Late last month, for only the second time ever, a sitting U.S. president formally blocked a foreign acquisition, due to purported security concerns involving the foreign firm’s deployment of wind turbine technologies near a 47,000-acre (19,021-hectare) U.S. Navy test and training site in Oregon. The order, following a ruling by the Committee on Foreign Investment in the United States (CFIUS), went so far as to order the firm to dig up any foundations it had poured for its wind towers, and to remove all equipment from the premises with dispatch.
Ten days later, a congressional report raised national security concerns prompted by what it said were spying capabilities embedded in the technologies of Chinese telecom giants Huawei and ZTE. And yet another forthcoming U.S. intelligence report was expected to yield harsh findings about Chinese intellectual property theft. Politically tinged accusations have flown in every direction in the aftermath — between parties in the U.S. and between U.S. and Chinese officials.
The Chinese company involved in the Oregon case — wind farm developer Ralls Corp., owned by two executives at industrial conglomerate SANY Group — responded to the presidential action by suing President Barack Obama, Treasury Secretary Timothy Geithner and CFIUS.
“In response to President Obama’s Order issued last Friday prohibiting a jobs-creating wind farm project in Oregon at a time when American people need more jobs, Ralls Corporation filed its Amended Complaint in court today,” said Tim Xia, the Atlanta-based counsel for Ralls, on Oct. 1. “In doing so, Ralls continues to show its profound faith in transparency and due process, and seeks only fair treatment under the law and the Constitution.”
According to an Oct. 18 report in the South China Morning Post, a recent blog post by SANY Group CEO Xiang Wenbo was a little more heated: “The deeper reason for the ban is the rise of China's high-end manufacturing threatens US core economic interests. In my opinion, this action indicates China's economic honeymoon with the US and Europe is over!”
An objective look at the Ralls case’s specifics casts light on procedural and real estate aspects that may improve how all parties do business in the future. In the meantime, one expert says, a record year for Chinese FDI into the U.S. — which surpassed $6 billion year-to-date during the third quarter — should continue unabated.
That could be reassuring to economic developers, especially those in communities such as Peachtree City, Ga., where SANY Group not long ago inaugurated a $25-million, 300-job complex. Asked how the kerfuffle might influence SANY’s plans, the company downplayed the situation:
“SANY America manufactures and sells cranes, excavators and port container-handling machinery. While our cranes are used in construction of wind farms, we don’t manufacture the SANY turbines,” said Tim Frank, chairman of SANY America Inc. “The situation with Ralls Corp. isn’t expected to have any impact on SANY America’s business.”
SANY Group began in 1989 as a small welding material factory, and by 2011 had grown to a $21-billion company with five industrial parks in China, five global R&D and manufacturing bases and 21 sales companies around the world. The company employs nearly 60,000 people in more than 150 countries, and ranks sixth among the top 50 global construction machinery manufacturers. Site Selection’s New Plant Database shows the company has made major facility investments in the U.S., Indonesia, Germany and India since 2009, in addition to its base in Brazil.
The group’s reach extends well beyond boom cranes. It recently reached an agreement with fellow Chinese conglomerate CCCC to develop Doha Port in Qatar in time for the 2022 World Cup.
The Back and Forth
The President took his action pursuant to section 721 of the Defense Production Act of 1950, as amended by the Foreign Investment and National Security Act of 2007 (“section 721”). The order directs Ralls Corporation to divest its interest in four wind farm project companies that it acquired earlier this year, and to take other actions related to the divestment. The wind farm sites — Pine City, Mule Hollow, High Plateau, and Lower Ridge, collectively known as the Butter Creek Projects — are all within or in the vicinity of restricted air space at Naval Weapons Systems Training Facility Boardman in Oregon. A number of other wind farms are located in the region. The Butter Creek projects, originated in 2009, were sold to Greek firm Terna, which in turn was seeking to sell them to Ralls.
