Maybe.
Let’s use a typical U.S. sponsored private equity fund as an example. In this example, the limited partnership (“Fund”) is registered in the Cayman Islands and managed by a U.S.-based investment firm through a U.S.-based general partner (“GP”) entity and U.S. citizens in New York making investment decisions. See Figure 1.
Under the regulations administered by the Committee on Foreign Investment in the United States (“CFIUS”), the term foreign person means: (1) any foreign national, foreign government, or foreign entity; or (2) any entity over which control is exercised or exercisable by a foreign national, foreign government, or foreign entity.[1] The term foreign entity generally includes any partnership organized under the laws of a foreign state if its principal place of business is outside the United States.[2] The term principal place of business means, in the case of an investment fund, where the fund’s activities are primarily directed, controlled, or coordinated by or on behalf of the general partner.[3]
With these definitions in mind, even though the Fund in our example is organized outside the United States, given that the Fund is managed and controlled by a U.S. GP and U.S. citizens, the Fund’s principal place of business likely would be considered the United States. Accordingly, unless the Fund previously represented to the U.S. Government, or any other government entity, that its principal place of business is outside the United States (e.g., for tax purposes), the Fund likely would not be considered a foreign entity for CFIUS purposes.
Unfortunately, the legal analysis does not end there though. Indeed, the next step in determining whether the Fund could be considered a foreign person for CFIUS purposes requires an evaluation of whether the Fund could be considered an “entity over which control is exercised or exercisable by a foreign national, foreign government, or foreign entity.”
This analysis often requires a review of the underlying fund documents and related agreements, including the limited partnership agreement and side letters (as applicable), as well as an understanding of the Fund’s underlying LP base and associated voting rights, to confirm whether any foreign person LPs in the Fund could be considered to have the ability to exercise control over the Fund.[4] In the investment fund context, we often think of this in terms of whether any foreign LPs could be considered to have leverage over and, therefore, potentially have “control” (which, for CFIUS purposes, is more akin to substantial influence) over the GP.
For example, if a foreign LP has the ability to vote 18% of the LP interests in the Fund and the underlying limited partnership agreement requires an 85% vote of the LPs to dissolve the fund, that foreign LP has the ability to block dissolution of the fund. Similarly, if the limited partnership agreement requires a 90% vote to remove the GP (with or without cause) and a foreign LP has a 13% vote, that foreign LP has the ability to block removal of the GP. Both rights could be considered to provide the foreign LP with leverage over the GP and control over the Fund. Indeed, the CFIUS regulations explicitly indicate that control, a concept over which CFIUS has broad discretion, includes having the ability to, among other things, dissolve an entity or, in the investment fund context, remove the general partner. If a foreign LP has control over the Fund, CFIUS could consider the Fund to be a foreign person. See Figure 2.
In addition to math calculations associated with voting rights, CFIUS, which has broad discretion to decide whether an investor is a foreign person, also might consider, among other things, whether there are any formal or informal agreements or arrangements between foreign LPs in the Fund that might otherwise enable them to act in concert and collectively leverage control over the GP or the Fund.
At this point, you might be asking “What if a foreign LP sits on the limited partner advisory committee (“LPAC”)?” or “What if a majority of the LPs in the fund are foreign persons?” Taking each of those questions in turn, the CFIUS regulations clarify that an investment by a fund in connection with which a foreign person LP is a member of the LPAC is not within the jurisdiction of CFIUS as long as certain requirements are satisfied.[5] With respect to the second question, a fund majority owned by foreign LPs (e.g., 10 foreign person LPs each own 6% of the LP interests) would not automatically be considered a foreign person for CFIUS purposes. Instead, the answer would come down to the extent to which one or more of the foreign LPs could be considered to have control over the fund by virtue of, for example, voting rights.[6] As noted above, this includes determining whether any of the foreign LPs have formal or informal agreements to act in concert with respect to the fund.
