The New World of Foreign Direct Investment
1 . After more than a half century of increasingly liberalized world trade, there are signs of change. Do you see world trade patterns evolving in new and different directions? What does this mean for your country and your clients?
World trade patterns are experiencing historic disruptions that promise to permanently alter the course of global trade in the future. There is a marked movement away from the international trade model which has dominated global governmental policies since the end of World War II. The trend suggests that governments are increasingly embracing bilateral trade agreements among nations as well as placing a greater reliance on the role played by regionalized trading blocs. Many nations are already adopting policies that transparently favor national economic priorities and self-interests. This movement away from a global trading system is changing how and where United States companies will make investment decisions outside of the U.S. and will also promote increased inbound investment opportunities for the U.S.
2 . Historically, foreign direct investment was embraced by governments as a way to strengthen domestic economies. Has your country’s government adopted an aggressive posture in regulating foreign investors?
For half a century, the United States was a priority target for foreign investors because of the size of its large consumer-driven economy. This open-door policy is transforming because the U.S. government has begun to recognize the vulnerabilities of its domestic economy as many leading U.S.-developed technologies (such as advanced semiconductor chips) have been the target of competing countries and industries. This concern is reflected in recent initiatives by the Biden Administration to shield high value U.S. technologies from being acquired by foreign companies or countries that are perceived as a strategic threat to the U.S. economy.
Just as this book is going to press, a related trend is emerging which was sparked by the passage of the Consolidated Appropriations Act 2023, signed into law by President Biden on December 29, 2022. It focuses on identifying possible national security threats to the U.S. economy posed by outbound investments which impact strategic sectors of the U.S. economy. This new law will initially direct the U.S. Treasury Department, Department of Commerce and other agencies to examine outbound investments that involve China and Russia and could affect U.S. national security in areas such as artificial intelligence, quantum computing and, semiconductors and related equipment. I anticipate this will eventually lead to the implementation of a program responsible for also screening outbound investments in the future.
3 . Are there specific sectors of your country’s economy or industries where foreign direct investment is barred or highly regulated?
For political and national security reasons, the United States Congress has historically shielded key industrial sectors within the U.S. economy so as to restrict, or in some cases block, foreign direct investment (FDI) from non-U.S. investors and governments. Examples are:
- Airlines. The U.S. Department of Transportation has established limits on foreign ownership in U.S.-based air carriers [49 U.S.C. §40102(a)(15)].
- Transportation. Title 46 of the United States Code outlines certain barriers to FDI in the U.S. maritime industry.
- Mining. The Mineral Leasing Act of 1920 (as amended) governs the disposition of certain U.S. natural resources and defines what opportunities are open to foreign investors.
- Ports. The Deep Water Ports Act of 1974 restricts FDI to certain defined levels in deep water oil and liquid natural gas ports.
- Defense. Executive Order No. 12829, the National Industrial Security Program, defines which contractors may access U.S. government classified information and which companies are barred under “foreign ownership, control or influence” (FOCI).
- Communications & Media. The Communications Act of 1934 (as amended) restricts the percentage of ownership which is permitted for a foreign corporation or investor seeking U.S. communications licenses, including broadcast, wireless personal computer systems, cellular and aeronautical.
- Nuclear Energy. This is a highly complex and regulated area, and FDI in the nuclear energy field is significantly limited. See the Atomic Energy Act of 1994, 68 Stat. 919.
- Agriculture. The Agricultural Foreign Investment Disclosure Act of 1978 outlines the reporting requirements when a “foreign person” desires to acquire an interest in 10 or more acres of agricultural land in the United States.
- Banking. The banking sector of the U.S. economy is highly regulated with respect to foreign financial institutions. See the International Banking Act as amended by the Foreign Bank Supervision Enhancement Act of 1991.
- Real Estate. In December 2015, former President Obama signed into law provisions easing the obligations imposed on some foreign investors covered by the 1980 Foreign Investment in Real Properties Tax Act (FIRPTA).
4 . The global supply chain has been collapsing worldwide since 2020. How has this impacted businesses in your country and what steps has your country’s government taken to respond?