Thilo Hanemann is research director at Rhodium Group, an economic research firm based in New York. His team has tracked more than 600 Chinese FDI transactions in the U.S., and declares that Chinese firms now employ around 27,000 people in the United States, up from fewer than 10,000 just five years ago.
“I think there is a lot of misperception of what the decision and the president’s executive order mean and don’t mean,” says Hanemann in an interview. “First, it’s not a political move by the president to position himself as tough on China.” In essence, it was a procedural matter.
CFIUS issued mitigation measures including the complete halt of the projects in late July, not long after the Navy had objected to the siting of one of the wind farms.
“In compliance with the July Order, Ralls immediately suspended construction at the wind farms,” says the Oct. 1 complaint from Ralls. “By that point, Ralls had completed installation of all five turbine foundations at the Upper Plateau wind farm, had partially installed all five turbine foundations at the Pine City wind farm, and had partially installed two turbine foundations at the Lower Ridge wind farm. All foundations were designed and installed to fit Sany turbines. On July 26, 2012, in a good-faith effort to address CFIUS’s concerns, Ralls informed CFIUS that it was considering selling the Project Companies, with several American buyers having expressed interest. Ralls believed that a sale of the Project Companies would address CFIUS’s concerns in issuing the July Order, and it requested CFIUS’s guidance on the matter. On July 31, 2012, Ralls informed CFIUS that it intended to complete transfer of the Project Companies to a U.S. buyer as early as the end of that week.”
But CFIUS issued further restrictions a week later that included the prohibition of such a sale to any buyer. On September 13, 2012, at the end of a 45-day investigation phase, CFIUS transmitted a report to the President describing CFIUS’s assessment of the purported risks. Ralls says it has never been told of the evidence. “Ralls has never seen this report, nor has it had any opportunity to rebut its allegations or the supposed facts on which its conclusions are premised,” says the complaint. But neither party budged. And on Sept. 28, the presidential order was issued.
We’re Still Good, Right?
Hanemann says the decision “does not mean a more restrictive U.S. policy toward Chinese investment. In my view it demonstrates continuity with regard to certain concerns related to geographic proximity to installations.”
He cites three precedents in the past few years involving attempted acquisitions by Chinese firms of First Gold, Emcore and Nevada Gold.
“In all cases, the companies the Chinese tried to acquire were too close to a military installation, and therefore not allowed by CFIUS. Given those precedents, usually that’s one of the things a CFIUS lawyer would check first.” Emcore, for instance, operates facilities in a New Mexico industrial park where a number of defense contractors work on equipment for the military.
Hanemann says Chinese firms have not had trouble in general in acquiring other wind farms that are not close to such sensitive areas. SANY itself has wind farms in Texas. And a firm named Gold Wind is pursuing a large project in Illinois. “In all of these cases, there has been no intervention,” he says. “The U.S. continues to be open to Chinese investment, while screening for a narrow set of concerns, one of which is espionage.”
The official statement of the Ralls decision emphasized that point:
“The Administration will continue to ensure that the United States remains the most attractive place for businesses to locate, invest, grow, and create jobs,” said the White House. “The President’s decision is specific to this transaction and is not a precedent with regard to any other foreign direct investment from China or any other country.”
The White House action followed a recommendation from CFIUS. In assessing the transaction’s impact on national security, CFIUS conducted both a 30-day, first-stage review, and an additional 45-day, second-stage investigation. “CFIUS’s detailed analysis took into account all relevant national security factors, including those elements enumerated in section 721. CFIUS also received a thorough analysis of the threat posed by this transaction from the Office of the Director of National Intelligence, as required by section 721.
