United States: SPACs And CFIUS: Due Diligence Considerations

Special purpose acquisition companies (SPACs), which provide unique opportunities to raise capital from a diverse group of investors and invest in companies, are currently flourishing as investment vehicles. The United States remains the primary market for SPAC listings globally, and many Asian and European investors are piling into the U.S. SPAC market. In 2020 alone, investment firms in mainland China, Hong Kong, and Singapore raised billions of dollars on the New York Stock Exchange and Nasdaq via SPACs. In fact, by February 18, 2021, eight SPACs sponsored by Asian companies on U.S. exchanges had already outraised the total amount raised by SPACs in Asia in 2020. This rapid increase in funding has drawn the attention of other countries: as the SPAC trend reaches its apex in the United States, other jurisdictions, including the U.K., Hong Kong and Singapore, are exploring the vehicle. 

However, SPAC investors and target businesses can raise national security and regulatory considerations, and in particular, the attention of foreign investment review mechanisms such as the Committee on Foreign Investment in the United States (CFIUS) and similar regimes in other countries. Market participants should ensure appropriate due diligence with respect to potential CFIUS reviews and timing considerations, particularly if the SPAC is investing in sensitive technologies, critical infrastructure, or companies that may handle substantial sensitive personal data, such as healthcare companies or businesses that develop mobile applications.

SPACs and CFIUS

As a result of the surge in U.S. SPACs involving foreign investors and because of the set acquisition timeframe, investors and target companies should be aware of how SPAC transactions could be impacted by foreign investment reviews conducted by CFIUS or other jurisdictional regimes. An interagency body of the U.S. government, CFIUS reviews foreign investments in or acquisitions of U.S. businesses for national security issues and, if national security issues are identified, can impose mitigation on such investments or acquisitions or, potentially, require that the transactions be unwound or prohibited. U.S. SPACs with foreign sponsors or foreign investors should understand how CFIUS review could impact the transaction-or face risks such as the collapse of a valuable deal or potential fines resulting from a failure to follow CFIUS requirements.

SPACs with Foreign Participants Should Evaluate CFIUS Risk

Broadly speaking, CFIUS jurisdiction may be triggered in each of the two phases of the SPAC process-during both the initial IPO and the subsequent de-SPAC process.

During the initial IPO, it is relatively unlikely that CFIUS would demand a national security review in relation to a foreign person's initial investment in a SPAC. While it is unclear whether CFIUS could exercise its authority over a SPAC that has not engaged in investment activity, SPACs that have not undertaken operations or sales or investment activity in the United States are unlikely to present defined national security risks that would attract CFIUS interest. In this regard, the initial IPO could be viewed as an initial fundraise by a private equity or venture capital fund.

CFIUS is likely to exercise authority to review a de-SPAC transaction through which a foreign investor obtains either a controlling equity interest in a U.S. business or a non-controlling interest in a U.S. business that meets certain CFIUS requirements, particularly if the U.S. business is engaged in critical technology sectors, deals with critical infrastructure, or handles sensitive personal data.

As such, sponsors of or investors in SPACs should be aware that CFIUS may review de-SPAC transactions in certain circumstances:

