Changing U.S. National Security Rules: What This Means For Mergers And Acquisitions
Article by Blakes Competition & Antitrust Group and Blakes Foreign Investment Group - Blake, Cassels & Graydon LLP
Investments involving Canadian companies face increasing scrutiny from Canada's security and intelligence agencies and closest allies (the U.S., the U.K., Australia and New Zealand, known as the Five Eyes). Since 2009, the Investment Canada Act has provided a process that allows the Canadian authorities to review, block or remedy foreign direct investments in Canadian businesses on national security grounds. This national security review mechanism has even been applied in M&A transactions involving Canadian businesses with only tangential connections to Canada.
Security and intelligence agencies are increasingly cooperating in their reviews of national security threats from foreign direct investments. Because of this close cooperation, developments — particularly in the U.S. — are critical for Canadian companies to monitor closely.
Recent changes implemented in the U.S. under a new pilot program are likely to result in increased scrutiny of investments by Canadian companies or in Canadian companies with U.S. operations due to a new mandatory reporting requirement that came into effect on November 10, 2018 ("Pilot Program").
Under the new rules, investors are required to notify the U.S. government of investments in certain sensitive industries, even when the investment does not result in the foreign investor gaining control of the U.S. business (i.e., minority investments).
The Pilot Program follows other changes that have been made to the U.S. national security review process.
- Canadian companies looking to make investments in the U.S. or which hold U.S. subsidiaries will now need to assess whether the new rules could apply to their investments. These rules can affect deal timing, and companies may want to consider this when negotiating transaction agreements.
- Due to the filing requirements for minority investments under the Pilot Program, Canadian security and intelligence officials are more likely to become aware of minority investments that would not have otherwise been reportable in Canada under the Investment Canada Act.
- Investors engaged in investments that fall within the scope of the Pilot Program must submit a mandatory declaration filing to the Committee on Foreign Investment in the United States (CFIUS). CFIUS can then request that the investor file a full notice or initiate a unilateral national security review if CFIUS has concerns.
SCOPE OF THE PILOT PROGRAM
Prior to the implementation of the rule changes, Canadian and other foreign investors could notify CFIUS when an investment resulted in foreign "control" of a U.S. business. These notifications were voluntary but allowed investors to ensure that the investment would not be challenged after closing. Upon receiving notifications, CFIUS would review investments to determine whether they threatened U.S. national security. Where CFIUS determined that a notified investment did threaten national security, CFIUS could recommend that the President block or remedy the investment.
Under the Pilot Program, declarations to CFIUS are mandatory in certain circumstances both for controlling and non-controlling investments when certain criteria are met:
Nature of the U.S. Business. A U.S. business falls within the scope of the Pilot Program where it operates in one of 27 specified industries and produces, designs, tests, manufactures, fabricates or develops critical technologies that are used in connection with a specified industry activity or that are designed by the business specifically for use in a specified industry.
Nature of the Investor. The Pilot Program applies to all non-U.S. investors regardless of their country of origin or residence. The Pilot Program excludes certain indirect investments by investment funds as well as investments involving air carriers.
Nature of the Non-Controlling Investment. In the case of a non-controlling investment, the Pilot Program applies when the investment provides the foreign investor with:
- Access to any material non-public technical information in the possession of the U.S. business
- Membership or observer rights on the board of directors or equivalent governing body of the U.S. business or the right to nominate an individual to a position on the board of directors or equivalent governing body of the U.S. business, or
- Involvement, other than through voting of shares, in substantive decision-making of the U.S. business regarding the use, development, acquisition or release of critical technologies
The Pilot Program does not apply to transactions signed before October 11, 2018, or transactions completed before November 10, 2018.
Investments that fall within the scope of the Pilot Program are subject to a mandatory declaration filing with CFIUS. Parties may elect to file a standard notice of the investment instead of a mandatory declaration.
A mandatory declaration is an abbreviated notice that should be roughly five pages in length. The declaration must contain certain specified information regarding the investment and the foreign investor.
Investors must submit their declarations 45 days before closing. If they fail to do so, they may be liable for civil penalties up to the value of the investment. Once CFIUS has determined the mandatory declaration is complete, it has 30 days to review the investment.
The Pilot Program increases the number of Canadian investments in the U.S. that will be subject to a national security review. Therefore, the timing and potential remedy implications of national security reviews are likely to take on increased importance in deal structuring. It is important to consider these issues carefully at the outset of the diligence process.