The U.S. outbound investment security program, or Outbound Investment Rules, went into effect on Jan. 2, 2025, and financial institutions have had a few months to adjust to the new regulations.
The U.S. Department of the Treasury established the rules under authority granted in the International Emergency Economic Powers Act (IEEPA). The Outbound Investment Rules create a regulatory framework designed to prohibit or require notification of certain investments made by U.S. persons in entities located in a country of concern or involved in certain categories of advanced technologies or products. While the Outbound Investment Rules primarily target U.S. persons and their subsidiaries operating in countries of concern or with respect to certain advanced technologies, the rules could potentially apply to financing transactions entered into by U.S. financial institutions.
Several months in, this alert covers several practical considerations and approaches that financial institutions have taken and additional considerations they should consider as they look to extend credit moving forward. It is critical for financial institutions to be familiar with the current Outbound Investment Rules and monitor any updates to the rules going forward as the current administration considers expansion, as detailed in the America First Investment Policy it issued on Feb. 21, 2025.
Outbound Investment Rules Background
Under the Outbound Investment Rules, U.S. persons, (defined as any U.S. citizen, lawful permanent resident, entity organized under the laws of the United States or jurisdiction within the United States including any foreign branch of any such entity, or person in the United States (§ 850.210(a)(1))) cannot enter into prohibited transactions and are required to notify the Treasury Department of certain notifiable transactions. The definition of U.S. persons under the final Outbound Investment Rules is broad and picks up controlled foreign entities of U.S. persons and persons temporarily located in the United States (e.g., on business trips or vacations).
The Outbound Investment Rules concern transactions by U.S. persons that involve a “covered foreign person,” defined as persons or entities associated with a country of concern (currently China and the Special Administrative Regions of Hong Kong and Macau), who is engaged in a “covered activity.” Covered activities are those involving semiconductors and microelectronics, quantum information technologies, and AI.
Covered activities are either prohibited or require notification, depending on the technology.
Prohibited Transactions
Prohibited transactions include transactions involving (1) producing and developing semiconductors and microelectronics that fall under specific technical classifications, (2) producing and developing quantum information technologies that fall under specific technical classifications, and (3) persons that are designated as falling under other restricted export rules engaged in either prohibited transactions as described in (1) and (2) or notifiable transactions as described below (§ 850.224(a)-(m)).
The technical thresholds for semiconductors and other microelectronics are industry specific. For example, the technical thresholds include producing or developing a “technology designated exclusively for use in or with extreme ultraviolet lithography fabrication equipment” (§ 850.224 (b)(3)). Other qualifications include “NOT-AND (NAND) memory integrated circuits with 128 layers or more” (§ 850.244(d)(3)).
The technical thresholds for transactions involving quantum information technologies and AI systems are also industry specific. For example, the technical specification include AI systems that are designed for military end use as well as “[n]etworking to scale up the capabilities of quantum computers, such as for the purposes of breaking or compromising encryption” (§ 850.224 (j)(1) and (i)(1)).
Also prohibited are transactions involving persons that are designated under certain restricted export rules, including persons “[d]esignated as a foreign terrorist organization by the Secretary of State under 8 U.S.C.” (§ 850.224 (m)(6)) as well as persons listed on the “Department of Treasury’s list of Non-SDN Chinese Military Industrial Complex Companies (NS-CMIC List)” (§ 850.224 (m)(5)).
Notifiable Transactions
Notifiable transactions include transactions involving semiconductors and microelectronics and quantum information technologies that do not fall under the technical specifications laid out in § 859.224 (§ 850.217). The Outbound Investment Rules do not include a comparable notifiable transaction classification for persons designated under certain export rules.
Coverage of Financing Transactions
Generally, loans or similar debt instruments are not considered covered transactions by the Outbound Investment Rules except under the following circumstances:
- Acquisition of an equity interest or contingent equity interest in a person that the U.S. person knows at the time of the acquisition is a covered foreign person (§ 850.210(a)(1)).
- Provision of a loan or a similar debt financing arrangement to a person that the U.S. person knows at the time of the provision is a covered foreign person, where such debt financing affords or will afford 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 (§ 850.210(a)(2)).
- Conversion of a contingent equity interest into an equity interest in a person that the U.S. person knows at the time of the conversion is a covered foreign person, where the contingent equity interest was acquired by the U.S. person on or after Jan. 2, 2025 (§ 850.210(a)(3)).
On its face, the above would not implicate ordinary course loans, but a foreclosure on collateral could result in a covered transaction. In its notes the Treasury Department states that “[n]either the issuance of a secured loan or similar debt financing for which equity is pledged as collateral, nor the acquisition of such secured debt on the secondary market, is an acquisition of an equity interest. However, foreclosure on collateral where the debtholder takes possession of the pledged equity is an acquisition of an equity interest[.]”
Two exceptions exist. The transaction would not be covered when (a) the transaction closes and the equity is pledged prior to the effectiveness date of the Outbound Investment Rules, or (b) the U.S. person did not know at the time of issuing or acquiring the debt that the pledged entity was a covered foreign person.