The global supply chain is broken. Because COVID-19 brought this issue to the forefront, many mistakenly assume the pandemic was the cause of the supply chain collapse. It was not; COVID-19 merely exposed problems that had been impacting the supply chain for years. Beginning in the 1980s, companies worldwide began to shift their sourcing of materials and components from domestic suppliers to foreign countries where labor costs were much lower. China was the major beneficiary of this trend, and its economy grew twentyfold over three decades. Today, China can no longer offer “cheap labor” as an incentive to locate manufacturing facilities there. Basically, the reason is the once popular management theory of “just in time” manufacturing – that is, maintaining inventories at low levels and only ordering a component or raw material right before it is needed – proved to be inherently flawed. This led to supply chain fractures that spiked during the pandemic.
In response to the fractured global supply chain, the United States government adopted a wide variety of incentives to promote more domestic sourcing of components and materials, particularly where an industry or company has a technology or product that is important to U.S. national security interests. An example of such an incentive is requiring products sold to the U.S. government or its agencies to contain increasingly higher percentages of “domestic” (U.S.) content in order to qualify for government funding.
5 . In M&A transactions as well as joint ventures in your country, what are the most critical issues foreign investors must evaluate prior to contemplating a transaction?
The Exon-Florio Act of 1988 (Exon-Florio)
Exon-Florio was enacted by the U.S. Congress in 1988 in reaction to growing concerns surrounding increasing acquisitions of key U.S. businesses by Japanese and other foreign companies. It is intended to regulate foreign investment based on “national security issues.” Exon-Florio permits the President of the United States to monitor potential FDI as well as projects and joint ventures with U.S. companies doing business worldwide where national security is involved. The President has the power to halt a proposed project, or even reverse a completed transaction between a U.S. company and a foreign entity or government if:
- credible evidence exists that the transaction would negatively affect U.S. national security; and
- there are no steps the President could take to minimize those effects.
As a result of Exon-Florio, foreign investors for more than three decades have had to carefully analyze the potential national security implications of any proposed project in the U.S. before making any public announcement.
The Foreign Investment and National Security Act (FINSA)
Exon-Florio was strengthened by the enactment of FINSA following the September 11, 2001 terrorist attacks on New York City and Washington, D.C. FINSA mandates an even more comprehensive scrutiny of FDI in the United States. Under FINSA, proposed FDI transactions involving “critical infrastructure” in the U.S. receive more rigorous reviews. FINSA requires the Executive Branch of the U.S. government to report annually to the U.S. Congress as to when and how national security interests may be affected by FDI. When a transaction involves an entity which is controlled or owned by a foreign government, FINSA mandates a formal examination of the proposed deal. Beginning with Exon-Florio and continuing through the present day, the group within the U.S. government charged with conducting such reviews is called The Committee on Foreign Investment in the United States (CFIUS).
The Committee on Foreign Investment in the United States (CFIUS)
CFIUS is an inter-agency task force which draws on key individuals from throughout the United States government having the authority to oversee proposed FDI transactions in the U.S. CFIUS is composed of representatives from the Departments of Homeland Security, Justice, Defense, Treasury, Commerce, State and Energy, along with members of the Office of U.S. Trade Representatives and the Office of Science & Technology Policy. CFIUS monitors FDI transactions, both large and small, that have a potential impact on U.S. national security. CFIUS has the authority to approve or disapprove a proposed transaction or to reverse a completed deal if it is found to be against U.S. policy or critical to national security interests.
The standard CFIUS review applies to proposed transactions involving (1) a foreign entity that (2) desires to acquire control of a U.S. business that (3) possesses products, services or intellectual property that are (4) fundamental to U.S. national security interests or critical to U.S. infrastructure. The definition of a foreign entity is “any foreign national, foreign government, foreign entity, or any other entity over which control is exercised or exercisable by a foreign national, foreign government, or foreign entity.” It is important to note that CFIUS reviews transactions involving existing businesses. It does not apply to “Greenfield” investments where a foreign party is going to actually start a business from the ground-up. However, the definitions of “national security” and “critical infrastructure” are broad and not well defined.
