Key Takeaways:

• On October 28, 2024, the U.S. Treasury Department’s Office of Investment Security published a final rule (the “Outbound Investment Rule”) establishing new regulatory controls on certain technology-related investments by U.S. persons in or related to the People’s Republic of China, Hong Kong and Macau.
• The Outbound Investment Rule, which prohibits certain investments and requires reporting regarding others, will take effect on January 2, 2025. We expect that Treasury will issue additional information and other guidance in advance of the effective date. Meanwhile, Congress is actively considering legislation that may further limit outbound investments focused on China.
• U.S. investors should consider using the time remaining this year to determine the scope of transactions that may be subject to the Outbound Investment Rule and update investment diligence, approval and management processes as necessary.

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Introduction

On October 28, 2024, the U.S. Treasury Department’s (“Treasury”) Office of Investment Security published a final rule implementing Executive Order 14105 (the “Outbound Investment Rule”) and establishing new regulatory controls on certain investments by U.S. persons in or related to the People’s Republic of China and the Special Administrative Regions of Hong Kong and Macau (collectively, “China”).

These investment controls apply not only to direct U.S. investment into China but also to certain indirect investment activities of U.S. persons, including passive investment into non-U.S. investment funds that themselves invest in or alongside Chinese companies. U.S. persons also are required to take “all reasonable steps” to ensure controlled non-U.S. entities also comply with the new rules, as if U.S. persons.

The Outbound Investment Rule’s effective date is January 2, 2025. However, these may not be the only outbound investment compliance obligations imposed on U.S. persons in the coming months. U.S. lawmakers are actively negotiating their own legislation to regulate outbound U.S. investment with the goal to adopt further outbound investment restrictions and requirements during the lame duck session, and the Trump Administration is very likely to favor continued implementation and expansion of these limits.

Considered together, this means that the remaining months of the year provide a brief transition period to the new investment controls, and U.S. investors should consider using this period to conduct risk-based assessments of their international investment activities and determine whether internal investment approval and management processes should account for the new obligations and related diligence expectations of the Outbound Investment Rule. At a minimum, we expect many U.S. investors will adopt new diligence processes and consider whether related representations and commitments are warranted, particularly where the target is a non-U.S. investment fund.

Below, we discuss the key definitions and concepts of the new regulations; additional details for definitions are in the Appendix.  

On November 20, 2024, we are hosting a webinar on the Outbound Investment Rule and its implications. Please register here if you are interested in attending.

What Does the Outbound Investment Rule Require, and Who Must Comply?

Most fundamentally, the Outbound Investment Rule imposes either a notification requirement or an outright prohibition on China-related investment activities by a U.S. person (involving quantum information technologies, artificial intelligence and semiconductors and microelectronics, as set forth in the Appendix).

For this purpose, a “U.S. person” is:

• a United States citizen or a lawful permanent resident, wherever located;

• an entity organized under the laws of the United States or any jurisdiction within the United States (including foreign branches of any such entity), wherever doing business; or

• any person physically present in the United States.

Notably, U.S. persons are obligated to ensure not only their own compliance but must also take “all reasonable steps” to ensure their “controlled foreign entities” also comply with the Outbound Investment Rule as if U.S. persons (as discussed further below). Under the rule, a “controlled foreign entity” is any entity in which a U.S. person directly or indirectly:

• holds more than 50 percent of the outstanding voting interests or voting power of the board;

• is a general partner (“GP”), managing member or equivalent; or

• for a pooled investment fund, is an investment adviser.

• For a U.S. person, Treasury intends to assess whether “all reasonable steps” were taken with respect to the U.S. person’s controlled foreign entities’ compliance under a facts-and-circumstances review and highlight certain measures that a U.S. person may take relative to its controlled foreign entities, including compliance commitments, governance rights, internal controls, periodic training, internal reporting and documented testing and auditing.

Finally, a U.S. person (individual or entity) that has authority to make or substantially participate in decisions on behalf of a non-U.S. entity is prohibited from “knowingly directing” a transaction by that non-U.S. entity if the U.S. person knows, at the time of the transaction, that engaging in that activity is prohibited to the U.S. person under the Outbound Investment Rule.

This restriction is intended to close “a potential loophole” through which a U.S. person could direct a non-U.S. investment fund to make an investment prohibited to the U.S. person and potentially may apply to U.S. persons serving on an LPAC or similar advisory body to the extent that the body has the ability to control investment decisions of an investment fund or decisions of the GP (or equivalent) regarding current fund investments. However, the Outbound Investment Rule provides a safe harbor for U.S. persons that recuse themselves from the decision-making process in alignment with particular restrictions set out in the rule.

What Activities Are Targeted by the Outbound Investment Rule?

