFIUS may consider the contingent equity interest for purposes of assessing its jurisdiction (potentially triggering jurisdiction upon acquisition of the contingent equity interest, as opposed to upon conversion). The CFIUS regulations specifically provide that, in determining whether to consider contingent equity interests for jurisdictional purposes, the Committee will consider, inter alia:

• The imminence of conversion or satisfaction of contingent conditions;
• Whether conversion or satisfaction of contingent conditions depends on factors within the control of the acquiring party; and
• Whether the amount of interest and the rights that would be acquired upon conversion or satisfaction of contingent conditions can be reasonably determined at the time of acquisition.²

In the typical lending transaction—where default is neither imminent nor within the control of the lender at the outset—CFIUS will disregard the contingent equity interest until conversion.

CFIUS Considerations upon Default

Although lending transactions generally are not subject to CFIUS review, the Committee’s jurisdiction can be triggered immediately where, as a result of imminent or actual default or other condition, there is a significant possibility that a non-U.S. lender may acquire:

• Control of a U.S. business (constituting a covered control transaction); or
• Qualifying access or rights over a TID U.S. business (constituting a covered investment).

With respect to scenario one, the CFIUS regulations define control broadly to include “the power, direct or indirect, whether or not exercised . . . to determine, direct, take, reach, or cause decisions regarding . . . important matters affecting an entity.”³ There is no minimum equity threshold or number of board seats required to constitute control. Even consent rights with respect to certain corporate actions—such as (1) major expenditures or investments; (2) entry into, termination, or non-fulfillment of significant contracts; (3) the appointment or dismissal of officers or senior managers; or (4) the reorganization, merger, or dissolution of the business—can be sufficient to support a finding of control. Given the low threshold for establishing control, a non-U.S. lender’s exercise of default remedies could trigger CFIUS’s jurisdiction. The fact that CFIUS jurisdiction exists does not necessarily mean that a CFIUS filing will be warranted; however, it would be prudent for the non-U.S. lender to consider whether the borrower’s national security risk profile (e.g., U.S. government touchpoints; dealings in export-controlled technology; close proximity to sensitive U.S. government facilities; access to sensitive personal data of U.S. citizens) is likely to be of interest to the Committee.

With respect to scenario two, as noted above, the newly effective CFIUS regulations extended the Committee’s jurisdiction to review non-passive, non-controlling investments in TID U.S. businesses. In this context, a non-passive, non-controlling investment is one that affords a foreign investor (1) board member or observer rights; (2) access to material nonpublic technical information in the possession of the TID U.S. business; or (3) involvement in “substantive decisionmaking” of the TID U.S. business (defined to include involvement in decisionmaking regarding specific contracts, corporate strategy and business development, research and development, critical technology, critical infrastructure, and sensitive personal data). Importantly, if exercise of default remedies would result in a non-U.S. lender acquiring any of the foregoing rights in respect of a U.S. company that develops critical technology for use in a designated, sensitive industry, the transaction would trigger a mandatory CFIUS filing (backed by a significant monetary penalty).⁴ For other TID U.S. businesses, a non-U.S. lender’s exercise of default remedies under these circumstances would be subject to CFIUS’s voluntary filing jurisdiction.

Conclusion

Although the economic uncertainty from COVID-19 may present attractive commercial opportunities for sophisticated investors and lenders, recent regulatory developments have significantly expanded CFIUS’s jurisdiction to review foreign investments in U.S. businesses. The Committee’s jurisdiction can be triggered both by direct investments (including in distressed assets) and when a non-U.S. lender acquires financial or governance rights characteristic of an equity investment, as a result of default or other contingency. In some cases, CFIUS notification may be warranted or even required, in order for non-U.S. lenders to protect their investments. As such, prior to exercising default remedies, non-U.S. lenders should consider potential CFIUS implications, particularly as most active credit arrangements were negotiated prior to promulgation of the current CFIUS regulations.