PRIVILEGED & CONFIDENTIAL — ATTORNEY-CLIENT COMMUNICATION / ATTORNEY WORK PRODUCT
CALDERWOOD & HARKNESS LLP 1750 K Street NW, Suite 800, Washington, DC 20006 399 Park Avenue, 31st Floor, New York, NY 10022
MEMORANDUM
June 28, 2023
TO: Beatrice Holloway, Responsible Partner, Mergers & Acquisitions Margaret "Peggy" Ashworth, Of Counsel, National Security & CFIUS
FROM: Priya Venkataraman, Associate, International Trade & Sanctions Lt. Col. (Ret.) David Caruso, Senior Counsel, Government Contracts & Export Controls
RE: CHIPS and Science Act — Implications for Halcyon Semiconductor AG's Acquisition of Marlowe Asset Management Photonics Inc. and Post-Closing Eligibility for U.S. Semiconductor Incentives
MATTER: Halcyon Semiconductor AG / Marlowe Asset Management Photonics Inc. — CFIUS Filing & Mitigation
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I. Executive Summary
The purpose of this memorandum is to analyze the implications of the CHIPS and Science Act of 2022, Pub. L. No. 117-167 (the "CHIPS Act" or the "Act"), for Halcyon Semiconductor AG's ("HSAG") planned acquisition of Marlowe Asset Management Photonics Inc. ("VPI"), with particular focus on the following issues:
(a) whether VPI would remain eligible for CHIPS Act incentive funding following its acquisition by a German parent company;
(b) whether the "foreign entity of concern" ("FEOC") guardrail provisions of the CHIPS Act would be triggered by HSAG or any of its affiliates, thereby disqualifying VPI from participation in federal semiconductor incentive programs;
(c) the interaction between CHIPS Act eligibility requirements and the ongoing review by the Committee on Foreign Investment in the United States ("CFIUS"); and
(d) strategic recommendations for the CFIUS voluntary notice filing and National Security Agreement ("NSA") negotiation process in light of the CHIPS Act considerations.
Our high-level conclusion is as follows: HSAG is not a "foreign entity of concern" under the statute or the Department of Commerce's implementing regulations. Germany is an allied nation and a member of NATO, the European Union, and other multilateral frameworks that align with U.S. national security interests. Accordingly, VPI should remain eligible for CHIPS Act funding programs following the closing of the acquisition, subject to compliance with the guardrail provisions that restrict "covered entities" receiving federal incentives from engaging in significant transactions involving the expansion of semiconductor manufacturing capacity in "foreign countries of concern" — principally the People's Republic of China (including Hong Kong and Macau), the Russian Federation, the Islamic Republic of Iran, and the Democratic People's Republic of Korea.
However, HSAG's existing China subsidiary — Halcyon Semiconductor (Shanghai) Co., Ltd. — which reported FY2022 revenue of $81.4 million (representing approximately 1.3% of HSAG's total consolidated revenue) and which is limited to consumer-grade power management integrated circuits with no gallium-nitride ("GaN") or defense-related activities — will require careful analysis under the guardrail provisions. While the Shanghai subsidiary's current operations do not appear to constitute a per se disqualification, HSAG will need to commit to refraining from any material expansion of semiconductor manufacturing capacity at that facility for the duration of the ten-year guardrail period applicable to any CHIPS award. Proactive disclosure and careful management of this issue in both the CFIUS and CHIPS contexts will be critical.
This memorandum supplements the CFIUS Risk Assessment & Mitigation Strategy Memo dated June 20, 2023, and should be read in conjunction with the Preliminary CFIUS Jurisdiction Memorandum dated June 15, 2023, both of which were prepared in connection with this matter.
II. Background on the Transaction
A. Transaction Structure
HSAG (Halcyon Semiconductor Aktiengesellschaft) is a publicly traded German semiconductor company listed on the Frankfurt Stock Exchange (XETRA: HLC), with a market capitalization of approximately €14.8 billion as of June 1, 2023, and full-year 2022 consolidated revenue of €6.12 billion. HSAG is headquartered in Munich, Germany, and is a leading global manufacturer of analog and mixed-signal semiconductors, power management integrated circuits, and specialty sensor components. HSAG's shares are widely held, with no single shareholder holding more than 7% of outstanding ordinary shares. There is no ownership or control by any government of a foreign country of concern, and HSAG is not subject to the jurisdiction or direction of any such government.
HSAG proposes to acquire 100% of the outstanding equity of VPI (Marlowe Asset Management Photonics Inc.), a Delaware C-corporation incorporated on February 14, 2009, and headquartered at 7400 Ridgeline Parkway, Colorado Springs, Colorado 80919. VPI is currently owned by a consortium of private equity sponsors — principally Ridgecrest Ventures Fund III and Cascadian Capital Partners Growth Fund II — together with VPI's founders and certain members of management who hold equity participation.
The acquisition will be effected through Halcyon US Holdings Inc., a newly formed Delaware C-corporation incorporated on June 5, 2023, which will serve as the direct U.S. acquisition vehicle. Halcyon US Holdings Inc. is a wholly-owned subsidiary of HSAG and was formed for the sole purpose of consummating this transaction.
The total purchase price is $1.42 billion on a cash-free, debt-free basis, subject to customary working capital adjustments, plus a potential contingent earnout of up to $85 million payable over a three-year period following closing, based on the achievement of specified revenue and EBITDA milestones. The Stock Purchase Agreement ("SPA") was executed on June 10, 2023.
The acquisition financing consists of: (i) a $900 million senior secured term loan facility, with Meridian National Bank acting as administrative agent and Atlas Commercial Lending AG and Pacific Basin Credit Corp. serving as co-lead arrangers; and (ii) a $520 million equity contribution from HSAG through Halcyon US Holdings Inc. The financing commitments were obtained prior to execution of the SPA and are not subject to any conditions relating to CFIUS clearance, although the SPA itself contains a customary CFIUS clearance condition precedent to closing.
B. VPI's Semiconductor Business
VPI designs and manufactures advanced gallium-nitride ("GaN") power amplifier chips and high-electron-mobility transistor ("HEMT") modules used in defense radar systems, satellite communications platforms, and next-generation 5G wireless infrastructure. VPI is widely recognized within the U.S. defense industrial base as a leading domestic producer of GaN-on-silicon-carbide ("GaN-on-SiC") semiconductor devices for national security applications.
