According to press reports, the Committee on Foreign Investment in the United States (CFIUS), an interagency governmental body with authority to review foreign acquisitions in the United States that may threaten to impair the national security, has asked Huawei Technologies Ltd. (Huawei), a Chinese telecommunications equipment firm, to seek approval for a May 2010 transaction involving the US firm 3Leaf Systems (3Leaf). Huawei and 3Leaf did not notify CFIUS before the transaction and did not seek CFIUS approval. CFIUS did not learn of the transaction until after its completion.

CFIUS will review the six-month-old transaction for possible national security concerns. This unusual step by CFIUS, to initiate examination of a completed transaction, raises the prospect of rescission of the transaction or other measures by the government. These events illustrate the serious risk that companies may take in deciding not to notify CFIUS of a foreign acquisition in the United States that might broadly implicate the national security.

California-based start-up 3Leaf created virtual server technology for business enterprise data centers. Reportedly, Huawei acquired technology and key personnel from 3Leaf, but Huawei did not acquire equity or any physical assets of 3Leaf. According to the press reports, the firms did not notify the government because they unilaterally concluded that the deal did not raise national security concerns and because Huawei did not acquire all of 3Leaf’s assets. Huawei has said that it filed export control classification requests with the Department of Commerce related to 3Leaf technology.

Under the Foreign Investment and National Security Act (FINSA), the President, acting through CFIUS, can investigate proposed transactions that may result in control of a US business by a foreign person, and can suspend or block such transactions if they threaten to impair the national security. CFIUS considers, among other factors, potential national security-related effects from the foreign acquisition of US-critical technologies or infrastructure, including telecommunications.

Parties to prospective transactions that might have national security implications typically submit joint voluntary notifications to CFIUS. If the parties do not notify CFIUS before a transaction is completed, CFIUS has the authority to initiate a review of the transaction and to mitigate any threat to the national security that arises. In addition, the President may suspend or prohibit the transaction if the President concludes that the transaction impairs the national security.

Transaction parties should never assume that any other licensing or approval from the US government, including approval related to national security, extinguishes their obligations under FINSA. Though CFIUS review formally is limited to cases where other laws do not provide “adequate and appropriate authority to protect the national security,” CFIUS ultimately decides on a case-by-case basis whether other laws are sufficiently protective.

The parties to the transaction apparently believed that the acquisition solely of technology and employees put the transaction outside the scope of CFIUS review. CFIUS regulations, 31 C.F.R. § 800.302(c), exclude “[a]n acquisition of a part of an entity or of assets, if such part of an entity or assets do not constitute a US business.” In 31 C.F.R. § 800.301(c) (Example 4), however, the regulations note that acquisition of “substantially all” of a US company’s assets, specifically the company’s employees, technical know-how, and customer relationships, would not be excluded. By choosing to review this transaction, CFIUS may be indicating its intent to include in the scope of covered transactions ones that involve the foreign acquisition of key elements of a US company’s knowledge and its critical workforce.

CFIUS always takes into account the background of a foreign acquirer when it performs a national security analysis. That likely played a significant role here, as the US government has previously stated its view that Huawei has close relations with the Chinese military, members of Congress have recently publicly raised concerns with other potential business transactions by Huawei, and CFIUS did not approve a 2008 Huawei transaction involving 3Com.

CFIUS is the ultimate arbiter whether, under all the circumstances, a transaction is subject to its review. Although notification of CFIUS is voluntary, and parties are expected to exercise judgment in determining whether a planned transaction calls for CFIUS review, parties run significant risks of a costly and disruptive clash with the government if they unilaterally determine that their transaction is not subject to review and the government disagrees. If, out of an abundance of caution, parties notify CFIUS and CFIUS concludes that a transaction is not a covered transaction, then the parties will receive a letter stating so, and they will then have a “safe harbor” from further review (assuming no material facts of the transaction later change).

Understanding the CFIUS process and analyzing potential US government national security concerns are essential aspects of any cross-border transaction involving a sensitive sector of the US economy.

For more information on the CFIUS process and US foreign investment regulation more generally, please contact Timothy J. Keeler, Simeon M. Kriesberg, or Dave M. Wharwood.

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