Revised National Critical Capabilities Defense Act of 2022 Proposes Expansive Outbound Investment Review Regime

Revised National Critical Capabilities Defense Act of 2022 Proposes Expansive Outbound Investment Review Regime

June 16, 2022, Covington Alert

On June 13, a bipartisan group of U.S. lawmakers released draft legislation that would establish a new regime to regulate certain outbound investment and other business activities to address perceived national security risks. The legislation, titled the National Critical Capabilities Defense Act of 2022 (“Revised NCCDA”), is intended to replace an earlier bill (H.R. 6329) (the “Bill”) that was included in the much broader America Creating Opportunities for Manufacturing, Pre-Eminence in Technology, and Economic Strength Act of 2022 (H.R. 4521) (the “COMPETES Act”) introduced in the House of Representatives in January 2022, and which we reported on here. While the sponsors of the Revised NCCDA stated publicly that the new proposal is intended to be narrower in scope, and to be responsive to concerns expressed by the business community regarding the prior version of the bill, the Revised NCCDA is in some respects broader than its earlier iteration, implicating a wider range of business activities and transaction parties. The new proposal also is lacking in certain key details necessary to an administrable regulatory regime.

As detailed in our January client alert, the concept of an outbound review process in the U.S. is not new—it first arose in early drafts of what ultimately became the Foreign Investment Risk Review Modernization Act of 2018 (“FIRRMA”), which updated the statutory authorities governing the Committee on Foreign Investment in the United States (“CFIUS”). Relatedly, the national security concerns that are motivating Congress to pass outbound review legislation are also not new. The U.S. government is increasingly concerned with the transfer of certain technology to China, and the risk that U.S. businesses may help advance Chinese capabilities through certain investments. This position receives rare bipartisan support on Capitol Hill, and also appears to have engagement from the White House, including from National Security Advisor Jake Sullivan, who signaled potential support for an outbound review process in a speech in July 2021. Thus, while the NCCDA would introduce uncertainty for international investment, it is becoming increasingly apparent that there is significant support within both political parties to implement some form of outbound investment review process.

The Revised NCCDA remains a work in progress with several key terms either bracketed and subject to further discussion, or yet to be defined altogether. If enacted, however, the Revised NCCDA would create, consistent with the previous version of the NCCDA, the Committee on National Critical Capabilities (the “Committee) for purposes of reviewing certain outbound business transactions and activities. Under the new proposal, both U.S. persons and foreign entities that engage in a “covered activity” would be required to notify the Committee in writing at least 45 days before undertaking the activity. The Committee would then review the notification and if it determines the covered activity poses an unacceptable risk to a national critical capability, the Committee may impose mitigation, or make a recommendation to the President to take certain actions, including suspension and prohibition of the activity. While the general structure of the Committee and the review process remains consistent with earlier drafts, the detail contained in the Revised NCCDA reflects a marked departure from the previous Bill, particularly with respect to the scope of activities subject to review.

Key provisions in the Revised NCCDA include the following:

• The Committee: As contemplated in the prior Bill, the Committee is an interagency committee comprising the heads of at least 12 U.S. government agencies, including the Office of the United States Trade Representative and the Departments of Commerce, State, Treasury, Defense, and Justice, among others. However, in a notable change from the earlier Bill, the United States Trade Representative is not designated to lead the process and instead, the President, or his designee, serves as the chairperson of the Committee.
• Mandatory Notification and Review: The sponsors of the new proposal have stated publicly that the Revised NCCDA would establish a “notification” regime only, with no new review or approval authority. The language as drafted, however, expressly provides for a “mandatory notification and review” process that would provide broad authority to the Committee to directly impose mitigation, in addition to making recommendations to the President, who could independently suspend or prohibit the activity.
• Covered Activities: As opposed to the previous Bill, which focused on “transactions,” the Committee’s scope of review would now apply to a broad range of activities. This is an important distinction, as it would actually expand the scope of the previous Bill to capture ongoing activity that does not meet the definition of a “transaction.”

The Revised NCCDA, therefore, applies to a broad range of activities, including the (i) development, production, expansion, or sale of a “national critical capability” to or in a country of concern; (ii) sharing, disclosure, transfer, or licensing of certain technology, design, and know-how, including through open-source technology, related to a “national critical capability”; and, in perhaps the most significant expansion, investments, capital provisions, consultations, and “guidance” that may facilitate access by an entity of concern to financial resources for a “national critical capability.” This expansion would potentially sweep in a range of financial investments as well as other advisory activities—which either were not in scope or were left ambiguous in the previous Bill.

