By Megan Bowman, UNSW

SYDNEY: 16 August 2013 - As reported on the CLMR Portal in June 2013, the proposed Smithfield-Shuanghui merger was submitted to the U.S. Committee on Foreign Investment (CFIUS) two months ago in order to review its effects on U.S. national security. At that time I opined that CFIUS would undoubtedly be highly considered in reaching a decision given that (a) this is one of the first agriculture deals to be reviewed by CFIUS and (b) it represents the largest Chinese takeover in America thus far. Perhaps unsurprisingly then, CFIUS announced on 24 July that it requires another 45 days to further investigate the proposal.

What is the background of this proposal that warrants such scrutiny? US-based Smithfield is the world’s largest pork processor and hog producer, and one of the biggest and oldest pork producers in the US. Hong Kong-based Shuanghui is the majority shareholder of China’s largest meat processor, Henan Shuanghui Investment & Development, which is publicly listed on the Shenzhen Stock Exchange. The total proposed deal is valued at US$7.1 billion, pursuant to which Shuanghui will pay $34 per share and assume Smithfield’s debt. This makes it the largest potential Chinese takeover of an American company to date.

Yet how does that, in and of itself, trigger legal issues of national security? The cynical answer is that it does not. A more complete answer requires some understanding of the US foreign investment regulatory regime and how the Smithfield-Shuanghui review process has unfolded.

The CFIUS regime is contained primarily in s.721 ‘Authority to Review Certain Mergers, Acquisitions, and Takeovers’ of the US Defense Production Act 1950 (50 U.S.C. App. § 2170) as amended by the Foreign Investment and National Security Act of 2007 and regulations. The regime also comprises the 1988 Exon-Florio Amendment to the Omnibus Trade and Competitiveness Act 1988, which grants the President the authority to block proposed or pending foreign acquisitions on the grounds of national security. This limb of the regime was instigated by the Reagan Administration via Executive Order 12661 at the height of concern over foreign acquisition, particularly by Japanese companies, of certain types of U.S. firms.

Importantly, at that time, President Reagan delegated his authority to administer the Exon-Florio provision to CFIUS, which relates to the power and process to conduct reviews, undertake investigations, and make recommendations - even though the legislation itself does not specifically mention CFIUS. James K. Jackson, on behalf of the Congressional Research Service, has noted that: “As a result of President Reagan’s action, CFIUS was transformed from a purely administrative body with limited authority to review and analyze data on foreign investment to one with a broad mandate and significant authority to advise the President on foreign investment transactions and to recommend that some transactions be blocked” (p.4).

In short, under the US regime, CFIUS has mandate to review certain foreign investment proposals “to determine the effects of the transaction on the national security of the United States” (s.721(b)(1)(A)).

S. 721 is applicable in the case of any proposed merger, acquisition or takeover “by or with any foreign person which could result in foreign control of any person engaged in interstate commerce in the United States” (s.721(a)(3)). This regulation also applies to any merger, acquisition or takeover that involves a “foreign government or an entity controlled by or acting on behalf of a foreign government” (s.721(a)(4)). However, this latter trigger is not relevant to the Smithfield-Shuanghui proposal given that Shuanghui is no longer a state-owned enterprise (SOE): Goldman Sachs and CDH Investments (a leading private equity firm in China) bought out the Chinese government’s interest several years ago.

Any party to the proposal can initiate a CFIUS review of it, which has the advantage of creating an expectation that the deal will be exempt from further review once approved (s.721(b)(1)(D)). Shuanghui voluntarily filed for CFIUS review in June 2013. In so doing, it triggered a 30-day period of review (s.721(b)(1)(E)).

On 24 July, CFIUS initiated further investigation of the effects of the Smithfield-Shuanghui proposal on U.S. national security, which enables a second legislative period of examination being 45 days (s.721(b)(2)(C)). Importantly, the US Treasury provided Guidance in 2008 on the exercise of this power by CFIUS. That Guidance states that CFIUS can only initiate further investigation in one of four circumstances: (1) it believes that the transaction threatens to impair the national security and that threat has not been mitigated; (2) a lead agency recommends, and CFIUS concurs, that an investigation be undertaken; (3) the transaction is a foreign government-controlled transaction; or (4) the transaction would result in foreign control of any critical infrastructure, if CFIUS determines that the transaction could impair national security and that risk has not been mitigated.

Yet the lack of clarity around which of these four scenarios the Smithfield-Shuanghui proposal comes under reveals the level of ambiguity or at least novelty of potential security issues inherent in this case.

Deals relating to agri-business or food supply are not specifically mentioned in the mandate of CFIUS. Indeed, there is no legislative definition of the term national security in the Exon-Florio statute. The only elements of national security explicitly enumerated in the legislation relate to control of ‘critical infrastructure’, being “systems and assets, whether physical or virtual, so vital to the United States that the incapacity or destruction of such systems or assets would have a debilitating impact on national security” (s.721(a)(6)) and ‘critical technologies’ being technology or components thereof that are “essential to national defense” (s.721(a)(7)). Neither of these factors is overtly relevant to the Smithfield-Shuanghui proposal.

Nonetheless, it is arguable that CFIUS’ jurisdiction is necessarily broad in order to satisfy the non-specific nature of ‘national security’. And although the Smithfield proposal does not fit within the illustrative list of factors for consideration by CFIUS contained in s.721(f), the legislation does permit CFIUS to consider “any other factors that the Committee finds appropriate in determining whether a transaction poses national security risk”. Indeed, the Guidance states that CFIUS must have regard to “whether a foreign person has the capability or intention to exploit or cause harm (i.e., whether there is a threat) and whether the nature of the U.S. business, or its relationship to a weakness or shortcoming in a system, entity, or structure, creates susceptibility to impairment of U.S. national security (i.e., whether there is a vulnerability).”

In practice, this is a very broad palate to work with. It catches the Smithfield proposal not for its subject matter or any (legal) issue of foreign ownership, but for the potential power it may give Shuanghui to disrupt food supply in the U.S.

These concerns are echoed in recent Australian political discourse. On 26 June 2013 the Australian Rural and Regional Affairs and Transport References Committee released its final report on the Foreign Investment Review Board (FIRB) ‘national interest’ test, being Australia’s equivalent to the U.S. ‘national security’ trigger. In that report, the Committee acknowledged that food insecurity represents a significant opportunity for Australia's agricultural industry but only if foreign investment in Australia remains commercially motivated and not by another government’s concerns about food security. “Australia will not have the capability to effectively contribute to the future global food task if its agricultural capital and trading markets are distorted by foreign government-owned companies who invest in Australian agriculture but do not participate in the market on a genuinely commercial basis.” (par 2.13). 

Indeed, the commercial nature of the Smithfield/Shuanghui deal was cleverly highlighted in their merger media release: “Shuanghui is committed to…continuing to work with American farmers, producers and suppliers who have been critical to Smithfield’s success” and it will be “business as usual – only better – at Smithfield. We do not anticipate any changes in how we do business operationally in the United States and throughout the world”.

Whether CFIUS is convinced of this remains to be seen. By mid-September CFIUS must submit a written report to Congress on the results of the Smithfield-Shuanghui investigation. Importantly, its decision will likely set policy for Chinese deals generally in the U.S., and may also influence policy decisions in other Western jurisdictions such as Australia. Watch this space.