VPI operates a 45,000-square-foot GaN-on-SiC fabrication facility located at 9200 Innovation Boulevard, Albuquerque, New Mexico 87113 (the "Albuquerque Fab"). The Albuquerque Fab is a key strategic asset, housing advanced epitaxial growth, lithography, and testing capabilities purpose-built for GaN semiconductor fabrication. The facility holds a Facility Security Clearance ("FCL") at the SECRET level under the National Industrial Security Program ("NISP"), with CAGE Code 7VK92, and is subject to oversight by the Defense Counterintelligence and Security Agency ("DCSA").
VPI employs 486 individuals, of whom 212 hold active U.S. government personnel security clearances at the SECRET or TOP SECRET level. The workforce includes highly specialized semiconductor engineers, physicists, and technicians with expertise in III-V compound semiconductor materials, GaN epitaxial growth, and RF/microwave circuit design — skill sets that are in extremely limited supply within the United States.
For fiscal year 2022, VPI reported revenue of $287.4 million and EBITDA of $61.2 million. Approximately 67% of VPI's revenue is derived from contracts with the U.S. Department of Defense and other U.S. government agencies, with the balance attributable to commercial 5G infrastructure and satellite communications customers. VPI currently maintains 14 active contracts with the Department of Defense, representing an aggregate contract backlog of approximately $193 million.
VPI's products include defense articles classified under Category XI(a)(3) of the United States Munitions List ("USML"), as set forth in the International Traffic in Arms Regulations ("ITAR"), 22 C.F.R. Parts 120–130, as well as dual-use components classified under Export Control Classification Number ("ECCN") 3A001 of the Commerce Control List, as administered under the Export Administration Regulations ("EAR"), 15 C.F.R. Parts 730–774. VPI holds DDTC Registration No. M-24817 as a manufacturer and exporter of defense articles and defense services under the Arms Export Control Act, 22 U.S.C. § 2778.
VPI's intellectual property portfolio is substantial, consisting of 47 granted U.S. patents and 12 pending patent applications covering GaN-on-SiC device architectures, epitaxial growth processes, thermal management techniques, and RF power amplifier circuit designs. Several of these patents are subject to government-purpose rights under the terms of DoD research and development contracts.
C. HSAG's Existing U.S. and China Operations
HSAG currently maintains a U.S. presence through its existing subsidiary, Halcyon US Inc., located at 11501 Alterra Parkway, Suite 300, Austin, Texas 78758. Halcyon US Inc. operates as a fabless semiconductor design center with approximately 320 employees. The Austin facility does not perform classified work, does not hold a Facility Security Clearance, and is focused on the design of commercial automotive and industrial sensor products. Halcyon US Inc. has no involvement with ITAR-controlled defense articles or EAR-controlled dual-use items in the higher-tier ECCNs.
HSAG also maintains a subsidiary in the People's Republic of China: Halcyon Semiconductor (Shanghai) Co., Ltd. (the "Shanghai Subsidiary"). The Shanghai Subsidiary reported FY2022 revenue of $81.4 million, representing approximately 1.3% of HSAG's total consolidated revenue of €6.12 billion. The Shanghai Subsidiary's activities are strictly limited to the production and sale of consumer-grade power management integrated circuits for the Chinese domestic market — specifically, voltage regulators, DC-DC converters, and battery management ICs used in consumer electronics, home appliances, and electric mobility products. The Shanghai Subsidiary does not engage in any GaN semiconductor design or manufacturing, does not produce any defense-related or dual-use semiconductor components, and does not handle any ITAR-controlled defense articles or EAR-controlled items classified under ECCN 3A001 or comparable classifications. The Shanghai Subsidiary is a wholly-owned subsidiary of HSAG's intermediate holding company, Halcyon Asia Pacific Pte. Ltd. (Singapore).
The existence of the Shanghai Subsidiary is a material consideration for both the CFIUS review and the CHIPS Act eligibility analysis, as discussed in detail in Sections IV and VI below.
III. Overview of the CHIPS and Science Act
A. Legislative Purpose and Structure
The CHIPS and Science Act was enacted on August 9, 2022, as Public Law 117-167, following bipartisan passage in both chambers of Congress. The Act represents the most significant piece of U.S. industrial policy legislation directed at the semiconductor industry in decades and was motivated by growing concerns over the concentration of advanced semiconductor manufacturing capacity in East Asia — particularly in Taiwan and South Korea — and the potential national security vulnerabilities arising from U.S. dependence on foreign-sourced chips for defense, critical infrastructure, and advanced technology applications.
Title XCIX of the Act — formally titled the "Creating Helpful Incentives to Produce Semiconductors (CHIPS) for America Act" — establishes approximately $52.7 billion in federal incentives designed to catalyze domestic semiconductor manufacturing, research, and workforce development. The legislative intent is to restore U.S. competitiveness in semiconductor fabrication, reduce supply chain vulnerabilities, and ensure that the United States maintains access to leading-edge and defense-critical semiconductor technologies.
The principal funding programs established by the CHIPS Act include:
• CHIPS for America Fund — approximately $39 billion in direct financial assistance (grants, cooperative agreements, and other incentives) for the construction, modernization, and expansion of semiconductor manufacturing facilities in the United States;
• CHIPS for America Defense Fund — $2 billion specifically allocated for investments in defense-related semiconductor capabilities, including mature-node semiconductor production essential to national defense systems, administered by the Department of Defense;
• CHIPS for America International Technology Security and Innovation Fund — $500 million to support international information and communications technology security and semiconductor supply chain activities; and
• CHIPS for America Workforce and Education Fund — $200 million for workforce development activities, including training programs for semiconductor technicians and engineers.
The Act is implemented primarily by the U.S. Department of Commerce, acting through the National Institute of Standards and Technology ("NIST") and the CHIPS Program Office established within Commerce. The Department of Defense plays a co-implementation role with respect to the CHIPS for America Defense Fund and participates in the interagency evaluation of applications for manufacturing incentives where national security equities are implicated.