• Exempted Activities: The Revised NCCDA does include certain exclusions from the scope of review, including any transaction that falls below a de minimis threshold (yet to be determined), and any transaction that occurred before the effective date of the bill (180 days from enactment). This latter exception is partially negated by the definition of “covered activity,” which is defined as “any activity that is ongoing or proposed” as of the effective date of the bill. Thus, while the Committee may not retroactively review “transactions,” it may still have the authority to review certain activities that pre-date the NCCDA but are ongoing after its enactment.

The Revised NCCDA also would exclude from its jurisdiction “ordinary business transactions,” currently defined to encompass the sale, transfer, license, or provision of certain goods and services that generally would not result in a foreign person gaining access to critical technology. However, the precise scope of “ordinary business transactions” appears to be under negotiation and the term is generally ambiguous. Further, the licensing exclusion appears to be relatively narrow: “covered activity” includes licenses involving “design, technology, IP, or know-how, including through open-source technology platforms.” The exclusion, in turn, only covers “the license of a finished item”—a term that is not defined—or the “license to a customer of a product.” A question remains as to the distinction between licensing IP and licensing a “finished item” or “product,” especially where a “finished” item may include multiple parts that themselves could constitute “finished” items.

• “National Critical Capability”: This definition is in certain ways more specific than in the previous Bill, though it is still defined by reference to an extensive list of “capabilities” that include semiconductor manufacturing, large-capacity batteries, pharmaceuticals, artificial intelligence, quantum technology, and ambiguously defined sectors such as “bioeconomy.” A separate category of covered activities includes activities by recipients or beneficiaries of U.S. government funding under the Bipartisan Innovation Act, which could, for example, include Creating Helpful Incentives to Produce Semiconductors (“CHIPS”) Act funding, or by entities that have an annual procurement of more than a certain dollar amount in goods or services by a U.S. national security agency.
• Extraterritorial Jurisdiction: Unlike the previous Bill, Covered Activities undertaken by any U.S. person, foreign person, or their affiliates—meaning activities by any entity in the world—would be subject to the mandatory review requirement. This means that foreign subsidiaries of U.S. companies that conduct business in a country of concern or with an entity of concern, or even third-party entities in allied countries that conduct business in a country of concern or with an entity of concern, would technically be within the scope of the review process as drafted. For instance, a German company in South Korea that may not even be aware of the new regime could be subject to a mandatory notification to the Committee. Indeed, even a Chinese company with no direct ties to the U.S. that manufactures semiconductor parts on Chinese home turf could technically be captured within the scope of the Revised NCCDA based on the current definition of covered activity.
• Covered Entities: Under the new bill, “entity of concern” is defined specifically to include not only those entities headquartered or domiciled in a country of concern (People’s Republic of China, Russia, Iran, North Korea, Cuba, and Venezuela per section 8(c)(2) of the Secure and Trusted Communications Networks Act of 2019), but also any entities “affiliated with” or “influenced by” a country of concern. This could have a meaningful impact on the scope of “covered activities” that would be subject to mandatory notification and review, as the definition of “covered activities” is in part tied to a country or entity of concern. By applying this proposed definition of entity of concern, it means that covered activities need not necessarily be with an entity headquartered or located in a country of concern, but instead could simply be any entity globally that is, for example, “influenced” by a country of concern. “Influence” is notably undefined.
• Process: The Revised NCCDA still lacks important detail with respect to the actual process of submitting a notice for Committee review. The draft contemplates that a review would be mandatory and that U.S. persons and foreign persons that “engage in or plan to engage in a covered activity” are required to submit a notice “45 days before engaging in such activity.” This language in itself is unclear, as it suggests that ongoing activity may be subject to review, but then simultaneously contemplates that the activity shall be reviewed before it is commenced. Additionally, no details are provided with respect to requirements for what would be contained in such a filing.

