Peter E. Fisch and Mitchell L. Berg
Peter E. Fisch and Mitchell L. Berg ()

Foreign investment in the U.S. real estate market has grown dramatically in recent years. Reports indicate that in 2016 alone, foreign investment surpassed $20 billion, with offshore buyers accounting for 43 percent of the 50 largest U.S. commercial real estate transactions.1 Advising a U.S. client in a transaction with a foreign counterparty requires familiarity with certain issues and potential complications. In particular, U.S. clients need to be aware of issues relating to (i) the ability to enforce judgments of U.S. courts against foreign counterparties; (ii) so-called “know your customer” diligence requirements as they are applied to foreign counterparties; (iii) foreign capital export controls; (iv) potential Committee of Foreign Investment in the U.S. (CFIUS) review; and (v) registering transactions with the Department of Commerce’s Bureau of Economic Analysis.2

Enforcing Judgments Abroad

In a transaction with a domestic counterparty, the ability to enforce a judgment against that counterparty is rarely an issue. With a foreign counterparty, enforcing a U.S. judgment is not a given. As a result, lenders often refuse to consider foreign guarantors unless those guarantors have significant U.S. assets. While a guaranty (or joint venture agreement or other agreement with a foreign counterparty) may be drafted to provide that the foreign counterparty (i) consents to U.S. court jurisdiction, (ii) appoints someone within the court’s jurisdiction to accept service of process, and (iii) accepts the preferred choice of law, none of these contractual provisions will matter if a judgment relating to the agreement cannot be enforced against the counterparty’s assets. Absent the ability to enforce the judgment abroad, the foreign counterparty is only at risk to the extent of its investment.

In the absence of treaties or conventions, countries are under no obligation to recognize or enforce foreign judgments, though the prevailing trend is toward greater recognition.3 While countries have entered into bilateral treaties4 and regional frameworks,5 efforts toward a widely adopted global enforcement convention have not been successful.6 The United States is not party to any bilateral, regional or global treaty or convention ensuring foreign enforcement of U.S. court judgments,7 leaving U.S. counterparties to rely on the laws of foreign jurisdictions for such enforcement. Countries differ greatly in their treatment of U.S. judgments. Some, such as the Netherlands, are highly restrictive, while others, such as Turkey and France, take a more liberal approach to enforcement.8

A U.S. party intending to enforce a judgment in a foreign jurisdiction should take certain steps to increase the probability of foreign enforcement, including (i) ensuring that the U.S. court has proper jurisdiction; (ii) making certain the U.S. judgment is final, valid and on the merits; and (iii) avoiding any procedural irregularities (notice, service, opportunity for court hearing, etc.). There are a number of other steps parties can take at the inception of a transaction to pre-empt issues with foreign enforcement. First, the U.S. counterparty can require the foreign counterparty to accept arbitration as the dispute resolution method under the agreement. Arbitral awards are likely to be easier to enforce abroad than judgments. For example, countries party to the New York Arbitration Convention (which has been widely adopted)9 agree to enforce arbitral awards in accordance with rules of procedure of the jurisdiction in which the judgment is awarded.10 Second, U.S. counterparties should consider requiring opinions of counsel qualified to practice in the jurisdiction where the foreign counterparty’s assets are located, that a court in that jurisdiction would enforce a U.S. judgment without initiating significant new legal proceedings. While the opinion itself provides more comfort than protection, any assumptions or exceptions in the opinion may be instructive on further steps that may be taken upfront to enhance the likelihood of enforcement. Finally, counsel to the U.S. counterparty can research the laws of the applicable jurisdiction to determine whether and how foreign judgments are enforced.11

“Know Your Customer”

‘Know your customer’ (KYC) requirements obligate U.S. lenders (and in some cases other transaction parties) to conduct due diligence on potential customers in order to prevent money laundering and to avoid transacting with certain prohibited persons. KYC requirements emanate from a variety of laws, regulations and enforcement agencies: Section 326 of the USA Patriot Act requires every financial institution to form a reasonable belief that it knows the true identity of its customers,12 the Treasury Department’s Financial Crimes Enforcement Network (FinCEN) has codified the requirements regarding lenders’ customer identification programs (CIPs),13 and the Bank Secrecy Act of 1970 was enacted to prohibit money laundering. The Office of Foreign Assets Control (OFAC) and the Dodd-Frank Wall Street Reform and Consumer Protection Act also give rise to other rules and regulations. In addition, individual institutions often impose internal controls over and above legal requirements, in part to protect against reputational damage. KYC requirements are particularly relevant when dealing with foreign counterparties.

