China-U.S. Trade Law : International Trade Lawyer & Attorney : Baker Hostetler Law Firm : Trade Remedies, Customs & Export Controls

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The largest-ever Hong Kong promotion in the United States will be held this summer to showcase Hong Kong's advantages for American companies looking to tap new business opportunities in Asia, particularly on the Chinese mainland.

"Think Asia, Think Hong Kong," will feature two major symposia in New York and Los Angeles on June 11 and 14 respectively. Speakers include The Honourable C Y Leung, Chief Executive of the Hong Kong Special Administrative Region and over 60 prominent senior executives from global companies will participate. The event is organized by the Hong Kong Trade Development Council, (HKTDC) with support from 14 Hong Kong partners and nearly 100 U.S. supporting organizations.

USA-Hong Kong Ties

"As the global economic balance continues to shift to Asia, Hong Kong is the ideal business platform from which to access the myriad regional business opportunities now available in the growing ASEAN area and Chinese mainland," said HKTDC Chairman Jack So. "Our low taxes, free economy, rule of law, English-speaking environment and world-class business services make us the preferred partner for any overseas businesses wishing to tap these growing possibilities."

There are approximately 1,400 U.S. firms in Hong Kong, concentrated in trading, banking and finance, and transport. As of October 2012, there were 333 regional headquarters and 536 regional offices of US companies in Hong Kong, ranking first among other regions.

U.S. exports to Hong Kong in 2012 grew by 41 percent from 2010 to over $37 billion. Over the past decade (2003-2012), U.S. exports to Hong Kong have surged by 177%. In response to the U.S.'s National Export Initiative, HKTDC launched the Pacific Bridge Initiative (PBI) to further encourage American companies to use the Hong Kong platform. Since its implementation, the number of "new-to-market export successes" increased by 124 percent year-over-year in 2011, while the dollar value of export successes was up by 161.4 percent.

Symposia Will Highlight Advice and Opportunities for Entering Asian Markets

The sessions will feature information on why U.S. companies should consider using Hong Kong's business advantages. These sessions also will consider how mainland enterprises have been expanding their international presence through Hong Kong, and what they are looking for when seeking global partners. In addition, there will be approximately 10 industry sessions to provide practical tips on selling consumer brands to China and throughout Asia, explore technology partnership opportunities, discuss finance-related topics, and learn about the latest trends of Chinese outbound investment and collaborations on film and digital entertainment.

Extended Networking Opportunities

More than 100 Hong Kong government officials and business leaders from a wide spectrum of sectors including lifestyle products, fashion, food and wine, technology, finance, accounting, legal, logistics and marketing will take part in the June program, and participate in business matching with U.S. companies onsite. The TATHK campaign is expected to attract more than 2,000 American corporate leaders, government representatives, heads of SME's and opinion leaders with a special interest in Asia.

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          Dr. Elliot J. Feldman last week led discussions on the U.S. presidential election’s impact on China-U.S. relations at the University of Chicago Center in Beijing, the Beijing Arbitration Commission, and two other fora in Shanghai and Guangzhou. The video clips he prepared from the presidential debates exposed substantial anti-China rhetoric but also more nuanced policy positions. He forecast more bilateral trade disputes, but noted that President Obama’s re-election should contain any escalation in animus toward China that might have been featured in a Romney Administration. 

            Additionally, Dr. Feldman addressed business audiences about the legal and political hurdles Chinese investors may face when they invest in the United States, based on the treatise, Mergers and Acquisitions in the United States: A Practical Guide for Non-U.S. Buyers, that . BakerHostetler LLP has published with Aspen/Wolters Kluwer/CCH. Dr. Feldman is the editor and coauthor of the treatise, which has been published in both English and Chinese.   

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Editor’s Note: Dr. Elliot Feldman on October 5, 2011 presented the following speech at China-U.S. Investment Forum 2011.

Our firm has published a treatise, in English and Chinese, entitled Mergers & Acquisitions in the United States: A Practical Guide for Non-U.S. Buyers. I am one of the authors and the overall editor. My status as Senior Partner in the firm has made me a book peddler.

The treatise contains twenty chapters covering how to make a deal, how to paper it, how to arrange for the best tax situation, due diligence for labor, pensions, intellectual property and government contracts, dealing with national security issues and reviews, the Foreign Corrupt Practices Act, export controls, trade, customs, immigration, tax and bilateral investment treaties, Sarbanes-Oxley, antitrust, products liability – all focusing on issues arising from foreign ownership of corporations and subsidiaries in the United States. We have paid special attention to Chinese investors. One might say that this treatise has been written for you.

The overwhelming message of this conference is that your investments are welcome in the United States. People here, people you may engage to help you, want you to succeed. We all understand and recognize the importance of your mission for you and for us.

Good wishes and good will count a great deal in producing success, but business is business. It is competitive and it can be tough. As China has embraced capitalism it has come to understand competition. In every business dealing, your adversary is potentially your friend, and your friend is potentially an adversary. Because of this paradox, we memorialize just about everything in legal documents.

Perhaps more than in any other country, the American tradition has been to rely on legal systems to prevent, or alternatively, to resolve business disputes. An inability to appreciate this aspect of American culture can become a competitive disadvantage, even a liability.

For these reasons, I want to begin our discussion with three things the treatise does not say, at least not explicitly, and I want to present these points as questions:

First, welcome to the United States. Do you have a lawyer? In the United States, business is not conducted without lawyers. My partners, in writing the treatise, constantly wanted to say, “Don’t try this on your own,” or “You need a lawyer to understand the labor laws,” for example. I removed all of that language in editing because I thought it obvious that, in a book written about law by lawyers, once a corporate decision-maker understands generally the subject matter, he would know to get a lawyer. The decision-maker would know that there is a wide range of legal issues that may affect the success of an acquired investment – the point of the book—and he would ask informed questions of a lawyer so he could understand the impact of those issues on his particular investment. He then would make well-informed decisions and would know that it is most efficient for the lawyer, first, to provide counsel, and then to handle the details and documents necessary to execute decisions. My experience, however, at least with China, has been that these conclusions are not so obvious. So, I am telling you. You can’t enter complex transactions – you can’t make deals here – without a lawyer.

A recent issue of the China Business Law Journal makes this point. Entitled “Culture Clash,” the article notes, “Chinese businesspeople may still prefer to do deals on a handshake and a prayer, rather than to do their homework,“ and “our research suggests that foreign and even Hong Kong companies are more likely than their Chinese counterparts to engage advisers to tackle pre-merger due diligence. They are also more likely to seek external help with issues involving human resources, and other matters that can be the key to the success or failure of a merger or acquisition.” Your partners and your competitors for investment opportunities in the United States seek competitive advantages based in large part on the knowledge and advice they take from lawyers. You will miss opportunities for success if you are not equally well informed and advised.

Second question, in two parts: do you have a lawyer in China? Do you trust her? I ask these questions because there is an important cultural difference between China and the United States when it comes to lawyers. Here, lawyers owe a fiduciary duty to their clients. They take an oath to be loyal to their clients, and they take their oath seriously. It is not only a business matter. It is a matter of ethics. Lawyers here frequently tend to be trusted advisers and confidantes because information provided to the lawyers typically cannot be disclosed to the government, and because the more information the lawyer has, the more accurate, insightful and valuable is the advice that the lawyer can give. In China, in our experience, at least, lawyers are treated more like employees. They are used for technical purposes, not as trusted advisers. The relationship, and the expectations, are different here.