B. Types of Incentives
The CHIPS Act authorizes several categories of federal incentives for qualifying semiconductor investments:
Direct Financial Assistance. Under Section 9902 of the William M. (Mac) Thornberry National Defense Authorization Act for Fiscal Year 2021 ("FY2021 NDAA"), as added by the CHIPS Act, the Secretary of Commerce is authorized to provide direct financial assistance — in the form of grants, cooperative agreements, or other financial instruments — to covered entities for the construction, expansion, or modernization of semiconductor fabrication, assembly, testing, advanced packaging, or research and development facilities in the United States. The size of individual awards is expected to range from tens of millions to several billion dollars, depending on the scope and strategic significance of the proposed project.
Federal Loans and Loan Guarantees. In addition to direct grants, the Act authorizes the provision of federal loans and loan guarantees to support qualifying semiconductor manufacturing investments. These instruments are intended to reduce the cost of capital for large-scale fabrication facility construction and to de-risk private-sector investment in domestic semiconductor production.
25% Advanced Manufacturing Investment Credit. Section 107 of the CHIPS Act added new Section 48D to the Internal Revenue Code, establishing a 25% investment tax credit for "qualified property" placed in service in a "qualified semiconductor manufacturing facility" after December 31, 2022, and before January 1, 2027. This tax credit is discussed in detail in Section VIII of this memorandum.
Research and Development Incentives. The Act also establishes the National Semiconductor Technology Center ("NSTC"), a public-private consortium intended to advance semiconductor research, prototyping, and workforce development. The NSTC is envisioned as a hub for collaborative pre-competitive research involving industry, academia, and government partners.
C. Eligibility — General Requirements
To be eligible for CHIPS Act manufacturing incentives, an applicant must be a "covered entity," which is broadly defined to include any entity that is a semiconductor manufacturer, a fabless semiconductor company, or a semiconductor materials, parts, or equipment manufacturer. The definition is intentionally broad and is designed to encompass the full spectrum of the semiconductor supply chain.
Applications for manufacturing incentives must relate to facilities located in the United States. The Act is explicitly designed to incentivize domestic semiconductor production, and federal financial assistance may only be used for the construction, expansion, modernization, or operation of semiconductor facilities on U.S. soil.
Applicants must demonstrate that the funded activity will "meaningfully contribute" to the economic and national security of the United States. This criterion requires applicants to articulate the strategic significance of their proposed investment, including the types of semiconductors to be produced, the end-use applications, the impact on domestic supply chain resilience, and the contribution to U.S. technological leadership.
Additionally, covered entities receiving CHIPS incentives must agree to certain reporting, audit, and compliance requirements, including the submission of periodic progress reports, the maintenance of records for audit purposes, and compliance with the guardrail provisions discussed in the following section.
IV. Foreign Entity of Concern (FEOC) Guardrail Provisions
A. Statutory Framework — Section 9902(a)(6)
The CHIPS Act's guardrail provisions are among the most consequential elements of the legislation for purposes of the HSAG/VPI transaction. Section 9902(a)(6) of the FY2021 NDAA, as amended by the CHIPS Act, prohibits any "covered entity" that receives CHIPS Act federal financial assistance from engaging in any "significant transaction" involving the "material expansion of semiconductor manufacturing capacity" in any "foreign country of concern" for a period of ten (10) years from the date of the federal award.
The term "foreign countries of concern" is defined by cross-reference to existing statutory authorities and currently encompasses the People's Republic of China (including the Hong Kong Special Administrative Region and the Macau Special Administrative Region), the Russian Federation, the Islamic Republic of Iran, and the Democratic People's Republic of Korea. This list may be updated by the Secretary of Commerce in consultation with the Secretary of Defense, the Secretary of State, and the Director of National intelligence.
The term "foreign entity of concern" is defined under 42 U.S.C. § 18741(a)(5) and includes, among other categories:
(i) any entity that is owned by, controlled by, or subject to the jurisdiction or direction of a government of a foreign country of concern;
(ii) any entity organized under the laws of, or having its principal place of business in, a foreign country of concern;
(iii) any entity that is included on certain designated lists maintained by the U.S. government, including the Entity List (15 C.F.R. Part 744, Supplement No. 4), the Specially Designated Nationals and blocked Persons List (maintained by OFAC), and certain other lists; and
(iv) any entity owned or controlled by, or acting for or on behalf of, an entity described in any of the foregoing categories.
The consequences of violating the guardrail provisions are severe. A covered entity that is found to have engaged in a prohibited significant transaction involving the material expansion of semiconductor manufacturing capacity in a foreign country of concern is subject to clawback of the full amount of federal financial assistance received, plus additional penalties as determined by the Secretary of Commerce. The clawback provision is designed to serve as a powerful deterrent against circumvention and to ensure that federal incentive dollars are not used to subsidize the offshoring of semiconductor capacity to adversary nations.
B. Commerce Department Implementing Regulations (15 C.F.R. Part 231)
The Department of Commerce has undertaken rulemaking to implement the guardrail provisions. The Commerce Department published a proposed rule on March 21, 2023, and is expected to publish a final rule in September 2023 (the final rule was published on September 22, 2023, effective immediately, and is codified at 15 C.F.R. Part 231). While the final regulatory text was not yet available as of the date of this memorandum, the proposed rule and associated Commerce Department guidance provide substantial insight into the anticipated regulatory framework.
Based on the proposed rule and related Commerce Department statements, the key elements of the implementing regulations are expected to include the following:
Definition of "Significant Transaction." The proposed rule defines a "significant transaction" as any transaction that involves an investment of $100,000 or more that expands semiconductor manufacturing capacity in a foreign country of concern. This threshold is intentionally low and is designed to capture even relatively modest investments that could, in the aggregate, contribute to semiconductor capacity expansion in adversary nations.
Distinction Between Legacy and Advanced Semiconductors. The regulations distinguish between "legacy semiconductors" — generally, semiconductors manufactured using older process technologies (e.g., those with feature sizes above 28 nanometers for logic chips, above 128 layers for NAND flash memory, or above certain technology nodes for DRAM) — and "leading-edge" or "advanced" semiconductors. Transactions involving the expansion of advanced semiconductor manufacturing capacity in countries of concern are subject to the strictest restrictions, while transactions involving legacy semiconductors are subject to less restrictive but still applicable guardrails. Specifically, the expansion of legacy semiconductor capacity in a foreign country of concern may be permitted under certain limited circumstances, subject to notification and approval requirements, but may not exceed 10% of the covered entity's existing capacity in such country over the guardrail period.
