Takeaways

The Department of Commerce released a proposed rule imposing guardrails preventing the “improper use of funds” made available under the CHIPS Act.
The proposed rule defines key terms that govern the scope of two clawback mechanisms in the law, which allow the government to recoup funds from recipients who engage in certain activities implicating foreign countries and/or foreign entities “of concern.”
The new proposed definitions also provide insight in the scope of Commerce’s initial review of applications to determine if they meet U.S. national security interests.

On March 21, 2023, the Department of Commerce (Commerce) released a Notice of Proposed Rulemaking (NPRM) imposing guardrails preventing the “improper use of funds” made available under the CHIPS Act of 2022, which creates a private sector incentive program to boost semiconductor manufacturing in the United States. The guardrails are designed to ensure that technology and innovation spurred by the CHIPS Act is targeted towards domestic investment in semiconductor facilities and equipment, exclusively, and does not benefit adversarial countries, principally China.

The NPRM provides clarity on two critical concepts that are important to prospective CHIPS Act recipients who do business in China and/or are affiliated with companies that do business in China:

  • First, the NPRM defines key terms—previously left undefined by the CHIPS Act statute—which govern the scope of two clawback mechanisms in the law which allow the government to recoup funds from recipients if engaged in certain activities abroad implicating “foreign countries of concern.” 
  • Second, the new definitions provide insight in the scope of Commerce’s initial review of applications to determine if they meet U.S. national security interests. 

As a proposal, the NPRM must go through a formal notice and comment period prior to taking effect, and Commerce must consider public comments before finalizing the rule. Any interested party, including semiconductor manufacturers, suppliers, customers, trade associations and other stakeholders may submit comments for agency review ahead of the May 22, 2023, deadline.

CHIPS Act Background
The CHIPS Act, enacted in August 2022, amended the National Defense Authorization Act for 2021 to establish a semiconductor incentives program, known as the CHIPS Incentives Program. This program provides funding, including via grants, cooperative agreements, loans, loan guarantees and other transactions, to support investments in the construction, expansion and modernization of facilities in the U.S. for the fabrication, assembly, testing, advanced packaging, production, or research and development of semiconductors, materials used to manufacture semiconductors, or semiconductor manufacturing equipment.

To secure an incentive, companies must apply to the Commerce Department for funding. In late February 2023, the Commerce Department opened the first CHIPS Act funding opportunity seeking applications for projects for the construction, expansion or modernization of commercial facilities for the front- and back-end fabrication of leading-edge, current-generation and mature-node semiconductors. Two additional funding opportunities—for materials and manufacturing equipment facilities, and for research and development facilities—will be announced later this year.

CHIPS Act Restrictions on Certain Investments and Affiliations
The CHIPS Act contains two clawback mechanisms to prevent recipients of CHIPS incentives funds from engaging in certain transactions with “foreign countries of concern,” namely, China, North Korea, Russia and Iran.

  • Under the Expansion Clawback, an awardee “may not engage in any ‘significant transaction’ … involving the ‘material expansion’ of ‘semiconductor manufacturing capacity’ in the China or any other foreign country of concern” over the following 10-year period. This prohibition is extended to the funding recipient’s “affiliates.” 

The Expansion Clawback restrictions on Chinese investments do not apply to (i) existing facilities or equipment used to manufacture legacy semiconductors or (ii) the material expansion of legacy semiconductor manufacturing that predominantly serves the market of a foreign country of concern. 

  • Under the Technology Clawback, the Department may claw back a funding award (or recover funding from the recipient entity) if an awardee knowingly engages in any “joint research or technology licensing effort with a ‘foreign entity of concern’ that relates to a technology or product that raises national security concerns,” provided that the Commerce Department communicated those concerns prior to the licensing.

For the most part, the CHIPS Act statute did not define key terms—like “significant transactions” or “material expansions,”—included in the clawbacks, leaving the ultimate scope ambiguous pending agency rulemaking.

