CFIUS Decision on Magnachip Deal Shows Long Reach of CFIUS

On December 13, 2021, Magnachip Semiconductor Corporation (“Magnachip”), an NYSE-listed Delaware corporation, and Wise Road Capital LTD (“Wise Road”), a Chinese private equity firm, announced that they would be terminating their proposed merger as they were unable to obtain approval of the transaction from the Committee on Foreign Investment in the United States (“CFIUS”). The parties entered into a merger agreement in March 2021, but did not file a notice with CFIUS until June 2021 after CFIUS exercised its call-in authorities and imposed an order prohibiting the parties from completing the transaction without CFIUS approval.

That CFIUS declined to approve an acquisition by a Chinese purchaser of a semiconductor company is not in itself surprising or particularly notable at this point. What is notable is that, based on information released by the company, Magnachip’s technical capabilities and the vast majority of its operations apparently resided outside the United States.

Thus, the transaction shows that CFIUS is willing to use even a nominal U.S. presence as a jurisdictional hook when it has significant national security concerns. Furthermore, once it establishes jurisdiction, CFIUS is willing to use the full range of its remedial powers to address such risks, even if the risks arise primarily from activities outside the United States. As a practical matter, this means that, in evaluating transactions with any U.S. nexus, parties should carefully consider whether activities of the target, even outside the United States, may be sensitive from a U.S. national security perspective and whether CFIUS could use any U.S. presence of the target company as a basis for affecting the viability of the overall transaction.

There are a number of important take-aways from the transaction:

1. The threshold for CFIUS jurisdiction is low. CFIUS has jurisdiction to review (among other things) any transaction that could result in foreign control of a “U.S. business.” The threshold for finding a U.S. business is rather low; a legal entity with any commercial operations stands a good chance of qualifying. According to Magnachip, in March 2021 when the merger agreement was entered, virtually all of its operations and employees were in South Korea or otherwise outside the United States, leaving Magnachip to serve largely as a U.S.-incorporated holding company of overseas operations. While it is possible that CFIUS considered Magnachip’s more expansive U.S. operations as they existed in the period leading up to the agreement (as discussed below), it would not be surprising if CFIUS asserted jurisdiction based on the U.S.-incorporated holding company alone. A legal entity or office that engages in anything that could be construed as interstate commerce would qualify as a U.S. business for CFIUS purposes.
   
   
2. Pre-transaction re-structuring to address CFIUS jurisdiction carries risk.  It appears that Magnachip may have reduced U.S. operations in the months leading up to the agreement (e.g., as recently as the end of 2019, Magnachip reported leased facilities and administrative, marketing, and R&D activities in California). It is unclear whether this reduction was motivated by commercial factors unrelated to the transaction or by CFIUS jurisdictional considerations. Regardless, the transaction serves as a reminder of two risks related to carving U.S. assets out of an otherwise foreign-to-foreign transaction. First, parties may initially think it will be easy to carve out target company U.S. operations, but such carveouts often are not clean, and any residual U.S. presence may be enough for CFIUS to assert jurisdiction. Second, CFIUS regulations provide that it can review any transaction, transfer, agreement, or arrangement, the structure of which is designed or intended to evade or circumvent CFIUS jurisdiction. CFIUS would be expected to closely scrutinize any pre-transaction restructuring to assess whether it can be disregarded. Thus, even if the target has no U.S. assets at the time of the transaction, CFIUS may assert jurisdiction if it has reason to believe that assets (e.g., equipment, contracts, personnel, etc.), were transferred pre-transaction to foreign affiliates in an attempt to avoid CFIUS jurisdiction.
   
   
3. Narrow basis for jurisdiction ≠ narrow national security concerns. CFIUS may have a narrow basis for jurisdiction but may nonetheless have huge concerns with a transaction. So long as there is some defensible basis for jurisdiction, CFIUS can exercise its full remedial authority. And the deeper the concern, the more motivated CFIUS will be to test the limits of its authorities.
   
   
4. CFIUS concerns may arise from non-U.S. activities. CFIUS generally focuses on national security concerns associated with U.S. activities. However, there is no clear proscription against CFIUS acting with respect to concerns related to activities outside the United States. As a practical matter, CFIUS may choose not to act with respect to non-U.S. activities because its practical ability to reach them and enforce any remedies may be limited. Doing so may also raise diplomatic considerations. In the case of Magnachip, since the transaction involved the transfer of interest in a U.S. holding company, CFIUS had an effective remedy that could be enforced in the United States. However, even if a foreign company’s U.S. presence is limited to a sales office, CFIUS could seek to use jurisdiction based on that sales office to impose costs on the company that make the global transaction unpalatable. CFIUS also has the ability to engage with foreign regulators if CFIUS’s remedial powers are limited as a practical matter. It is possible that, with respect to the Magnachip transaction, CFIUS engaged with the South Korean regulators, which requested a filing shortly after CFIUS imposed an interim mitigation order freezing the merger.
   
   
5. China and semiconductors remain subject to heavy scrutiny. It is well understood by now that Chinese investments and semiconductor investments are each subject to a high degree of scrutiny. Combine the two, as in this transaction, and CFIUS’s risk tolerance is likely to be very low. This is not the first time CFIUS has acted against a Chinese investment in a semiconductor firm with primarily foreign operations. In 2016 Fujian Grand Chip abandoned its attempted acquisition of German semiconductor manufacturing equipment producer Aixtron SE after the German government withdrew its approval of the deal, and President Obama subsequently prohibited the acquisition of Aixtron’s U.S. operations.
   
   
6. It’s hard to fly under the CFIUS radar. The combination of increased CFIUS resources devoted to identifying non-notified transactions, the expanded scope of issues that raise national security considerations, and the ever-expanding availability of information about transactions (including a CFIUS tip line) all reduce the scope for “flying under the radar,” which is a strategy some parties have used in the past. The Magnachip transaction, which was submitted to CFIUS for review only after CFIUS reached out, illustrates two points about CFIUS deal risk. First, for most transactions, and especially any public transactions or transactions involving a direct acquisition of a U.S. entity, parties should presume that CFIUS will catch the transaction. Second, assuming there is not a mandatory filing requirement, it is generally the buyer that bears most of the CFIUS risk in any given transaction. However, the Magnachip deal underscores that the seller assumes some risk of pre-closing intervention where it is not a sign-and-close transaction.