Definition of "Material Expansion." The regulations establish quantitative thresholds for what constitutes a "material expansion" of semiconductor manufacturing capacity. These thresholds vary depending on whether the semiconductors at issue are legacy or advanced, and are calculated based on production capacity measured in wafer starts per month or equivalent metrics.
Notification and Pre-Approval Requirements. Covered entities that intend to engage in any transaction involving semiconductor manufacturing capacity in a foreign country of concern are required to provide advance notification to the Commerce Department, and certain categories of transactions require pre-approval. Failure to comply with the notification requirements may itself constitute a violation of the guardrail provisions.
C. Application to HSAG
The analysis of the guardrail provisions as applied to HSAG proceeds as follows:
HSAG Is Not a "Foreign Entity of Concern." HSAG is a publicly traded German Aktiengesellschaft headquartered in Munich, Germany. Germany is not a "foreign country of concern" under the CHIPS Act. HSAG is not owned by, controlled by, or subject to the jurisdiction or direction of the government of any foreign country of concern. HSAG's shares are widely held on the Frankfurt Stock Exchange, and no shareholder associated with a foreign country of concern holds a material ownership stake. Germany is a NATO ally, a founding member of the European Union, and a longstanding partner of the United States in multilateral export control regimes (including the Wassenaar Arrangement, the Missile Technology Control Regime, the Australia Group, and the Nuclear Suppliers Group). Accordingly, HSAG itself does not trigger the FEOC disqualification.
The Shanghai Subsidiary Requires Careful Analysis. Notwithstanding HSAG's status as a non-FEOC entity, HSAG's ownership of Halcyon Semiconductor (Shanghai) Co., Ltd. — a subsidiary operating in a foreign country of concern — introduces a layer of complexity into the guardrail analysis. The Shanghai Subsidiary is organized under the laws of the People's Republic of China and has its principal place of business in Shanghai. However, the Shanghai Subsidiary's FEOC status (to the extent it may be characterized as an entity organized in a foreign country of concern) does not automatically disqualify its parent, HSAG, or its sister subsidiary, VPI, from eligibility for CHIPS Act funding.
The critical question is not whether HSAG has a subsidiary in a foreign country of concern, but rather whether HSAG (or any member of its corporate group) would engage in a significant transaction involving the material expansion of semiconductor manufacturing capacity in a foreign country of concern during the ten-year guardrail period. The guardrail provisions are prospective in nature — they restrict future conduct, not the mere existence of prior operations. Existing operations in a foreign country of concern are not, standing alone, disqualifying.
Turning to the specifics of the Shanghai Subsidiary's operations:
• The Shanghai Subsidiary engages exclusively in the production and sale of consumer-grade power management integrated circuits. These are mature-node, commodity semiconductor products manufactured using process technologies well above the thresholds for "advanced" or "leading-edge" semiconductors.
• The Shanghai Subsidiary does not design, manufacture, or sell any GaN semiconductor devices, any defense-related products, any ITAR-controlled defense articles, any EAR-controlled dual-use items classified under ECCN 3A001, or any other semiconductor components that are associated with advanced or defense-critical technologies.
• The Shanghai Subsidiary's FY2022 revenue of $81.4 million represents approximately 1.3% of HSAG's total consolidated revenue of €6.12 billion — a de minimis share of HSAG's global business.
• Based on information provided by HSAG management (Dr. Friedrich Ehrhardt, CEO, and Katarina Brückner, SVP Corporate Strategy), HSAG does not currently have plans for material expansion of semiconductor manufacturing capacity at the Shanghai facility. This representation will need to be confirmed in writing and formalized as a binding commitment in connection with any CHIPS application.
Under the guardrail provisions, HSAG would need to commit to not materially expanding semiconductor manufacturing capacity at the Shanghai facility (or at any other facility in a foreign country of concern) for ten years from the date of any CHIPS award to VPI. Given the limited scope of the Shanghai operations and HSAG's apparent lack of expansion plans for that facility, this commitment should be achievable.
Recommended Approach. We recommend that HSAG proactively disclose the existence and scope of the Shanghai Subsidiary's operations in any CHIPS application submitted by VPI (or by HSAG on VPI's behalf). The disclosure should emphasize the following points: (i) the Shanghai operations are limited to consumer-grade power management ICs and do not involve any advanced, leading-edge, or defense-related semiconductors; (ii) the revenue from the Shanghai operations is de minimis relative to HSAG's global business; (iii) HSAG has no plans for material expansion of semiconductor manufacturing capacity in China; and (iv) HSAG is prepared to make binding commitments to refrain from such expansion during the guardrail period. Proactive disclosure and transparency will be essential to securing Commerce Department approval and avoiding subsequent compliance issues.
D. Practical Implications for VPI Post-Acquisition
VPI's Albuquerque Fab facility — a domestic GaN-on-SiC fabrication facility producing advanced semiconductor components for defense, satellite, and 5G applications — is precisely the type of U.S.-based semiconductor manufacturing capacity that the CHIPS Act was designed to incentivize. The Albuquerque Fab represents a nationally significant asset in the III-V compound semiconductor space, and VPI's products directly support the national defense mission. VPI is, in short, an ideal candidate for CHIPS Act funding.
VPI's defense-related semiconductor capabilities — including GaN HEMT power amplifier modules for radar systems (including the AN/TPS-80 G/ATOR program), satellite communications transponders, and Missile Defense Agency transmit/receive modules — align squarely with the priorities of the CHIPS for America Defense Fund, which was specifically established to support the domestic production of semiconductors essential to national defense.