The new regulations target “covered transactions” that involve a “covered foreign person.”

Covered Transaction

Because the Outbound Investment Rule imposes investment restrictions, the activities captured by “covered transactions” (which do not include “excepted transactions,” as discussed below) all have an investment nexus and generally include:

• acquiring equity and contingent equity interests in a covered foreign person;

• providing debt financing to a covered foreign person that provides particular rights to the lending party;

• assisting with the establishment of a covered foreign person;

• entering into a joint venture with a covered foreign person to engage in certain activities; or

• passive investment in a non-U.S. investment fund that engages in a covered transaction.

For each covered transaction, a U.S. person generally must both engage in the covered activity and have “knowledge” that the activity involves a “covered foreign person.” For example, an acquisition of an equity interest or contingent equity interest is a “covered transaction” if a U.S. person knows at the time of its acquisition that the investment target is a “covered foreign person.”

Importantly, a U.S. person’s indirect actions also result in a covered transaction where the U.S. person acts through a non-U.S. intermediary, such as where a U.S. person uses a newly formed non-U.S. legal entity as an acquisition vehicle.

Covered Foreign Person

A “covered foreign person” is any of the following:

• a “person of a country of concern” engaged in a “covered activity”;

• a person that has a particular relationship (described below) with a “person of a country of concern” engaged in a “covered activity”; or

• a “person of a country of concern” participating in a joint venture engaged in a “covered activity.”

The Outbound Order identifies the People’s Republic of China, along with the Special Administrative Regions of Hong Kong and Macau, as a “country of concern.” Consequently, an entity from one of these jurisdictions is a “person of a country of concern” and, to the extent engaged in a “covered activity,” a “covered foreign person.”

As noted, the definition of a covered foreign person also encompasses a person that is not itself a “person of a country of concern” but has a significant connection to such a person engaged in a covered activity. In particular, a “covered foreign person” includes any person that meets two conditions:

• the person holds a specified interest in one or more “persons of a country of concern” engaged in a “covered activity,” where such specified interests include voting or equity interests, board rights or control rights to direct management or policies; and

• the person receives, on an annual basis, more than 50 percent of its revenue or net income from, or attributes 50 percent or more of its capital expenditure or operating expenses to, the “persons of a country of concern” engaged in a “covered activity.”

For the second condition, the first person aggregates relevant revenue, income, expenditures and expenses from all “persons of a country of concern” engaged in “covered activities” to determine if the 50 percent threshold is met but, in doing so, excludes any such figures if they are, for a particular “person of a country of concern,” less than $50,000.

Knowledge

As noted above, a U.S. person generally must know that a transaction involves a covered foreign person for the transaction to be a covered transaction.

For this purpose, “knowledge” includes both actual knowledge that a fact or circumstance exists or is substantially certain to occur, as well as an awareness of a high probability of a fact or circumstance’s existence or future occurrence or reason to know of a fact or circumstance’s existence. This definition is similar to the knowledge standard for purposes of U.S. export controls under the Export Administration Regulations.

In determining whether a U.S. person had knowledge or reason to know of a particular fact or circumstance, Treasury will assess if a U.S. person undertook a “reasonable and diligent inquiry” at the time of the transaction (as discussed further below).

Excepted Transactions

Certain “excepted transactions” are out of scope of the Outbound Investment Rule’s prohibitions and notification requirements (see the Appendix for a full list of excepted transactions, and below for discussion of an excepted transaction for certain LP investments).

Does the Outbound Investment Rule Impose a Review and Clearance Regime, Like CFIUS?

No, the Outbound Investment Rule does not provide for case-by-case review of transactions by U.S. authorities, which means expectations and obligations for U.S. persons arising under the Outbound Investment Rule differ from those under clearance regimes, such as foreign investment reviews by the Committee on Foreign Investment in the United States (“CFIUS”).

The Outbound Investment Rule instead follows a regulatory framework similar to U.S. sanctions and export controls, placing a compliance burden on U.S. persons to determine applicability and appropriate internal controls.

Accordingly, U.S. persons are expected to develop and maintain risk-based compliance approaches under which they must conduct appropriate due diligence and reach their own determinations of permissibility regarding outbound investments. Those determinations may be reviewed by U.S. authorities in an enforcement context, with the U.S. person facing potential liability for non-compliance (see penalties discussed below).

What Due Diligence Is Required by the Outbound Investment Rule?

As discussed above, the Outbound Investment Rule is not a strict liability regime and, if a U.S. person undertakes a “reasonable and diligent inquiry” but does not have knowledge of a fact or circumstance that would render a transaction a “covered transaction,” the U.S. person should not face liability for inadvertently missing a notification requirement or engaging in a prohibited investment. Conversely, a U.S. person that fails to conduct a reasonable and diligent inquiry may be deemed to have had reason to know of a fact or circumstance that would cause a transaction to be a covered transaction.

