Supply Chain Impact Gets Pride of Place in New CFIUS Executive Order
Noting that “unfair trade practices by competitor nations,” among other things, had “hollowed out” the U.S. industrial base and “siphoned innovation,” one of President Biden’s first acts as president was to issue an executive order directing federal agencies to assess “supply chain resiliency” – an issue that took center stage during the COVID pandemic and has yet to be resolved.[1]
On September 15, President Biden issued a new order – Executive Order 14083 (“EO”) – which directed the Committee on Foreign Investment in the United States (“CFIUS”) to focus on certain key factors as it evaluates the national security impact of a given foreign investment. In the long history of CFIUS, the EO is the first executive order to provide presidential direction on CFIUS reviews.
The new EO begins by noting that “[C]ertain [inbound] foreign investment may undermine supply chain resilience efforts and therefore national security by making the United States vulnerable to future supply disruptions.” (Emphasis added.)[2] The priority attention given to “supply chain resiliency” was no surprise, given the earlier executive order, and echoed concerns that have been voiced for years, both in and out of CFIUS reviews. As Mark Twain is reputed to have observed, “History does not repeat itself, but it often rhymes.”
Although some commentators have argued that the EO merely follows current practice, the reality is that the EO provides formal presidential direction where there previously was none. Ever. As the Administration made clear in a closed door briefing on the eve of the EO’s publication, the order is designed and intended to put investors on notice that certain issues matter more than others. Supply chain resilience is one of those issues.
The EO makes clear that it is forward thinking – concerned with the impact of foreign investment on both future as well as near-term disruptions in the supply chain. The EO states that
[t]hese vulnerabilities may occur if an investment shifts [1] ownership, [2] rights, or [3] control with respect to certain manufacturing capabilities, services, critical mineral resources, or technologies that are fundamental to national security – including because they are critical to United States supply chain resilience – to a foreign person who might take actions that threaten to impair the national security of the United States as a result of the transaction, or to other foreign persons, including foreign governments,
to whom the foreign person has commercial, investment, non-economic, or other ties (relevant third-party ties) [sic] that might cause the transaction to pose a threat to national security. (Emphasis added.)
There is a lot to unpack here. The EO emphasizes that the impact of a transaction on supply chain resilience is not the only factor to be considered – but it is nevertheless a factor that MUST be considered. It makes clear that the scope is not limited to ownership, but incorporates the transfer of rights and control – and that issues may arise in manufacturing, services, critical minerals, and critical technologies. Further, and this is especially important, it states that the president expects CFIUS to assess the impact on national security of a broad range of relationships implicated in the transaction – including non-economic relationships (e.g., family ties) and third party relationships (e.g., significant customers and suppliers).
Naming Names – Key Industries of Concern: A Roadmap for Deal Teams
The EO also directs CFIUS to assess “as appropriate, the covered transaction’s effect on supply chain resilience and security, both within and outside of the defense industrial base, in manufacturing capabilities, services, critical mineral resources, or technologies that are fundamental to national security, including:
microelectronics
artificial intelligence
biotechnology and biomanufacturing
quantum computing
advanced clean energy (such as battery storage and hydrogen)
climate adaptation technologies
critical materials (such as lithium and rare earth elements)
elements of the agriculture industrial base that have implications for food security,
and any other sectors identified in section 3(b) or section 4(a) of Executive Order 14017 of February 24, 2021 (America’s Supply Chains)” [for example, high capacity batteries, including electrical vehicle batteries]
It could hardly be more clear. The EO spells out, with specificity, a series of key industries and notes that CFIUS review may be required even if a transaction lies outside the defense sector. In so doing, it lays out a roadmap for deal teams assessing potential targets – and for targets assessing potential partners. No industry is off the table – but these industries are in the cross-hairs. And, here again, the EO emphasizes that review must extend, as appropriate, to “relevant third-party ties that might cause the transaction to pose [a threat to the supply chain.]”