Once a written notification has been submitted to the Committee, the Committee has 45 days to determine whether the activity in question poses an unacceptable risk to a national critical capability of the United States, based on a consideration of several factors. If the Committee identifies a risk to a national critical capability, the Committee may make a recommendation to the President to address the identified risks, including by imposing mitigation using existing authorities. The draft separately contemplates that the Committee may directly negotiate or impose a mitigation agreement with the parties prior to the President taking an action. Finally, it also suggests that the President may suspend or prohibit an activity. There is no statutory timeline for how long the mitigation process may take. The Committee also has the authority to initiate unilateral review of a covered activity for which written notification was not submitted, and also to impose mitigation for certain covered activities that have already been completed or voluntarily abandoned. Finally, similar to the previous Bill, Congress may request that the Committee initiate a review unilaterally.

• Penalties: The Revised NCCDA also provides for the imposition of civil penalties of up to $250,000 for parties who fail to comply with the mandatory notification requirement in connection with a covered activity. The penalty also applies to any violation of mitigation agreements arising from the review process. Any activities undertaken to evade the regime’s jurisdiction are also subject to the same civil penalties.
• Multilateral Coordination: The Revised NCCDA specifically calls for “multilateral engagement” with U.S. allies and partners, and even requires technical assistance to friendly countries for the development of similar mechanisms. The provision appears responsive to concerns that unilateral action of such magnitude by the U.S. could handicap U.S. companies, vis-à-vis foreign entities, including from allied countries, that do not face the same restrictions from their home countries.
• No Judicial Review: In addition to the lack of a defined process, the new proposal—consistent with the earlier Bill—lacks any express mechanism for appeal or judicial review of the Committee’s decision.

Questions and Issues

In addition to the ambiguities noted above, the Revised NCCDA, as proposed, presents a number of recurring themes that could pose barriers to implementation and compliance, including:

• Breadth: The inclusion of “activities” is a significant expansion of scope from the earlier Bill. Based on the definition of “covered activities,” the Revised NCCDA would appear to have extraterritorial jurisdiction covering not only U.S. entities but also foreign entities doing business anywhere in the world with no direct nexus to U.S. interstate commerce. “National critical capabilities,” though narrower by comparison to the original Bill, is still defined by reference to an extensive list of broadly defined sectors. “Influence” remains undefined, and could be construed broadly to include any entity anywhere in the world within the scope of covered entities, even those not headquartered or domiciled in a country of concern. Meanwhile, the proposed exceptions only apply to “transactions,” but not “activities,” pointing to unresolved internal dissonance within the draft itself.
• Implementation: Given the breadth of scope and its extraterritorial implications, the proposed bill raises questions about the administrative feasibility of the new review regime, including with respect to the resources, staff, and expertise that would be needed. Key details regarding process remain unanswered, including what would be included in the written notification to the Committee. It remains unclear whether ongoing activities predating enactment would be captured and whether recipients of government funding would be subject to review only with respect to the funded activity or with respect to their overall business activities, including those unrelated to the government funding. The sheer number of entities (including foreign entities) that would technically fall within the scope of the new regime also introduces questions about asymmetric implementation of review, in which U.S. businesses are more likely to bear the burden of the new requirements. It is difficult to imagine how compliance would be enforced for foreign entities conducting covered activities entirely in foreign countries, not to mention administrative challenges in tracking the entire universe of such covered activities.

The bipartisan supporters of the Revised NCCDA, including Senators Bob Casey (D-PA) and John Cornyn (R-TX) and Representatives Rosa DeLauro (D-CT), Bill Pascrell, Jr. (D-NJ), Michael McCaul (R-TX), Brian Fitzpatrick (R-PA), and Victoria Spartz (R-IN), continue to press for the inclusion of a version of the new proposal in the larger China-related legislation, but the bill also faces questions from the broader business community and other members of Congress. Given the challenges of passing the underlying bill with the narrow window of opportunity before the Congress recesses in August, the Revised NCCDA may not have a clear path to passage in the near term. Even if this version of the legislation does not pass, however, there will remain significant, bipartisan support for enacting some form of an outbound investment review regime, and, in turn, we can expect Members of Congress to attempt to include such legislation as part of other legislative vehicles in 2022, such as the Omnibus Appropriations bill and the National Defense Authorization Act. There also remains the prospect that the Biden Administration could promulgate an Executive Order to establish a review program and/or to commence a pilot program to study the issue further.

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If you have any questions concerning the material discussed in this client alert, please contact the members of our CFIUS practice.