The Department of Commerce Publishes a Proposed Rulemaking Aimed at Preventing the Improper Use of CHIPS Act Funding

On March 23, 2023, the Department of Commerce's (DoC) CHIPS Program Office, within the National Institute of Standards and Technology (NIST), published a new proposed rule aimed at preventing the improper use of Creating Helpful Incentives to Produce Semiconductors (CHIPS) Act funding. This proposed rule has significant business implications for CHIPS Act funding recipients and actors up and down the United States' semiconductor supply chain.

Brief Background on the CHIPS Act

The CHIPS Act is the largest federal investment program directed at boosting the domestic semiconductor manufacturing sector. It appropriates $39 billion for semiconductor manufacturing incentives over five years, provides tax credits worth roughly $24 billion, and authorizes $11 billion in federal research support. The CHIPS Act included funding and national security guardrails: requiring CHIPS funds be spent in the United States, mandating recipients not invest in semiconductor manufacturing outside the United States for 10 years post-CHIPS award, and prohibiting certain joint research or technology licensing with foreign entities of concern for technology with national security concerns. The DoC's proposed rulemaking attempts to further specify the CHIPS Act's funding and national security guardrails by defining related terms and processes.

Key Provisions in the DoC's Notice of Proposed Rulemaking for "Preventing the Improper Use of CHIPS Act Funding"

The DoC's proposed rule defines terms in the CHIPS Act, identifies prohibited transactions under the CHIPS Act's Expansion Clawback and Technology Clawback provisions, and describes the process for notifying the Secretary of Commerce of covered transactions.

Key Definitions in the Proposed Rule

Relating to the CHIPS Act's Expansion Clawback section, 15 U.S.C. 4652(a)(6), the proposed rule defines "foreign entity of concern," "significant transaction," and "material expansion."

• A "foreign entity of concern" includes over 16 referenced categories of foreign entities, such as a foreign terrorist organization under 8 U.S.C. 1189, an entity on "the Department of Treasury's list of Specially Designated Nationals and Blocked Persons (SDN List)," and, among others, an entity "owned 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))" like the Democratic People’s Republic of North Korea, the People’s Republic of China (PRC), the Russian Federation, and the Islamic Republic of Iran.
• "Significant transaction" is a transaction exceeding $100,000, or a series of transactions aggregated during a required agreement's term equaling $100,000 or more. The DoC chose $100,000 "to provide a clear and quantitative standard that captures even modest expansions by funding recipients of semiconductor manufacturing capacity in foreign countries of concern."
• "Material expansion" includes new facility construction and increased semiconductor manufacturing capacity measured at 5% of existing capacity. For context, the DoC explains the "definition is meant to allow for funding recipients that have existing facilities in a foreign country of concern to continue to operate and maintain their competitiveness by allowing for technological upgrades, as long as overall semiconductor manufacturing capacity is not increased by more than [five] percent."

The importance of these definitions should not be understated because they set material limits on CHIPS funding recipients' investments. Mainly, by accepting CHIPS Act funding, firms must accept limits to their continued enhancement of existing Chinese facilities through the interplay of "significant transaction" and "material expansion." The DoC describes this regulatory impact: "[a]mong the conditions of funding, all funding recipients will be required to enter into an agreement with the [DoC] prohibiting them from engaging in significant transactions involving the material expansion of semiconductor manufacturing capacity in a foreign country of concern."

The proposed rule details exceptions to the prohibition on semiconductor manufacturing capacity expansions and defines relevant terms to these exceptions such as, among others, "existing facility." "Existing facility" excludes facilities with "significant renovations" after the required agreement. The DoC states "transactions that significantly renovate an existing facility (i.e., add an additional line or otherwise increase semiconductor manufacturing capacity by 10% or more) will not fall under the exception for existing facilities or equipment for manufacturing legacy semiconductors in 15 U.S.C. 4652(a)(6)(C)(ii)(I)." Lastly, the proposed rule meaningfully distinguishes "funding recipients" from "covered entities." In the CHIPS Act, "covered entities" are those eligible to apply for CHIPS financial assistance, and, in the proposed rule, "funding recipients" are those that have been awarded and receive the CHIPS financial assistance.

Identified Prohibited Transactions or Restrictions for Clawback Provisions in the Proposed Rule

The proposed rule provides numerous restrictions or outright prohibitions on certain transactions. For example, neither a funding recipient nor its affiliates may knowingly engage in any joint research or technology licensing with a foreign entity of concern that relates to a technology or product that raises national security concerns. Further, the proposed rule limits existing legacy facility expansion by prohibiting funding recipients from adding new production lines or expanding a facility's production capacity beyond 10%.