Expansion Clawback
When enacted, the Expansion Clawback raised serious questions about the types of overseas investments that would constitute “significant investments,” causing “material expansions” in “semiconductor manufacturing capacity.” The NPRM provides details as follows:

The NPRM defines a “significant transaction” to mean a transaction—or series of transactions—whose value exceeds $100,000, meaning that even modest expansions of semiconductor manufacturing capacity by funding recipients in foreign countries of concern will be covered.

“Material expansion” is defined to mean the construction of new facilities and the addition of new semiconductor manufacturing capacity that increases manufacturing capacity by more than five percent. According to Commerce, the definition aims to allow funding recipients with existing facilities for legacy semiconductors in foreign countries of concern to continue to operate and maintain their competitiveness, as long as overall capacity is not increased by more than 10 percent.

The Expansion Clawback is also seemingly only to be applied to material expansion of “semiconductor manufacturing capacity,” with “semiconductor manufacturing” being defined by the NPRM as “semiconductor fabrication or semiconductor packaging.” This definition notably excludes expansion of facilities that manufacture equipment and materials that are then used in semiconductor manufacturing processes.

The Expansion Clawback also does not apply to investments in legacy semiconductor facilities, including new facilities, so long as the output of those facilities “predominantly serves the market of the foreign country of concern.” The NPRM defines a “legacy semiconductor” as:

  • A digital or analog logic semiconductor that is of the 28-nanometer generation or older; or
  • A memory semiconductor with a half-pitch greater than 18 nanometers for Dynamic Random Access Memory or less than 128 layers for Not AND flash that does not utilize emerging memory technologies.

This “legacy semiconductor” definition, however, does not include semiconductors meeting those technical specifications that:

  • Are critical to national security;
  • Have a post-planar transistor architecture (e.g., fin-shaped field field-effect transistors or gate all around field-effect transistors); or
  • For purposes of packaging facilities, that are packaged utilizing three-dimensional integration.

The NPRM further defines “predominantly serving the market of a foreign country of concern” to mean service models where “85 percent of the output of the semiconductor manufacturing facility by value is incorporated into final products that are used or consumed in that market.”

The NPRM provides procedures for Commerce’s review of potentially restricted investments by funding recipients or their affiliates. Specifically, a review may either be initiated by the Secretary of Commerce based on a recipient company’s self-reported notification or as a “non-notified transaction” based on information provided by other government agencies or obtained from other sources. Commerce will then review a transaction for compliance with the proposed regulations and make an initial determination of compliance within 90 days. The recipient company may then respond to the determination. Unless the Secretary makes a final determination that a transaction does not violate the provisions of the regulation, the funding recipient must cease or abandon the transaction and submit evidence substantiating its abandonment within 45 days of the Secretary of Commerce’s determination. If such transaction is not abandoned, Commerce is authorized to clawback funds.

Technology Clawback
The NPRM extends the Technology Clawback, which bans funding recipients from certain joint research or technology licensing efforts with foreign entities of concern, to “affiliates” of funding recipients in addition to the funding recipients themselves. This is an expansion of the CHIPS Act statute.

The NPRM also adds definitions for “joint research,” “technology licensing” and “technology or product raising national security concerns.” These definitions are aimed at restricting the ability for foreign entities of concern to benefit from the receipt of technological innovations related to products that raise national security implications. Under the NPRM, this includes “a technology or product that raises national security concerns,” such as a semiconductor critical to national security or any item listed in Category 3 of the Commerce Control List that is controlled for national security reasons.

Affiliation Rules
Both the Expansion and Technology Clawbacks extend to recipients of CHIPS Act funding and their “affiliates” who make investments in a “foreign country of concern” or engage in certain technology/licensing agreements with “foreign entities of concern,” which the proposed rule defines broadly as any of the following:

  • Any subsidiary of the funding recipient, i.e., any entity in which the funding recipient directly or indirectly holds at least 50 percent of the outstanding voting interest;
  • Any parent entity of the funding recipient, i.e., any entity that directly or indirectly holds at least 50 percent of the outstanding voting interest in the funding recipient; or
  • Any entity in which the funding recipient’s parent entity or parent entities directly or indirectly hold at least 50 percent of the outstanding voting interest.