Following the acquisition by HSAG, VPI would need to apply for CHIPS incentives as a subsidiary of a foreign-headquartered parent company. While the CHIPS Act does not contain a blanket exclusion for U.S. subsidiaries of foreign-headquartered companies, the application would need to address the foreign parent's status, including the FEOC analysis and guardrail compliance considerations discussed above. Commerce Department guidance issued in connection with the CHIPS Program Office's initial round of applications has indicated that foreign-headquartered companies with U.S. subsidiaries are eligible for CHIPS incentives, provided that the applicant demonstrates compliance with the guardrail provisions and the investment will meaningfully contribute to U.S. economic and national security. Several foreign-headquartered semiconductor companies — including companies based in Taiwan, South Korea, and Europe — have announced major U.S. fabrication facility investments with the expectation of receiving CHIPS incentives.
We recommend that VPI apply for CHIPS funding independently, as a standalone U.S. entity (specifically, as Marlowe Asset Management Photonics Inc., a Delaware C-corporation and wholly-owned subsidiary of Halcyon US Holdings Inc.), rather than as part of a broader HSAG group application. Applying as a standalone U.S. entity will simplify the eligibility analysis, reduce the complexity of the guardrail compliance assessment, and allow VPI to emphasize its U.S.-based operations, U.S. workforce, and U.S. defense mission without the need for extensive discussion of HSAG's global corporate structure. The application would, of course, need to disclose VPI's ultimate foreign parent and the corporate group's China operations, but the framing of VPI as the applicant entity — rather than HSAG — would be strategically advantageous.
V. Interaction Between CHIPS Act and CFIUS Review
A. Parallel but Distinct Processes
The CFIUS review of the HSAG/VPI transaction, conducted under the authority of Section 721 of the Defense Production Act of 1950, as amended, 50 U.S.C. § 4565, and the implementing regulations at 31 C.F.R. Part 800, is a national security review of the acquisition itself. CFIUS evaluates whether the transaction poses a risk to U.S. national security and, if so, whether such risk can be mitigated through the imposition of conditions (typically in the form of a National Security Agreement or National Security Agreement and Proxy Agreement) or whether the transaction should be prohibited.
CHIPS Act eligibility, by contrast, is a separate and independent determination made by the Department of Commerce regarding whether a covered entity qualifies for federal semiconductor incentive funding. The two processes are governed by distinct statutory authorities, administered by different (though overlapping) sets of agencies, and result in different types of government action.
However, the two processes share overlapping policy objectives and involve overlapping interagency stakeholders. Both CFIUS and the CHIPS Act are directed at protecting the U.S. semiconductor supply chain, preventing foreign adversary access to critical technologies, and strengthening domestic semiconductor manufacturing capacity. The Department of Defense, the Department of Commerce, and the intelligence community play significant roles in both contexts. From a practical standpoint, the personnel within these agencies who evaluate CFIUS filings in the semiconductor sector are often the same individuals (or closely coordinate with those) who evaluate CHIPS Act applications.
It is important to note that CFIUS clearance does not automatically confer CHIPS Act eligibility. An acquisition that receives CFIUS clearance — even with a fully executed NSA — must still independently satisfy the CHIPS Act's eligibility criteria and guardrail provisions. Conversely, CHIPS Act eligibility does not affect the outcome of a CFIUS review. The two determinations are made independently, on the basis of different legal standards, and neither precludes nor compels the other.
B. CFIUS Considerations Informed by CHIPS Act
Notwithstanding the independence of the two processes, there are significant strategic considerations at the intersection of CFIUS and the CHIPS Act that should inform our approach to the CFIUS filing and NSA negotiations.
First, CFIUS may view favorably a transaction in which the foreign acquiror credibly commits to maintaining or expanding U.S. semiconductor manufacturing capacity. The CHIPS Act reflects a bipartisan consensus that the United States must rebuild its domestic semiconductor manufacturing base, and a transaction that advances this objective — by bringing additional capital, technology, and market access to a U.S. semiconductor manufacturer — aligns with CFIUS's broader policy goals. HSAG's stated intention to invest in the expansion of VPI's Albuquerque Fab and to leverage VPI's GaN-on-SiC capabilities for both defense and commercial applications is consistent with these objectives and should be emphasized in the CFIUS filing.
Second, the NSA negotiation process may incorporate commitments that overlap with CHIPS Act guardrail requirements. For example, the NSA is expected to include provisions restricting the transfer of VPI's technology and intellectual property to HSAG's non-U.S. operations (including the Shanghai Subsidiary), requiring the implementation of cybersecurity controls consistent with NIST SP 800-171, mandating the segregation of VPI's classified and export-controlled data from HSAG's broader corporate IT infrastructure, and limiting the access of non-U.S. persons to VPI's facilities and information. Many of these requirements are directly analogous to — and would facilitate compliance with — the CHIPS Act's guardrail provisions.
Recommendation: In the CFIUS joint voluntary notice (to be filed on approximately July 14, 2023, Case No. CFIUS-023-07-3841), we should include a discussion of HSAG's commitment to maintaining VPI's U.S. semiconductor manufacturing footprint and its intention to preserve VPI's eligibility for CHIPS Act incentives. We should also reference HSAG's broader strategic rationale for the acquisition, which includes the desire to establish a significant GaN semiconductor manufacturing presence in the United States, consistent with the policy objectives of the CHIPS Act. This framing will help position the transaction as aligned with U.S. national security interests and may favorably influence the CFIUS agencies' evaluation.
C. NSA Provisions That May Facilitate CHIPS Compliance
The anticipated National Security Agreement for the HSAG/VPI transaction will likely include a comprehensive suite of security provisions designed to mitigate the national security risks associated with foreign ownership of VPI. Based on precedent NSAs in comparable semiconductor and defense-technology transactions, we expect the NSA to include the following provisions, among others:
• Technology Control Plan ("TCP"): A detailed plan governing the handling, storage, transmission, and access to VPI's classified and export-controlled technical data, including restrictions on the sharing of such data with HSAG's non-U.S. operations;
• Data Segregation Requirements: Physical and electronic segregation of VPI's classified and sensitive unclassified data from HSAG's broader corporate IT systems, with access controls implemented at the network, application, and user levels;
• Facility Access Restrictions: Limitations on the access of non-U.S. persons (including HSAG employees) to VPI's Albuquerque Fab and other secured facilities, with visitor approval procedures and escort requirements;
• Cybersecurity Requirements: Implementation of cybersecurity controls consistent with NIST SP 800-171 (Protecting Controlled Unclassified Information in Nonfederal Systems and Organizations) and, for classified work, compliance with NIST SP 800-53 and the Defense Federal Acquisition Regulation Supplement ("DFARS") cybersecurity clause at DFARS 252.204-7012;
• Government Security Committee ("GSC"): Establishment of a Government Security Committee consisting of cleared U.S. citizen board members and a Facility Security Officer responsible for the oversight of classified activities and compliance with the NSA; and
• Third-Party Compliance Monitoring: Appointment of an independent third-party compliance monitor (we understand that Whitmore Compliance Group LLC has been identified as a potential candidate) to conduct periodic audits and report to CFIUS on VPI's compliance with the NSA terms.