Third question: If you were to be dissatisfied with the legal services your lawyer might provide, would you expect to pay the lawyer’s bill? For lawyers, time is money, and when you use your lawyer’s time, even if you don’t like the result, you need to pay for it. Chinese companies unfortunately have acquired a reputation in the United States for not paying their legal bills, even when the agreed upon advice has been given. Perhaps because of the different relationships and expectations that I mentioned, Chinese companies do not seem to value legal advice as much, and agreements to pay for such advice are given less significance. There are exceptions of course, but it is the overall impression that may matter most. In the United States, engagement of counsel is a contract and bills must be paid. Over time, it will become more difficult for Chinese companies refusing to pay bills to find good counsel, which will become a critical problem for companies seeking valuable advice to keep pace with their competitors.

These are candid, perhaps even tough, opening remarks, especially on a panel of lawyers. But, as you can see, I have been around for awhile, and I am devoted to the proposition that China and the United States must understand each other, learn from each other, and work closely together for the prosperity of the whole world.

Too often, now, I have seen contracts major Chinese corporations have entered with Americans in which the Chinese either engaged inadequate counsel, or no counsel, or did not trust their counsel enough to achieve agreements favorable for their objectives. Such failures lead to resentments, misgivings, and missed opportunities for Chinese corporations to succeed. They are not necessary. So, as you consider investing in the United States, get a lawyer, preferably a legal team of many specialties, and trust them.

I urge you to think strategically about your investments, and for the long term. Even as the United States population is only about 25 percent the size of yours, we continue to be the world’s greatest consumers. Until recently, you have been making things we have been buying, but enormous pressure has built up that Americans need to be making more of the things that Americans are buying. In capitalism, profits still go to the owners of the means of production. There is no reason why Chinese cannot be the owners of some of the means of production in the United States, making things for Americans to consume, and to sell to other parts of the world.

The first wave of Chinese foreign investment has concentrated on the natural resources of other countries, buying and shipping them back to China. China must now embark more seriously on a second wave, not in a race to control the resources of others, but to invest in the long term for everyone’s prosperity. The opportunities for such investment and engagement are without limit.

You must start your quest by determining what it is you want to buy, and how it will fit with who you already are and what you or your company want to be. Americans – lawyers, investment bankers, consultants – can all help you identify specific targets of acquisition or merger, but only when you are able to articulate what you want, why you want it, the form you want it in, and what you can afford to pay for it.

Most of those first considerations are internal to your companies, but if you want a lawyer to understand fully what you are trying to do, you should include a lawyer in the discussions from the beginning. In negotiating the deal and packaging it with proper and legally complete documents, lawyers are not merely draftsmen decorating your thoughts with the right phrases. They are craftsmen making sure your interests are protected under the law. You cannot negotiate agreements and sign documents without lawyers who appreciate fully what you are trying to do.

There is a lot to do before getting to a handshake. We have encountered Chinese companies that understand taxes to be an important part of a deal, but few who have appreciated that the domicile of an enterprise and its structure (whether wholly foreign-owned or a subsidiary or sheltered through an offshore holding company, or a number of other possibilities) can determine whether the deal will be profitable or will lose money and fail. Taxes should not decide whether to make a deal, but certainly must be part of the consideration as to where and how to make it.

In deal-making a favorite phrase is “due diligence.” Conventionally, it refers to examining the financial books of a company – assets in buildings and equipment, liabilities in loans and accounts due, inventory on hand and in the pipeline. Traditional Mergers & Acquisitions lawyers concentrate on these considerations. In our treatise, we think of due diligence a little differently. A great attraction to investing in the United States is the presence of a highly educated and skilled work force. However, the work force can also be a serious liability. You need to know, before entering a deal, whether the labor force is unionized, whether there are health and pension plans that must be honored. There is a law in the United States – the WARN Act -- that prevents you from taking over a company and firing all the workers. Due diligence requires knowing all about the work force and its contractual and legal entitlements.

As the United States has become a service-based economy, the value and importance of intellectual property has become so important that it often exceeds, by far, the value of factories and inventory. In our view, potentially the greatest value in a deal will be found in intellectual property. However, intellectual property can also be contested. Before you invest, you need a complete inventory of the intellectual property. You need to know who owns it, whether and how it will convey in a merger or acquisition, and whether it is subject to pending or potential patent or trademark or trade secret lawsuits. Losing such lawsuits can destroy the value of a company.

Foreign ownership can mean the termination of contracts with the U.S. government. You need to know whether the company in which you are considering investment does business with the government, how dependent it is on that business, and whether the kind of business it is doing will be impacted by your financial intervention. A thorough examination of government contracts is also part of the due diligence process.

China is not unfamiliar with proposed projects implicating national security in the United States. There is a myth in China, however, that these projects always and must turn out badly. In fact, they can and usually do succeed, but there must be proper preparation, not only as to the legal process known as “CFIUS,” but the political process that lines up popular support. My partner Mike Oxley dealt with these issues intensively in Congress, and has written a chapter for our treatise all about them.

There is much more, of course, but I have no more time. I urge you to leap the first hurdle and get lawyers you trust and will engage from the very first steps in your journey. Then, start the journey with a detailed check list of what you need to know in order to make a deal. Finally, be prepared to make the deal. Become an investor here. Share in the profits of operating in the most technologically and economically advanced place in the world.

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The European Union has moved ahead of the United States in negotiating a bilateral investment treaty with China, as predicted previously here on Baker Hostetler’s China U.S. Trade Law blog. Chinese Commerce Minister Chen Deming and EU Trade Commissioner Karel De Gucht made the announcement on Thursday, July 14, 2011 in Beijing following the 25th meeting of the joint economic and trade commission between China and the European Union.

Both China and the European Union expressed concerns that likely will be key topics of the negotiations. As reported by Xinhua, Europe’s primary concerns are compulsory certification regulations, export credits, and exports of raw materials. For China, primary concerns are high tech trade, registration of herbal medicine, and Europe’s policies applying anti-subsidy, or countervailing duties, to China. These issues are unlikely to stand in the way of a treaty agreement, however, because China has demonstrated a significantly increased commitment to its economic relationship with Europe and is eager to continue attracting foreign investment.

Even before this month’s news about raising the United States’ debt ceiling, China appears to have been shifting its trade and investment focus away from the United States and toward Europe. Economists tracking China’s purchases of U.S. Treasury debt have observed an unexplained gap between the decrease of those purchases and an increase in China’s foreign exchange reserves. The Chinese government remains guarded about its foreign exchange holdings, but some economists believe the gap can be explained by a redirection of foreign investment to Europe.

The announcement of bilateral investment treaty negotiations also comes on the heels of Premier Wen Jiabao’s five-day tour of Hungary, Germany and England, which began on June 24. Trade between the EU and China has risen rapidly this year—twenty-one percent higher than last year, when bilateral trade totaled $480 billion (by comparison U.S.-China trade in 2010 totaled $457 billion). And China is reported to be the fastest rising destination for European exports.

