What the Smithfield deal can teach Chinese investors

The Committee on Foreign Investment in the United States (CFIUS) recently approved the largest ever takeover of a US business by a Chinese company. Shanghui International Holdings's $7.1 billion acquisition of US pork processer Smithfield Foods was completed after receiving approval from CFIUS in September 2013 following its 45-day investigation into the national security implications of the transaction. The deal triggered heated debate over foreign takeovers in the US and the transparency of the government review process.

Chinese interest in US companies has not been without controversy, even though the vast majority of Chinese investments in the US have been approved, or have not required approval under CFIUS. The outcome of the Smithfield transaction has been much anticipated as it is expected to lead to more investments from China into the US. It also encourages Chinese companies seeking to acquire controlling interests in US companies to plan ahead and notify CFIUS of proposed transactions that may or may not have national security implications early in the investment process.

What is CFIUS?

CFIUS is an inter-agency committee chaired by the Secretary of the Treasury that consists of members representing major executive departments and agencies. It is charged with reviewing deals that would result in a foreign person having control of a US trade or business – so called covered transactions.

Control is broadly defined in the CFIUS regulations but, essentially, means the power to direct or decide important matters affecting the business. For example, the power to appoint and dismiss officers, select new lines of business or control the finances of a company is indicative of control. The control can be direct or indirect and side agreements or disproportionate voting rights could cause a minority interest holder to control the business. The regulations specify certain minority shareholder protections that do not convey control, like the power to prevent the sale of all or substantially all of the company's assets. The threshold question in any CFIUS review is whether it involves a covered transaction, which in turn depends on an analysis of control. If there is no covered transaction, CFIUS does not have the authority to review the deal.

The committee focuses on the national security implications of foreign investments in the US that constitute covered transactions. National security is not defined for CFIUS purposes. However, the enabling statute lists factors considered by CFIUS in determining whether a covered transaction poses a national security risk. Such factors include the potential national security effects on US critical technologies, the long-term projections of US requirements for sources of energy and other critical resources and infrastructure. Critical infrastructure means a physical or virtual system or asset so vital to the US that its incapacity or destruction would have a debilitating impact on national security.

Guidance issued by the Department of the Treasury makes it clear that the concept of national security should be broadly interpreted and that it includes acquisitions of US businesses outside the traditional defence sector. The committee does not focus on any particular US business sector. The guidance focuses on two characteristics of a deal: the nature of the US business being acquired and the identity of the foreign person acquiring control of the business. CFIUS has found that transactions present national security considerations because they involve US businesses that provide goods or services that directly or indirectly contribute to US national security. The acquirer's identity is particularly relevant if it is controlled by a foreign government.

Notifying CFIUS of a transaction is voluntary. However, the committee may initiate its own review in some circumstances. A transaction may be reviewed and prohibited after it has been concluded.

Review and investigation

The CFIUS process consists of four phases. First, there is a pre-filing stage during which the parties to a transaction prepare the notice and preliminary consultations with committee staff may occur. Such early engagement of CFIUS staff is advisable, including the submission of a draft filing. CFIUS does not issue advisory opinions. However, the pre-filing period gives CFIUS staff an opportunity to familiarise itself with the transaction and ask questions, which helps submitters prepare and file a complete notice.

The second phase, a 30-day review period, begins once parties submit the notice and CFIUS deems it complete and disseminates it to CFIUS members. During this phase, the committee reviews the transaction to determine the effects of the transaction on national security, using various factors set forth in the CFIUS regulations to make that determination. It may enter into mitigation agreements or impose conditions on the transaction to address any national security concerns it may have.

The third phase consists of an additional 45-day investigation of the effects of a covered transaction on national security. CFIUS must conduct this additional investigation if, during the initial review period, (i) it determines that the transaction (a) is a foreign government-controlled transaction, (b) would result in foreign control of any critical infrastructure in the US and could impair national security, and such impairment was not mitigated during the initial review period, or (c) threatens to impair national security and the threat was not mitigated during the initial review period, or (ii) the lead agency recommends, and CFIUS agrees, that an investigation should be undertaken. However, an investigation of a foreign government-controlled transaction or a transaction involving foreign control of critical infrastructure is not required if the Secretary of the Treasury and the head of the lead agency determine, based on the committee's initial review, that the transaction will not impair national security. As in the initial review phase, CFIUS may enter into mitigation agreements or impose conditions on the transaction to mitigate its national security concerns during the investigation phase. It is common for the parties to meet with CFIUS staff members during both the initial review and investigation phases.

If CFIUS determines not to conduct the additional investigation, or if, after the additional investigation, it determines that there are no remaining unresolved national security concerns, then the transaction qualifies for a safe harbour. Subject to the terms of the safe harbour and any mitigation agreement or conditions imposed by CFIUS, the transaction may proceed without the possibility of suspension or prohibition. If, however, the committee decides to recommend that the President suspend or prohibit the transaction, requests that the President make a determination with regard to the transaction, or is unable to reach a decision on whether to recommend that the President suspend or prohibit the transaction, the process will enter a fourth phase in which CFIUS sends a report to the President requesting the President's determination as to whether to block or unwind the transaction.

If CFIUS refers a transaction to the President, the President has the authority to block the transaction if he has credible evidence that the foreign investment will threaten to impair national security. However, to invoke this authority, the President must determine that other US laws are inadequate or inappropriate to protect national security. The President's decision must be made within 15 days of the completion of the investigation.

If the review process or investigation is not going well, often the parties will voluntarily withdraw their notice rather than risk presidential suspension or prohibition. It is rare for CFIUS to complete its review with a recommendation that the President block the transaction. From 2009 to 2011, 269 transactions were reported to CFIUS. Of those, 12 were withdrawn during the initial review. There were investigations of 100 transactions, with 13 notices withdrawn during the investigation. No transactions were blocked during the period, although, as discussed below, President Obama issued a high profile order blocking a transaction for national security reasons in 2012.

All information submitted to CFIUS, including during the pre-filing stage, is confidential.