When looking to acquire an existing U.S. business, foreign investors basically have two options:
- Advance Notice to CFIUS. The foreign investor can agree to submit to CFIUS the details of its intention in advance of making an investment in the United States. The foreign investor at this time must disclose to CFIUS the nature, purpose, scope and expected closing date of the transaction. The assets to be acquired must be specifically described, and the investor must disclose information about itself, including a description of its business activities and any ties to foreign government agencies.
- No Advance Notice to CFIUS. If a foreign government is not directly involved, a foreign investor, unless otherwise mandated, can elect to proceed with an investment without first advising CFIUS. However, the risk of this option is the possibility that CFIUS will later decide to review and reject the deal after it is complete. There is no time limitation on CFIUS’ ability to review a finalized transaction.
When CFIUS becomes involved, there is a defined timeframe in which it can act. The majority of transactions in which CFIUS is given advance notice for review are cleared within 30 days. If the proposed transaction clears, it has “safe harbor” protection, meaning that the CFIUS decision is final and cannot be reversed (unless, of course, an investor misrepresented information or otherwise acted fraudulently). If after 30 days it is still unclear whether the transaction should be approved, CFIUS can take an additional 45 days to either:
- unanimously clear the transaction;
- propose a mitigation plan to the parties; or
- submit its recommendation to the President.
Once a proposed FDI project is sent to the President, the President has 15 days to review the transaction and reach a final decision. Presidential decisions are not subject to judicial review.
If CFIUS determines that a transaction resulting in the foreign ownership or control of a U.S. business will have possible negative national security implications, the foreign investor can work to cooperate with the U.S. government to complete the transaction by making concessions. If successful, CFIUS and the parties will execute a “mitigation agreement” instituting the changes necessary to satisfy national security concerns.
On October 20, 2022, the U.S. Treasury Department (as Chair of the CFIUS members) issued the long-expected Enforcement and Penalty Guidelines. It is clear at this early point that CFIUS authorities going forward will penalize companies which commit CFIUS violations. The underlying motivation of the Guidelines is to encourage “voluntary self-disclosures” of any possible violations, such as material misstatements, failure to make a mandatory disclosure, or non-compliance with a mitigation agreement negotiated with CFIUS authorities. Penalties can be significant (such as USD 250,000 per violation). Also, penalties may in some cases reference the value of a transaction. While it will be some time before the impact of the Guidelines are fully understood, counsel should carefully review them now. Also, if investors have previously acquired a foreign investment which may have been subject to CFIUS purview, they need to investigate whether CFIUS guidelines were violated before they acquired an interest.
When CFIUS determines that a proposed FDI transaction may result in foreign ownership or control of a U.S. business that will have negative national security implications, the foreign investor can request the opportunity to work with the U.S. government to complete the transaction to the mutual satisfaction of both parties. If successful, CFIUS and the parties will execute a “mitigation agreement” which outlines the changes necessary to satisfy any concerns regarding national security. CFIUS frequently requires mitigation agreements in the form of board resolutions, security control agreements, special security agreements, proxy agreements, and/or voting trust agreements. Once a mitigation agreement is approved and the transaction is completed, CFIUS has the authority to continue monitoring ongoing compliance with the agreement.
The Foreign Investment Risk Review Modernization Act (FIRRMA)
On August 13, 2018, the Foreign Investment Risk Review Modernization Act of 2018 (FIRRMA) was signed into law. FIRRMA significantly expands the authority of CFIUS to review future foreign investments in the United States. A primary focus of FIRRMA is to prevent the theft of trade secrets and intellectual property of U.S. companies as well as to keep foreign companies from investing in or purchasing assets near U.S. military bases. FIRRMA also strengthens and expands the CFIUS review process and will likely make it more difficult for foreign companies to successfully invest in the U.S. if national security interests are potentially at risk.
Parties now face a more challenging and complex analysis when deciding whether they need to file for clearance under the new FIRRMA regulations. The underlying issue being – is a CFIUS filing mandatory? Transactions are no longer limited to those that result in the foreign control of a business. CFIUS can now look at transactions where there is less foreign control by the investor.
There are two new rationales for asserting CFIUS jurisdiction:
- defined real estate transactions; and
- “TID U.S. businesses,” which are defined as businesses which are involved in critical technologies, critical infrastructure, and/or sensitive personal data.
