National Security Issues in Cross-Border Mergers, Acquisitions, & Joint Ventures
June 2, 2004
David Dempsey - Northern Virginia
Jonathan Epstein - Washington
In today’s security conscious environment, U.S. companies and their potential
foreign partner or corporate parent must understand and address U.S. national
security requirements early in their discussions involving potential
cross-border mergers, acquisitions, or joint ventures. No company wants to see
the negative publicity and delay that has marked some high profile mergers where
the government has raised “national security” issues. This is particularly
important where a foreign interest will acquire, or make a significant
investment in, a U.S. defense, aerospace, telecommunications, or information
technology (IT) company. Each company’s M&A team must know what to look for
during due diligence, and factor in government approvals/notifications into
transaction timelines.
Exon-Florio Notification
This ostensibly voluntary notice made to the Committee on Foreign Investment
in the U.S. (“CFIUS”), an interagency committee, has become a de facto
requirement whenever a foreign entity seeks to acquire control over a U.S.
entity where there may be “National Security” implications. The term “National
Security” is undefined and broad, and CFIUS, in recent years, has taken an
interest in mergers involving telecommunications, IT, and other high-technology
companies. In the absence of a filing, the President has the authority to block
or unwind a merger or other transaction.
An informed decision on whether the parties should submit an Exon-Florio
notice to CFIUS must be made early in negotiations. Not only should the CFIUS
thirty-day review period be factored in to the closing schedule, but obtaining
the requisite detailed information for the notice should be done in conjunction
with other due diligence efforts. More importantly, it is often necessary to
lay the groundwork with specific U.S. Government agencies that may claim
interest in the potential transaction, and provide necessary assurances before
filing the notice. For example, the FBI may seek assurances (in the form of a
Memorandum of Understanding) that a targeted U.S. telecom and Internet service
provider will continue to allow the FBI access to their systems, pursuant to the
CALEA (Communications Assistance to Law Enforcement Act) and other authority.
Government Contracts Related to National Security & Classified Contracts
Where the involved U.S. company performs classified U.S. Government
contracts, either as prime or subcontractor, these contracts must be disclosed
in the Exon-Florio notice. Under these circumstances, the U.S. and foreign
parties to the transaction will likely have to establish institutional measures,
acceptable to the relevant agencies, that insulates and protects classified
information and contract performance from disclosure to the foreign company (by
export or otherwise). Such measures are frequently referred to as Foreign
Ownership Control or Influence (“FOCI”) mitigation plans.
A U.S. company performing classified work will normally have an industrial
Facility Clearance (“FCL”) in place that has been issued by the Defense Security
Service ("DSS") or other agency. Unless properly mitigated through
institutional measures, foreign ownership or control (such as significant
foreign investment or appointment of foreign directors or officers) can
invalidate the FCL. Without a valid facility clearance and procedures necessary
to handle classified information, the contractor cannot perform classified
contracts.
The primary institutional measures to mitigate FOCI are: (i) A “Proxy
Agreement” under which the foreign parent's ownership interest and authority is
exercised by three independent directors, who are cleared U.S. citizens with no
prior relationship with either party and who operate the U.S. company quite
independent from the foreign parent; (ii) a “Special Security Agreement” (SSA),
where the foreign parent is allowed to have representative “inside director(s)”
on the board of the U.S. company, but is otherwise excluded from decisions of
the U.S. company affecting classified contracts; and (iii) where the foreign
“interest” is minimal (e.g., the employment of a non-U.S. citizen
director or officer), the company may be able to mitigate the foreign interest
by a board resolution(s) excluding the non-U.S. citizen from access to
classified information.
Where classified government contracts are present in the potential
transaction, the parties need to formulate and present a FOCI mitigation plan as
soon as they have agreed to proceed with the transaction. Because the FOCI
mitigation methods described above will restrict a foreign parent company's
ability to control a U.S. subsidiary post acquisition, the companies may decide
to sell off portions of the U.S. company to a third-party, or alternatively
create a special U.S. corporate entity that will handle classified information
and perform classified work. In addition, because there are no U.S. Government
timelines for resolving these national security concerns, these issues must be
addressed at the outset in order not to significantly delay or postpone closing
or cause unanticipated post-closing complications.
Antitrust Review
M&A lawyers are familiar with the Hart-Scott-Rodino notice requirements
required in any significant merger. However, where the U.S. company is in the
defense industry, the Department of Defense (DoD), has its own procedures, will
conduct its own antitrust assessment, and will provide input to the Federal
Trade Commission/Department of Justice. M&A lawyers need to take into account
this DoD process, as it can have a profound effect on the anti-trust review
process.
National security issues arise with increasing frequency in cross-border
transactions. When these issues are addressed at the beginning of merger or
significant investment negotiations, the parties can cogently assess and address
these national security issues. This can avoid the kind of impasse and negative
publicity that has marked some recent mergers.