These NSA provisions serve a dual purpose in the CHIPS Act context. If VPI ultimately applies for CHIPS incentives, the existence of a robust NSA — with ongoing third-party monitoring, technology transfer restrictions, and cybersecurity controls — would demonstrate a strong compliance posture to the Commerce Department. The NSA would provide Commerce with assurance that VPI's operations remain insulated from the potential risks associated with foreign ownership and that the guardrail provisions will be respected. Moreover, the NSA's specific restrictions on VPI's interactions with HSAG's non-U.S. operations — particularly the Shanghai Subsidiary — would directly reinforce CHIPS guardrail compliance by establishing structural barriers to the transfer of CHIPS-funded technology or know-how to a foreign country of concern.
In short, the CFIUS process and the anticipated NSA are complementary to CHIPS Act compliance objectives. We should approach the NSA negotiations with an eye toward ensuring that the NSA terms not only satisfy CFIUS's national security requirements but also position VPI favorably for a subsequent CHIPS Act application.
VI. Potential Restrictions on VPI's CHIPS Act Participation Post-Acquisition
A. Application Timing Considerations
A threshold strategic question is whether VPI should apply for CHIPS Act incentives before or after the closing of the acquisition. Each approach presents distinct advantages and risks.
Pre-Closing Application. If VPI were to submit a CHIPS application before closing — while VPI is still owned by Ridgecrest Ventures Fund III, Cascadian Capital Partners Growth Fund II, and the founders — the application would benefit from VPI's status as a fully U.S.-owned entity, thereby avoiding the foreign ownership and FEOC guardrail issues altogether. However, this approach presents several significant complications. The subsequent change in ownership to HSAG (through Halcyon US Holdings Inc.) would need to be disclosed to the Commerce Department and could trigger a re-review of VPI's eligibility and the adequacy of its guardrail compliance commitments. Commerce may require HSAG's consent and commitments as part of the re-review process, effectively converting the application into a post-acquisition application. Additionally, submitting a CHIPS application while the CFIUS review is ongoing could create confusion between the two processes and potentially complicate the CFIUS timeline.
Post-Closing Application. If VPI applies for CHIPS incentives after the closing of the acquisition — as a wholly-owned subsidiary of Halcyon US Holdings Inc., which is in turn wholly owned by HSAG — the application would need to address HSAG's foreign parent status and the Shanghai Subsidiary's operations from the outset. While this approach requires VPI to confront the foreign ownership and guardrail issues directly, it has the advantage of presenting a complete and transparent picture to the Commerce Department, avoiding the complications of a mid-process ownership change, and allowing VPI to leverage the protections afforded by the fully-executed NSA.
Recommendation. We recommend that VPI defer any formal CHIPS application until after CFIUS clearance has been obtained and the acquisition has closed. This approach will avoid the complications of overlapping processes, allow VPI to present a complete application that addresses the foreign ownership structure and guardrail compliance commitments, and enable VPI to cite the fully-executed NSA as evidence of its strong compliance posture. VPI should begin preparation of CHIPS application materials during the first quarter of 2024, following the anticipated closing (targeted for approximately February 9, 2024, subject to satisfaction of all closing conditions, including CFIUS clearance and FAR 42.12 novation approvals).
B. National Security Guardrails Beyond FEOC
The CHIPS Act's guardrail provisions extend beyond the FEOC restrictions discussed in Section IV. Section 9902(a)(6)(C) of the FY2021 NDAA authorizes the Secretary of Commerce to impose additional conditions on awards that are necessary to safeguard the national security of the United States. These additional conditions may include, among other things:
• Restrictions on research activities involving foreign nationals of concern, including limitations on the employment or engagement of personnel who are nationals of foreign countries of concern in CHIPS-funded research and development activities;
• Requirements for enhanced security protocols at CHIPS-funded facilities, potentially exceeding those otherwise applicable under the NISP or standard commercial cybersecurity frameworks;
• Restrictions on the publication or dissemination of research results generated with CHIPS funding in a manner that could benefit foreign adversaries; and
• Requirements for supply chain integrity, including restrictions on the use of semiconductor manufacturing equipment, materials, or components sourced from foreign countries of concern in CHIPS-funded fabrication processes.
These additional national security guardrails may intersect with the Technology Control Plan provisions of the NSA. For example, the NSA's TCP is expected to restrict the access of HSAG's non-U.S. person employees to VPI's classified and export-controlled information. Similarly, CHIPS award conditions may restrict the involvement of non-U.S. nationals in CHIPS-funded research and development activities. To the extent possible, these requirements should be harmonized to avoid duplicative or conflicting compliance obligations.
HSAG personnel who are non-U.S. persons would be restricted from accessing CHIPS-funded technology and facilities under both the NSA and potential CHIPS award conditions. This restriction would apply to HSAG's German employees, its employees in other non-U.S. locations, and — most significantly — any employees of the Shanghai Subsidiary. The structural separation between VPI and HSAG's non-U.S. operations, as mandated by the NSA, would support compliance with these restrictions.
C. Clawback and Enforcement Risks
The CHIPS Act's clawback provisions represent a significant financial risk that must be carefully managed. If VPI receives CHIPS funding and HSAG subsequently engages in a prohibited significant transaction involving the material expansion of semiconductor manufacturing capacity in a foreign country of concern — including, most relevantly, any material expansion of the Shanghai Subsidiary's semiconductor operations — VPI would be subject to clawback of the full amount of federal financial assistance received, plus additional penalties.