What’s the Market Like? What’s the Investor’s History in the Industry? CFIUS Needs to Know
The EO also makes clear that CFIUS review must involve an assessment of:
the degree of diversification through alternative suppliers across the supply chain, including suppliers located in allied or partner economies;
whether the United States business that is party to the covered transaction supplies, directly or indirectly, the United States Government, the energy sector industrial base, or the defense industrial base; and
the concentration of ownership or control by the foreign person in a given supply chain,
among other factors that the Committee determines to be appropriate in considering whether the covered transaction may undermine the resilience and security of supply chains critical to national security.
The EO thus requires CFIUS to look at the market in which the U.S. business operates to assess the impact of a transaction on “the resilience and security of supply chains critical to national security.” First, the EO states that CFIUS review must extend to alternative sources of supply – including (and this is important) “suppliers located in allied or partner economies.” This is mandatory. Therefore, in conducting due diligence on a potential transaction, it will be important to determine whether alternative sources of a supply are available – if not domestically, then in allied countries and among reliable foreign partners (e.g., the Five Eyes, South Korea, Japan). If so, a deal may be salvaged – or salvageable – even if domestic sources are few and far between.
Second, the EO also takes pains to highlight three customers it especially cares about – the U.S. Government, the energy industrial base, and the defense industrial base. That’s plainly not the sum total, but the impact of a deal on these three customers must be considered. No real surprises here, but the industrial base can cover a lot of territory. If the “want of a horseshoe nail” can bring down a kingdom, the lack of a custom ball bearing or semiconductor can have a similarly outsized effect.
Finally, the EO makes clear what CFIUS counsel have observed for some time: the concentration of ownership by a foreign investor in a given industry is a potential problem, even if a transaction, taken by itself, presents no perceived threat.
How Should Deal Teams Read the EO?
What does this mean for deal teams considering the prospect of CFIUS review?
- The role of a target in critical supply chains matters, even if it is a small company, and even if it lies outside the traditional defense sector.
- Certain industries matter most, and investments in these industries should be viewed as mandatory candidates for CFIUS review – all as spelled out – with specificity – in the EO. Bypassing CFIUS review in such cases on grounds that filing is ostensibly voluntary runs the significant risk that the transaction will be called in for review post-closing.
- The market matters – The parties should fully understand the industry as well as the target – and should evaluate potential alternative sources of supply. This is not an antitrust review – this is a national security review. What matters is not only whether alternative sources exist, but also how quickly they can deliver, and their track record as suppliers.
- An investor’s history in a market matters. An investor that is acquiring its second, third, or fourth company in a given sector, antitrust considerations aside, will get careful review and may be rebuffed, even if the company is otherwise “clean” and the transaction presents no significant threat in and of itself.
- Third-party relationships matter. Even if an investor presents no apparent risk, CFIUS may deem its relationships with third parties as problematic – for example, major customers or suppliers in sanctioned countries or “countries of concern” that may influence the investor’s stewardship of its new U.S. asset, or kick up the risk of technology transfers.
As always, preparation is key, which is why it’s important to work with counsel who are experienced in CFIUS reviews. The fact that a transaction triggers one or more factors highlighted in the EO does not mean that a transaction is at risk of rejection – but it does mean that the parties need to know and understand these factors – and be prepared to address hard questions during CFIUS review.
Supply chain resilience is not the only consideration called out in the EO. The EO also requires CFIUS to assess the impact of foreign investment on U.S. technology leadership, industry concentration, cybersecurity, and sensitive personal data. In all cases reviews must include an assessment of the risks posed by third-country entanglements. In future alerts we’ll break down the other components of this historic order.
[1] See Executive Order 14017, available at: https://www.whitehouse.gov/briefing-room/presidential-actions/2021/02/24/executive-order-on-americas-supply-chains/
[2] Our September 19 Client Alert provided an overview of the EO – the first executive order to provide presidential direction on the scope and substance of CFIUS reviews. Available at: https://www.stroock.com/news-and-insights/cfius-due-diligence-just-got-a-whole-lot-harder. Given the importance of the EO, today’s Client Alert, one of several we plan to write, breaks down its component parts in order to give full attention to the issues it raises.