Customer Identification Programs (CIPs) require lenders to: (i) verify the identity of persons seeking to open accounts; (ii) maintain accurate records; and (iii) determine whether a person appears on prohibited government lists. An issue that often arises between foreign borrowers and U.S. lenders is the level of beneficial ownership that triggers CIP requirements. While there is no clear universal standard, as every financial institution is required to implement CIP appropriate for its size and type of business, the Federal Financial Institutions Examination Council (FFIEC) has identified factors that financial institutions should use to determine whether an account is considered high risk, including whether an account is offshore.14

While lenders are generally required to identify beneficial owners with as little as a 25 percent interest in the customer, as the risk profile of the entity increases, the percentage of ownership required to trigger CIP review decreases, often to as low as 10 percent.15 KYC review is often a long lead time item, and U.S. parties engaged with foreign counterparties (who may not be familiar with the stringent U.S. requirements) need to be mindful of the need for appropriate disclosure by the foreign counterparty and the potential delay that may result from the process. Foreign counterparties should also ensure that they respond to KYC requests in a manner that does not violate privacy laws imposed by the counterparty’s domestic legal system, such as the EU general data privacy regulation.16

Capital Control Issues

China recently imposed capital export controls that limit the ability of Chinese nationals and entities to export capital abroad, and other countries could follow with similar laws.17 These recent regulatory changes in China can impact the flow of capital into the U.S. real estate market and have on occasion interfered with the completion of U.S. real estate transactions.18 In light of such controls, U.S. parties need to ensure that foreign buyers and joint venture partners will be able to deliver the required funding at closing, and foreign counterparties need to take steps to ensure that committed funds will be available for their intended purpose.19 Capital control regimes vary widely and are dynamic, so it is important for foreign investors and their advisors to stay abreast of the current rules and to anticipate new restrictions before entering into definitive agreements. U.S. parties should also be mindful of the fact that a shift in the regulatory regime governing the foreign counterparty can create misalignment of interests, as the foreign investor may, as a result of regulatory pressures, need immediate liquidity at a time where a liquidity event may not be optimal.

Foreign investors can protect against shifting capital control regulations through ownership of cash-flowing offshore assets that can be used to fund future acquisitions. Moreover, foreign investors considering an offshore transaction should reserve sufficient capital offshore as and when possible in an amount sufficient to meet future investment objectives, ensuring that future capital export restrictions do not interfere with pending investments. Sellers of property to foreign investors, in addition to conducting due diligence with regard to capital controls to which a foreign counterparty may be subject, may require larger than usual deposits and/or proof of available capital at signing. In addition, U.S.-based investors considering joint ventures with foreign partners should consider provisions in their agreements protecting against the consequences of future misalignment of interests after the consummation of the joint venture (for example, by limiting the foreign investor’s ability to trigger a disposition).

CFIUS

The Committee of Foreign Investment in the U.S. (CFIUS) is an inter-agency committee led by the Treasury Department authorized to review transactions that could result in control of a U.S. business by a foreign person from a national security perspective. If a transaction is deemed potentially detrimental to U.S. national security, CFIUS can request that the president determine whether to suspend or prohibit the transaction or take other preventative measures.20 While real estate acquisitions have not historically been subject to CFIUS, the acquisition of the Waldorf-Astoria Hotel by Anbang Insurance Group led to CFIUS scrutiny, purportedly in part because the hotel is the permanent residence of the U.S. representative to the United Nations. CFIUS approved this transaction but has prohibited others.21

CFIUS applies to transactions that could result in the ability of a foreign entity to “determine, direct or decide” important business matters affecting any person engaged in interstate commerce.22 Covered transactions include acquisitions and joint ventures. The voluntary filing system, which encourages parties to consult with CFIUS in advance of filing before CFIUS, provides for an initial 30-day review period with a potential additional 45-day investigative period. Whether or not a transacting party seeks approval, CFIUS may initiate review on its own, even after a transaction has closed. Counsel to foreign buyers should alert clients early on to potential CFIUS filing requirements, especially in light of the fact that the Trump administration has indicated a desire to strengthen the committee.23

U.S. Dept. of Commerce Filing

Under rules promulgated by the Department of Commerce’s Bureau of Economic Analysis, U.S. businesses must report when a foreign entity acquires a voting interest therein or in a segment or operating unit thereof.24 The filing is for statistical reporting, and is required when: (i) the total cost of acquisition is greater than $3 million; (ii) the U.S. business enterprise will operate as a separate legal entity; and (iii) the transaction will result in at least 10 percent of the voting interests in the acquired entity being held by a foreign entity. The reporting requirement includes acquisitions of real property, but excludes residential real estate not acquired for profit-making purposes.25

The filing is required no later than 45 days after the acquisition closes, with penalties for failing to report including monetary fines and possible imprisonment for up to one year. Filing is relatively simple and extensions are generally available upon request.

