United States

United States

Foreign Investment Regulations: The effects on national security

Most foreign investments in US wind projects are unlikely to contravene national security law. But it is possible, and it is worth understanding the legislation, says the man who helped craft it.

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Wind energy is rapidly becoming a widespread and important power source. Each of the past several years has seen a significant increase in wind energy capacity and power generation and, by 2008, the US had the largest installed wind capacity in the world. Wind provided 42% of the country's new electric generating capacity last year - more than any other source - but still accounts for only 1% of total US electricity needs. Wind energy also seems poised to make large gains in the future as it continues to benefit from tax incentives and a growing interest in renewable energy.

In order to continue this growth, however, the wind energy industry requires financial investment. The American Wind Energy Association (AWEA) estimates that, at a minimum, an efficient wind power facility requires an initial investment of US$20 million. By 2008, a total of US$17 billion had been invested in wind energy in the US. And, today, there are around 85,000 people employed in the sector.

Much of this funding comes from Europe, where wind plays a much greater role in the supply of electricity. Denmark generates 20% of its electricity from wind, and Germany 7%. These countries have ambitious wind energy development plans for the next two decades. There are European investors supporting projects in Iran, Turkey, Bulgaria, South Africa, China and many other countries, as well as throughout Europe.

Thanks to the US's traditionally open investment environment, US industry has always enjoyed foreign investment throughout the economy, and the wind energy sector is no different. Two years ago, European utilities, helped greatly by easy credit and a strong euro, were very active in the US market, often paying handsome fees for development companies just to gain a foothold in the market. That has changed dramatically, but interest continues, especially in wind energy projects that will permit high quality, smaller investments.

Despite the pressure imposed on financial institutions by the economic crisis, at least 20 banks are active in wind energy development in the US, most of them from outside the country, and the number of equity investors from overseas is expanding rapidly.

Whenever foreign investment is contemplated, however, there are some legal issues to consider. While the United States is generally open to foreign capital, there is a regulatory process that reviews foreign investment for potential effects on national security. Since 1988, the Committee on Foreign Investment in the United States (CFIUS) has been the body charged with this task.

The CFIUS statute authorises the US President to investigate the impact of mergers, acquisitions and takeovers by foreign persons on US national security. If a transaction would result in an impairment of national security that could not be mitigated by agreement with the parties, the President may block the transaction or order the divestiture of an already completed deal. The probability of such an outcome is low, however, and the President has only once blocked a transaction under this provision.

While filing a notice with CFIUS about a planned transaction is voluntary, doing so provides certainty that the transaction has received regulatory approval and will not be subject to an inquiry after a deal has been closed. In deciding whether to file with CFIUS, the parties should determine whether the subject of the deal or the identity of the foreign investor potentially raise a question as to whether the deal will affect US national security. A CFIUS notice involves answering a set of questions about the parties, the transactions and the assets at stake. Typically, the parties should be prepared to wait 30 days for a decision.

While CFIUS reviews transactions only for potential national security implications, that concept includes effects on critical infrastructure, such as major energy assets. Critical infrastructure refers to systems that are so vital to the country that their incapacity or destruction would have a debilitating impact on national security. As is the case of all energy systems, wind farms can be considered to be major energy assets and so could compromise national security. Therefore, anyone who is party to foreign investment transactions in US wind farms or the wind energy industry needs to understand the CFIUS process.

In determining whether to go through the CFIUS review process, parties should consider whether the foreign investment is even subject to CFIUS's jurisdiction and, if it is, whether it is in the parties' interest to file a voluntary notice.

Under jurisdiction

The CFIUS regulations are broadly worded and cover any transaction "by or with any foreign person, which could result in control of a US business by a foreign person." CFIUS generally has jurisdiction to review mergers and acquisitions that may result in foreign control of a US business in any industry. A US subsidiary controlled by a foreign entity simply counts as a "foreign person" for CFIUS purposes. Transactions may result in "control" in many ways and, unfortunately, there is no single, clear definition of this. It is broadly defined as the "power, direct or indirect, whether or not exercised, to determine, direct, or decide important matters affecting an entity." It is important to note that "control" does not require that the foreign person owns more than 50% of the voting or equity interests of the entity or that foreign persons are directors or officers of the business.

In order to determine which deals are covered by the CFIUS process, it is helpful to look at those that are exempt and work back from there. For example, a purchase of US assets is not necessarily a purchase of a US business. If a foreign person acquires land, for instance, such a purchase is not covered. What is critical is what that land is used for. If a foreign person enters into a long-term lease, it may not be covered if that foreign lessee does not make most or all business decisions concerning operation of a leased entity, as an owner might do. A foreign loan made to a business would not be a transaction under CFIUS legislation, as long as the creditor does not have any financial or governance rights over that business. Yet a foreign lender about to foreclose on a wind energy farm may be subject to CFIUS review. Any transaction that results in foreign control of any person engaged in interstate commerce in the US is likely to fall under CFIUS's remit, unless specifically exempted.

