The U.S. Outbound Investment Regulations (the “Regulations”) came into force on January 2, 2025, and implement the U.S. outbound foreign investment program initiated on August 9, 2023, by Executive Order 14105. The Regulations impose restrictions and reporting requirements on certain U.S. investment transactions involving entities from the People’s Republic of China (the “PRC”) and the Special Administrative Regions of Hong Kong and Macau that engage in the development or production of certain advanced technologies. Additional background to the Regulations can be found in our blog post Final U.S. Regulations on Outbound Foreign Investment: Key Changes and Their Implications.
Transactions that have a direct nexus to the U.S. and China may be in-scope, but the Regulations may also affect non-U.S. lenders whose decision-making processes involve U.S. individuals (whether citizens, permanent residents, or others physically present in the U.S.) and apply where non-PRC obligors or pledgors have certain relationships with entities from the PRC, Hong Kong or Macau. In this alert, we consider when the Regulations may apply to loan transactions and the potential regulatory implications. We also discuss the steps lenders are taking in loan documentation and their risk management processes to address the Regulations, where appropriate.
Covered Loan Transactions
The Regulations are primarily focused on investments but may also apply to loans originated or acquired by a lender that is a “U.S. Person” (each, a “U.S. lender”) and involving a “Covered Foreign Person” engaged in a “Covered Activity” where such loan includes certain equity-like features or certain equity collateral (each, a “Covered Transaction”).
- U.S. Person: A “U.S. Person” includes entities organized in the U.S. (and their foreign branches), U.S. citizens and permanent residents, and any individual physically present in the U.S. (including individuals temporarily in the U.S. under a visa or visa waiver). Note also:
- Foreign subsidiaries of a U.S. lender are not directly subject to the Regulations, but their U.S. parent company is required to take all reasonable steps to ensure compliance with them.
- Any employee in a senior, decision-making role (including as a member of a committee that makes investment decisions) that is a U.S. Person working for a non-U.S. lender should not knowingly direct that lender to engage in any transaction that would be prohibited if undertaken by a U.S. Person. This issue can be avoided if such employees recuse themselves from certain decision-making activities relating to transactions previously identified as potentially falling within the scope of the Regulations.
- Covered Activity: Engaging in a “Covered Activity” includes the development or production of certain technologies in the fields of advanced semiconductors, microelectronics, quantum computing, and artificial intelligence (“AI”).
- Covered Foreign Person: “Covered Foreign Persons” include entities that engage in any Covered Activity and are either (a) organized or headquartered in the PRC, Hong Kong, or Macau, including government-owned entities; (b) citizens of the PRC, Hong Kong, or Macau; (c) offshore entities directly or indirectly owned or controlled by any of the foregoing; and (d) certain non-PRC entities with ownership or material governance rights, coupled with a material financial relationship with, any of the foregoing.
- Equity-like features: The Regulations may apply to loans with equity-like features, e.g., loans that are convertible into equity of, include an interest in profits of, provide the right to appoint members of the board of directors (or equivalent) of, or involve other comparable financial or governance rights in relation to, a Covered Foreign Person.
- Equity collateral: The Regulations may also apply to loans secured by equity collateral if a U.S. lender acquires a direct or indirect equity interest in a Covered Foreign Person following enforcement or restructuring. Exceptions may apply to collateral (i) comprising certain publicly-traded shares or regulated investments, (ii) pledged prior to January 2, 2025, (iii) pledged in a transaction not known to a U.S. lender to be a Covered Transaction, or (iv) pledged to a loan syndicate where no U.S. Person can initiate action against the collateral or acts as the syndication agent (the “Syndicate Exception”).