To assess if a U.S. person undertook a “reasonable and diligent inquiry” at the time of a transaction, Treasury will consider the totality of relevant facts and circumstances, with a focus on certain factors listed under the Outbound Investment Rule, including consideration of inquiries made by the U.S. person, contractual representations or warranties obtained by the U.S. person, efforts to obtain and consider non-public information and public information, the presence or absence of warning signs, the use of available public and commercial databases and indications that the U.S. person purposefully avoided learning or seeking relevant information.

Treasury declined to adopt prescriptive diligence standards or include a diligence safe harbor in the Outbound Investment Rule but offered some general considerations:

• U.S. persons should not limit their diligence for a transaction to information already in their possession but, at the same time, will not be expected to consider all publicly available information.

• There is no general expectation that diligence will be conducted on persons that are not party to a transaction, although inquiries to such persons may be necessary in some cases.

• In cases where a U.S. person faces difficulties in obtaining relevant information about a transaction, the U.S. person may seek representations or warranties from transaction counterparties regarding pertinent information, such as the investment target or counterparty’s ownership, investments and activities.

• A U.S. person generally will be expected to consider a counterparty’s responses or statements in light of other information from commercially available information sources and publicly available information.

What Obligations Apply If New Information Indicates a U.S. Person Missed a Notification or Conducted a Prohibited Investment?

A U.S. person is subject to notification obligations if the U.S. person acquires actual knowledge after completion of a transaction that would have resulted in the transaction constituting a “covered transaction” had the U.S. person known of the relevant facts at the time of the transaction. This requirement applies regardless of whether the relevant transaction would have been a notifiable or prohibited transaction.

A U.S. person must submit such notification no later than 30 calendar days following the U.S. person’s acquisition of actual knowledge in the case of post-transaction knowledge.

What Are the Notification Requirements?

Notifications will be required to be submitted electronically on Treasury’s Outbound Investment Security Program website pursuant to filing instructions that Treasury will issue prior to the effective date of the Outbound Investment Rule.

The notification form will require U.S. persons to provide certain information about the transaction, including information about the U.S. person, the covered foreign person, the covered transaction and the relevant national security technologies and products. If a U.S. person does not provide all required information in the notification, the U.S. person must explain why the information is unavailable and their efforts to obtain such information. If such information subsequently becomes available, the U.S. person must submit the information to Treasury no later than 30 calendar days following such availability. U.S. persons must also notify Treasury no later than 30 days after learning of a material omission or inaccuracy in any notification submitted to Treasury.

Copies of a U.S. person’s notification to Treasury and supporting documentation must be retained by the U.S. person for 10 years from the date of filing.

Do U.S. Persons Face Obligations for Non-U.S. Funds They Manage?

Yes, under the Outbound Investment Rule, U.S. fund managers are subject to compliance obligations with respect to, and face potential liability for, the activities of non-U.S. funds they manage or advise.

A non-U.S. fund with a U.S. GP, managing member or equivalent, or a U.S. investment advisor, is considered a controlled foreign entity of the U.S. person. As a result, the U.S. person must take “all reasonable steps to prohibit and prevent any transaction by [the non-U.S. fund] that would be a prohibited transaction if undertaken by a U.S. person,” as well as file a notification for any transaction by the non-U.S. fund that would be a notifiable transaction if engaged in by a U.S. person.

Are U.S. LP Investors in Non-U.S. Funds Affected by the Outbound Investment Rule?

To begin with, and as discussed above, certain LP investments are excepted transactions not subject to the Outbound Investment Rule. Specifically, a U.S. LP’s investment in a non-U.S. fund will be an excepted transaction if the LP’s committed capital is not more than $2,000,000 on an aggregate basis or the LP secures a binding contractual assurance at the time of its capital commitment that its contributions will not be used to engage in a transaction that would be a prohibited or notifiable transaction, as applicable, if engaged in by a U.S. person (regardless of the amount of the U.S. LP’s committed capital).

In addition, the Outbound Investment Rule provides an exception for transactions made after the effective date of the Outbound Investment Rule (i.e., January 2, 2025) pursuant to a binding, uncalled capital commitment entered into before the effective date of the Outbound Investment Rule. This exception would not apply if a U.S. person executes a binding agreement with an investment target (i.e., not an investment fund), but the completion date falls after January 2, 2025.

Assuming an exception does not apply, a U.S. LP’s investment in a non-U.S. fund will be a covered transaction if the U.S. LP knows at the time of its investment that the non-U.S. fund “likely will invest” in a person of a country of concern that is in a specified sector and the non-U.S. fund in fact subsequently undertakes a transaction that would be a covered transaction if undertaken by a U.S. person.