With respect to syndicated financing transactions, lenders in a syndicate can generally rely on one of the exceptions set forth in the Outbound Investment Rules. If the covered transaction is the result of a voting interest in a covered foreign person being acquired upon default or other condition under the loan and the loan was made by a syndicate of financial institutions, then participant lenders are generally carved out to the extent that they are not able to initiate an action vis-à-vis the debtor and are not the “syndication agent.” While the Outbound Investment Rules use the term “syndication agent,” the more common term used in typical U.S. syndicated credit agreements is “administrative agent.”
Administrative agents, however, should be aware that in the event they realize on collateral for the benefit of their lender group, that realization could be considered a covered transaction under the Outbound Investment Rules.
Knowledge Under Outbound Investment Rules
Financial institutions must be aware of the level of diligence they must undertake in connection with a loan or investment to satisfy the knowledge requirement. If a financial institution did not have knowledge at the time of issuing or acquiring the debt that the pledged equity was in a covered foreign person, the foreclosure on such equity would not trigger a covered transaction.
Knowledge under the Outbound Investment Rules is defined as “(a) [a]ctual knowledge that a fact or circumstance exists or is substantially certain to occur; (b) [a]n awareness of a high probability of a fact or circumstance’s existence or future occurrence; or (c) [r]eason to know of a fact or circumstance’s existence.” The Outbound Investment Rules require that U.S. persons conduct a “reasonable and diligent inquiry.” The Treasury Department will consider a number of factors to determine if that standard was met (§ 850.216). A U.S. person’s efforts to obtain and consider public and nonpublic information with respect to the transaction, the contractual representations or warranties the U.S. person has obtained or attempted to obtain from the transaction counterparty, and the absence of warning signs in their diligence are some of the factors the Treasury Department will consider (§ 850.214).
Penalties, Statute of Limitations
Failing to comply with the Outbound Investment Rules includes both civil and criminal penalties. The civil penalties include a fine of $377,700 (inflation-adjusted for 2025 as published by the Treasury Department and effective through Jan. 14, 2026) or “twice the amount of the transaction that is the basis of the violation with respect to which the penalty is covered” (§ 850.701(a)(1)), whichever is greater. Under § 850.701(b), the secretary of the Treasury Department can refer criminal violations to the attorney general.
The Outbound Investment Rules allow the secretary to “nullify, void, or otherwise compel the divestment of any prohibited transaction entered into after the effective date of this part” (§ 850.703(b)).
As regulations under the IEEPA, the Outbound Investment Rules has a 10-year statute of limitations.
Practical Application in Debt Financings
As financial institutions and borrowers continue to structure debt financings, they should consider the impact that the Outbound Investment Rules will have on transaction timelines and documentation. Financial institutions on bilateral transactions and administrative agents on syndicated loans should consider additional diligence measures and language to insert into credit agreements or other loan documentation.
Three primary areas that financial institutions can focus on to ensure compliance with the Outbound Investment Rules are:
- Additional diligence: Financial institutions on secured financing transactions should be aware that they must now conduct a “reasonable and diligent” inquiry to determine if a borrower is or could reasonably become a covered foreign person. Financial institutions should ensure diligence is conducted thoroughly to avoid any determination by the Treasury Department that the lender should have had knowledge with respect to a borrower’s or its subsidiaries’ activities. During the diligence and structuring phase of a transaction, financial institutions should make sure that they are communicating early and often with borrowers so they can complete their required diligence quickly and efficiently. Practically speaking, while the Outbound Investment Rules deviate from the broader approach taken with respect to sanctions by targeting certain sectors of investment, a similar approach to diligence can be applied. In addition to having counsel engage in discussions on the applicability of the Outbound Investment Rules and what (if any) activities of a borrower could be covered, some institutions engaged directly with borrowers on diligence memos and questionnaires to expedite the process and alleviate negotiations in the documentation stage.
- Credit agreement and loan document provisions: Financial institutions should also consider revisions to their model credit agreements or other loan documentation to incorporate representations and warranties and covenants designed to provide them with necessary diligence at the onset of a transaction and during the life of a deal. On Jan. 2, 2025, the Loan Syndications and Trading Association (LSTA) published suggested language to be included in documentation. As that language and other firm-specific provisions continue to be incorporated into loan documentation, financial institutions should monitor those provisions to address any gaps from either a lender’s perspective or where additional flexibility could be appropriate for borrowers in certain sectors. While there has been some push back from borrowers on the general LSTA provisions on the basis that ongoing covenants limit their flexibility with respect to transactions that are notifiable or potentially excluded or able to be approved, financial institutions should take a case-by-case analysis to assess risks with respect to specific borrowers (e.g. more scrutiny should be applied to an international technology company than a U.S.-based pizza chain).
- Monitoring: In addition to initial diligence and inclusion of appropriate credit agreement language, financial institutions should continue to monitor updates to the Outbound Investment Rules — in particular, any expansion of covered activity as contemplated by the AFIP — and ensure that their compliance departments and procedures are appropriately equipped to handle ongoing diligence requirements over the life of a loan (e.g. incremental facilities, amendments, etc.).
The Outbound Investment Rules take a “sectoral approach” to regulations aimed at protecting U.S. national security, and violations could result in significant monetary fines for financial institutions that do not engage in appropriate diligence and structuring with their debt instruments. Financial institutions navigating the Outbound Investment Rules should engage qualified counsel to discuss market provisions and procedures.