Twelve agreements were signed between China and Hungary during the visit, and China has shown interest in purchasing Hungarian state bonds, as well as investing in the government-owned airline and rail companies. The China Development Bank reportedly has made a one billion euro credit available for joint business ventures with Hungary.

China and Britain reached trade agreements worth $2.2 billion and set goals for doubling trade between the two countries to $100 billion by 2015. British natural gas company, the BG Group, signed a $1.5 billion financing deal with Bank of China.

China and Germany signed agreements worth more than $15 billion, including purchases of aircraft and collaborative automobile investments. China already has a trade deficit with Germany, and German exports of high-technology goods continue to increase.

China also has given Europe repeated assurances that it would invest in European sovereign debt, including purchases of Greek government bonds, in order to continue to support Europe and the euro. EU Trade Commissioner De Gucht has maintained that China cannot be the solution for Europe’s debt crisis, but admits that the Chinese investment “certainly helps.”

Meanwhile, China is urging the United States to act responsibly and protect the interests of debtholders in deciding whether to raise the U.S. debt ceiling. Chinese ratings agencies have downgraded U.S. sovereign debt, which might be dismissed were it not for the fact that the three largest U.S. credit rating agencies lean ever more in that direction with the August 2 deadline fast approaching with no agreement in the U.S. Congress to raise the debt ceiling.

Europe has the attention of the Chinese for the moment. The United States will have to get its economic house in order, before it can start courting China again for an investment treaty. It also would not hurt for the United States to approve Free Trade Agreements with Colombia, Panama and South Korea, which have been in limbo since they first appeared to be concluded during the George W. Bush administration in 2006 and 2007, to show that a politically sensitive agreement like a U.S.-China investment treaty ultimately can get done. Perhaps the EU-China negotiations will lead to additional Chinese reforms that will help pave the way for a future U.S.-China treaty, but for now it would seem the United States has a lot of catching up to do.
 

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This text is based on presentations on this subject made recently by Mr. Burke to the American Chamber of Commerce in Beijing, the American Chamber of Commece in Shanghai, and the CCH/Wolters Kluwer conference for in-house legal counsel in Beijing.

 Some Chinese Mistakenly Think They Are Unwelcome

Chinese direct investment in the United States is increasing. Last year Chinese companies doubled the amount of money they invested in the United States compared to 2009.

There are many reasons why Chinese companies would want to acquire or set up operations in the United States. Most costs of doing business in the United States, other than labor, are now cheaper than in areas of China with the advanced infrastructure that modern industrial operations need. Production in the United States often provides better access to customers; allows companies to take advantage of Buy American provisions when selling to government agencies; and enables companies to avoid trade barriers, such as antidumping or countervailing duties assessed on imports from China.

Notwithstanding these reasons for investing in the United States, many Chinese companies are hesitant to do so because of media reports on national security reviews of foreign investment that have given the impression the United States is hostile to foreign investment, or at least investment from China. The media have created the impression that Chinese companies are forced to abandon acquisitions in the United States because of political opposition and national security reviews by the Committee on Foreign Investment in the United States (“CFIUS”).

The reality is that the United States welcomes most Chinese investment. The United States has no restrictions on greenfield investment by foreigners, except for some state (non-federal) laws that limit the ability of foreign persons to purchase farmland. Thus, foreigners may create new U.S. businesses on the same basis as Americans. Recent examples of Chinese greenfield investments in the United States include Tianjin Pipe’s steel pipe mill in Texas; Suntech Power’s solar panel assembly plant in Arizona; and American Yuncheng’s gravure cylinder plant in South Carolina.

CFIUS national security reviews apply only to the acquisition of existing U.S. businesses. Even in those circumstances, only three to seven percent of foreign acquisitions each year go through the CFIUS process. Blocked acquisitions are rare; projects blocked presented unique challenges.

Chinese Transactional Failures Have Been Exceptions

A handful of Chinese acquisitions have been abandoned as a result of CFIUS review, or political opposition. However, circumstances unique to each transaction, not general hostility to Chinese investment, caused those deals to fail.

One failure was Northwest Non Ferrous International Investment Co. Ltd.’s attempted acquisition of Firstgold Corp., a gold mining company in Nevada. That acquisition was abandoned just before the end of a CFIUS review due to the expectation of an unfavorable CFIUS recommendation. Questions had been raised because of sensitive military and intelligence installations adjacent to the mines. Had those mines been located elsewhere, the acquisition likely would have sailed through the national security review.

The failed acquisitions receiving the most press attention recently include Huawei Technologies Co. Ltd.’s attempt to acquire 3Com and, more recently, assets from 3Leaf Systems. Huawei bought intellectual property rights from 3Leaf Systems, a developer of cloud computing, without filing a notification with CFIUS. CFIUS learned about the transaction and self-initiated a national security review that resulted in a recommendation that Huawei be ordered to divest.

There were several reasons why the 3Leaf transaction ended badly for Huawei. The Pentagon had serious concerns about the technology that were magnified by a lingering mistrust of Huawei following the 3Com transaction and its mishandling of the CFIUS process in the 3Leaf case. The more important reason, however, was a more general mistrust of Huawei in the U.S. Government due to allegations of close corporate connections to the People’s Liberation Army, espionage, intellectual property theft, and support for terrorist regimes (Iran, Iraq and the Taliban). These circumstances were peculiar to Huawei. The Huawei transactional failure does not indicate any general hostility to Chinese investment.

The Legal Framework And Its Operation: CFIUS And FINSA

Congress enacted the Foreign Investment National Security Act Of 2007 (“FINSA”) on July 26, 2007 in reaction to Dubai Ports World and other controversies to improve accountability and transparency in the CFIUS process. FINSA provides that the President may “suspend or prohibit any covered transaction” whenever the President finds credible evidence “that the foreign interest exercising control might take action that threatens to impair the national security.” However, the purpose of FINSA set out in the preamble to the legislation is “[t]o ensure national security while promoting foreign investment ....” Thus, FINSA reinforces that, notwithstanding the need to protect national security, promoting foreign investment in the United States remains the policy of the U.S. Government. The following statistics on CFIUS reviews in the three years (2008 to 2010) since FINSA became law demonstrates that this law is not an impediment to the vast majority of foreign acquisitions of U.S. business:

•      National security reviews                                                                                313
•      Extended investigations                                                                                    83
•      Voluntary withdrawals (most re-filed and subsequently cleared)             42
•      Cases submitted to the President                                                                    0

To be governed by FINSA a transaction must be a covered transaction, which means that the transaction must involve a foreign person obtaining control over an existing US business. A covered transaction can be blocked only if it would impair national security and that impairment cannot be remedied through some other means.

FINSA defines “covered transaction” to mean “mergers, acquisitions, or takeovers . . . by or with foreign persons which could result in foreign control of persons engaged in interstate commerce in the United States.” It only covers transactions involving an existing US business. As noted previously, greenfield investments, such as the Tianjin Pipe project in Texas, are not covered. It covers an acquisition of one foreign company by another if control of a U.S. business were to change.

The regulations implementing FINSA, which the Treasury Department published for CFIUS, define “control” as:

the power, direct or indirect, whether or not exercised, through the ownership of a majority or a dominant minority of the total outstanding voting interest in an entity, board representation, proxy voting, a special share, contractual arrangements, formal or informal arrangements to act in concert, or other means, to determine, direct, or decide important matters affecting an entity . . . .