Two such exemptions may offer comfort to wind energy companies. First, there is an exemption for a foreign investor holding 10% or less of the voting rights in a company, solely for the purpose of passive investment.

Second, and most notable for the wind energy industry, the review process specifically excludes start-up or greenfield investments. Therefore, initial foreign investments in new US wind farms may fall entirely outside the scope of the CFIUS regime. Before arriving at that happy conclusion, however, the parties should closely examine exactly what the foreign investor is purchasing. Is the purchase of stock or membership interests in an existing business? If the foreign investment is made in a business that has acquired certain development rights or secured permits or transmission privileges, is that business developed beyond what might be considered greenfield? Just when does a start-up start?

CFIUS regulations do not cover an acquisition of assets or part of an entity if they do not constitute a US business. In this context a business is generally defined as any entity - or even a group of assets not organised as a legal entity - operating as a business. A foreign person's investment in a new wind farm would fall under the greenfield exception if the wind farm is not yet a going concern. For example, if the foreign person separately acquires wind turbines, land on which to site the wind farm, and necessary supplies and technologies, all with the intent of creating a start-up wind farm, this would constitute a true greenfield investment exempt from the CFIUS process. If the foreign investor puts in money and others contribute accumulated rights and/or assets already operating as a business, the exemption may not apply.

When a foreign person purchases all or part of a recently-begun wind farm enterprise, determining whether the exemption applies can be difficult. While the business may be considered a start-up because it is relatively new, it will not be considered a greenfield investment if it is already operating as a business. In that scenario, the foreign investment would fall under the CFIUS regime.

Considering this distinction, deals may need to be carefully structured to assure the parties that they are eligible for greenfield exemption.

Seeking certainty

Assuming the transaction is covered by the CFIUS process, the parties still may not need to file with CFIUS. The parties may wish to discuss the matter with CFIUS before making the filing decision. The risks of opting not to file must be weighed carefully and the parties must then decide whether it is in their best interests to file a notice.

The primary benefit of a CFIUS filing is that it provides the parties with certainty following approval. Once CFIUS approves a deal, which must be determined within the statutorily defined deadlines - 30-day initial review, plus an additional 45-day investigation in certain cases - the US Government will not investigate the deal again on the grounds of national security. Therefore, as a general rule, it makes sense to file a notice unless resources, such as time, are particularly short or other compelling reasons exist. The filing process is fairly straightforward and a notice can be prepared relatively quickly. Before completing the application, parties may call CFIUS to review what information could be included to speed up the approval. This will include "personal identifier information" about the backgrounds of members of the board of directors and senior company officials of entities in the ownership chain of the foreign acquirer. There are penalties for material misstatements.

One less process to worry about

If the parties are not inclined to file voluntarily, however, we still recommend that parties notify CFIUS of any deals that may reasonably have national security implications.

While few wind farm investments are likely to encounter turbulence from CFIUS, for peace of mind, an investor might seek CFIUS clearance for certain types of investments, such as: offshore wind farms involving undersea mapping or navigation issues; elevated facilities in US Air Force or commercial flight paths; or stations close to a national security installation.

Another factor worthy of consideration is the identity of the foreign investor. If a foreign government, or an entity controlled by a foreign government, is involved, then it would be more advisable to file a CFIUS notice. Also, CFIUS would be more interested in acquisitions in the energy sector by certain countries, such as China, Russia and Middle Eastern countries, than by traditional allies such as Canada or the United Kingdom. Finally, parties should consider exactly what a foreign owner could potentially do with a particular wind farm that might negatively affect national security. For example, there have been recent press reports that foreign spies have infiltrated the US electric grid and may have the ability to disrupt the power supply at will. If a foreign owner of a US wind farm could use that system to engage in espionage, obtain sensitive technology, or disrupt other energy transmission or distribution channels, then national security might be an issue.

On the other hand, if the wind farm is solely capable of providing power generation that at worst could be shut off, then there seems to be little risk.

All that said, it is prudent to explore the reaction of national and homeland security agencies to the particular wind farm project being acquired by calling CFIUS. The committee employs reasonable people, who are knowledgeable about the process and the enabling legislation, and are usually very forthcoming. Informal discussions can be carried out without triggering an obligation to file.

If there is any reason to believe that the subject of the deal or any party involved would raise a red flag with the US Government for national security reasons, then our law firm suggests filing with CFIUS. There are few situations where the urgency to close a deal warrants the uncertainty created by not filing. In an era of risk abatement, the offer of safe harbour is hard to resist.

- By invitation, Stewart Baker former assistant secretary for policy, US Department of Homeland Security.

About the Author: Stewart Baker is former assistant secretary for policy at the US Department of Homeland Security. He is now a partner at Steptoe & Johnson LLP. He helped draft the current CFIUS regulations.

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