The clawback risk is not limited to actions taken by VPI itself. Because the guardrail provisions apply to the "covered entity" and its affiliates, any material expansion of semiconductor capacity in a foreign country of concern by any member of the HSAG corporate group — including HSAG's parent company, any intermediate holding company, or any subsidiary — could trigger the clawback with respect to VPI's CHIPS award. This creates a situation in which VPI's eligibility for CHIPS funding is, in effect, contingent on the conduct of the entire HSAG corporate group over a ten-year period.
This risk should be factored into HSAG's overall strategic planning for its China operations. As a practical matter, HSAG must determine whether the continued operation of the Shanghai Subsidiary is strategically necessary given the potential implications for both CHIPS Act eligibility and the CFIUS review. The Shanghai Subsidiary's $81.4 million in annual revenue, while not insignificant in absolute terms, represents only 1.3% of HSAG's total revenue. If the continued operation of the Shanghai Subsidiary could jeopardize VPI's eligibility for tens or hundreds of millions of dollars in CHIPS incentives and tax credits, a cost-benefit analysis may favor the divestiture or wind-down of the Shanghai operations.
We note separately that the CFIUS review may independently raise concerns about HSAG's Shanghai operations. The CFIUS agencies' preliminary national security concerns, if and when issued (anticipated in October 2023), may address the Shanghai Subsidiary and may require commitments regarding the segregation of VPI's activities from the Shanghai operations. Any such CFIUS-imposed restrictions would complement the CHIPS Act guardrail requirements.
VII. CHIPS for America Defense Fund — Special Considerations for VPI
A. Overview of the Defense Fund
The CHIPS for America Defense Fund was established with an allocation of $2 billion to support investments in semiconductor manufacturing capabilities essential to national defense. The Defense Fund is administered by the Department of Defense, in coordination with the Department of Commerce, and is specifically designed to address the defense industrial base's dependence on domestic semiconductor production capacity for critical defense systems.
The Defense Fund's priorities include the production of mature-node semiconductors (including compound semiconductors such as GaN and gallium arsenide) that are essential for defense applications but that may not be commercially attractive at scale, as well as the development of trusted and assured semiconductor supply chains for classified and sensitive defense programs. VPI's GaN power amplifier chips and HEMT modules — which are used in defense radar systems (including the AN/TPS-80 Ground/Air Task-Oriented Radar program), satellite communications transponders, and Missile Defense Agency transmit/receive modules — are squarely within the Defense Fund's scope.
The Defense Fund represents a particularly attractive opportunity for VPI because the fund's mandate is specifically tailored to the types of semiconductors VPI produces and the types of defense programs VPI supports. Unlike the broader CHIPS for America Fund, which is primarily focused on high-volume logic and memory semiconductor fabrication, the Defense Fund is focused on specialized, lower-volume compound semiconductor capabilities that are critical to national defense but that may not attract sufficient private investment without federal support.
B. Eligibility of Defense Contractors Under Foreign Ownership
VPI's status as a defense contractor under foreign ownership introduces additional considerations for the Defense Fund application. VPI currently holds a Facility Security Clearance at the SECRET level (CAGE Code 7VK92) under the NISP, and 212 of its 486 employees hold active U.S. government personnel security clearances. The continued maintenance of VPI's FCL post-acquisition is a prerequisite for both VPI's ongoing performance of classified defense contracts and its potential eligibility for Defense Fund awards.
Following the acquisition by HSAG, VPI will operate under a National Security Agreement that functions as a Special Security Agreement ("SSA") equivalent under the NISP Operating Manual (DoD 5220.22-M, now superseded by 32 C.F.R. Part 117). The SSA structure provides for the establishment of a Government Security Committee consisting of cleared U.S. citizen directors who are responsible for the oversight of VPI's classified operations and who serve as the interface between VPI and the U.S. government on security matters. Col. (Ret.) Bryce Hendrickson has been identified as the candidate for the role of Facility Security Officer and a member of the GSC, bringing extensive experience in defense security administration and industrial security program management.
The Defense Fund may impose additional restrictions on entities operating under foreign ownership, even where the foreign owner is an allied-nation company such as HSAG. These additional restrictions could include enhanced reporting requirements, additional oversight by the Defense Counterintelligence and Security Agency, or limitations on the scope of Defense Fund awards available to foreign-owned entities. We do not anticipate that these additional restrictions would be prohibitive, but they should be factored into the application strategy.
The GSC structure under the NSA, combined with the third-party compliance monitoring by Whitmore Compliance Group LLC, would help demonstrate to the Department of Defense that VPI's classified defense work remains under robust U.S. government oversight notwithstanding the change in ownership. This compliance infrastructure would strengthen VPI's Defense Fund application by providing assurance that Defense Fund investments will be adequately protected.
We recommend engaging with the Department of Defense — which is expected to serve as a co-lead agency in the CFIUS review — to explore whether DoD would support a VPI Defense Fund application post-closing. Early engagement with DoD on this question could yield valuable insights into the agency's receptivity and any additional requirements that may be imposed.
C. Coordination with Active Government Contracts
VPI's 14 active contracts with the Department of Defense, representing an aggregate backlog of approximately $193 million, demonstrate established and deep relationships with key defense customers. These existing contractual relationships are a significant asset for purposes of a Defense Fund application, as they establish VPI's track record of reliable performance in support of national defense programs.
VPI's principal active defense contracts include the following:
• U.S. Army CERDEC (Communications-Electronics Research, Development and Engineering Center): Contract value of $52.3 million for the development and production of GaN power amplifier modules for next-generation electronic warfare systems;
• Air Force Research Laboratory (AFRL): Contract value of $41.7 million for research and development of advanced GaN-on-SiC device architectures for airborne radar applications;
• Missile Defense Agency (MDA): Contract value of $38.9 million for the production of transmit/receive modules for ground-based and sea-based missile defense radar systems;
• Subcontract to Ironclad Defense Systems Inc. for NAVSEA (Naval Sea Systems Command): Subcontract value of $34.1 million for GaN power amplifier components integrated into shipboard electronic systems; and
• Department of Homeland Security, Science and Technology Directorate (DHS S&T): Contract value of $26.0 million for the development of GaN-based sensor components for border security and critical infrastructure protection applications.
