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On August 1, 2018, Congress passed the National Defense Authorization Act for 2019 (NDAA), which includes the Foreign Investment Risk Review Modernization Act (FIRRMA) and was signed into law by the president on August 13, 2018. FIRMMA is designed to "modernize and strengthen" the Committee on Foreign Investment in the U.S. (CFIUS), an interagency committee led by the U.S. Department of Treasury, which reviews proposed foreign investments in U.S. businesses and can advise the president to block such deals on national security grounds. The NDAA also includes the Export Controls Act of 2018 (ECA), which makes changes to U.S. export controls administered by the U.S. Department of Commerce Bureau of Industry and Security and was also signed into law that same day.

Private equity funds were initially upset that they might be swept up in the changes wrought by this legislation. Their concerns were due mostly to the changes in what constituted a covered transaction and the inclusion of the concept of "other investment." The definition of "covered transactions" was greatly expanded: (i) CFIUS is currently authorized to review mergers, acquisitions, and takeovers that may result in control of a U.S. business by a foreign person and (ii) FIRRMA creates four additional kinds of "covered transactions," which would include:
  • Real estate transactions: Purchases or leases of land, air, or sea ports, or of land located near U.S. military installations and other sensitive locations;
  • Certain non-controlling investments: Certain non-controlling investments in U.S. businesses involving "critical infrastructure," "critical technologies," or "sensitive personal data" of U.S. citizens. "Critical technologies" is defined to include "emerging and foundational technologies" as discussed further below;
  • Change in rights of foreign person: Any change in rights that a foreign investor has in a U.S. business if the change may result in foreign control of the U.S. business or a non-controlling investment involving "critical technology," "critical infrastructure," or "sensitive personal data" of U.S. citizens; and
  • Evasion and circumvention: Any transaction intended to evade or circumvent review by CFIUS.

The definition of "other investment" brings within the scope of CFIUS review transactions where a foreign person, either directly or indirectly, (i) gains access to any material nonpublic technical information in possession of a U.S. business; (ii) serves as a member of or an observer to the board of directors (or equivalent governing body); or (iii) is involved (other than through the voting of shares) in decision making of a U.S. business regarding (A) the use, development, acquisition, or release of sensitive personal data of U.S. citizens maintained or collected by the U.S. business; (B) the use, development, or acquisition of critical technologies; or (C) the management, operation, manufacture, or supply of critical infrastructure.

Private equity firms lobbied effectively that, in particular, the addition of the concept of "other investments" could be construed to apply to any private equity fund that had foreign limited partners, which covers nearly all U.S. funds of any substantial size. In response to these concerns, the final version of the bill signed into law created a "safe harbor" for private equity funds by expressly excluding from the analysis funds with foreign limited partners, as long as certain parameters are met by those funds. Nonetheless, private equity firms need to understand and adhere to these parameters in order to fit into the safe harbor, or they may well run afoul of FIRRMA.

FIRRMA explicitly provides that a foreign person's indirect investment—due to the foreign person being a limited partner or a member of the advisory board or a committee of the fund—will not trigger FIRRMA, provided (i) the fund is managed "exclusively" by a U.S. person; (ii) the advisory board or committee on which a foreign limited partner sits does not have the ability to approve, disapprove, or otherwise control (A) investment decisions of the fund or (B) decisions made by the General Partner; and (iii) the foreign person does not otherwise have the ability to control the fund, including the following: (A) investment decisions regarding portfolio companies, (B) decisions related to portfolio companies, (C) dismissing, blocking the dismissal of, selecting, or determining the compensation of the general partner (or equivalent); and (D) the foreign person does not have access to material non-public technical information by participating on the advisory board or committee.

Private equity firms that have foreign investors—particularly investments from government-owned sovereign funds—should carefully structure their investment funds to comply with this "safe harbor." For example, it may be advisable to impose recusal obligations on foreign investors that hold a seat on a fund's limited partner advisory committee with respect to any investment approvals that violate concentration limits or other matters that run afoul of the "safe harbor." Similar recusal obligations may be necessary for foreign investors that do not hold an advisory committee seat if the fund documents give similar approval rights to its limited partners or investors as to the "safe harbor" matters.