• Controlling investments ("covered control transactions"). CFIUS has jurisdiction over transactions where a foreign person acquires a controlling interest in a U.S. business (i.e., the ability to "determine, direct, or decide" important matters affecting the U.S. business).
  • U.S. SPACs controlled by foreign investors. If a U.S. SPAC is controlled by a foreign investor and seeks to engage in a controlling investment in a U.S. business through a de-SPAC transaction, the SPAC should consider CFIUS implications. A foreign investor can acquire a controlling interest through the acquisition of a dominant minority shareholding stake or by acquiring certain decision-making rights with respect to the SPAC.
  • Foreign SPACs obtaining a controlling interest in U.S. businesses. Similarly, foreign SPACs that obtain control directly over a U.S. business, or indirectly, by acquiring a foreign business that owns a U.S. business, may also be subject to CFIUS jurisdiction. As long as a "foreign person" obtains control over a "U.S. business," CFIUS jurisdiction may be triggered.
• Non-controlling, non-passive investments ("covered investments"). CFIUS also has jurisdiction over some non-controlling, non-passive investments by foreign entities in defined situations. These situations arise, for example, where the foreign investor has access to information or rights to board participation in certain U.S. businesses involved in critical technologies, critical infrastructure, or sensitive personal data (a "TID U.S. business").
  • U.S. SPACs with minority foreign investors seeking an opportunity to invest in a TID U.S. business. If a U.S. SPAC with minority foreign investors seeks to invest in a TID U.S. business, they should be aware that CFIUS jurisdiction can be triggered if the foreign investor could obtain any of the following rights in relation to the TID U.S. business:

1. Access to material non-public technical information;
2. Membership or observer rights on, or the right to nominate an individual to a position on, the board of directors or equivalent governing body of the TID U.S. business; or
3. Any involvement in substantive decision making of the TID U.S. business regarding the use, development, acquisition, safekeeping, or release of sensitive personal data; the use, development, acquisition, or release of critical technologies; or management, operation, manufacture, or supply of critical infrastructure.

This means that if through the transaction the foreign investor obtains a board seat on a TID U.S. business or involvement in substantive aspects of a TID U.S. business, CFIUS may have jurisdiction over the transaction. As a result, foreign sponsors and other SPAC participants may wish to consider at the outset of negotiations how their governance rights may implicate CFIUS jurisdiction. For instance, if a foreign person forgoes board seats, observer rights, or access to sensitive U.S. business information, the transaction may not fall under CFIUS jurisdiction.

• Mandatory declaration triggers. SPAC sponsors and investors should also be aware that certain transactions must be submitted to CFIUS at least 30 days prior to closing. There are two categories of transactions that trigger this mandatory filing requirement:
  • Investments in U.S. critical technology businesses. A covered control transaction or covered investment involving a TID U.S. business that produces, designs, tests, manufactures, fabricates, or develops one or more critical technologies, the export of which to the foreign person would require a U.S. regulatory authorization.
  • Transactions involving foreign governments. When a foreign person in which the national or subnational governments of a single foreign state holds at least a 49 percent interest itself acquires at least a 25 percent interest in a TID U.S. business.
• Certain changes in foreign person's rights. Certain de-SPACs involving current foreign investors in target companies may also be subject to CFIUS jurisdiction if the transaction results in a covered control transaction or a covered investment. This means that if a current foreign investor in a TID U.S. business has a change in rights with respect to the post-closing U.S. business as a result of a de-SPAC transaction, that change in rights may result in CFIUS jurisdiction. For instance, if a current foreign investor in a TID U.S. business gains additional rights to appoint board members to the post-closing company's board of directors, this may result in CFIUS jurisdiction. For this reason, both SPACs and target companies may wish to consult a third party to provide diligence to determine whether such a change in rights might trigger CFIUS jurisdiction.

CFIUS and SPAC Timeframes

SPACs may also wish to consider how the CFIUS process may affect their deal timeframe. The average SPAC generally takes an average of 15 months from IPO to find a suitable target, and an additional five months to complete a business combination. This five-month period should be weighed against CFIUS's timeframe, which ranges depending on the type of filing parties make to CFIUS-either a joint voluntary notice or a declaration.

• Joint voluntary notices. Joint voluntary notices (JVNs) are longer, more detailed forms that are filled out by parties to a transaction on a voluntary basis. JVNs have a longer CFIUS review timeframe, which can last over 120 days in some circumstances. JVNs may result in a "safe harbor" guarantee that CFIUS will not re-open its investigation of the transaction following clearance. For this reason, many parties choose to file a JVN.
• Declarations. Declarations are short-form submissions to the Committee that have a 30-day assessment period. Following this assessment, CFIUS can conclude action, thereby providing safe harbor; inform the parties that CFIUS is unable to conclude action, which provides no safe harbor; request that parties file a JVN; or unilaterally initiate a JVN.