This means that U.S. LPs, at the time they invest in a non-U.S. fund, should conduct a “reasonable and diligent inquiry” to ascertain if the fund is likely to engage in one or more covered transactions. Treasury declined to provide a safe harbor under the Outbound Investment Rule for U.S. LPs that engage in good faith diligence.

Consequently, before U.S. LPs make an investment in a fund, appropriate risk-based due diligence should be considered to understand the fund’s intended investments. U.S. LPs also may wish to seek additional representations and commitments regarding the use of the U.S. LP’s capital by the fund.

Are Credit Funds in Scope of the Outbound Investment Rule?

A covered transaction under the Outbound Investment Rule includes a U.S. person’s direct or indirect “[p]rovision of a loan or a similar debt financing arrangement” to a covered foreign person that “afford[s] the U.S. person an interest in profits of the covered foreign person, the right to appoint members of the board of directors (or equivalent) of the covered foreign person, or other comparable financial or governance rights characteristic of an equity investment but not typical of a loan.”

Thus, to the extent a U.S. credit fund may extend debt financing with equity-like characteristics to covered foreign persons, such investments may constitute covered transactions under the Outbound Investment Rule. In addition, U.S. LP investors in a non-U.S. credit fund that undertakes such investments that would be covered transactions if undertaken by a U.S. person also may engage in a covered transaction by investing in such fund. As a result, such U.S. LP investors and credit funds should consider whether they face related obligations and due diligence expectations under the Outbound Investment Rule.

Are U.S. Persons Participating in Non-U.S. JVs Affected under the Outbound Investment Rule?

A U.S. person’s entrance into a JV with a person of a country of a concern will be a covered transaction if the U.S. person “knows at the time of entrance into the [JV] that the [JV] will engage, or plans to engage, in a covered activity.”

The Outbound Investment Rule does not require an assessment of the U.S. person’s intent to engage in a covered activity when entering the JV (as was proposed under the Proposed Rule). Rather, whether a U.S. person’s entrance into a JV with a person of a country of concern is a covered transaction will depend on the U.S. person’s knowledge with respect to the goals of the JV at the time the U.S. person enters the JV.

Thus, prior to entering into a JV with a person of a country of concern, U.S. persons also should conduct appropriate due diligence and seek representations, warranties and covenants with respect to the JV’s planned activities.

For existing non-U.S. JVs, the Outbound Investment Rule applies on a forward-looking basis and generally will not cover activities relating to an existing JV into which a U.S. person has already entered. However, Treasury makes clear that the Outbound Investment Rule may apply to future transactions involving an existing JV that meet the definition of a covered transaction (e.g., the acquisition of an additional equity interest in an existing JV that is a covered foreign person).

What Are the Penalties for Noncompliance under the Outbound Investment Rule?

Conduct that constitutes a violation of the Outbound Investment Rule includes:

• taking any prohibited action;

• failing to take any required action required within the timeframe and in the manner specified;

• making materially false or misleading representations to Treasury, or falsifying, concealing or omitting any material fact, when submitting any required information; or

• evading or avoiding any of the prohibitions.

The maximum civil penalty that may be imposed for violations of the Outbound Investment Rule is the greater of twice the amount of the transaction that is the basis for the violation or $250,000, which amount is subject to adjustment for inflation (the adjusted amount is assessed at $368,136 as of January 12, 2024). A voluntary self-disclosure may be considered a mitigating factor by Treasury in determining the appropriate enforcement response.

As under the Proposed Rule, a willful violation of the Outbound Investment Rule may result in criminal penalties of up to $1,000,000 and 20 years imprisonment.

Is Further Guidance, Rules or Legislation Expected?

Yes, Treasury has indicated that it anticipates issuing additional information and other guidance on the application of the Outbound Investment Rule before January 2, 2025 (including, as discussed above, instructions for filing required notification forms with Treasury).

In the coming months, we also expect Congress potentially to act, as limiting outbound investments focused on China is a bipartisan issue on Capitol Hill. However, the scope of any such legislation remains to be seen, including the extent to which any such legislation goes beyond the Outbound Investment Rule’s requirements. In addition, no clear statements have been made by Treasury about potential future expansions of the sensitive technologies and products covered by the Outbound Investment Rule, but as we have seen in other areas of U.S. trade regulation with respect to the PRC, multiple other sectors may be implicated by this new regime as future policy considerations develop.

Thus, the Outbound Investment Rule is not likely to be the last word with respect to controls on U.S persons’ outbound investments, and firms should be sure to stay apprised of any new or updated rules that may affect their activities.


This publication is for general information purposes only. It is not intended to provide, nor is it to be used as, a substitute for legal advice. In some jurisdictions it may be considered attorney advertising.