Amid FDI screening regime expansion, deal teams have opportunities to capitalise on newly available exemptions, but must beware novel complexities.
US intervention in the proposed acquisition of hotel-software company StayNTouch by a Chinese investor and UK intervention in the acquisition of satellite telecommunications company Inmarsat plc by a private equity-led consortium reiterate the range of foreign direct investments (FDIs) that can draw government attention, and the disruptive impact that such attention can bring to sensitive deals.
A desire by governments to control investments by businesses from states perceived as hostile in key sectors (such as defence, critical infrastructure, and advanced technologies) has fuelled a widening of the range of investments being caught. Recent moves by governments to further tighten FDI screening rules in response to the COVID-19 crisis will only accelerate this trend.
While more and more countries are introducing or expanding their FDI screening regimes, well-established regimes (such as that operating in the US) are maturing and offering exemptions that may prove helpful to some private equity investors — while also creating new complexities.
Staying Out of Scope — Recent Changes to CFIUS
In the case of private equity, the Committee on Foreign Investment in the United States (CFIUS) has historically focused on GP-exercised control. However, driven by a recognition that ownership structures may include parties that can access information or influence business decisions without the exercise of control, recently enacted amendments have afforded CFIUS enhanced powers to review investments by LPs, as well as minority investments by co-investors.
Relying on those authorities, CFIUS scrutinises LPs and co-investors from countries considered sensitive, and it will continue to do so, particularly as it seeks to identify perceived opportunistic investments in US businesses impacted by COVID-19. Exemptions for truly passive LPs and co-investors exist, and buyout firms must consider the composition of fund investors in light of the changes, particularly relating to governance issues and information rights.
Another change to CFIUS is a carve-out for certain “excepted” investors from Australia, Canada, and the UK. On the face of it, this looks to exempt a significant block of LP investors and co-investors from scrutiny. However, structuring a transaction to fit within the new rules is likely to be difficult.
Tips for Deals Involving Sensitive Targets
Undertaking a detailed review of the target and its business in light of national security sensitivities is essential. If a transaction falls within CFIUS’ scope, the screening process may well involve extensive disclosure requirements that can impact deal timetables.
The investors involved in the deal also require careful review. If a co-investor’s presence is likely to cause delays, deal teams should consider post-completion involvement, particularly in competitive bid situations in which sellers may be deterred by regulatory uncertainty. In the case of buyout funds, we are increasingly seeing provisions in LP agreements that either restrict the rights of LPs or give GPs the right to restrict such rights if necessary to avoid triggering FDI filings.
Deal teams should consider opening a dialogue with regulators to allay concerns. CFIUS may accept undertakings as a condition of clearance, including prohibiting or limiting the transfer of certain intellectual property, trade secrets, or know-how. The UK government has also accepted undertakings (e.g., in Advent’s 2019 takeover of aerospace company Cobham). However, buyout firms should be wary of undertakings that inhibit exit, for example, by restricting the range of potential buyers.
Other FDI Regimes
Multiple EU jurisdictions are actively enforcing FDI screening regimes within which many PE deals now fall. It is anticipated that the new EU FDI regulation will result in greater levels of FDI screening of deals by EU Member States. In the UK, a much-delayed National Security and Investment Bill is expected to introduce a far-reaching FDI screening regime that will capture acquisitions, including minority interests and assets (including intellectual property). Accordingly, this is an area that deal teams should continue to monitor.
In our view, the extent of FDI regimes has, for some time, required a multijurisdictional analysis in a similar way to antitrust. Nascent regimes and amended approaches mean that extensive work is required to mitigate unexpected delays or remedies.