If, based on the above, a fund could be considered a foreign person for CFIUS purposes, this would be the case regardless of what the underlying fund documents say about the rights or lack thereof afforded to limited partners. Thus, inserting language into a limited partnership agreement that says “no limited partner will have the ability to control investment or other decisions for the fund” would not prevent CFIUS from taking the position that the fund is a foreign person if a foreign LP has the ability to block, for example, removal of the GP. Similarly, a representation in a stock purchase or similar transaction agreement stating that “the Purchaser is not a foreign person as defined in Section 721 of the Defense Production Act of 1950” can just as easily be disregarded by CFIUS, and does not relieve the parties of their potential filing obligations with or potential enforcement actions by CFIUS.
One additional note of caution. When determining whether an LP is foreign for purposes of conducting the above-described analysis, it may not be enough to simply look at the nationality of the entity that made the direct investment into the Fund. Instead, it may be necessary to evaluate whether a U.S. investment vehicle entity that invested directly in the Fund is ultimately owned or controlled by a foreign person.[7]
Why does all of this matter?
The short answer is that even investments by funds managed by U.S. citizens through a U.S. GP can be within the jurisdiction of CFIUS if the underlying fund is considered a foreign person and can, in the case of investments in certain types of U.S. businesses, trigger a mandatory CFIUS notification. Failure to satisfy a mandatory CFIUS notification requirement is subject to monetary penalties up to the value of the transaction.
If, following the analysis set forth above, a U.S. sponsor determines that one or more of its funds could be considered a foreign person for CFIUS purposes, the U.S. sponsor should carefully consider the extent to which CFIUS could have jurisdiction over investments by those funds—which depends on whether the funds are (1) obtaining control over a target U.S. business; or (2) investing in a target U.S. business engaged in activities involving critical (i.e., export controlled) technology, certain types of critical infrastructure, or sensitive personal data (often referred to as a “TID U.S. Business”) and receiving certain non-controlling rights (e.g., a board or observer seat)) as a result of such an investment[8]—and, if so, whether the investment triggers a mandatory CFIUS notification or otherwise could be an investment in which CFIUS could be interested from a national security perspective. The latter analysis is more art than science and requires consideration of a number of factors, including the national-security-related vulnerabilities, if any, presented by the target U.S. business.
One final note regarding co-investments whereby a limited partner in a fund makes a direct or indirect (such as through a special purpose vehicle) investment in a company in which the fund is invested. Whether CFIUS has jurisdiction over such co-investments requires an analysis separate from whether the fund itself is a foreign person for CFIUS purposes and requires evaluating the extent to which the limited partner co-investor is obtaining governance or other rights in the company that could trigger CFIUS jurisdiction.
[1] See 31 C.F.R. § 800.208.
[2] See 31 C.F.R. § 800.220.
[3] See 31 C.F.R. § 800.239.
[4] A close review of the limited partnership agreement may be required in order to determine whether the GP has any voting rights. If the GP does not have any voting rights, the GP ownership interests in the Fund may need to be disregarded for purposes of determining the voting rights of each LP, including any foreign LPs.
[5] The fund must be managed exclusively by a general partner, managing member, or equivalent that is not a foreign person; the LPAC may not have the ability to approve, disapprove, or otherwise control: (i) investment decisions of the fund or (ii) decisions made by the general partner, managing member, or equivalent related to entities in which the fund is invested; the foreign person may not otherwise have the ability to control the fund, including the authority to: (i) approve, disapprove, or otherwise control investment decisions of the fund; (ii) approve, disapprove, or otherwise control decisions made by the general partner, managing member, or equivalent related to entities in which the fund is invested; or (iii) unilaterally dismiss, prevent the dismissal of, select, or determine the compensation of the general partner, managing member, or equivalent; and
the foreign person may not have access to material non-public technical information. See 31 C.F.R. § 800.307.
[6] CFIUS likely would aggregate voting interests held by foreign LP investors that are owned by the same foreign government, such as, for example, multiple sovereign wealth fund investors from the same country. Similarly, CFIUS likely would aggregate voting interests ultimately held by the same foreign national or foreign parent entity.
[7] Such an evaluation may require conducting due diligence on the ownership structure above the investing entity and, if necessary, communication with LPs.
[8] Any pre-existing ownership or shares held by a fund in the target U.S. business and any changes in the rights afforded to a fund also should be taken into account when conducting this jurisdictional analysis.