By: Elana Broitman
Participation by foreign lenders in U.S. transactions may trigger a statutory requirement to file a national security clearance process adjudicated by the Committee on Foreign Investment in the United States (CFIUS), a U.S. federal government body. While normally, lending transactions are not "covered" by CFIUS, such review may be appropriate in two circumstances:
- Where a foreign lender receives warrants, convertible debt, or other security instruments that provide such foreign party with control over U.S. business decisions; and
- Where a foreign lender finds itself in a position of control upon the default of the debtor company.
Even if the foreign lender is one of a group of otherwise domestic creditors, but has the ability to exercise control within the creditor group, such transaction may be covered by CFIUS, and thus a CFIUS filing by the parties to the transaction may be appropriate.
The result – either at the time of the initiation of the loan in the first scenario, or in anticipation or time of default in the second – is that the lender and debtor may need to apply to CFIUS to review and either clear the transaction or dictate deal terms that would mitigate the risk such foreign control would pose.
Potential Increase of CFIUS Review of Lenders
CFIUS has traditionally been associated with foreign purchases of or investments in U.S. businesses, rather than loans. As foreign lenders become more active in otherwise domestic transactions, particularly in sensitive industries such as defense, energy, technology, finance, or real estate in proximity to military locations, CFIUS interest could increase. According to the National Association of Realtors' "Commercial Lending Trends of 2015" survey[i], 20 percent of real estate clients or investors were foreign. Forbes has noted that recent legislative changes have increased incentives for foreign lenders to come to the U.S.[ii] This increase in activity by foreign lenders, particularly if notable defaults occur, may result in heightened scrutiny by CFIUS.
If the foreign lender is called in by CFIUS for a review, rather than filing voluntarily at such time as the Committee's jurisdiction is triggered, the Committee is likely to be more skeptical when determining whether the foreign lender's interests present a legitimate business transaction or whether national security risks are present. In some cases, foreign investors whose acquisitions were reviewed on a non-voluntarily notified basis have been forced to divest their interests.[iii]
Thus, whether as part of a workout in case of a default, or upon entering an unusual lending deal that provides ownership rights to the foreign lender, foreign entities providing credit in a transaction should factor in a CFIUS review with their counsel as part of their due diligence.
The Committee on Foreign Investments in the United States conducts national security reviews of foreign acquisitions of, or significant investments in, a U.S. asset that could pose a risk to U.S. national security. A review of whether a transaction is covered by CFIUS involves determining whether there is: (a) a foreign entity, (b) that is gaining control as a result of the transaction, (c) in a U.S. business involved in inter-state commerce, and (d) could impact on national security arising from the transaction.
The review – usually triggered by a voluntary joint filing by the parties to the transaction – is conducted by a Committee of nine core federal agencies: Department of the Treasury (chair), Department of Justice (DOJ), Department of Homeland Security (DHS), Department of Commerce (Commerce), Department of Defense (DOD), Department of State (State), Department of Energy (DOE), Office of the US Trade Representative (USTR), and the Office of Science & Technology Policy (OSTP), with other agencies added when their sectoral expertise is required.
The deliberations of the Committee are not public, and CFIUS has a very broad scope of review. National security does not only entail defense or intelligence issues. CFIUS reviews have included transactions in the following areas: (i) energy and other critical infrastructure, (ii) potential offshoring of a sole or limited supplier of an important defense product or service, (iii) technology, particularly with cutting edge military applications, (iv) potential for tampering with a significant food or pharmaceutical supplier, and (v) real estate located near military or intelligence installations.
An average CFIUS review requires about four months including:
- 4-6 weeks for legal analysis of all relevant aspects of the investor and the target, and drafting of the CFIUS filing;
- 1-2 weeks after submitting the file for the Committee to log it in and start the clock;
- 30 days for first stage review by CFIUS; and
- 45 days for second stage review (or "investigation") by CFIUS if known or potential risks cannot be resolved at this first stage, or if a foreign government's ownership is involved.
The CFIUS review typically runs concurrently with other deal diligence and negotiations.
Lending Transactions and CFIUS
The CFIUS regulations promulgated in 2008[iv] make clear that foreign lenders could be subject to CFIUS jurisdiction in certain circumstances either at the time the deal is structured or upon default.
If a deal is structured so that a lender gets rights to impact management decisions, exercise everyday control over the U.S. business, the right to appoint members of the board of directors of the U.S. business, obtains an interest in the profits of a U.S. business, or similar financial or governance rights, such transaction would be of interest to the Committee, assuming the other CFIUS elements were present. If such factors exist, the parties should consider filing for a CFIUS review prior to concluding the lending transaction.
Even in an otherwise traditional lending scenario, a foreign lender could trigger the "acquisition or investment" element of a CFIUS review upon the default of the US debtor if the foreign lender obtains a sole or controlling interest over the U.S. business. A foreign lender that is part of a syndicate may not trigger this element if the group is led by a US lender and the foreign entity has no rights to gain control over the U.S. business even in case of a default. But a foreign lender may trigger CFIUS jurisdiction if it controls the group of lenders or gains other rights over the debtor's management upon default.
The Committee may provide the foreign lender with the time needed to dispose of the U.S. business collateral, so long as the foreign person has made arrangements to transfer management decisions or day-to-day control over the U.S. business to U.S. nationals during the interim period.[v]
The Securities Industry and Financial Markets Association (SIFMA) recognized that the Foreign Investment and National Security Act of 2007 ("FINSA")[vi] raised such issues for foreign lenders, and thus commented on the rules at the time they were proposed.[vii] SIFMA recommended that the definition of control make clear that negative covenants protecting a lender against actions by a borrower that could reduce the borrower's creditworthiness do not, in and of themselves, constitute control if the lender does not attempt to influence the borrower's ordinary course of operations. The final rule made that clarification.
SIFMA also requested that the final regulations incorporate the presumptions that: (1) bona fide lending transactions involving established financial institutions will not be reviewed by CFIUS except under exceptional circumstances; and (2) lending transactions permitted to U.S.-regulated banks or bank holding companies will not be considered to establish control. The rule, however, did not make those changes, resting instead on indicia of control by the foreign institution.
What Should a Foreign Lender Do to Protect Its Interests?
At the time of conducting due diligence of the transaction, the lender should include additional inquiries regarding national security factors in a transaction, including intelligence or military tenants or neighbors in a real estate deal, sensitive government contracts, and cutting edge intellectual property and research and development programs, particularly with military and intelligence applications.
If there is the potential of a default of a company involved in a sensitive industry or one with sensitive contracts, know-how or proximity issues, the foreign lender should consider structuring the deal such that a U.S. lender is party to the transaction and would have the controlling interest if a default were to occur. Alternatively, the foreign lender could consider ensuring that a U.S. party would be available to temporarily manage the U.S. business in case of a default while the foreign lender considers potential steps to minimize CFIUS exposure.
If a default appears imminent or foreclosure proceedings begin, and the nature of the debtor's business sector or location would be of interest to CFIUS, the lender should consider notifying the Committee and requesting advice regarding potential CFIUS jurisdiction and concerns. A prompt informal inquiry or formal filing would minimize delay and risk for the lender's take over.
The first rule of thumb is awareness. If a lender may obtain interests in a U.S. business that may constitute control, it is prudent to get CFIUS counsel's review of whether such a transaction would trigger potential CFIUS jurisdiction. It is better to be informed and in a proactive position to change certain aspects of the transaction in order to avoid an additional regulatory delay or to proceed with a CFIUS review in tandem with the negotiation of the transaction.
This article is presented for informational purposes only and it is not intended to be construed or used as general legal advice nor as a solicitation of any type.