Of note is that the NPRM appears to tighten the definition of “affiliate,” hinging affiliation status on a 50 percent ownership threshold as opposed to the seemingly higher 80 percent threshold set forth in the CHIPS Act statute.

Under the NPRM, companies seeking CHIPS Act incentives that share common parents with companies that engage in semiconductor manufacturing in China and/or engage in certain joint licensing efforts will trigger the clawbacks.

Affiliation with Foreign Entities of Concern
The CHIPS Act and NPRM together define “foreign entities of concern” to include:

  • Entities designated a foreign terrorist organization;
  • Entities included on the Bureau of Industry and Security’s Entity List;
  • Entities included on the Department of the Treasury’s list of Non-Specially Designated Nationals Chinese Military-Industrial Complex Companies;
  • Entities identified in the Federal Communications Commission’s list of Equipment and Services Covered By section 2(a) of the Secure and Trusted Communications Networks Act of 2019 as providing covered equipment or service;
  • Entities determined by the Secretary of Commerce in consultation with the Secretary of Defense and the Director of National Intelligence, to be engaged in unauthorized conduct that is detrimental to the national security or foreign policy of the United States; or
  • “Any foreign entity that is … owned by, controlled by, or subject to the jurisdiction or direction” of a “foreign country of concern.”

The NPRM explains that a foreign entity that is “owned by, controlled by, or subject to the jurisdiction or direction” is one in which:

  • At least 25 percent of the person's outstanding voting interest is held directly or indirectly by that entity; or
  • It is subject to the jurisdiction or direction of a government of a foreign country or of a foreign political party where the person is a citizen, national or resident of the foreign country located in the foreign country, the person is organized under the laws of or has its principal place of business in the foreign country, or at least 25 percent of the person's outstanding voting interest is held directly or indirectly by the government of a foreign country or a foreign political party.

By definition, any company that is headquartered in China would be a “foreign entity of concern,” raising many considerations for potential CHIPS Act recipients with “affiliates” that are based in China.

In particular, “foreign entities of concern” are not eligible to receive CHIPS Incentives funding. Further, in recently published Commerce Department guidance, the agency has stated that it will extend this statutory prohibition and review applications for involvement of foreign entities of concern and will not approve any applications where a foreign entity of concern—through control, access to information, or other mechanisms—poses an undue risk to a project or U.S. national security interests.

Taken together, U.S.-based CHIPS Act applicants with Chinese affiliates should prepare for heightened scrutiny during the application period.

Takeaways for CHIPS Act Funding Recipients
Companies that are poised to take advantage of the funding opportunities in the CHIPS Act must be aware of these proposed regulations and their impact on potential funding. In particular:

  • The clawback provisions—as expanded through the NPRM—are intrinsically linked to eligibility to receive CHIPS Act funding. Companies that are engaging in or are in business with companies engaged in activities subject to the clawback provisions may not be able to capitalize on CHIPS Act funding without risking those funds being clawed back.
  • Further, companies who participate in substantial activities in China or with Chinese companies must exercise care in determining whether they comply with the restrictions contemplated by the NPRM before applying for CHIPS Act funding.

The rules contemplated by the NPRM are not yet final. Companies who are impacted or may be impacted may wish to submit comments ahead of the May 22 deadline. Pillsbury is working with many clients who wish to register with Commerce.

Pillsbury’s Public Policy and International Trade teams are ready to assist potential recipients in navigating this emerging regulatory framework to ensure they can capitalize on funding opportunities while ensuring regulatory compliance.

These and any accompanying materials are not legal advice, are not a complete summary of the subject matter, and are subject to the terms of use found at: https://www.pillsburylaw.com/en/terms-of-use.html. We recommend that you obtain separate legal advice.