CFIUS is now authorized to review certain investments which are viewed as “non-controlling” but are not fully passive in nature. The U.S. government is concerned when a foreign person has:
- membership rights or observer rights on a TID U.S. business board of directors; or
- any involvement in decision making in a TID U.S. business (other than simply voting shares); or
- access to substantive non-public proprietary information of a TID U.S. business.
FIRRMA regulations define what is necessary to be considered a TID U.S. business:
- critical technologies (examples include items on commerce content list [CCL], software, defense materials, emerging technologies);
- critical infrastructure (examples include oil and gas, telecoms, water, finance, defense industries, ports, power);
- companies handling sensitive personal data (examples include individual personal data, genetic information, collections of data companies).
Also because of FIRRMA, some real estate transactions will now be subject to CFIUS review and approval. Examples include real estate located near military bases, missile fields, and/or maritime ports and airports. There are exceptions so that many types of real estate purchases are not subject to CFIUS review and approval.
Next, the U.S. government is concerned when other foreign governments are involved in TID U.S. businesses. This is an area where CFIUS requires a filing at least 30 days prior to a controlled transaction.
Finally, when investment funds are involved, a careful review of FIRRMA regulations is required. There are certain types of investments that are now covered by CFIUS and FIRRMA.
6 . What is the best strategy for acquiring interests in real estate or other tangible property in your country? Is this more difficult for foreign investors?
There are a number of United States laws and regulations which limit and, in some cases, prohibit FDI in certain industries, including real estate. Assuming a foreign investor is permitted to invest in U.S. real estate, a limited liability company (LLC) or a limited partnership (LP) are the most common legal vehicles. Either can provide liability protection for the owner(s).
Forming an LLC or an LP gives an investor two advantages. First, an LLC/LP provides the same insulation from liability as does a corporation. Second, an LLC/LP is taxed as a partnership (pass-through of profits and losses directly to owners) and is generally more flexible from an operational standpoint. Owners of an LLC/LP are qualified if they are corporate entities, individuals, or both. Because real estate investments are a complicated undertaking, the unique factors of each specific investment will suggest the best business structure to select.
A foreign investor needs to understand one important aspect of real estate in the United States – the U.S. maintains a comprehensive set of laws designed to protect the environment. Any investor (domestic or foreign) who purchases title to U.S. real estate may be legally obligated to “remediate” or clean-up any existing environmental problems on or within the property, even if those problems were caused by prior owners. For example, “Brownfield Sites” where former industrial plants once operated or older buildings which contain asbestos or other hazardous materials will pose significant and often costly risks of remediation to the purchaser. This is why before foreign investors decide to purchase real estate in the U.S., comprehensive due diligence needs to be conducted in order to confirm whether any environmental problems exist on the targeted property.
7 . What laws or regulations exist in your country to protect data exchange and privacy, and is the protection of intellectual property challenging for foreign investors?
Data exchange and privacy law is a rapidly developing field fueled by the continued advances of technology. Electronic information by its nature transcends national boundaries into places where laws can differ greatly. Foreign investors will find the current state of data exchange and privacy laws in the United States both complex and, at times, confusing. There are no national comprehensive data exchange and privacy laws because the U.S. legal system operates on federal, state, and local levels, and so laws are not uniform. Even at the state level, privacy laws can vary greatly, with California having the most stringent laws in place to protect privacy.
The commercial and health sectors are also heavily regulated. The U.S. Federal Trade Commission and the Department of Health and Human Services administer data exchange and privacy laws for the commercial and health sectors. The Federal Trade Commission Act (FTC Act) and Health Insurance Portability and Accountability Act (HIPAA) are important statutes.
Federal Trade Commission Act (the FTC Act)
Health Insurance Portability and Accountability Act (HIPAA)
Medical information is highly regulated by HIPAA. The law applies to any entity that deals with medical information, including foreign investors doing business in the United States. The Standards for Privacy of Individually Identifiable Health Information regulates how medical information is collected and used. For example, an employer may not disclose an employee's health-related information with other employees and must maintain employee health records separate from other company records. An employer is required to designate one person from the company to have sole access to health-related information. Foreign investors need to understand that HIPAA creates a duty for companies to take reasonable steps to protect private health information exchanged or stored through electronic mediums.
