Mario Mancusco of Kirkland; TatianaSullivan of Stroock; and Richard Matheny of Goodwin.

Expanded provisions for nationalsecurity review of real estate transactions involving foreigninvestors in the United States were among the biggest changes underdraft regulations released by the U.S. Treasury Department lastweek.

The proposals for expandedreview by the Committee on Foreign Investment in the U.S. (CFIUS),the interagency panel at the Department of the Treasury, couldcatch some real estate investors and funds off-guard, internationaltrade and national security lawyers said. 

"Even in non-control real estatetransactions where an investor has minority investment with certainrights, if they fall within the categories that CFIUS has laid out,CFIUS will have jurisdiction," said Mario Mancuso, an adviser tocorporate boards and international trade and national securitypractice leader at Kirkland &Ellis in Washington,D.C. 

"They will have to think aboutit unless they want to run the risk of CFIUS unwinding the deal.Real estate gets a lot of attention in these proposed regulations,"Mancuso said.

The proposedrules coverreal estate located in or near scores of airports,maritime ports, military bases, and national security installationsacross the United States, many concentrated near the Washington,D.C./Northern Virginia metro area and in SouthernCalifornia.

David Hanke, an internationaltrade and national security partner at ArentFox in D.C., said, "Therule-makers were clearly trying to maximize certainty andpredictability for investors, but it's possible this newfoundjurisdiction over real estate could impact investment near thesespecific facilities."

The draft rules implementing theForeign Investment Risk Review ModernizationAct (FIRRMA) reflect the federal government's growing concernabout purchasing and leasing of properties that could be used forsurveillance or intelligence-gathering by foreign actors, lawyerssaid. They were released Sept. 17 in a 135-page document asproposed rule 31 CFR Part802. 

The real estate rules are farmore expansive than the ones that existed prior to FIRRMA,which was enacted with bipartisan support in Congress last year.CFIUS already had authority to review for national securityconcerns transactions where a foreign acquirer had the ability togain control of a U.S. business. But now, under FIRRMA, CFIUS'sauthority is expanded to review non-control investments and realestate transactions that previously fell outside itsjurisdiction.

Covered real estate transactionsinclude any in which a "foreign person" purchases, leases, or isgranted a concession of covered real estate that affords a foreignperson certain property rights as detailed in the draftregulations, as summarized in client memo released byStroock &Stroock & Lavan onMonday. A "foreignperson" is defined in the regulations, however, as a "foreignnational," "foreign government," "foreign entity," or any entityover which control is exercised or exercisable by any ofthese.

A CFIUS review could result in atransaction being cleared, blocked with a presidential order, orrequired to take mitigation steps such as selling off a particularproperty in order to win approval. Filingfor national security risk review of real estate transactions isvoluntary, not mandatory; however, CFIUS can call for review of atransaction where the parties haven't voluntarily filed.

A relatively recent example of areal estate deal that was terminated because of CFIUS objectionsunder the prior rules occurred in 2016 during theObama administration, when CFIUS rejected China's Anbang InsuranceGroup Co.'s bidto purchase the Hotel del Coronado in San Diego from the BlackstoneGroup, which then scuttled the deal. The committee wasconcerned about the property's proximity to U.S. Navyinstallations.

More recently, CFIUSordered HNA Group to sell itsmajority holding last year in a Manhattan buildingwhose tenants included a police precinct assigned to protect TrumpTower, according to news reports.

Tatiana Sullivan, an attorneywho recently joined Stroock from the Department of Defense, whereshe was responsible for FIRRMA development, said: "If implementedin their current form, the new rules will require foreign investorsand foreign-controlled companies in the United States to do muchmore due diligence as part of theirtransactions." 

Sullivan also said someindustries such as oil and gas, where companies engage in purchaseand lease arrangements as a regular part of their business, may bemore affected than others. Entities that are already under foreigncontrol also could come under scrutiny, and that would includetheir U.S. subsidiaries, she said.

A spokeswoman for the RealEstate Roundtable, a trade group in Washington, D.C., representing real estate owners, managers, developers, and lenders,said the group is studying the proposed regulations and plans tofile comments before the Treasury Department deadline.

The U.S. Treasury has requestedcomments in writing by Oct. 17. Final rules are expected early nextyear.

Covered Real Estate and Transactions

Under the proposed regulations,"covered real estate" includes certain large airports and maritimeports; properties within a mile of any of more than 100 militaryinstallations identified in the regulation, or within extendedrange—99 miles of the one-mile "close proximity" boundary—of 32military installations, as well as any part of 23 named militaryinstallations and located within 12 nautical miles of the U.S.coast; and real estate on or near missile fields spread out overColorado, Montana, Nebraska, North Dakota, andWyoming. The sitesare listed in a lengthy appendix. 

Many of the installations on thelist are in Virginia and Maryland, and several are near San Diego,Santa Barbara, and Los Angeles in California. Bases outside LasVegas and in Florida also are on the list, along with others acrossthe country.

