On March 21, 2023, the Department of Commerce (“Commerce”) published a Notice of Proposed Rulemaking (the “Commerce Proposed Rule”) to implement certain provisions of the CHIPS and Science Act of 2022 (“CHIPS Act”) that place restrictions on certain activities of businesses receiving federal funding pursuant to the CHIPS Act (“Commerce Guardrails”). On the same day, the Department of the Treasury (“Treasury”) also published a Notice of Proposed Rulemaking (together with the Commerce Proposed Rule, the “Proposed Rules”) to implement the Advanced Manufacturing Investment Credit (“ITC”), including its own restrictions on certain activities that, in broad strokes, parallel the Commerce Guardrails (together with Commerce Guardrails, “CHIPS Guardrails”) (Covington alert).
The Proposed Rules are relevant to companies that are considering applying for Section 9902 funding under the CHIPS Act or planning to take advantage of the ITC. They are also potentially relevant to companies that do business with such parties. As described below, CHIPS Guardrails will impose meaningful constraints on the types of activities or investments into which affected parties can enter. The Proposed Rules also may contain hints with respect to the general direction of U.S. government policy, articulating concepts and definitions that could be applied in other regulatory regimes, including potential regulation of outbound investments.
Commerce and Treasury have requested public comments on the Proposed Rules by May 22, 2023. Further, Commerce has specifically requested comments on the “extent and nature of . . . pre-existing arrangements” relating to joint research or technology licensing, presumably to evaluate the issue of retroactive application for activities that predate CHIPS Guardrails but will be ongoing after its enactment.
We offer the following high-level comments:
- The “affiliate” definition would expand the universe of entities subject to CHIPS Guardrails well beyond the funding or ITC recipient (“Recipient”). The proposed definition would sweep in remote entities within the Recipient’s corporate family that may be several degrees of separation from the Recipient, as long as they are under common control. Thus, if a U.S. subsidiary of a foreign corporation accepts CHIPS Act funds or takes advantage of the ITC, it would bring the foreign parent corporation and all of its controlled subsidiaries globally within the scope of the CHIPS Guardrails restrictions. This definition of “affiliate” may be subject to challenge under the Administrative Procedure Act because the statute provides for a higher threshold of an 80% ownership to be considered an affiliate, but the Commerce Proposed Rule lowered this threshold to 50%.
- Restrictions apply to transactions with “foreign entities of concern” located anywhere in the world. The Proposed Rules restrict Recipients from engaging in certain transactions (i.e., transactions involving joint research or technology licensing relating to a technology or product that raises national security concerns, as determined by the Secretary) with “foreign entities of concern.” This term is defined to include a broad range of individuals and entities, including Chinese nationals located in China, companies organized under the laws of China (including for example Chinese subsidiaries of U.S. companies), and non-Chinese companies 25% or more of whose voting interests are directly or indirectly owned by the Chinese government. “Foreign entity of concern” even includes the Recipient’s subsidiaries organized under the laws of China and its Chinese employees located in China.
- However, the Proposed Rules still leave meaningful room for Recipients to engage in semiconductor-related activities and expansion of manufacturing in foreign countries of concern. First, “material expansion in . . . manufacturing capacity” is defined purely in quantitative terms, measured in wafer starts per month for semiconductor fabrication facilities. Consistent with this definition, Commerce’s commentary accompanying the Commerce Proposed Rule affirmatively states that the rule “would also allow recipients to upgrade technology at existing foreign facilities (in compliance with export controls) if overall production capacity is not increased.” Second, the Proposed Rules bifurcate the restriction on material expansion for legacy semiconductors and non-legacy semiconductors and provide greater flexibility to expand capacity for legacy semiconductors. Whereas the Proposed Rules permit only up to a 5% increase in output for leading edge and current generation technologies, they allow up to a 10% increase in output of legacy semiconductors manufactured at either an existing facility or a new facility that predominately serves the market of a foreign country of concern.
- Key Open Questions: Key issues that may require clarification through the comments process include:
- Scope of “Foreign Entities of Concern”: The statutory term “foreign entities of concern” includes any foreign entity that is “[o]wned by, controlled by, or subject to the jurisdiction or direction of a government of a foreign country that is a covered nation (as defined in 10 U.S.C. 4872(d)).” The Proposed Rules arguably expanded the scope of this term beyond what the statute contemplates. First, the agencies interpret the term “entity” to include a natural person. Second, the Proposed Rules’ interpretation of the above phrase to include all entities organized under the laws of China is quite broad. This phrase “subject to the jurisdiction or direction of a government” could be interpreted more narrowly as requiring some affirmative government influence, as discussed here.
- Affiliated vs. Unaffiliated Foreign Entities of Concern: The Proposed Rules do not differentiate between affiliated foreign entities of concern (e.g., a Recipient’s own subsidiaries in China) and unaffiliated foreign entities of concern. As a result, a Recipient’s own, wholly-owned subsidiaries in China would be treated in the same manner as a Chinese state-owned entity for purposes of the Guardrails restrictions.
- Scope of Technology Clawback: The Proposed Rules include a technology clawback provision that restricts Recipients from knowinglyengaging in joint research or technology licensing efforts with a foreign entity of concern that relates to a “technology or product that raises national security concerns.” As currently drafted, “technology licensing” is defined broadly to include patent licensing and sharing of “know-how,” which may include such intellectual property provided in connection with products being sold. Further, the Proposed Rules suggest that even technology or products for which a party has obtained an export license under the U.S. Export Administration Regulations may be subject to these restrictions, if the technology “raises national security concerns” as defined in the Proposed Rules. In other words, these rules do not contemplate a carve out for ancillary intellectual property or existing export licenses.
Covington has been involved in advising on and shaping the legislation for clients since its original draft was introduced in April 2021, and we stand ready to advise on its contents and specific opportunities for individual clients. If you have any questions concerning the material discussed in this post, please contact the members of our CFIUS, Public Policy, Government Contracts, and Tax practices.
 For the ITC, there was no statutory prohibition against activities of an affiliate, but Treasury adopted the affiliate prohibition from the Commerce Proposed Rule.
 Unlike the Commerce Proposed Rule, Treasury’s proposal for the ITC further requires that this joint research or technology licensing materially expand the semiconductor manufacturing capacity of the Recipient or its affiliates.