A ten percent passive investment in a U.S. company generally would not be enough to meet this definition of control. However, contractual arrangements that give a foreigner control of important matters can cause a transaction in which the foreign entity does not obtain any equity to be a “covered transaction.”

CFIUS’s implementing regulations define “foreign person” to be “(a) Any foreign national, foreign government, or foreign entity; or (b) Any entity over which control is exercised or exercisable by a foreign national, foreign government, or foreign entity.” This definition includes US subsidiaries of foreign companies.

Neither FINSA, nor the implementing regulations, defines “national security.” Consequently CFIUS has broad discretion to define national security on a case-by-case basis. Other provisions in FINSA, the implementing regulations, the legislative history and CFIUS’s subsequent actions indicate the following key areas in which national security concerns are likely to arise:

1. Defense industries, which would include companies that provide “defense articles” or “defense services” that are subject to heightened export controls under the International Traffic in Arms Regulations (“ITAR”) and the defense industrial base, which provides products needed for making military items;
2. Proximity to critical government facilities, as shown in the Firstgold case;
3. Critical infrastructure, defined in the implementing regulations as “a system or asset, whether physical or virtual, so vital to the United States that the incapacity or destruction of the particular system or asset . . . would have a debilitating impact on national security.” The company’s system or assets have to be big enough to make a difference under this definition.
4. Critical technologies, which would include (a) items controlled under the ITAR, (b) items controlled under Export Administration Regulations for national security, chemical and biological weapons proliferation, nuclear proliferation or missile proliferation reasons (probably only if the item needed a license to be exported to the acquiring company’s home country), (c) items controlled under the Export and Import of Nuclear Equipment and Materials Regulations, and (d) items controlled under the Export and Import of Select Agents and Toxins Regulations (threats to plant, animal or human health);
5. Energy and other critical resources, including essential raw materials for defense industries and critical infrastructure.

FINSA requires heightened review of proposed transactions in which a foreign government would obtain control of a U.S. business. There is a presumption that transactions by foreign governments or entities controlled by foreign governments receive an additional 45-day extended investigation beyond the initial 30-day review under which CFIUS clears most transactions. This presumption can be waived if the Treasury Secretary and the head of the other agency designated as the lead for the particular CFIUS review “jointly determine . . . that the transaction will not impair the national security of the United States.”

When a transaction is considered to be foreign government-controlled, FINSA requires CFIUS to consider the adherence of the country to non-proliferation control regimes, the U.S. relationship with the country, specifically on cooperation with counter-terrorism efforts, and the potential for diversion of technologies with military applications.

Conclusion

The United States is open to investment, but potential investors do need to pay attention to legitimate national security concerns. For the vast majority of foreign investors, including investors from China, the CFIUS review process is not an impediment. Greenfield investments do not require a CFIUS review. Most cross-border mergers and acquisitions do not require a CFIUS review. Most CFIUS reviews clear the transaction within 30 days. Only a handful of transactions have been abandoned as a result of national security concerns.

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Chinese leaders have participated in high-level strategic talks with both the United States and Europe in recent months, during which China reiterated its interest in a bilateral investment treaty (BIT) with each of them. EU officials went to Beijing in December 2010 for the Third China-EU High-Level Economic and Trade Dialogue, and President Hu Jintao met with President Obama in Washington D.C. in January 2011.

There are similarities in China’s economic relationships with these two trading partners—the United States and Europe both seem to be increasingly dependent on China for the health of their financial markets and economic growth. However, differences in the relationships suggest that China may be closer to reaching a BIT with the EU than with the United States.

The United States may appear, on the surface, to be more dependent on China for financial support than Europe. China holds over $900 billion of U.S. sovereign debt. Notwithstanding the United States’ financial troubles, China continues to hold vast sums of U.S. treasuries, which has played a critical role in financing the U.S. wars in Iraq and Afghanistan, as well as the expanding costs of U.S. “homeland security” and domestic social programs. The United States has told China that it will focus “on reducing its medium-term federal deficit and ensuring long-term fiscal sustainability,” and has asked China to stimulate a domestic demand that would absorb more U.S. exports, but even if the two countries did as suggested, China still would remain the largest financial backer of U.S. debt.

Recently, as Portugal, Italy, Ireland, Greece and Spain all have threatened the stability of the euro, China has taken on a larger role as a banker for Europe. China reportedly bought €6 billion of Spanish bonds, committed to buy another €5-6 billion of Portuguese bonds, and pledged to back Europe in its efforts to bail out Greece. China’s euro commitments are still far from the level of its holdings in dollars, but the precarious state of the euro, and therefore the European Union, means that E.U. leaders may have a more compelling need for cooperation with China than the United States.

President Obama has been promoting China as a market for U.S. exports and as a solution (rather than the problem) for reducing the trade deficit, stimulating economic growth, and promoting job expansion. In his 2011 State of the Union address, he said, “To help businesses sell more products abroad, we set a goal of doubling our exports by 2014 — because the more we export, the more jobs we create here at home. Already, our exports are up. Recently, we signed agreements with India and China that will support more than 250,000 jobs here in the United States.” 

E.U. leaders similarly have been looking at China to stimulate exports, economic growth and jobs. China has been the second-largest foreign market for European goods, and exports grew last year by more than thirty percent. The promise of new jobs is especially important for Europe. There have been strikes and threats of strikes in Greece, Portugal, Italy and the U.K., and fears that public sector jobs will be cut substantially as the European governments try to reign in public spending and get their financial houses in order. 

Europe and the United States both have significant trade imbalances with China but, according to the European Commission’s Vice President, Joaquin Almunia, the E.U. is focused less on revaluation of the yuan and more on increasing E.U. companies’ investments in China. In addition, Europe appears to be increasingly more willing to relax export controls on high-tech goods, which might help reverse some of the trade balance and, perhaps more importantly, would gain the appreciation of Chinese officials who have complained about such restrictions among their Western trading partners.

As Europe’s interdependence with China is accelerated by the debt crisis, so also, it would seem, Europe will leap ahead of the United States in signing a BIT with China. When the two delegations discussed trade and investment issues in Beijing last December, China emerged with a commitment from the European delegation that the Europeans would “speed up a feasibility study for a bilateral investment treaty.” During President Hu’s visit to Washington, negotiations for a U.S.-China BIT were mentioned, but members of the U.S. Congress subsequently have complained about the Obama administration’s inaction on a BIT, and even FTAs with Colombia and Panama, pending for years, have remained tied up by labor rights interest groups. Negotiations and ratification of a U.S.-China BIT, although an eventual likelihood, certainly will not be easier than finalization of the agreements in Central and South America.

As the United States seems slowed by trade politics in pursuing the investment treaty that might help open the Chinese market for American companies and attract more Chinese investment into the United States, China should have an easier time accepting the terms of a BIT with Europe than with the United States. E.U. BITs typically have not provided guarantees for market access during the pre-investment phase, but rather only after the investment has been established. By contrast, U.S. BITs require that the host government provide foreign investors national treatment, for example—meaning the same rights as domestic investors—at the pre-investment stage, which remains one of the hurdles to agreement on a U.S.-China BIT.