Relating to "foreign entit[ies] of concern," the proposed rule designates three new entity categories that it considers engaged in conduct detrimental to the national security or foreign policy of the United States: (1) entities on the Bureau of Industry and Security's Entity List, (2) entities included on the Department of the Treasury's list of Non-Specially Designated Nationals (SDN) Chinese Military-Industrial Complex Companies (NS-CMIC List), and (3) entities on the Federal Communications Commission's list of Equipment and Services Covered in Section 2(a) of the Secure and Trusted Communications Networks Act of 2019 that provide covered equipment or services.

Outlined Processes in the Proposed Rule

Under the CHIPS Act, funding recipients must notify the Secretary of Commerce of any planned significant transaction involving the material expansion of semiconductor manufacturing capacity in a foreign country of concern, which includes those that may meet an exception. The proposed rule requires potentially eight specific pieces of information in the notification including, among others, the funding recipient's and the transaction's parties' contact information; organizational and ownership structure information; and a transaction description. Such a notification must be certified by the funding recipient's Chief Executive Officer, President, or equivalent position. In addition to these requirements, the proposed rule outlines processes for response notifications, the DoC's transaction review, and remedies like the DoC recovering CHIPS funding.

In addition to the funding recipient's notice-initiated review process, the proposed rule allows the Secretary of Commerce to initiate its own review. The proposed rule states "[w]here the Secretary believes that a transaction may be prohibited[,] [i]nformation may be submitted to the Department, including by persons other than a funding recipient, via notifications@chips.gov." If the Secretary of Commerce initiates its own review, the proposed rule requires the Secretary to "notify the funding recipient in writing." Further, upon the Secretary's initiated review, the proposed rule requires the Secretary to consult with the Secretary of Defense and the Director of National Intelligence.

Business Considerations for CHIPS Funding Recipients From the Proposed Rulemaking

This proposed rule has significant potential to impact investments in semiconductor manufacturing capacity and such investments in countries of concern, like the PRC. From these foreign country of concern guardrails, the DoC may expend additional resources on scrutinizing any semiconductor manufacturing investment in places like the PRC. For instance, the relatively low $100,000 "significant transaction" threshold makes CHIPS funding less attractive to companies with existing substantial investment in the PRC because such companies may use CHIPS funding only if they comply with the "material expansion" definition. This may limit companies with existing substantial investment in the PRC to only minor enhancements to Chinese facilities. Consequently, such companies may now decide against CHIPS funding altogether. 

Importantly, potential CHIPS funding recipients should remember that violating the CHIPS Act or the future final rule could result in a total clawback of CHIPS funding. Per the proposed rule, such "clawbacks" will materialize as transfers of funds to the government equal to the funding award amount, plus interest. Any funding recipient subject to partial or complete clawbacks will likely face significant business impacts and potential ripples of regulatory enforcement. Additionally, CHIPS funding recipients who violate regulatory requirements could face corporate reputational impacts from negative public scrutiny, or even expensive, time-consuming litigation. Given these serious business concerns, CHIPS funding recipients must prioritize and place a premium on compliance with existing and developing regulatory schemes.

How to Comment, Next Steps, and Timeline

Interested parties will find comment instructions and options here. Commenters must submit their written comments on or before May 22, 2023. This proposed rule will likely become effective after the comment period closes, but formal federal rulemaking can take significant time before being effective.

Conclusion

The proposed rule implementing the CHIPS Act's funding recovery measures will bolster CHIPS Act incentives for domestic investment in semiconductor manufacturing facilities and equipment. With this proposed rule, semiconductor manufacturing firms can better predict outcomes and assess risks involved with pursuing and using CHIPS Act funding for covered investment opportunities. However, by properly heeding these economic and national security guardrails, CHIPS Act funding recipients may handsomely benefit from these government funded investment opportunities.

For more information on what potential CHIPS Act funding applicants should know about recent funding opportunities, read another of our recent Advisories: First CHIPS for America Funding Opportunity Released: What Potential Applicants Should Know (March 8, 2023).

*Bryan R. Williamson contributed to this Advisory. Bryan is a graduate of the University of Oregon School of Law and is employed at Arnold & Porter's Washington, DC office. Bryan is admitted only in Washington. Bryan is not admitted to the practice of law in Washington, DC.

© Arnold & Porter Kaye Scholer LLP 2023 All Rights Reserved. This Advisory is intended to be a general summary of the law and does not constitute legal advice. You should consult with counsel to determine applicable legal requirements in a specific fact situation.