Issues Relevant To The Defense Industry In The Bankruptcy Context

1. Introduction

   The U.S. defense industry is expected to be under increasing financial stress over the next several years. Specifically, reduced Government spending will negatively affect defense contractors who rely primarily on Government contracts and fail to diversify their revenue base. Because some of these companies may either seek to reorganize their capital structures or file for bankruptcy in the near term, it is important for interested parties to consider national security and Government contract issues that may affect the restructuring of a U.S. defense contractor.

   Although U.S. Government policies encourage investment in the United States, transactions that could result in foreign control of a "U.S. business," including a defense contractor, may involve review by the Committee on Foreign Investment in the United States ("CFIUS"). CFIUS, an inter-agency U.S. Government committee composed principally of Executive branch agencies, reviews transactions that raise national security issues. Although review is ostensibly voluntary, CFIUS may request that parties submit a transaction for review if a voluntary filing has not been made, and may initiate its own review if the parties decline to file. The President ultimately has the authority to block a transaction, or unwind it after closing, if there is credible evidence to believe that the foreign acquirer might take action that threatens to impair the national security and other provisions of law do not provide "adequate and appropriate" authority to protect the national security.

   CFIUS has jurisdiction over mergers, acquisitions, or takeovers "by or with a foreign person," which could result in foreign control of a U.S. business when the transaction raises national security considerations. For purposes of CFIUS review, the U.S. business includes not only businesses organized as legal entities, but also assets that are operated as a business undertaking, even where not separately incorporated. Control exists where a foreign person has the ability to "determine, direct or decide" important business matters affecting an entity. By design, the test is not a bright-line test; instead, it is a functional definition that is quite fact-specific. While a majority ownership interest in a U.S. business generally will constitute control, in other cases control may be found where a foreign person acquires a partial ownership interest that is accompanied by significant governance rights, such as the ability to block or determine important matters. In addition, CFIUS has jurisdiction over the sale of a U.S. business by one foreign person to another, and the acquisition of one foreign company by another, where what is conveyed includes control over a U.S. business.

   There is no definition of "national security" in the CFIUS statute or applicable regulations, thus affording CFIUS a fair amount of discretion in determining whether a transaction presents national security considerations. The analysis that CFIUS undertakes entails examining the threat posed by the foreign acquirer and the vulnerabilities posed by the U.S. business in light of the potential consequences for national security. While acquisition of a U.S. defense contractor engaged in national security matters would clearly warrant CFIUS review, other less obvious considerations may draw the attention of CFIUS. CFIUS review extends to transactions involving "critical infrastructure," such as bridges, telecommunications, utilities and technology, whether or not supplied to the U.S. Government. Further, a U.S. entity, even if not itself sensitive, may have facilities located near sensitive military or national security installations. Indeed, in a recent case, a Chinese-owned corporation was forced to unwind its purchase of membership interests in wind farm projects, after CFIUS initiated a review post-closing that was likely triggered by the location of the wind farms near a sensitive Navy installation.1

   If a proposed transaction involves the transfer of Government contracts as assets, additional issues can be presented by the Anti-Assignment Act. Under that Act, with a few exceptions, Government contracts may not be assigned to other parties without the consent of the U.S. Government. Although the bankruptcy process generally provides mechanisms for contracts to be assumed by a reorganized debtor or assigned to a third party, the Anti-Assignment Act may prevent such Government contracts from being assumed or assigned without the consent of the U.S. Government. Governmental consent may or may not be forthcoming, and if granted, may carry conditions.

   These national security and Government contract issues most commonly arise in the context of bankruptcy or restructuring transactions that propose: (i) the sale of a U.S. debtor's assets under section 363 of the Bankruptcy Code or pursuant to a chapter 11 plan of reorganization; or (ii) the assumption or assignment of a U.S. debtor's Government contracts...