It is not unusual for European negotiators to wait for the results of American negotiations and then seek comparable terms. The course of Chinese accession to the WTO was marked by such a strategy. However, in those negotiations, China was primarily obliged to accept tough terms. The BIT negotiations define more equal ground for the negotiating parties. Europe may not wait for the United States to extract better terms because it may not want to wait, and it may not think the United States is in a position to fare better in negotiations. Moreover, because the Europeans typically are not as demanding as the United States in BIT negotiations, China likely will find completion of a deal with Europe more attractive, and will be able to get it done more quickly.

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Chinese companies increasingly are looking to the United States not just as an export market, but also as a place to set up business. While labor costs remain higher in the United States, many other costs are lower and U.S. production allows companies to serve their customers better, take advantage of Buy American provisions in government contracting, and avoid trade barriers. Bloomberg, in a December 2010 article titled Chinese Companies Expand to U.S. Soil and Markets, reported that Chinese companies invested $2.81 billion in U.S. projects or acquisitions during the first nine months of 2010. CNN Money reported that in 2010 Chinese companies acquired or announced they were establishing more than 50 companies.

Direct Chinese investment in the United States would likely be even greater were it not for press reports that have created the impression that the United States is hostile to investment from China. The press is full of terms such as CFIUS (the Committee on Foreign Investment in the United States) and FINSA (the Foreign Investment National Security Act), and tales of Chinese companies forced to abandon planned acquisitions of U.S. companies. Some Chinese companies have been forced to abandon their acquisition plans. However, each of those celebrated cases presented unique circumstances that would not exist for the vast majority of Chinese companies who may wish to set up operations in the United States. The reality is that the United States remains one of the world’s economies most open to foreign investment, including from China.

With a few very limited exceptions, such as airlines, foreigners are as free to invest in greenfield projects that create new businesses in the United States on the same basis as Americans. Recent Chinese greenfield investments in the United States include a $1 billion steel pipe mill that Tianjin Pipe is planning to build this year near Corpus Christi, Texas; Suntech Power Holdings’ solar panel assembly plant in Arizona; and American Yoncheng Gravure Cylinder plant in Spartanburg, South Carolina. These and many other Chinese greenfield investments have not faced any significant opposition and in many cases have been able to benefit from state and local government investment incentives.

The United States does have procedures for reviewing certain foreign acquisitions of existing businesses under FINSA, conducted by CFIUS. However, as the U.S. Treasury Department noted when it published its guidance on the CFIUS process in December 2008, “CFIUS focuses solely on any genuine national security concerns raised by a covered transaction, not on other national interests.”

The President of the United States may order the divestment of a foreigner’s controlling interest in a U.S. business should he determine that such control threatens U.S. “national security.” The CFIUS review system works through voluntary filings by those parties to proposed transactions who seek to take advantage of the safe harbor that a CFIUS approval prior to an acquisition provides. The safe harbor prevents the President from undoing the deal pursuant to his authority under FINSA.

The CFIUS process is disciplined by the authority FINSA provides CFIUS to self-initiate a review as to whether any “covered transaction” threatens U.S. national security at any time. That authority is seldom used, but its existence means that foreign acquirers should give serious consideration to voluntary CFIUS filings before any national security questions may be asked.

For most companies, CFIUS review takes only thirty days. By seeking it voluntarily before the acquisition is consummated, the foreign acquirer can obtain assurance that its investment would not be destroyed by a CFIUS review, perhaps years after the acquisition. For a small number of companies, CFIUS review may become an additional forty-five day in-depth investigation. Even at this stage, however, most acquisitions are approved, although often with conditions.

A handful of Chinese acquisitions of existing U.S. businesses have been stopped either as a result of the CFIUS review process, or as a result of intense political opposition. However, in each of those cases, circumstances unique to the particular transaction, and not any hostility to Chinese investment in general, are what caused the transaction to fail. For example, when Northwest Non Ferrous International Investment Co., Ltd. dropped its plans to acquire a Nevada mining company, the reason for the unfavorable CFIUS review was the extremely sensitive nature of U.S. military installations that were adjacent to the mines to be acquired. (See The United States Remains Open To Chinese Investment). Had those mines been located elsewhere, the acquisition likely would have sailed through with little opposition. There was no objection to Chinese acquisition of gold mines. The objection was to the proximity to military installations.

Another deal effectively blocked by a CFIUS review was the proposed acquisition in 2007 by Huawei Technologies Co. Ltd. (“Huawei”) of a significant ownership stake in 3Com Corporation. Two major concerns reportedly led CFIUS agencies to oppose the deal. The first was the inclusion in the deal of 3Com’s subsidiary Tipping Point, which sells network-based intrusion prevention equipment used by the Pentagon and U.S. intelligence agencies. The second was specific to Huawei. There were allegations in the press that Huawei had engaged in corporate espionage and intellectual property theft and was involved in high tech exports to Saddam Hussein’s regime and the Taliban. The combination of mission critical U.S. military technology and an acquirer with a particularly bad reputation from the perspective of U.S. national security interests caused that deal to fail, not any general opposition to Chinese companies acquiring specific U.S. businesses.

China National Offshore Oil Corporation’s (“CNOOC”) attempted acquisition in 2005 of Unocal, a U.S. energy company, was halted by congressional and public opposition before it could undergo a CFIUS review. That opposition arose because of concerns that critical energy supplies would pass out of US control. The fact that CNOOC is a Chinese state-owned enterprise did heighten those concerns. But it was the concern over access to critical energy supplies, and not anti-Chinese animus, that drove the opposition to that deal. Very few businesses that Chinese companies may seek to acquire will present these types of concerns. And, in hindsight, many observers think that, had CNOOC not pulled out, CFIUS would have approved. Unfortunately, CNOOC did not stay involved long enough to find out.

The United States remains committed to an open investment environment and treating foreign investors, including those from China, on an equal footing with their domestic competition in the vast majority of cases where the foreign investment does not threaten to impair the national security of the United States. It was for this reason that Congress set the initial CFIUS review deadline at thirty days, to coincide with the thirty day antitrust review period under the Hart-Scott-Rodino procedures.

Even after the implementation of FINSA, most cross-border mergers and acquisitions do not require a CFIUS review. Nevertheless, CFIUS national security reviews of proposed acquisitions of U.S. businesses are going to be a crucial part of the transaction for many foreign investments in existing U.S. businesses.

The most important considerations for success in a CFIUS review are understanding in advance the institutional and other concerns of the CFIUS member agencies, and creative thinking about how to demonstrate that those concerns are not threatened, or to mitigate them. In most cases early attention to the CFIUS process and to the legitimate concerns of the member agencies can ensure smooth and timely proceedings that result in CFIUS clearance without restrictions, or on terms that preserve the value of the transaction for all parties. Voluntary review, taking advantage of the law’s safe harbor provision, likely would have helped Chinese enterprises in all of the failed transactions, and sensitivity to possible political concerns would have contained the fallout and bruised feelings in those instances where national security legitimately prevailed.

To say the outcomes of such cases in China would have been no different or worse would not be good enough. The United States is not deliberately discriminating against foreign, nor specifically Chinese, investment, but like any sovereign it is mindful of its sovereignty, and its security.