Regulatory Requirements
U.S. lenders must make reasonable and diligent inquiries about each borrower’s business to determine whether the origination or acquisition of a loan or the foreclosure on equity collateral acquired since January 2, 2025, may constitute a Covered Transaction. This could include obtaining public and non-public information relating to the borrower, its ownership structure and its affiliates, and determining whether the borrower, any other loan party or any of their respective subsidiaries (collectively, “Relevant Persons”) is a Covered Foreign Person or may conduct Covered Activities. PRC state security laws may present challenges during diligence, as PRC, Hong Kong, and Macau entities may be prohibited from providing information to foreign parties concerning activities that may be within the scope of the Regulations.
If a loan constitutes a Covered Transaction, a U.S. lender should not proceed with the transaction if it involves prohibited Covered Activities. In the case of non-prohibited Covered Activities, a U.S. lender must notify the U.S. Treasury Department (the “Treasury”) of the loan within 30 calendar days after closing. Notifications are submitted via an online portal on the Treasury website. Thereafter, a U.S. lender has no ongoing obligation to conduct diligence under the Regulations but must notify the Treasury if it later gains “actual knowledge” that any transaction undertaken since January 2, 2025, was in scope. The Treasury will consider the extent of a U.S. lender’s diligence efforts – including any protections included (or at least sought) in the loan documentation – in determining whether a U.S. lender has complied with its obligations under the Regulations.
Implications for Loan Documentation
U.S. lenders should consider including appropriate provisions in loan agreements if they have reason to believe the Regulations may apply.
- U.S. Transactions: In January 2025, the Loan Syndications and Trading Association (LSTA) issued a market advisory on the Regulations including model representations and covenants for loan transactions originated in the U.S. The scope of these model clauses should be carefully calibrated for the relevant transaction, as they may be too broad or too narrow, depending on the transaction’s geographical or sectoral nexus to the Regulations. Depending on the circumstances, one or more of the following provisions may be appropriate:
- Representation: U.S. lenders may require borrowers to represent that they and any other Relevant Persons (i) are not Covered Foreign Persons and (ii) do not engage (and have no intention to engage) in any Covered Activity, any activity that would constitute a Covered Activity if such person were a U.S. Person, or any other activity prohibited by the Regulations. This representation may include confirmation that borrowers have undertaken reasonable and diligent inquiries concerning their and any other Relevant Person’s relationships with entities that may qualify as Covered Foreign Persons.
- Negative Covenant: U.S. lenders will generally require a negative covenant with similar coverage to the above-described representation. This may include a covenant that no Relevant Person (i) will be a Covered Foreign Person at any time or (ii) engage in any Covered Activity, any activity that would constitute a Covered Activity if such person were a U.S. Person, or any other activity prohibited by the Regulations.
- Notification Requirements: Some U.S. lenders have expanded the notice covenant in their loan agreement to include a subsidiary of the borrower becoming a Covered Foreign Person or the loan becoming a Covered Transaction as a material event that requires notification to lenders.
- Non-U.S. Transactions: For loan transactions originated outside the U.S., the parties must still carefully consider the Regulations if the loans may be syndicated to U.S. lenders.
- Heightened Diligence: Loan transactions with a nexus to the PRC, Hong Kong, Macau or to any Covered Activity will require heightened due diligence by U.S. lenders under the Regulations. In some recent non-U.S. transactions, lenders inquired as to compliance with the Regulations even when the borrower did not conduct Covered Activities as its primary business but used relevant technology (particularly AI).
- Syndicate Exception: Parties to non-U.S. loan agreements may opt not to include representations or covenants relating to the Regulations in reliance on the Syndicate Exception. U.S. lenders wishing to participate in such transactions should conduct their own due diligence in relation to the Regulations and make their own determination that such exception is applicable.
Looking Forward
We do not believe it is necessary for representations and covenants relating to the Regulations to be included where no direct or indirect geographical or sectoral nexus to the Regulations exists, nor do they need to be included in non-U.S. loan documents where an exception applies. As loan market participants become more familiar with the requirements of the Regulations, we expect representations and covenants relating to the Regulations to be increasingly tailored to the facts and circumstances of each relevant transaction.
Special thanks to Matthew Bopp, an Associate in the Banking Group, for his contribution to this alert.
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