National Security Issues in Cross-Border Mergers, Acquisitions, & Joint Ventures
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.
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.
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.