Finally, CFIUS approval is not always the end of the story. It is important to pay attention to potential concerns of Congress and the general public. The law may authorize execution of a project. Popular opinion translated in Congress can still stop one.
 

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      Washington, D.C., partner Elliot J. Feldman, leader of Baker Hostetler's international trade practice, recently was interviewed by China’s National Economic Weekly regarding how to invest in the United States. The National Economic Weekly is a Xinhua News Agency affiliation that has a circulation of 200,000 and a very large online readership.

      Feldman highlighted several important issues that were unknown to most Chinese business leaders but were emphasized in Mergers & Acquisitions in the United States: A Practical Guide for Non-U.S. Buyers, a treatise for CCH/Wolters Kluwer/Aspen coauthored by a team of 27 Baker Hostetler attorneys under his direction. First, he recommended potential Chinese investors to start Greenfield projects, and carefully select origination and destination of their investment to fully utilize preferential tax treatments offered by bilateral investment treaties and U.S. tax laws.

       Episodes of failed Chinese investment initiatives in the United States have persuaded many Chinese that national security is a post 9/11 excuse to restrict China in the U.S. economy. However, in Feldman’s view, China’s business leaders have no reason to be deterred by the Committee on Foreign Investment in the United States’ review process. The United States is the most open major economy in the world, and the treatise demystifies how to navigate through this process by providing specific and detailed guidance, through real-world examples.

      Additionally, he reminded the Chinese investors not to miss the forest for the trees. For instance, they need to evaluate carefully intellectual property rights, which could be the most valuable asset to be acquired in a deal for a U.S. company. Also, it is prudent and wise to retain the best lawyers and other professionals in conducting due diligence. Although expenses might seem high, it pays off in the long run to engage the best. He alerted the Chinese business community that minimizing potential legal risks is as important as maximizing financial profits in investing in the United States.

      At the end of the interview, Feldman advised the Chinese business leaders to adopt the German management model once they set up facilities in the United States. In order to win the hearts and minds of U.S. politicians and people, he suggested Chinese companies hire more U.S. workers and actively engage them in operations.
 

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Recent U.S. free trade agreements (“FTAs”) and comments from U.S. government officials suggest that obligations to respect and enforce internationally recognized labor standards could become part of the text offered by the United States for the negotiation of a bilateral investment treaty (“BIT”) with China. The trend of making labor rights more prominent in U.S. FTAs and BITs is likely to continue for agreements currently being negotiated under President Obama and a Congress controlled by the Democratic Party, including the U.S.-China BIT.

         The United States approaches its negotiations of BITs by working from a model text that has evolved from prior BITs and free trade agreements. In 2004, the United States developed a Model BIT that it has used as the basis for negotiating BITs and investment chapters in FTAs. The 2004 Model BIT contains a brief chapter on Investment and Labor providing that the parties may not weaken their domestic labor laws in violation of internationally recognized labor standards to encourage investment in their respective territories.

         Revisions to the 2004 Model BIT were being made last year, and reportedly will conclude with a new Model BIT text to be released by the government sometime during the next three months. The 2010 Model BIT is likely to serve as the foundation for U.S. negotiations of a BIT with China. Administration officials have not stated publicly the extent to which the 2010 U.S. Model BIT will include provisions protecting labor rights, and in some respects it would be logical to reserve agreement on labor rights for FTAs. FTAs cover a much wider range of policy issues than BITs, and application of international labor standards is more comprehensible in the context of agreements specifically addressing trade.

         Despite the logic, there are indications that the revised 2010 U.S. Model BIT is likely to include enhanced obligations to protect labor rights and to address breaches of those obligations. On May 10, 2007, Congressional Democrats and leading officials in the Bush Administration reached agreement on a set of labor rights provisions that were inserted in U.S. FTAs with Peru, Colombia, Panama and South Korea. The Democratic Senator from Montana, Max Baucus, who is also Chairman of the Senate Finance Committee and known to be an influential force on international trade issues, reportedly would like to see the labor rights provisions from what is now known as the “May 10 agreement” carried forward in future U.S. BITs, including the 2010 Model BIT. A July 2009 report to Senator Baucus from the U.S. Government Accountability Office criticized the inadequate efforts, primarily of prior U.S. administrations, to ensure that governments with whom the U.S. had negotiated FTAs (specifically, Jordan, Morocco, Singapore and Chile) were making significant progress toward adoption and enforcement of fair labor laws. Thus, the interagency review of the 2010 Model BIT provides an opportunity to raise standards and expectations.

        Labor interests have exerted their influence inside the Office of the U.S. Trade Representative as the Administration has been developing its trade policy. Although the President’s promotion of exports in his State of the Union Address indicated a desire to expand trade, there remains in the Democratic Party suspicion of trade as a vehicle to export jobs as well as goods and services. Inclusion of apparently enforceable labor standards in international agreements would provide some cover against allegations that, were jobs exported, at least they would not be exported to foreigners working under substandard conditions.

         The Obama Administration has filled its ranks – in the White House and in several agencies – with officials who have strong views on protections for workers. Given the President’s and Democratic Party’s dependence on labor interests for their political base (a political reality China already has experienced in the application of the Section 421 safeguard over commercial tires), labor rights are likely to play an important role in the negotiation of a BIT with China, as well as any other BITs or FTAs negotiated during the Obama Administration.

         The “May 10 agreement” labor provisions that could be included in the 2010 Model BIT adopt the rights expressed in the 1998 ILO Declaration on Fundamental Principles and Rights at Work:

(a) freedom of association and the effective recognition of the right to collective bargaining;

(b) the elimination of all forms of forced or compulsory labor;

(c) the effective abolition of child labor; and

(d) the elimination of discrimination in respect of employment and occupation.

          Recent U.S.-FTAs incorporate these rights as mutual, reciprocal obligations undertaken by the FTA partners. Parties must agree not to waive or otherwise derogate from statutes implementing these international standards in a manner affecting trade or investment between the parties, and they must commit to effectively enforce their labor laws. They must ensure access to tribunals to enforce labor laws and procedural guarantees of transparency and due process.

          The agreements provide dispute resolution procedures in the event that these rights are not believed to be respected and enforced by the FTA partner. The process, however, is fashioned to blunt attacks on foreign labor practices. In the Korea-U.S. FTA, for example, the dispute process over labor rights is potentially lengthy, with multiple stages of consultation between the governments before an arbitral panel eventually is formed to adjudicate and the awards are not self-executing. Although the dispute settlement process does allow for compensation and sanctions as potential remedies for a party’s failure to implement an award, there are abundant opportunities for international diplomacy and negotiation to avoid an outcome requiring strict enforcement. The dispute settlement framework seems designed to cushion the effects of a violation of the labor obligations, and to allow governments opportunities to save face in the event of an alleged breach.

          Were the 2010 Model BIT to go beyond the text of recent FTAs by establishing well-defined labor standards with strict and efficient dispute settlement mechanisms, accession to such a BIT with the U.S. could be problematic for China. The All-China Federation of Trade Unions is the only legally authorized union in China, and critics claim that it is more interested in preserving stability for the government than it is in protecting workers’ rights. U.S. labor organizations have argued that even where China has the appropriate labor laws on its books, enforcement of those laws consistent with international standards remains unreliable. The Obama Administration has heard from some in the United States that China never will agree to the adoption and enforcement of international labor standards and reportedly is weighing those views carefully.

