Increasing Regulations to Impact Foreign Investment in U.S. Real Estate
Recent regulatory changes on foreign direct investment into the U.S. will have a significant impact on non-U.S. investors who are considering the U.S. market. The 2018 Foreign Investment Risk Review Modernization Act (FIRRMA) has expanded the scope of the Committee on Foreign Investment in the United States (CFIUS) national security risk reviews for foreign direct investment. These reviews will have a specific focus on investments into companies that have critical technology, critical infrastructure, sensitive personal data, and real estate that is located near national security facilities. The increased regulatory focus will heighten the potential risk of executing any foreign direct investment in these key areas.
CFIUS is a government body that reviews investment transactions for their potential impact on national security. To obtain CFIUS clearance for foreign direct investment into the U.S., the parties to the transaction must develop a comprehensive understanding of the potential threats the foreign acquirer and their country could have on U.S. national security, as well as the possible vulnerabilities foreign access, control and potential exploitation of the U.S. targets’ sensitive assets and or operations could create. To facilitate a successful deal, it is imperative that the parties to the transaction gain this understanding early in the process and well before they engage with CFIUS. This will allow them to proactively address potential national security issues and concerns that CFIUS is likely to focus on during its review.
The CFIUS final regulations were published in January 2020 and took effect on February 13, 2020. To better understand the issues at hand, let’s take a brief look at the history of CFIUS.
CFIUS was initially established in 1975 by executive order. In 1988, as part of the “Exon-Florio” amendment to the Defense Production Act of 1950, legislators required that all foreign investments that might affect national security must be reviewed. If it is determined said investments pose a threat to national security, the president may unilaterally block the investment. The CFIUS mandate was further expanded in 1992 by the Byrd Amendment to the Defense Production Act requiring review of all acquisitions involving a foreign government. It was not until the 2007 Foreign Investment and National Security Act that the CFIUS review process was codified and replaced the 1975 executive order. No additional reform was made until the 2018 FIRRMA legislation was issued. However, this legislation called for a comprehensive overhaul of the CFIUS review process and significantly expanded the scope of its authority.
CFIUS uses a risked-based analysis to evaluate the following three areas of transactions involving foreign entities and governments:
- Develop a comprehensive understanding of the threat posed by the foreign acquirer.
- Develop a comprehensive understanding of the vulnerability exposed by the target U.S. business’ technology and operations.
- Determine the potential national security consequence if these threats and vulnerabilities were combined.
Impacts on Real Estate Transactions
Prior to FIRRMA, CFIUS’ authority was limited to transactions in which a foreign acquirer would obtain control of a U.S. entity. While FIRRMA preserves this authority over these transactions, which they refer to as “covered control transactions,” it expanded CFIUS’ authority in other areas, one of which being real estate transactions. This includes any purchase or lease by, or concession to, a foreign person of certain real estate that could provide the foreign person with the ability to collect intelligence on or conduct surveillance of national security activities.
The covered real estate falls within these regulations:
- Any real estate that is located in or will function as part of a covered port.
- Located within close proximity (one mile) of certain military installations identified in the regulations.
- Located within the extended range (99 miles) of certain military installations identified in the regulations.
More specifically, the new regulations provide CFIUS the authority to review non-exempted real estate transactions if they provide the foreign party with three of the following four property rights:
- The ability to physically access the real estate.
- The ability to exclude others from physically accessing the real estate.
- The ability to improve or develop the real estate.
- The ability to attach fixed or immovable structures or objects to the real estate (e.g., affix a satellite dish on a building or structure).
It does not matter if these property rights are currently not exercised or shared with another person or if the property is subject to any easement or other encumbrance.
The new regulations do allow for excepted real estate investors to avoid the requirement for deal review by CFIUS, and they would include a foreign national who is a citizen of one or more excepted real estate countries and/or a foreign government of an excepted real estate foreign state. The new regulations have only identified four countries (Australia, Canada, United Kingdom and Northern Ireland) for excepted foreign state status. This was determined based on an evaluation of these countries’ robust intelligence sharing and integration of their defense industrial base with the U.S. As other countries enhance their policies around foreign direct investment, they, too, could possibly receive exempted status.
CFIUS Reporting and Review Process
Foreign real estate investments in the U.S. are not required to be reported to CFIUS. However, if after review the parties to a transaction believe the transaction should be declared to CFIUS, they could voluntarily declare the transaction. CFIUS will then review the declaration. When the declaration is accepted by CFIUS, its 30-day assessment period will begin. CFIUS will then notify the parties if the transaction is considered covered.
If the transaction is determined to be covered, CFIUS will request the parties involved in the transaction file a voluntary notice. Upon acceptance of the written notice to CFIUS, the 45-day review period will begin. During the review period, CFIUS will determine if the deal raises any national security concerns. Upon completion of the review, CFIUS will undertake an investigation if a member of the committee notifies the staff chairperson that they believe the proposed transaction could threaten national security, or the lead review agency (e.g., Treasury Department, Department of Justice, etc.) recommends and CFIUS agrees that an investigation be completed. If CFIUS decides not to proceed with an investigation, then the review has been completed and the transaction would move forward.
If during the review or investigation periods national security issues are identified, the lead agency on behalf of CFIUS may negotiate, enter into or impose, and enforce a mitigation agreement or condition with any party to the covered transaction to mitigate any threat that arises as a result of the transaction.
This investigation must be completed within 45 days, upon which CFIUS will send a report to the president:
- Recommending that the president suspend or prohibit the transaction.
- Indicating CFIUS was unable to reach a conclusion if the president should suspend or prohibit the transaction.
- Requesting that the president make a determination on the transaction.
If CFIUS decides not to send a report to the president, the review under Section 721 of the Defense Production Act will be concluded and the parties to the transaction will be notified.
The CFIUS review process can be a long, drawn out process that could delay the closing of the potential transaction. However, proper planning for the CFIUS review can help mitigate this issue.
Impact of the CFIUS Review Process
The CFIUS review process is highly confidential and protected from public disclosure. However, prior to this expansion of CFIUS’ authority, there has been a number of high-profile deals that have been blocked by the president due to the CFIUS review findings.
Under the new regulations, more potential foreign direct investment deals will fall under the CFIUS review requirement. As such, consider the following:
- Longer timelines for deal closure to allow for the completion of the CFIUS review process.
- Increased costs to close the deal due to more comprehensive diligence assessment related to intellectual property, customer base and data capture, which could lead to potential national security risks leading to the development and implementation of mitigation solutions.
- Expanded diligence into the acquiring company’s ultimate and beneficial ownership structure to identify any relationships with foreign governments or countries.
- Increase in execution deal-risk in the transaction if CFIUS seeks to impose mitigation measures.
To address these new challenges, U.S.-based companies that are anticipating obtaining foreign direct investment and foreign entities looking to make investments into U.S.-based companies or real estate should consider a pre-transaction risk assessment to gain insight into any potential issues that could arise from the CFIUS review process. Furthermore, parties should identify if the deal structure itself could create any CFIUS issues. Completion of a comprehensive risk assessment and deal structure evaluation will help organizations identify and quantify the CFIUS review risks and preemptively implement mitigation strategies to minimize CFIUS review risk and additional compliance costs prior to deal closing.
Ultimately, these new regulations are important for strengthening U.S. national security. But, as with most regulations, being proactive in addressing potential issues can alleviate problems and facilitate deal flow.
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