“In light of the President’s order, Ralls amended its complaint on October 1, 2012, to add claims against the President for ultra vires actions, unconstitutional deprivation of property without due process, and unconstitutional violation of the right to equal protection under the law,” said the Ralls lawsuit, which asked for expedited consideration due to the presidential order’s divestment deadline of December 27, 2012. The case will be heard in the U.S. District Court of Washington DC on November 28,
“In the meantime, moreover, Ralls cannot access the relevant properties, is required to remove all items from the properties, is restricted in its ability to sell Sany items for use at the properties, is restricted in its ability to sell the companies and their assets, and is required to allow government employees to review and inspect its premises, records, documents, equipment, and technical data (including software), as well as interview its executives, employees, and agents, anywhere in the United States,” said the plaintiffs, who also posited that the FAA’s issuance of a “Determination of No Hazard” was supposed to have included a U.S. Dept. of Defense review.
They also said other foreign-made wind farm equipment in the Boardman area did not receive the same degree of scrutiny. According to the Ralls complaint, seven foreign-made turbines currently in operation lie inside the restricted airspace Ralls was prohibited from doing business in: five made by REpower, a German company owned by an Indian conglomerate, and two made by Danish firm Vestas, which maintains a headquarters in Portland.
But DoD is one thing and CFIUS is another. An article contributed to the China Law Review on Sept. 27 — the day before the White House’s order — by New York law firm Kaye Scholer sums up the lessons to be learned:
“First, the Ralls case vividly demonstrates the importance of filing for CFIUS review in any case where there is any question respecting the national security implications of a transaction,” says the firm. “Second, the Ralls case further demonstrates that a decision by an individual agency, here the Federal Aviation Administration, coupled with the acquiescence of another agency (here, the Navy) “under protest” on matters involving national security, will not be viewed as a substitute for CFIUS review, even if one of the agencies is a defense agency. CFIUS was established as a multi-agency body precisely to ensure that foreign acquisitions get broad review. Further, the fact of the FAA and Navy reviews in this case were ample warning that CFIUS would take an interest in this case.
Third, companies that proceed with transactions in the absence of CFIUS review, do so at their risk. The law is clear that transactions that are not reviewed and cleared by CFIUS are open to scrutiny in perpetuity. Divestment is a costly remedy.”
In addition, says Hanemann, past espionage by Chinese firms, in concert with poor corporate governance in China in the past, means the government pays close attention to such issues, and its concern is not a government secret.
“The decision certainly confirms that Chinese investors face special scrutiny with regard to espionage concerns,” he says. “It’s not a new thing. It’s a known concern. Any lawyer dealing with CFIUS is aware of these concerns. CFIUS does not discriminate against Chinese investors. At the same time, China raises special concerns, due to its special political system and several characteristics of its economic system. Given the extensive track record of China in commercial and industrial espionage, that’s legitimate.
“The case confirms that closing deals with a certain risk profile without first notifying CFIUS is a big mistake,” he says. “Legal counsel should have known better.” He cites similar case involving Huawei and Three Leaf, a California company in cloud computing. Huawei officials thought conversations with U.S. Dept. of Commerce officials sufficed, and did not file with CFIUS, whose staff found out about the deal when some employees of the California firm suddenly showed Huawei on their LinkedIn profiles. Ultimately, Huawei had to withdraw.
“They should have filed with CFIUS when they saw there was a certain risk profile instead of pressing ahead with the transaction,” says Hanemann, “but they were under time pressure to finish the project because of tax credits.” A similar tax credit scenario was part of Ralls' story.
Most agree the chances of the court overturning the presidential order are slim. But the court may end up offering some clarifications, says Hanemann.
“Ralls complains that CFIUS and the president overstepped the line and their mandate, and the court may help to clarify some of these questions,” he says. “From a broader perspective, the Ralls case points out an important inconsistency in Washington’s ability to address espionage concerns with regard to different entry modes.” If SANY had not acquired the wind farm developers, but rather developed the projects as greenfield projects on leased land, he says, “CFIUS would probably not have had a legal mandate to investigate. It speaks against acquisitions as an entry mode, which I think is a bigger topic related to the case.”