         A dispute-settlement model based on the Korea-U.S. FTA, however, might be palatable if China were to see in it sufficient flexibility for negotiation, diplomacy, and the ability to preserve a public face of sovereignty with respect to its labor laws. The United States currently appears to be making serious progress on BIT negotiations with China’s competitors, India and Vietnam. Were these countries to move more rapidly to agreement on the inclusion of meaningful protections for labor rights, competition and comparative advantage may create additional incentives for China to accept such provisions in a BIT with the United States. China might then hope to mitigate their impact, whether through the kind of consultation processes suggested in the Korea-U.S. FTA, or by maintaining the appearances of a commitment to enforcement as circumstances may require.
 

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Despite the joint announcement of the United States and China that both countries would “expedite negotiation on a bilateral investment treaty” (abbreviated in English as a “BIT”), the notion of a BIT between the United States and China, two of the world’s five largest economies, remains inconceivable for some. On the U.S. side, there are significant political obstacles: free trade and foreign investment typically are not successful campaign platforms for U.S. politicians during an economic recession, especially in an election year. U.S. politicians would not likely accept a BIT while strong disagreement remains over China’s currency policies. China’s pegging of the yuan to the dollar remains an irritant (indeed, the only trade issue on President Obama’s agenda in Beijing in November), notwithstanding that it may have enabled critical flows of debt-financing while the United States endured the depths of a recession while still needing billions for military actions in Iraq and Afghanistan. There are obstacles on Chinese protection and enforcement of U.S. intellectual property, controlled Chinese capital markets, and laws raising national treatment concerns for American investors trying to establish investments in China, according to Amy Tsui’s BNA Int’l Trade Daily article.  Political support for a BIT with China does not look promising, particularly with a Congress whose Democratic leadership is often openly suspicious of Chinese trade and investment intentions.

China has its own policy disagreements with the United States, including on trade issues such as the United States’ safeguard duties on Chinese tires. China also has been reluctant to embrace international arbitration of investor-state investment disputes to the degree that the United States would demand using the 2004 U.S. Model BIT as the basis for negotiations.

Notwithstanding these obstacles, there are reasons to believe that a U.S.-China BIT is not a question of “whether” but “when.” When the Bush Administration announced in June 2008 that the United States and China had been discussing a BIT as part of the Strategic Economic Dialogue, at least one observer wondered whether the announcement meant a deal had been completed. According to a U.S. official, talks of a U.S.-China BIT already had been going on for seventeen months. Under the Obama Administration, it appears that discussions are continuing “in technical stages [but] have not yet reached political decisions.” (“ACIEP Report on Model BIT Lacks Consensus on Critical Issues,” Inside U.S. Trade, Oct. 2, 2009.)

BITs are smaller in scope than free trade agreements (“FTAs”). The negotiations, therefore, are much more attainable, in terms of both the substance and the political capital expended to reach an agreement. BITs tend to favor the country in the agreement that is the larger exporter of capital, which usually has meant that the United States stood to benefit far more than its treaty partner. Of the approximately 60 countries with whom the United States previously has agreed on BITs or FTA investment chapters, Canada and South Korea are the only significant exporters of capital.

U.S. businesses see BITs as a way to open up access to foreign markets, and China would be no exception. For many years, U.S. industries have been looking for ways to improve access to China’s one billion consumers and to eliminate restrictions on or disincentives to foreign investment, particularly as, during recent years of high economic growth, the Chinese have accumulated unprecedented wealth for a developing country.

China, unlike most of the United States’ treaty partners in prior BITs, has become a significant exporter of capital, but this fact probably makes a BIT even more likely. Since 1998, China has been renegotiating BITs it had with many European countries in order to provide greater protection for its own investors doing business in Europe. Recently, China also has been in BIT negotiations with Canada. As China increases its investments in the United States, it becomes increasingly likely that China will want the same protections for its investors doing business there.

There have been critics in the United States fearing that BIT provisions for international investor-state arbitration circumvent U.S. judicial, legislative and regulatory processes, and many certainly would oppose a BIT with China given the implications for U.S. environmental and labor standards. And yet, there is little reason for anyone to believe that the United States would be overrun with foreign claims under a U.S.-China BIT. Notwithstanding Canada’s significant investments in the United States market, in the sixteen-year period since the adoption of NAFTA’s investment chapter no arbitration tribunal has required the United States to pay on a single claim.

Political concerns over U.S. national security restrictions on investment have subsided since 2005 when CNOOC’s bid to purchase UNOCAL was blocked, as discussed in our previous post in December. Specific transactions still may be blocked, but those decisions appear to be driven more by the national security analysis of a particular case than by reactionary measures to calm an agitated Congress, as discussed in our earlier post in January.

U.S. industry representatives have recommended that the United States should consider softening the “essential security” exception in its Model BIT language to allow foreign investors greater assurances that their investments will not be disrupted by disguised protectionist motivations.  (“ACIEP Report on Model BIT Lacks Consensus on Critical Issues,” Inside U.S. Trade, Oct. 2, 2009.)  While they plainly intend for the exception to be softened as to foreign countries’ restrictions on foreign U.S. investment, the reciprocal nature of such a provision would be appealing to the Chinese as well. There may not be enough sympathy in Congress, however, for such a departure.

Negotiation of a China-U.S. BIT will not be quick and easy, but it remains likely. China is an expanding market attracting foreign investment from around the globe. American enterprises want to invest there and would like more security for their investments. Such incentives historically have driven the United States to negotiate BITs.

This time, however, there is an added and critical dimension. China has amassed capital and is beginning to invest abroad. The United States not only is an attractive market; the United States also needs a substantial share of that investment for the growth of its own economy. Chinese businessmen, like Americans, want investment security. This time, therefore, the BIT partners share a common vision of an agreement that will attract investment to their own countries while protecting their citizens investing abroad. Such unusual balance may make the negotiations more difficult, but they also make a positive result more likely.
 

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This blog posted an article titled “Setting The Record Straight: The U.S. Is Open For Chinese Business; Don't Worry Too Much About National Security Reviews” on December 12, 2009. Two weeks later Northwest Non Ferrous International Investment Co., Ltd. (“Northwest”) dropped its plans to acquire a Nevada mining company because a national security review under the Foreign Investment National Security Act “FINSA” was coming to an unfavorable conclusion. We do not stand corrected.

The rejection of the Northwest acquisition was based on unique facts and not because of opposition to Chinese investment generally. Chinese companies should not let this case dissuade them from acquiring companies and otherwise investing in the United States.

Northwest proposed to acquire control over a mining company, Firstgold Corp., all of whose operations are adjacent to Naval Air Station Fallon, the U.S. Navy’s premier tactical air warfare training center. The Navy opposed a company owned by the Chinese Government having control of property from which its most sensitive training activities might be monitored. Also in that area are other security and military assets so sensitive that the U.S. Government treats even their identities as classified information.

