Clifford Chance

The abandonment of the Wise Road Capital - Magnachip merger on CFIUS grounds sends a message that parties should not underestimate the scope of CFIUS jurisdiction or the depth of due diligence in the US FDI mechanism.

Transaction Background

In December 2021, Wise Road Capital, a Chinese private equity firm, and Magnachip Corp., a New York Stock Exchange (NYSE) listed company with operations primarily in South Korea, announced that they had abandoned a planned merger in the face of CFIUS opposition. This marks the end of a tumultuous nine months for the parties – nearly three times the length of a "standard" CFIUS review process.

As detailed in Magnachip's Securities and Exchange Commission (SEC) filings, the $1.4 billion merger was announced in March 2021 with CFIUS initially intervening in May 2021. According those filings, the parties believed a CFIUS filing was neither mandatory nor recommended because of Magnachip's limited US presence. While Magnachip is listed on the NYSE and maintains a Delaware entity, the company indicated that it performs manufacturing, R&D, and sales activities in South Korea and maintains most employees, tangible assets, and IT systems outside of the United States, and that this limited US presence was insufficient for CFIUS to have jurisdiction to conduct a review. CFIUS, however, disagreed, directing the parties to file a formal notice (which was filed in June 2021), and blocked the parties from finalizing the transaction until CFIUS review had concluded, stating the deal posed "risks to national security," and that the parties failed to "adequately mitigate the identified risks" in August. Despite the parties withdrawing and refiling their notice in September to provide additional time to obtain clearance, they were unable to reach an agreement that mitigated the CFIUS-identified US national security risks to the satisfaction of the Committee. In the face of an all-but-certain US presidential blocking of the transaction, the parties voluntarily elected to abandon the merger.

China, Semiconductors, and CFIUS

That CFIUS intervened in a transaction involving the semiconductor sector is unsurprising given the US FDI mechanism's recent history in that space, particularly for transactions involving Chinese investment. 2016 was a particularly intense year for Chinese investors in the sector in terms of CFIUS scrutiny: the Lumileds transaction was reportedly withdrawn after CFIUS review, Fairchild Semiconductor rejected a potential Chinese investment because of potential CFIUS risk, GCS Holdings entered into a joint venture to make chips with its potential buyer after CFIUS objected to an initial acquisition attempt, and a Chinese investor's attempt to acquire German semiconductor company Aixtron was also blocked by the Committee. This rash of CFIUS activity in the sector continued into 2017 and 2018, with CFIUS blocking the Canyon Bridge-Lattice and Broadcom-Qualcomm transactions respectively.

The Broad Scope of CFIUS Jurisdiction

With the addition of mandatory filing requirements to the CFIUS process in 2018 and potential fines up to the value of the transaction, transaction parties understandably focus their attention on whether a transaction requires a CFIUS notification (a "mandatory" filing) under the current regulations. As evidenced by the Magnachip transaction, however, the calculation of whether to submit a CFIUS filing voluntarily is not so straightforward, in large part, due to CFIUS' broad jurisdiction to direct inquiries into non-notified transactions. Of note for the Magnachip transaction, while the parties may have reasonably concluded that a mandatory filing was not implicated given the company's limited US presence, CFIUS nonetheless asserted jurisdiction over the transaction, in this instance as a "covered control transaction" (defined as any acquisition by a non-US entity that could result in "control", whether directly or indirectly, over any "US business" by a non-US person).

As highlighted in our recent client briefing on CFIUS' 2020 Annual Report (here) and evidenced by the abandoned Magnachip transaction, CFIUS has become increasingly cognizant of the perceived risk from non-notified transactions. The Committee has dedicated significant resources to identifying and intervening when it deems necessary, in the form of directed inquiries into non-notified transactions. Thus, parties to a transaction falling within CFIUS' jurisdiction who elect to forgo a voluntary notification should carefully evaluate the potential risk of receiving a CFIUS directed inquiry and prepare accordingly for such an occurrence.

"Carve outs," "Vulnerability," and CFIUS

While case-by-case details of CFIUS reviews are not a matter of public record, part of CFIUS' substantive focus during a review is the ‘vulnerability’ presented by the US business being acquired. ‘Vulnerability’ measures how sensitive the US business is from a national security perspective. One method that parties use to reduce national security vulnerability is a "carve out" of the sensitivity business line – for example selling a sensitive R&D facility to a US buyer. When the entire US business is carved out of a broader global business, this can legitimately deprive CFIUS of jurisdiction altogether. Based on publicly available information, Magnachip's US business may have been subject to a carve out prior to the Wise Road Capital transaction that reduced its substantive US footprint and associated national security vulnerability. Proactively carving out potentially sensitive elements of a transaction, however, may not be as straightforward a solution as it seems. Under the CFIUS regulations, transactions designed to evade or avoid CFIUS review, which may include proactively carving out US elements, are specifically included within CFIUS jurisdiction. While we cannot know for certain, it is possible that Magnachip's proactive actions may have had the complete opposite intended effect, and in fact, opened the door for CFIUS review.

Key Takeaways

As seen in this transaction, the semiconductor sector remains high-risk from a US foreign direct investment perspective, with Magnachip joining a long line of CFIUS-blocked transactions in the sector. Further, even when a mandatory filing is not required, parties should carefully evaluate the decision of whether to submit voluntarily – particularly when the national security vulnerability is thought to be mitigated by an attempted carve out. Parties who elect to forgo a voluntary notification should be prepared in the event of receiving a directed inquiry – particularly in the semiconductor sector and when Chinese investors are among the parties. Transaction parties should ensure that they employ counsel who understand the US FDI environment and can properly balance the need for a filing with the commercial risks incurred when declining to make a US FDI filing.