"Covered real estatetransactions" include any purchase, lease, or concession to aforeign person or a change in the rights that affords them aminimum of three of the following rights: (1) the right to physicalaccess to the property; (2) the right to exclude physical access;(3) the right to develop the property or improve it; or (4) theright to attach fixed or immovable structures orobjects.

The regulations, however,provide general exceptions for real estate within "an urbanizedarea or urban cluster," single housing units, certain retailconcessions, certain commercial office buildings, and certaintribal properties.  

Penalties for withholdinginformation or providing misleading information carry a civilpenalty of up to $250,000 per violation. As with the rest of thenew CFIUS draft regulations, there is a proposed "white list" ofcountries or investors that can be excepted from therequirements.  

Corporate partner NevenaSimidjiyska, co-chair of the international trade practice groupat Fox Rothschild in Philadelphia, said she believed that interms of the expansion of CFIUS jurisdiction over real estatetransactions, the leasing provision would have the greatestreach.

"There is a lot of leasing going on to foreign parties the wayit is defined, so that is going to be the biggest change. Whenevera U.S. party is considering leasing to a foreign party, itis going to have to make sure it doesn't fall within the regulatedreal estate here," she said.

But Simidjiyska also said thatthe fact the rules only call for voluntary filing may reduce theoverall impact, at least as compared to the draft regulationsregarding TID businesses: critical technologies, infrastructure,and sensitive personal data that require mandatory filings incertain cases under the new rules.

Whether dealing with mergers andacquisitions (M&A), investment, or a real estate transaction, addressingconcerns often involves structuring the transactions in a way thatdoesn't trigger CFIUS jurisdiction, she said. For example, makingsure that foreign real estate acquirers don't have certain rightsrelated to the property.

Hanke said CFIUS should try tomake the process as user-friendly as possible for real estateinvestors.

"Allowing the use of short-formdeclarations is a smart way to do that. Pure real estate deals canbe more straightforward than technology or data-relatedtransactions, for example, so hopefully most can be reviewed andcleared relatively quickly."

An indirect effect ofthe proposed rules, however, could be on real estate financing,even though that is not actually stated inthe regulations, said Richard Matheny, a litigationpartner and head of Goodwin Procter's global trade practice in Washington,D.C.

Even though the proposedregulations don't require mandatory filing, "lenders may pushborrowers to go through the CFIUS process in order to protect theirsecurity for the land," he said. "I anticipate that lendinginstitutions will be taking a look because they want to make surethat their security is protected, so I expect CFIUS provisions tobe put into their lending for real property."

Draft Rules Address Growing Security Concerns

Lawyers familiar with theevolution of FIRRMA legislation said the new real estateregulations are in response to a rising numberof situations like the one in 2012, when the Chinese-ownedRalls Corp. bought four U.S. wind farm properties inOregon, including onelocated near a U.S. naval base that trained drone aircraftpilots.

After the U.S. Navy objected,CFIUS contacted Ralls Corp. and suggested the company voluntarilyfile a notice with the committee. Ralls did so, and onCFIUS' recommendation, President Barack Obama, under theregulations then in effect, ordered the company to divest the property within 90days and to remove concrete bases it had installed for windturbines within 14 days. He also blocked the sale of the project toany third party unless it also complied with conditions. BeforeRalls, the last time a president had blocked a deal for nationalsecurity reasons was in 1990 under President George H.W.Bush.

RallsCorp. then filed a lawsuit against CFIUS charging a lackof due process. The company initially lost in federal districtcourt, but won a partial victory in the D.C. Circuit onappeal thatwould have remanded the case back to district court and forcedCFIUS to disclose additional information about its decision-makingprocess. But CFIUS and Ralls negotiateda settlement in October 2015, the terms of which weren'tdisclosed.

In 2017, Cosco ShippingHoldings Co. Ltd., anocean container shipping company incorporated in mainland China,announced plans to acquire shares of Hong Kong-based OrientOverseas International Ltd., which held a 40-year concession tooperate a large container-shipping terminal in Long Beach,California, triggering a CFIUS review. 

In that case, Cosco executivesmet with CFIUS officials in April 2018 and proposed to divest theLong Beach terminal to satisfy U.S. officials' national securityconcerns. They signed an agreement in July 2018 totransfer the ownership of theterminal to atrust whose principal trustee is a U.S. citizen.

Mancuso said CFIUS had signaledits thinking about foreign real estate investments by its agencypractice in the last couple of years.

"Real estate has long been arefuge for foreign investors, not just institutional investors,because U.S. real estate was seen as a refuge from a dangerous andvolatile world," he said. "But with respect to the most dynamicparts of the real estate market, the government is saying, 'Wewelcome foreign investment, but we think foreign investment in realestate can be a real risk, and we are going to expand ourjurisdiction, so you investors should think about the risks beforeyou engage in those transactions.'"

From: CorporateCounsel