As the Ralls verdict awaits, the interplay of U.S. commerce continues. (Among the best record-keepers is the U.S.-China Business Council at www.uschina.org.) And all parties might do well to heed the words of Assistant Secretary of the Treasury Marisa Lago, in a November 2011 speech in Beijing, China:
“Our policy and our record are clear: The United States welcomes foreign investment from all countries, including China. That said, the United States and China have a broad and complex relationship. There remains mistrust, particularly on military questions. And, as we have seen occasionally in both countries, when business deals just do not work out for purely commercial reasons, opponents of greater economic engagement will see conspiracies lurking in the shadows. In the United States, you will hear many voices in our public, unfettered policy debates. But we should not confuse fiction for fact, exceptions for the rule, criticisms of policy arguments with the actual policies, or the occasional deals that fall through with the reality that many, many more succeed.”
How to Connect
“We expect cumulative Chinese global investment abroad to top $1 trillion by 2020,” said a Rhodium Group report issued this summer. “In the past decade, the United States received on average about 17 percent of global FDI flows. If the United States manages to attract a similar share of China’s global OFDI (10-20 percent), the U.S. can expect $100-$200 billion of investment between 2010 and 2020.”
A new assessment of FDI flows calculated by the Rhodium Group shows that Chinese firms are now operating in at least 37 of 50 states and have investments across a wide range of US industries. Chinese investment in the United States grew from less than $1 billion annually before 2008 to $2 billion in 2009 and $5 billion in 2010. While fewer deals were made in the second half of 2011, dragging down the full year figure to $4.5 billion, investment picked up again in the first months of 2012.
Several large scale acquisitions have already closed, for example Sinopec Shanghai Petrochemical Co.'s (Sinopec) $2.5 billion investment in five shale oil and gas fields owned by Oklahoma-based Devon Energy Corp. and the $2.6 billion acquisition of movie theater operator AMC Entertainment Holdings by China's Dalian Wanda Group Co. Several big manufacturing deals are also in the pipeline for 2012, such as Golden Dragon Precise Copper Tube Group, Inc.'s $100 million copper tubing plant in Alabama, and a massive $5 billion solar project by ENN Mojave Energy Corp. in Nevada. If the ENN deal goes through, it would be equivalent to all Chinese investment in the United States in 2011.
The diplomatic and trade intrigue notwithstanding, what are Hanemann’s recommendations for territories looking to court Chinese investment?
“It is certainly smaller local organizations that are a lot more active and successful in promoting Chinese investment than the federal institutions,” he says. The first step is ensuring there’s a long-term commitment, independent of party politics, to promoting investment from China . “We generally see states doing well that established those institutions a long time ago,” he says.
Energy and natural resources lead the way, followed by a growing interest in U.S. advanced manufacturing.
A lot of Chinese companies are trying to move up the value chain,” he says. If you have regional clusters such as auto parts, aviation, and other industries where you have very strong growth in China, there is great interest from these companies in order to position themselves better in a fast-growing market.” High value-added services will be the next sector to see interest from Chinese investors, he says.
Hanemann says it’s important to establish a physical presence in China. Then, once an initial Chinese investment takes place in your territory, work the connections that inevitably arise.
“You see states that have major Chinese investment usually attract similar Chinese companies,” he says. Lenovo’s gradual increase of investments in North Carolina is a great example of incremental investment by a single firm. Energetic individuals help too, he notes, citing successful leaders in Toledo, Ohio; Texas, Indiana, South Carolina and Georgia.
“One of the most important things for those local investment promotion agencies is to know what Chinese investors need, and what their value proposition is for them. There is not enough knowledge about situations of the Chinese economy, really in-depth knowledge about what’s driving those new investors abroad, and how a city or state fits into their profile, is probably the single most important factor.”
That includes knowledge of weak knowledge on the part of first-time Chinese investors. The challenges can include visa procurement, language and state regulatory environments. As for what’s driving those investors to look in the first place, he cites the example of Wenzhou, a private-sector entrepreneurial hub that just started a trial for a new policy framework that allows individuals to make FDI investments. Citizens are still officially restricted to taking $50,000 out of China per year. But banks are being granted more freedom in interest rates, and a gradual liberalizing of outflows is occurring.