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China Inc. and the CFIUS National Security Review (Page 2 of 3)

This slice of the data will become more important as the volume and sophistication of Chinese firms looking to enter the U.S. market increases. So far it suggests that Chinese firms are not being grossly singled out. China, however, is not the U.K.; should the U.S.-China trust deficit deepen, further hurdles may arise, as may an aversion to investing. For now, Chinese companies are faring better than even they seem to think in entering the United States.

Take 5

Another way to come at the question of how Chinese companies are faring is to look at the issue from the bottom up. Below are five illustrative transactions involving Chinese firms that reflect a range of issues and experiences when it comes to CFIUS review of Chinese investment.

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1)    Mitigate and Acquire

One example of a successful Chinese acquisition this year involved Wanxiang USA, a unit of the Chinese auto parts giant Wanxiang Group. In January 2013, Wanxiang USA was cleared to acquire the assets in bankruptcy of U.S. lithium-ion battery maker A123. The complicating factor was that the U.S. Department of Energy had previously provided $250 million in grants to A123 in 2009. The company had drawn down nearly $133 million in grants before filing for Chapter 11 bankruptcy in October 2012. To mitigate concerns relating to Wanxiang potentially acquiring A123’s contracts with the U.S. defense sector and taxpayer funded core battery technology that could be used to develop military applications, A123 excluded from the transaction A123’s military contracts, which were sold separately to Illinois-based Navitas Systems for $2.25 million.

The Wanxiang experience underscores the role of mitigation agreements in enabling Chinese firms to proceed with investments in a manner that balances investment and security imperatives. From 2009-2011, 8 percent of cases (22) resulted in the use of legally binding mitigation measures. CFIUS is increasingly requiring parties to enter mitigation agreements or otherwise imposing mitigation requirements as a condition for closing, accounting for only two cases in 2008, yet eight and nine cases in 2011 and 2010, respectively. The ability to craft and consent to such mitigation measures and agreements will become a key element for Chinese firms seeking to invest in the United States

2)    If at first you don’t succeed…

The leading example of an unsuccessful Chinese bid in the United States remains energy giant CNOOC’s bid for Unocal in 2005 – an experience that still gives pause to many Chinese firms. The year the deal collapsed, volume for China-inbound deals fell from $2 billion and eleven deals to three deals totaling less than $1 billion. CNOOC’s bid triggered a Congressional storm regarding Chinese influence over U.S. energy supply; an acquisition’s “potential effects on U.S. requirements for sources of energy…” is, indeed, one of the risk factors explicitly identified in Exon-Florio. CNOOC withdrew its bid and Chevron later acquired Unocal with a lower bid.

In February 2013, however, CFIUS cleared the U.S. component of the $15.1 billion acquisition by CNOOC of Nexen Inc., a Canadian energy company with a modest amount of assets in the United States. Although CFIUS scrutinized the transaction closely (CNOOC had to withdraw and refile its voluntary notice),  its ultimate clearance is notable given opposition from certain quarters in Congress; the target sector, energy, being one of identified national security sensitivity; and CNOOC’s prior blocked bid. CNOOC’s experience underscores the case-by-case nature of CFIUS review where even a firm with a fraught history involved in sensitive sectors may clear the CFIUS process in a subsequent go-around, lending credence to the review process.

3)     Location, Location, Location

In contrast to Wanxiang and CNOOC, a bid by Ralls Corp., a Delaware corporation owned by two Chinese nationals, failed and ended up in unprecedented and ongoing litigation. Ralls sought to acquire four wind-farm projects in Oregon without initially filing a notice with CFIUS. The acquisition was halted by CFIUS and, later, by a rare presidential order mandating divestment due to the farms being “all within or in the vicinity of restricted air space at Naval Weapons System Training Facility Boardman in Oregon.” On at least two prior occasions, Chinese investments in the mining sector in Nevada similarly failed due to the targets’ proximity to U.S. military installations.

In the first-ever direct challenge to the validity of a CFIUS order, Ralls brought a lawsuit against CFIUS and U.S. President Barack Obama in the U.S. District Court for the District of Columbia. A ruling was issued on February 22 largely upholding the U.S. government’s motion to dismiss the case, yet allowing Ralls to proceed with a limited due process claim regarding the process that led the Obama administration to issue its divestment order. On October 9, however, the court dismissed Ralls’ due process claim on the grounds that it failed to substantiate it; the court took particular note of Ralls’ failure to initially file a voluntary notice with CFIUS. In its holding, the court noted that no statutory conditions were placed on the president’s discretion to block a transaction, according deference to the executive branch on a matter of national security. Ralls has since filed an appeal with the U.S. Court of Appeals for the District of Columbia.

The Ralls case has implications for all investors relating not just to the limited nature of legal recourse vis a vis CFIUS review but also to the proximity issue of the target’s assets to sensitive facilities. Given that at least three Chinese investors have run afoul of the proximity issue, Chinese firms will have to contend with this factor – no matter how seemingly benign the actual target of their investment – for scrutiny derived from U.S. concerns regarding espionage.

4)    “Not Interested in the U.S. Anymore”

If Ralls’ unsuccessful bid had an unspoken undercurrent of espionage, Chinese telecommunications giant, Huawei, has had to deal with the issue upfront. In addition to having withdrawn its bid for 3Com, a network equipment manufacturer, in 2008 and having had its 2011 acquisition of 3Leaf, a cloud computing company, blocked, Huawei has had to respond to targeted Congressional scrutiny for its founder’s alleged links with the Chinese military.

In October 2012, the House Permanent Select Committee on Intelligence issued an “Investigative Report on the U.S. National Security Issues Posed by Chinese Telecommunications Companies Huawei and ZTE” recommending that CFIUS “must block acquisitions, takeovers, or mergers involving Huawei. Overseas, a UK Parliamentary body has expressed similar concerns regarding how Huawei is “embedded” in the country’s critical national infrastructure, although it did not find evidence of specific problematic activities.

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