The chart below provides a comparison of the CFIUS timeframe for JVNs and declarations:

• Submitting declarations or filing joint voluntary notices. As noted earlier, mandatory declarations must be filed at least 30 days prior to closing the transaction. Although a declaration may result in a safe harbor guarantee from CFIUS, declarations can also result in a determination that CFIUS is unable to conclude action, or a request that parties file a JVN to investigate the transaction further. For this reason, parties should consider whether to file a JVN with the Committee in the first instance.

Potential Outcomes of the CFIUS Process

SPAC participants should be aware that there are many potential outcomes of the CFIUS review process. These outcomes may have significant consequences for the viability and value of a SPAC investment because CFIUS has broad authority, among other things, to prohibit or unwind an investment, to require the divestment of critical parts of the target company, to impose burdensome compliance frameworks, or to impose substantial costs on the acquired company through monitoring and oversight mechanisms. The outcomes of the CFIUS process can include:

• CFIUS clearance without mitigation. If CFIUS completes its review of a transaction and does not identify any national security risks with the transaction, it may clear the transaction without imposing conditions on the transaction, which permits the parties to complete the investment. In the case of JVNs, this means that CFIUS provides a safe harbor. For declarations, CFIUS may decide to grant safe harbor or notify the parties that it is unable to conclude action on the basis of the declaration. The majority of CFIUS cases end up clearing the CFIUS process without mitigation.
• CFIUS mitigation. If CFIUS identifies national security risks during the review process and finds that other provisions of law do not provide adequate authority to address the risks, it can impose mitigation conditions on a transaction through a mitigation agreement. These mitigation conditions depend on the specific risks identified with a transaction, and can include relatively straightforward provisions, such as U.S. government access and inspection rights, to complex requirements, such as establishing and overseeing access controls to protect sensitive data or technology or separating integrated businesses or operations.
• Presidential referral. If CFIUS has identified national security risks related to a covered transaction and believes that mitigation cannot address the identified national security risks, CFIUS can recommend that the President suspend, prohibit, or unwind a transaction, or can refer the transaction to the President for a decision.
• Withdrawal. Parties that have submitted JVNs to the Committee may request that the notice be withdrawn prior to CFIUS concluding action. CFIUS then decides whether to grant the withdrawal request.

Potential Penalties for Non-Compliance

Under the CFIUS regulations, parties can be subject to civil penalties for failing to submit mandatory filings or for violating a CFIUS mitigation agreement. These penalties can be severe, up to $250,000 or the value of the transaction, whichever is greater. For this reason, SPAC participants may want to consider how their investment may be impacted by the CFIUS process, particularly if they believe their investment is in a TID U.S. business that could trigger the mandatory declaration requirement.

CFIUS Diligence Protects Investment Value

Early and thorough CFIUS diligence helps market participants understand the risks inherent in potential SPAC targets and establish the compliance frameworks, business contingencies, and legal protections necessary to protect investment value.

Upon identifying a potential acquisition target, a SPAC with one or more foreign investors needs to conduct a comprehensive CFIUS review of the target company's operations, technology, and current investors to determine whether CFIUS jurisdiction would be triggered upon a de-SPAC transaction. Likewise, a potential target company would also need to conduct proper diligence to assess whether it would be considered a TID U.S. business and to assess whether it engages in certain activities with respect to critical technology. This diligence would typically include performing an export control analysis to determine if the mandatory filing requirement would be triggered.

SPAC participants, including sponsors, investors, target companies, and law firms advising clients, can benefit from working with a third party that provides CFIUS services, such as due diligence. Because the clock starts ticking as soon as SPACs are listed, issuers and potential target companies need to be aware of potential CFIUS risks as quickly as possible to allow the acquisition process to go smoothly.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.