Treasury finalizes rule restricting US outbound investment in China, including Hong Kong and Macau

On October 28, 2024, the US Treasury Department announced the Final Outbound Investment Rule implementing President Joe Biden’s August 2023 “Outbound Order” (Executive Order 14105). The Outbound Order and associated Final Outbound Investment Rule restrict investments by US persons in certain technologies and products deemed to pose a threat to US national security.

Effective January 2, 2025, the Final Outbound Investment Rule will (1) require US persons to notify Treasury of certain transactions involving a “covered foreign person” and (2) prohibit US persons from engaging in any “covered transaction” involving a “covered foreign person” who engages in a “covered activity.”

The Final Outbound Investment Rule marks a major change in the US investment environment and a major step forward in US monitoring of outbound investments. According to the White House, the rule is designed to keep Americans safe “by preventing countries of concern [currently defined as the People’s Republic of China (inclusive of Hong Kong and Macau)] from advancing in key technologies that are critical to their military modernization.” These outbound investment restrictions complement existing US export controls that limit exports to countries of concern (currently defined as China, inclusive of Hong Kong and Macao) of a wide range of technologies and products.

Congressional support for the Final Outbound Investment Rule is bipartisan, but many members of Congress have expressed that the restrictions do not go far enough. The Chair of the Select Committee on Strategic Competition Between the US and the Chinese Communist Party – Representative John Moolenaar (R-MI-02) – called on Congress to pass legislation that would restrict US investment in a broader scope of technologies. A proposal included in the Senate’s current draft of the National Defense Authorization Act would require US persons to disclose investments in China related to semiconductors, artificial intelligence (AI), quantum computing, hypersonics, satellite-based communications, and LiDAR remote sensing technology.

Types of transactions subject to the Final Outbound Investment Rule

Effective January 2, 2025, unless an exception applies, US persons will be prohibited from engaging in, or required to notify the US government of, any (1) “covered transaction” involving (2) a “covered foreign person” (3) “who is engaged in covered activities.” Each of these key elements are defined below. The Final Outbound Investment Rule applies to US persons and any entity in which a US person directly or indirectly holds more than 50 percent of the outstanding voting interest or voting power of the board. If a covered transaction is notifiable, the US person must notify Treasury within 30 days of the completion date.

“Covered transaction” includes:

• Acquisition of an equity interest or contingent equity interest in a covered foreign person
  
  
• Provision of debt financing
  
  
• Conversion of certain interests, including contingent equity interest or convertible debt in a covered foreign person
  
  
• Greenfield or Brownfield Investments
  
  
• Entrance into a joint venture, and
  
  
• Investment as an LP into a pooled investment fund that invests in a covered foreign person.

“Covered foreign persons” include:

• Person of a country of concern:

• A citizen or permanent resident of a country of concern (who is not a US citizen or permanent resident)
  
  
• An entity with a principal place of business in, headquartered in, or incorporated in a country of concern
  
  
• The government of a country of concern, or
  
  
• Any entity in which any of the above persons individually or in the aggregate, directly or indirectly, hold at least 50 percent of the outstanding equity interest, voting power of the board, or equity interest.

• Particular relationship with a person of a country of concern: A “particular relationship” means: (1) holding a specific interest, such as a voting interest, board seat, equity interest, or the power to direct or cause the direction of the management or policies, in a person of a country of concern, and (2) deriving more than 50 percent of revenue, net income, capital expenditure, or operating interest from the person of a country of concern

• Joint venture: A joint venture with a person of a country of concern if the joint venture engages (or intends to engage) in a covered activity

“Covered activities” include the activities listed below related to AI, quantum computing, and semiconductors and microelectronics. Depending on the activities of the Covered Foreign Person, the transaction may be either prohibited or notifiable.

