Western Nations Don a Protectionist Mask for COVID-19

As the term “N95 mask shortage” dominates the news cycle, the spread of the COVID-19 pandemic and resulting medical equipment and drug shortages have caused the world’s nations to adopt protectionist measures that will reshape the regulatory and legal landscape for investment and deal-making across the global health care and pharmaceutical industries.

Manufacturing and supply chain dependency laid bare by COVID-19

COVID-19 has brought to the forefront concerns that Western economies were unprepared for a pandemic. A particular acute and well-publicized shortage in personal protective equipment (PPE) for health care providers has made the lowly N95 protective mask an object of international concern. Shortages of N95 masks have resulted in visceral stories about disposable masks being reused for multiple days, or simply unavailable for health care providers. In March 2020, Alex Azar, the U.S. Secretary of Health and Human Services, testified that there were only about 40 million N95 masks available — around 1% of the projected need for such masks in the United States. The shortages have affected other areas in the health care sphere, such as low-margin and low-tech but essential pharmaceutical components. For example, on February 28, 2020, the FDA put out an unprecedented warning of a shortage in raw material for an unidentified critical drug.

These COVID-19 related shortages have many causes, including the use by health care organizations of just-in-time inventory management built to optimize efficiency rather than resiliency and the lack of planning by governments for a pandemic. Another common thread is the large extent to which the manufacturing and supply of critical equipment and pharmaceuticals originates in China, which was first to be struck by the pandemic.

A shift in production to the “war economy”

The shortages of equipment and pharmaceuticals have caught the world on its back foot, and countries are scrambling to respond and meet the urgent needs.

  • In February, in response to Chinese President Xi Jinping’s call, approximately 2,500 companies, including state-owned oil producer Sinopec, retooled factories to manufacture N95 masks leading to the production of 200 million face masks (a twenty-fold increase from a month prior).
  • On March 18, 2020, France declared a state of sanitary emergency and gave the French Prime Minister the power to implement measures limiting freedom of movement, freedom of enterprise and freedom to congregate, as well as the power to requisition any goods or services deemed necessary.
  • In March 2020, President Trump invoked the Defense Production Act of 1950 (DPA), which grants the federal government broad authorities to enlist private companies to assist with meeting the demands of a national emergency, and has ordered General Motors to produce ventilators pursuant to the DPA.

Rationing of equipment and medical care has become another strategy to manage shortages. South Korea is limiting the distribution of face masks to its citizens. In March 2020, Italy enacted a blanket authorization for the requisition of goods and services that are necessary to address the pandemic emergency. New York State, hardest hit by COVID-19 and facing what appears to be an impending critical shortage of ventilators, has activated its 2015 protocol to determine which patients will get access to a ventilator — and which other patients will be left without.

Export control measures are resurging as countries aim to protect their domestic production

As a response to product shortages and weaknesses in the supply chain, governments are now adopting protectionist measures to maximize their chances to attend to their citizens’ needs.

China first, then other countries such as India, Germany, Taiwan and France, have begun to restrict exports of medicine and protective equipment during the first months of 2020. For instance, on March 4, 2020, Germany enacted a ban on the export of several types of medical protection gear, including face masks, medical gloves, and protective clothes. On the same day, France requisitioned all stocks of protective masks and banned their export from French territory. The European Union has now joined in with a new regulation requiring an authorization for the export of certain products to countries outside of the European Union.

In the longer term, the COVID-19 crisis is likely to expand the scope of existing foreign control regimes to sectors that have proved to be critical in the current environment

On March 25, 2020, the European Commission issued new guidelines aimed at preserving European Union companies and critical assets, in particular in sectors such as health, biotechnology, medical research and infrastructure. On March 29, 2020, Australia’s government announced that during the COVID-19 crisis, all inbound investment into Australia will be subject to review by the Foreign Investment Review Board (FIRB), regardless of the nature of the foreign investor, industry sector, or deal size. FIRB reviews may now take up to six months to accommodate the increased workload.

In the United States, we expect a similar heightened scrutiny of health care and pharmaceutical transactions from the Committee on Foreign Investment in the United States (CFIUS). Although CFIUS has historically had jurisdiction over foreign acquisitions of control of U.S. businesses and has been authorized to act in response to “the control of domestic industries and commercial activity by foreign citizens as it affects the capability and capacity of the United States to meet the requirements of national security,” CFIUS filings were voluntary, and it is believed that CFIUS reviews of transactions involving pharmaceutical products, medical devices, and PPE have been relatively infrequent.

With the enactment of the Foreign Investment Risk Review Modernization Act of 2018 (FIRMMA), which amended Section 721 of the DPA, CFIUS has expanded jurisdiction over controlling and certain noncontrolling investments in U.S. businesses that develop or produce “critical technologies,” and can mandate pre-closing reviews of such transactions in certain instances. The current definition of “critical technology” under the regulations implementing FIRRMA depends principally on export control classifications.

The export control classification for PPE does not appear to be relevant to the current situation. Export control classification 1A004 under the Export Administration Regulations (EAR) covers products designed for use against biological agents (including pathogens and toxins) that have implicitly been weaponized intentionally, through selection or modification, for use against humans or animals. Moreover, EAR classification 1A004 explicitly excludes occupational health and safety equipment developed for use in the civilian pharmaceutical and medical industries.

Barring an expansion of the EAR or of CFIUS’s authority under FIRRMA to cover transactions involving makers of commercial PPE, CFIUS may not be able to provide sufficient long-term protection for remaining domestic producers.

From stricter export regulation to heightened foreign investment control, protectionist measures adopted in response to COVID-19 are complex and are evolving quickly as the crisis unfolds.

Please get in touch if you would like to discuss the legal and regulatory impact of those measures on your investment or deal-making activities.