Due to the sensitive nature of the government installations, any acquisition by a foreign company, including companies based in NATO countries, would have raised national security concerns. Whether China created more concern is entirely speculative and ultimately unknowable. However, Chinese companies should not view the CFIUS result in this case as based on an objection focused on China, but rather as based on the serious national security concerns it definitely presented regardless of the foreign country. FINSA requires CFIUS to consider whether the acquiring company is state-owned. However, given the serious national security concerns raised by the location of Firstgold’s facilities, the result likely would have been the same even had the acquirer been a private company.

Northwest’s lawyers have described extraordinary but failed efforts to make the acquisition compatible with national security concerns. Their memorandum to Northwest, published on the New York Times website, reports that the Committee on Foreign Investment in the United States (“CFIUS”) looked closely at all kinds of scenarios to mitigate the national security concerns, but concluded that none of them would be feasible because all four of Firstgold’s properties are located adjacent to Naval Air Station Fallon or other military sensitive locations.

The lawyers’ report demonstrates that CFIUS’ goal is not to block investments. Instead, CFIUS seeks to mitigate national security concerns. The exceptional facts in this case are that all of the operations to be acquired raised concerns. When national security is at issue, it usually affects some part of the deal and can be mitigated. Here, all of the deal was implicated; mitigation (such as spinning off some part of the deal while preserving the essential economic value) apparently was impossible.

Northwest acted wisely in this case, seeking a CFIUS review before investing because of uncertainties about national security. Reportedly, Firstgold did not want to request CFIUS review. Northwest could have invested, only to have CFIUS recommend and the President of the United States undo the deal, not because of animus toward Chinese investment, but because of the serious implications for national security.

It is important not to misinterpret the Northwest case. It proves the utility and wisdom of early CFIUS review, not an objection to Chinese investment. Notwithstanding CFIUS’ rejection of Northwest’s proposed acquisition of Firstgold, the United States remains one of the economies most open in the world to foreign investment, including from China.
 

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Chinese and other foreign companies considering investments in the United States often are confused about the degree to which the United States is open to foreign investment. They hear terms such as CFIUS, Exon-Florio and FINSA and claims that the United States is now hostile to foreign investment, especially from China and the Middle East.

The reality is that the United States remains one of the economies most open in the world to foreign investment. When it comes to greenfield investments creating new businesses in the United States, foreigners are as free to invest as domestic concerns. The United States does have procedures for reviewing foreign acquisitions of existing businesses under the Foreign Investment National Security Act of 2007 (“FINSA”), conducted by the inter-agency Committee on Foreign Investment in the United States (“CFIUS”), presided over by the U.S. Treasury Department. However, as the Treasury Department noted when it published its CFIUS guidance, “CFIUS focuses solely on any genuine national security concerns raised by a covered transaction, not on other national interests.”

Notwithstanding today’s difficult economic climate and the confusion over national security reviews of foreign investment, Chinese companies obviously remain interested in acquiring U.S. companies. For example, on October 23, 2009 BGP Inc., a subsidiary of China National Petroleum Corporation, agreed to a joint venture with ION Geophysical Corporation, a Houston, Texas based company specializing in seismic products used in oil and gas exploration. According to ION’s press release, the transaction, which would result in the Chinese company owning 16.66% of ION, is contingent upon obtaining clearance of the transaction from CFIUS. This proposed acquisition is likely to face an exhaustive and extended CFIUS review because it is in a particularly sensitive sector, energy, and the ultimate acquirer is a Chinese state-owned enterprise. Although CFIUS may require some conditions designed to mitigate national security concerns, the transaction probably will be approved.

Congress passed FINSA in 2007 following controversies over the China National Offshore Oil Corporation’s attempted acquisition in 2005 of Unocal, a U.S. energy company, and Dubai Ports World’s acquisition in 2006 of a British company that managed several major seaports in the United States. These controversies focused congressional attention on CFIUS; the earlier Exon-Florio procedures for review of foreign acquisitions; potential harm to U.S. national security that could arise from foreign control of energy, infrastructure and critical technologies; and on investments by state-owned entities. The public debate over these cases and a new law, however, was not one-sided and the Administration convinced Congress to balance national security concerns with the need for the United States to remain open to foreign investment. FINSA, legislated on July 26, 2007, is not a barrier to foreign investment, but a balance of investment with national security.

FINSA covers any transaction that “could result in control of a U.S. business by a foreign person.” It covers transactions that could result in the switch of control from one foreign person to another. However, it does not cover greenfield investments or a strictly real estate transaction. Control over an existing U.S. business must be at stake. “Control” is defined very broadly. Thus, even the acquisition of a relatively small minority stake in a company could be covered by FINSA.

FINSA does not pose a significant barrier to the vast majority of foreign acquisitions of U.S. businesses because, although all such acquisitions are covered transactions, the President’s authority under FINSA to suspend or prohibit a covered transaction can be exercised only when the President finds that “the foreign interest exercising control might take action that threatens to impair the national security.” Neither the statute, nor its implementing regulations, defines “national security” and Congress intended CFIUS to interpret that term broadly to include, among other things, energy, critical materials, critical technologies, homeland security and infrastructure. Nonetheless, where there is no plausible connection between the business conducted by the U.S. company to be acquired and national security, FINSA will not be an issue.

Whenever a transaction covered by FINSA might affect national security, FINSA provides a review process whereby the parties to the transaction can seek clearance from CFIUS before they have invested a great deal. A CFIUS review is not mandatory, but companies generally seek one whenever there is a possibility that the transaction could be considered to affect national security. Once a transaction has been cleared by CFIUS, it cannot subsequently be challenged under FINSA unless one of the parties to the transaction submits false or misleading material information.

Companies take advantage of the CFIUS safe harbor – the preclearance -- by submitting a voluntary notice of a proposed transaction providing the detailed and extensive information that CFIUS’ regulations require for such notices. The filing of the notice commences a 30 day initial review process. Most transactions are cleared within this initial 30 day period.

When any of the CFIUS member agencies have unresolved national security concerns with a proposed transaction, a formal 45 day investigation begins. The parties typically resolve transactions that go through this second stage by agreeing with the government to mitigate the agencies’ national security concerns.

Mitigation agreements can involve modifications to the transaction, certain limitations on the new foreign owner’s exercise of control, or extra protections for critical technologies or facilities. A very small number of transactions pose national security concerns that cannot be mitigated successfully. Those transactions usually are abandoned before the completion of the CFIUS process. It is rare for CFIUS to complete its review with a recommendation to the President that a transaction be blocked.

The United States remains committed to an open investment environment, treating foreign investors on an equal footing with their domestic competition. It was for this reason that Congress set the initial CFIUS review deadline at 30 days, to coincide with the 30 day antitrust review period for mergers and acquisitions. The expanded view of national security mandated by FINSA does mean that CFIUS national security reviews are a crucial part of transactions involving foreign investment, but it is no more onerous than an antitrust examination.

Most important for success in a CFIUS review is understanding in advance the concerns of CFIUS member agencies, creative thinking about how to demonstrate that those concerns are not threatened, and where perceived threat may be reasonable, creative proposal to mitigate them. In most cases early attention to the CFIUS process and to the legitimate concerns of the member agencies, Congress, and the public, can ensure smooth and timely proceedings that result in CFIUS clearance without restrictions, or on terms that preserve the value of the transaction for all parties.

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