ENDNOTES:

1. Wolf Richter, “Foreign investors are piling into the U.S. commercial real estate bubble,” Business Insider, March. 19, 2017, http://www.businessinsider.com/foreign-investors-pile-into-us-real-estate-2017-3.

2. Foreign investment also presents a number of tax issues, which are beyond the scope of this article.

3. Ralf Michaels, “Recognition and Enforcement of Foreign Judgments,” Max Planck Encyclopedia of Public International Law, 2009; https://travel.state.gov/content/travel/en/legal-considerations/judicial/enforcement-of-judgments.html.

4. See, for example, the Treaty of 19 November 1896 between Switzerland and Spain. Albert J. Van den Berg, Yearbook Commercial Arbitration, International Council for Commercial Arbitration, Volume XXX-2005, 2006.

5. See, for example, the Bustamante Code of 1928 with respect to Latin America. Ralf Michaels, “Recognition and Enforcement of Foreign Judgments.”

6. For example, the Hague Choice of Court Convention has not been widely adopted. https://www.hcch.net/en/instruments/conventions/status-table/?cid=98.

7. https://travel.state.gov/content/travel/en/legal-considerations/judicial/enforcement-of-judgments.html.

8. Ralf Michaels, “Recognition and Enforcement of Foreign Judgments.”

9. http://www.newyorkconvention.org/list+of+contracting+states.

10. United Nations Conference on International Commercial Arbitration, Convention on the Recognition and Enforcement of Foreign Arbitral Awards, 1958, http://www.newyorkconvention.org/11165/web/files/original/1/5/15432.pdf.

11. Patrick Doris, “Enforcement of Foreign Judgments 2016,” Getting the Deal Through, published by Law Business Research Ltd, https://www.walderwyss.com/publications/1516.pdf.

12. Practical Law Finance, “USA Patriot Act and Know Your Customer Requirements for Lenders,” https://www.gpo.gov/fdsys/pkg/PLAW-107publ56/pdf/PLAW-107publ56.pdf.

13. https://www.federalregister.gov/documents/2016/05/11/2016-10567/customer-due-diligence-requirements-for-financial-institutions; 31 C.F.R. §1020.220.

14. https://www.fdic.gov/regulations/examinations/bsa/ffiec_cip.pdf (other factors include foreign private banking and trust accounts, accounts of senior foreign political figures, and out-of-area and non-face-to-face accounts).

15. Mark E. Plotkin and B.J. Sanford, “Patriot Act: The Customer’s View of ‘Know Your Customer’—Section 326 of the USA Patriot Act,” Bloomberg Corporate law Journal, Vol. 1:670.

16. See generally, https://b-hive.eu/news-full/2017/3/29/what-you-should-know-about-kyc-vs-data-privacy.

17. “The rise in China’s foreign exchange reserves is bad news for global real estate,” Business Insider, March 12, 2017, http://www.businessinsider.com/chinese-capital-controls-effect-on-real-estate-2017-3.

18. See Putzier, Konrad and Solomont, E.B., “Building a Great Wall Around Money From China,” The Real Deal, May 1, 2017, https://therealdeal.com/issues_articles/building-a-great-wall-around-money-from-china/ (speculating that HNA, a Chinese based conglomerate, expatriated money out of China “before the latest controls took effect.”).

19. “Out With a Bang: Anbang Reportedly Ends Bid for Starwood,” The Real Deal, March 31, 2016, https://therealdeal.com/2016/03/31/out-with-a-bang-anbang-reportedly-ends-bid-for-starwood/ (noting that Anbang reportedly gave up its bid for Starwood as a result of regulations requiring Chinese insurance companies from investing no more than 15 percent of their assets abroad).

20. https://www.treasury.gov/resource-center/international/foreign-investment/Documents/CFIUSGuidance.pdf.

21. For example, Ralls’ acquisition of certain wind farms located near or within a restricted naval weapons systems training facility was blocked at the recommendation of CFIUS, but was later permitted after a lengthy court battle which concluded with a settlement. See James K. “The Committee on Foreign Investment in the United States (CFIUS),” Congressional Research Service, June 12, 2017, https://fas.org/sgp/crs/natsec/RL33388.pdf.

22. 31 C.F.R. §800.204.

23. David Francis, “The Lights Are on at the Committee on Foreign Investment in the United States but Nobody is Home,” Foreign Policy, June 22, 2017, http://foreignpolicy.com/2017/06/22/the-lights-are-on-at-the-committee-on-foreign-investment-in-the-united-states-but-nobody-is-home/.

24. 15 C.F.R. 801.

25. https://www.bea.gov/surveys/pdf/be13/which-be13-form-do-i-file.pdf.