• AI

• Prohibited: Developing AI systems designed exclusively for or intended to be used for military, government intelligence, or mass-surveillance end uses
  
  
• Notifiable: Developing AI systems intended for cybersecurity, digital forensics, or penetration testing

• Quantum computing

• Prohibited: Developing or producing quantum computers or certain critical components
  
  
• Notifiable: None

• Semiconductors and microelectronics

• Prohibited: Developing or producing design automated software for integrated circuit design or advanced packaging and the development of an integrated circuit that meets or exceeds the performance parameters in Export Control Classification Number 3A090.a, or integrated circuits designed for operation at or below 4.5 Kelvin
  
  
• Notifiable: Designing an integrated circuit that is not specified as prohibited is notifiable

Exceptions for investment funds and publicly traded securities

The Final Outbound Investment Rule does not apply to the following excepted transactions:

• An investment in any publicly traded security
  
  
• An investment that is less than $2 million by a US person limited partner in a non-US person pooled investment fund or where the limited partner has secured a binding contractual assurance that its capital in the fund will not be used to engage in a prohibited or notifiable transaction. Certain aspects of this exception remain unclear – including for example, whether a US person limited partner investment in a pooled investment fund with existing equity in covered foreign persons is considered a covered transaction. Treasury expects to publish further guidance on this question and others in the coming weeks
  
  
• A US person investment in a derivative
  
  
• A US person’s full buyout of all interests in an entity held by a person of a country of concern
  
  
• An intracompany transaction between a US person parent and its subsidiary to support ongoing operations
  
  
• Fulfillment of prior commitments entered prior to the date of the Outbound Order (August 9, 2023)
  
  
• The acquisition of a voting interest in a covered foreign person upon default or other condition involving a loan, and
  
  
• The receipt or exercise of employment compensation by an individual in the form of stock or stock options.

Requirements to comply with the Final Outbound Investment Rule

Due diligence expectations: “Reasonable and diligent inquiry”

The Final Outbound Investment Rule requires that a US person make a “reasonable and diligent inquiry” to assess whether a proposed transaction is subject to the prohibitions or notification requirements. Although the restrictions only apply in situations where the US person investor has “knowledge” of facts or circumstances that would subject the transaction to the restrictions, willful ignorance of facts or circumstances or failure to make such a reasonable and diligent inquiry may result in a violation.

“Knowledge” includes actual knowledge, awareness of a high probability, or reason to know of a fact or circumstance that a transaction would be subject to the prohibitions or notification requirements of the Final Outbound Investment Rule.

Treasury’s assessment of whether a US person has undertaken a reasonable and diligent inquiry is based on the totality of facts and circumstances, including the following factors:

• The scope of the US person’s inquiry of the investment target at the time of the transaction
  
  
• Contractual representations or warranties the US person obtained or attempted to obtain regarding the investment target’s activities and ownership
  
  
• Efforts made by a US person to obtain and consider relevant and available nonpublic and public information
  
  
• Whether the US person purposefully avoided learning or seeking relevant information
  
  
• The presence or absence of warning signs, including an investment target’s evasive or nonresponsive engagement to due diligence inquiries, and
  
  
• The use of available public and commercial databases to identify and verify relevant information.

Violations and penalties

Violations of the Final Outbound Investment Rule can be subject to civil and criminal penalties under the International Emergency Economic Powers Act (IEEPA). Additionally, the Secretary, in consultation with heads of relevant agencies, is authorized to nullify, void, or otherwise compel divestment of any prohibited transaction entered into after January 2, 2025.

If a US person learns that a transaction was notifiable or prohibited after the transaction is completed, then notification to Treasury is required. US persons may submit a voluntary self-disclosure for actual or apparent violations of the Final Outbound Investment Rule. As with other voluntary self-disclosure regimes, Treasury will take such disclosure into account as a mitigating factor in assessing the appropriate penalties.

Conclusion

The Final Outbound Investment Rule signals the start of what many expect to be expanded restrictions on US persons investing in China. As it stands now, any US company, lender, or investor operating in or adjacent to AI, quantum computing, or semiconductors and microelectronics, is encouraged to reevaluate their due diligence processes, revise their fund and transaction documents, and consider the applicability of these new rules in any activities that may, directly or indirectly, involve a country of concern.

DLA Piper has a robust National Security and Global Trade practice that provides global coverage and deep experience with complex compliance, licensing, and enforcement matters. Find out more about the implications of these new restrictions for your business by contacting any of the authors, or any of the partners in the National Security and Global Trade practice: Christine Daya, Melanie Garcia, Nicholas Klein, Richard Newcomb, and Ignacio E. Sanchez.