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$2 Million Deal = Big CFIUS Mistake

March 7, 2011

Huawei Technology – 3Leaf Systems Acquisition Falls Apart.  In late February 2011, several days after the Committee on Foreign Investment in the United States (“CFIUS”) informed Huawei Technologies Co. that it would recommend to President Obama that he order the company to divest itself of 3Leaf Systems, the company announced that it would not await a Presidential determination, but instead would abandon its efforts to finalize the acquisition of the U.S. technology company.

Huawei is a Chinese telecom company with reported ties to the China’s People’s Liberation Army.  3Leaf was a U.S. company which was a developer of technology allowing groups of computers to work together as a more powerful system (i.e., cloud computing).  In May 2010, for $2 million, Huawei purchased 3Leaf’s patents and intellectual property along with hiring many of 3Leaf’s employees.  Only when the Pentagon learned of the transaction did the parties retroactively file for a review by CFIUS.

The Pentagon and many Members of Congress have long argued that Huawei is closely connected to the Chinese army and has in the past supported the Taliban and the Iranian National Guard.  As a result, national security concerns have arisen over the company’s potential ability to disrupt or intercept U.S. telecommunications.  In fact, this is not the first instance in which Huawei has raised concern in the United States – a 2007 attempt to purchase 3Com was withdrawn; in 2010 Sprint excluded the Chinese company from a major contract to upgrade its cellular network; and, a lawsuit has been initiated by Motorola alleging collusion and the stealing of trade secrets.  With the most current 3Leaf transaction, Huawei has argued that it did not file for a CFIUS review because it did not feel that the $2 million purchase of intellectual property and computer servers warranted such a review.  While the CFIUS process is highly confidential, reports are that the Pentagon raised concerns about the transaction as did several key Senators and Members of Congress.

At the conclusion of the retroactive review in mid-February 2011, CFIUS reportedly informed Huawei that it should divest itself of the acquired assets of 3Leaf or it would take the rare step of recommending to the President that the deal be unraveled.  The company initially declined CFIUS’ divesture request and stated that “to withdraw and divest would have tarnished our brand and reputation.”  However, several days after pledging to fight the CFIUS finding through the Presidential review period, Huawei announced that it would abandon the deal.  The China Ministry of Commerce stated that, “to some extent, this obstruction and interference is affecting China-U.S. trade and economic cooperation.”  A Huawei statement announced that, "This was a difficult decision, however we have decided to accept the recommendation of CFIUS to withdraw our application to acquire specific assets of 3Leaf."  It added, “The significant impact and attention that this transaction has caused were not what we intended.”  
The United States government most often welcomes and encourages foreign investment in U.S. companies, so long as national security and critical infrastructure and technology are not threatened.  While Huawei may be a unique instance due to longstanding concern over the ownership of the company, its intentions with U.S. investments, and resistance to past U.S. investment opportunities, this most recent deal is an ideal example of how not to approach a foreign investment or acquisition in a U.S. company

Charles Hunnicutt, Troutman Sanders LLP leading CFIUS practitioner, indicated that this acquisition and review “confirm CFIUS’ longstanding assertion that there are no ‘bright line’ standards applied in determining whether or not a transaction raises foreign control or national security concerns.  Such cases will always be determined on a case-by-case basis.”   Charles added that “U.S. companies and foreign investors should always undertake a pre-acquisition internal analysis to determine whether a CFIUS review is warranted, or if one is even desired in order to provide safe harbor from post-closing review and challenge.  Clearly even a relatively small $2 million acquisition can raise concerns.”  While there was certainly a lot of behind the scenes confidential disclosures and negotiations during the retroactive review in an effort to clear the deal, the damage may have already been done by the companies’ failure to notify CFIUS of the proposed transaction.  It has, in fact, been opined that Huawei’s limited acquisition was specifically designed to avoid any CFIUS review.  Whether or not the deal ever could have been approved will remain a question.  What is clear, however, in the fallout is that CFIUS continues to play a very active role in reviewing foreign direct investment in the United States and both U.S. companies and foreign investors should always carefully analyze whether a CFIUS filing may be in their best interest.

CFIUS and National Security Reviews
CFIUS is a multi-agency committee established within the Executive Branch that historically has monitored the impact of and coordinated U.S. policy on foreign investment in the United States.  The relevant statutes authorize the President to investigate foreign acquisitions, mergers and takeovers, and even asset purchases of U.S. companies, and where necessary, suspend or prohibit any foreign acquisition for national security purposes. One key factor for CFIUS officials in any review is the application of the term "control".  The term is certainly applicable in instances where the foreign investor would hold majority ownership of a U.S. company.  However, the term may also be applied and affect transactions where a foreign investor may only be purchasing a dominant minority ownership stake.  Another key factor is the application of the term “national security” which remains undefined and, thus, leaves the government with broad discretion to interpret the term and determine whether a particular transaction constitutes a risk.

Troutman Sanders LLP Experience with CFIUS Reviews
Troutman Sanders is increasingly called upon by both our domestic and international clients to provide advice on regulatory and legislative matters related to U.S. national security.  Our work in this area frequently concerns corporate mergers, acquisitions, divestments or other commercial investments requiring national security reviews where foreign direct investment is involved. 
Companies and their counsel should consider notifying CFIUS of a transaction if it will allow a foreign entity to control a U.S. company and the deal arguably could raise political or national-security related concerns.  For example, investors from countries like China, Russia, and the Middle East will likely receive heightened scrutiny.  Furthermore, companies should consider notifying CFIUS if the proposed investments involve “critical infrastructure” – defined as systems or assets so vital to the United States that a breakdown in them “would have a debilitating impact on national security, national economic security, national public health or safety.”

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