At the U.S. federal level, specific guidance is difficult to obtain, as the regulations operate on a “reasonableness” standard. Reasonable measures for data privacy can be achieved by following the NIST Cybersecurity Framework.
The strongest data exchange and privacy laws now exist in the European Economic Area (EEA). While data privacy in the United States is generally handled as an aspect of consumer protection, it is viewed as a human right in the European Union (EU). The EU continues to broaden the reach of its data privacy regulations in response to increases in data breaches across the globe from hackers, terrorists, and law enforcement and security agencies. The status of data exchange and privacy regulation between the EU and the U.S. remains unsettled and is subject to change. Foreign investors doing business in the U.S. and within the EEA must accept the reality that when data leaves one country, it must have the same protections as it did in the originating country. The invalidated EU-US Privacy Shield was replaced by the US-EU Trans-Atlantic Date Privacy Framework to safeguard commercial cross-border data flow.
8 . Describe the most common legal structures used by foreign investors when doing business in your country.
There are five basic legal structures for businesses operating in the United States:
- Sole Proprietorship.
- General Partnership.
- Limited Partnership [LP].
- Limited Liability Company [LLC] and Limited Liability Partnership [LLP].
Foreign investors have access to the same legal business structures as U.S. entities.
The sole proprietorship and the general partnership are rarely selected by foreign investors because these structures do not provide adequate levels of legal protection from liability.
Limited partnerships (LPs) and limited liability partnerships (LLPs) are utilized less often because they are not always appropriate for conducting business except in specific areas (such as real estate).
The two business structures most often selected by foreign investors in the United States are the corporation and the limited liability company (LLC). Both offer significant protections for their owners. It is important to understand there is no federal law in the United States governing the formation of corporations and LLCs. LLCs and corporations instead are formed pursuant to the business organization laws of each of the 50 states. While some differences may exist between states regarding formation requirements, fees and reporting, the basics are often quite similar.
One major difference between an LLC and a corporation is taxation. An LLC is taxed as a partnership for federal income tax purposes. A corporation, because it is considered a separate legal entity (a “legal person”), the income and losses of the business do not pass through personally to the shareholders. The corporation itself is taxed on the income it generates at the federal and state tax rates applicable only to corporations. Shareholders are then personally taxed on any income (via dividends or distributions) that is paid to them by the corporation.
In short, both the immediate and long-term needs and goals of an investment need to be analyzed carefully prior to selecting the most appropriate structure to operate the business.
9 . What are the most attractive opportunities for foreign investors in your country at this time?
The economy of United States is so large that highlighting the most attractive investment opportunities is a challenge. What follows are four areas that currently have significant potential.
- Energy. The U.S. is largely self-sufficient in the production of energy from natural gas and petroleum reserves. As a result, industries related to transportation and storage of petroleum and refining natural gas into commodities such as plastics present particularly attractive investment opportunities.
- Infrastructure. As this book is going to press, the Infrastructure Investment and Jobs Act of 2022 was signed into law which will update the U.S. public transit infrastructure, highways and bridges, ports, railways, EV investments and transmission grids. While there will be some restrictions on how and when those projects are designed and contracted, it is a significant area of opportunity.
- Medical. One positive result of COVID-19 was that it forced the United States and its pharmaceutical and medical supply industries to refocus on where products/drugs are sourced. The significant shortage of needed PPE and medical equipment during the pandemic will serve to incentivize non-U.S. entities to expand or set up new operations in the U.S.
- Semiconductor Technologies. The Securing Semiconductor Supply Chains Act of 2022 became law in August 2022. Known as the “CHIPS Act”, it encourages, through both government grants and incentives, the manufacturing of semiconductor chips and equipment in the U.S. Expect this to expand greatly over the next decade.
10 . Do specific laws or mechanisms exist in your country to protect foreign direct investors?
As a general rule, the United States treats foreign investors and U.S. citizens and entities in the same way. No special laws at the federal level grant foreign investors special status over domestic investors. However, as described more fully in the answer to Question 5, if a foreign investor voluntarily seeks CFIUS clearance in advance, then after receiving CFIUS approval, the foreign investor will receive a “safe harbor” for its investment.