These contracts not only demonstrate VPI's importance to the defense industrial base but also represent potential demand signals for the types of semiconductors that a CHIPS Defense Fund investment would support. A Defense Fund application by VPI could credibly argue that federal investment in VPI's GaN fabrication capabilities would directly support the production of semiconductors required by these and future defense programs.
We note that eight of VPI's 14 active DoD contracts will require novation proceedings under FAR 42.12 following the change in ownership to HSAG. Novation is the process by which the government formally recognizes a new contractor entity (or a new parent of the existing contractor) as the successor to the rights and obligations of the original contractor. The novation proceedings should be initiated promptly after closing to ensure continuity of contract performance and to avoid any disruption to VPI's defense contract activities. The timely completion of novation proceedings will also be relevant to the Defense Fund application, as Commerce and DoD will want assurance that VPI's defense contract relationships will survive the ownership transition intact.
VIII. 25% Advanced Manufacturing Investment Tax Credit (Section 48D IRC)
A. Overview
Section 107 of the CHIPS Act added new Section 48D to the Internal Revenue Code, establishing a 25% investment tax credit (the "Advanced Manufacturing Investment Credit" or "Section 48D Credit") for "qualified property" placed in service in a "qualified semiconductor manufacturing facility" after December 31, 2022, and before January 1, 2027 (with construction-commencement requirements extending through 2029 for certain projects).
For purposes of the credit, "qualified property" includes tangible depreciable property that is an integral part of the operation of a semiconductor manufacturing facility, including fabrication equipment, cleanroom infrastructure, testing and metrology tools, and other capital assets used in the manufacturing process. "Qualified semiconductor manufacturing facility" means any facility for which the primary purpose is the manufacturing of semiconductors or semiconductor manufacturing equipment, located in the United States.
The 25% credit is elective and is claimed on the taxpayer's U.S. federal income tax return for the taxable year in which the qualified property is placed in service. The credit is subject to the same guardrail provisions applicable to direct CHIPS incentives — that is, the taxpayer must not engage in any significant transaction involving the material expansion of semiconductor manufacturing capacity in a foreign country of concern during the applicable period.
B. Interaction with Foreign Ownership
Critically, the Section 48D credit does not contain an explicit foreign ownership exclusion. The credit is available to any taxpayer that places qualified property in service in a qualified semiconductor manufacturing facility in the United States, regardless of the taxpayer's ultimate ownership structure. This means that VPI, as a Delaware C-corporation filing U.S. federal income tax returns, would be eligible to claim the Section 48D credit for qualifying capital expenditures at the Albuquerque Fab notwithstanding VPI's ownership by a German parent company.
HSAG, as a German parent, does not trigger the FEOC disqualification for purposes of the Section 48D credit, for the same reasons discussed in Section IV.C above. However, the credit is subject to the guardrail provisions, which require that the taxpayer (and its affiliates) not engage in any significant transaction involving the material expansion of semiconductor manufacturing capacity in a foreign country of concern. Accordingly, HSAG's Shanghai operations would need to be managed in the same manner described above — i.e., HSAG must commit to refraining from material expansion of the Shanghai facility during the applicable period.
The specific tax structure for claiming the Section 48D credit should be analyzed in consultation with Pemberton Kline LLP, VPI's transaction tax advisor (engagement partner: Richard Pemberton). Key issues for Pemberton Kline to address include: (i) the appropriate entity-level structure for maximizing the credit (i.e., whether the credit should be claimed by VPI directly or by Halcyon US Holdings Inc.); (ii) the treatment of the credit under the consolidated return rules, if applicable; (iii) the interaction of the credit with the purchase price allocation under Section 338(h)(10) or Section 1060, if relevant; and (iv) the availability of the credit for capital expenditures incurred in connection with any post-acquisition fab expansion.
C. Strategic Value
The Section 48D credit could provide substantial tax benefits for VPI's current and planned capital expenditures. HSAG has indicated that a key strategic rationale for the acquisition is the opportunity to invest in the expansion and modernization of VPI's Albuquerque Fab, including the potential addition of a new clean room wing, the installation of next-generation epitaxial growth equipment, and the upgrade of existing lithography and testing tools. These capital expenditures, if qualifying under Section 48D, would be eligible for a 25% investment tax credit, potentially yielding tens of millions of dollars in tax savings.
The Section 48D credit should be factored into the overall return-on-investment analysis for the $1.42 billion acquisition. To the extent that HSAG plans significant post-acquisition capital expenditures at the Albuquerque Fab — and to the extent those expenditures qualify for the 25% credit — the effective after-tax cost of the fab expansion would be materially reduced. This consideration strengthens the economic case for the acquisition and provides an additional incentive for HSAG to maintain VPI's CHIPS Act eligibility.
IX. Recommendations
Based on the analysis set forth in this memorandum, we make the following recommendations:
A. CFIUS Filing Strategy
1. Include CHIPS Act Discussion in CFIUS Filing. The joint voluntary notice (to be filed on approximately July 14, 2023, CFIUS Case No. CFIUS-023-07-3841) should include a substantive discussion of HSAG's commitment to maintaining and expanding VPI's U.S. semiconductor manufacturing capacity and VPI's eligibility for CHIPS Act incentives. This discussion should frame the acquisition as consistent with the policy objectives of the CHIPS Act and should highlight the benefits to the U.S. semiconductor supply chain and defense industrial base.
2. Proactively Disclose Shanghai Operations. The notice and all subsequent RFI responses should proactively disclose the existence and scope of HSAG's Shanghai Subsidiary operations, emphasizing the limited scope of those operations (consumer-grade power management ICs only, $81.4 million in revenue representing approximately 1.3% of HSAG total revenue, no GaN or defense-related activities). Proactive disclosure will build credibility with the CFIUS agencies and avoid any perception that HSAG is attempting to conceal material information.
3. Align NSA Terms with CHIPS Eligibility. In the NSA negotiations, we should seek provisions that are consistent with, and do not inadvertently undermine, VPI's eligibility for CHIPS Act incentives. In particular, the Technology Control Plan, data segregation requirements, and restrictions on VPI's interactions with HSAG's China operations should be structured to reinforce CHIPS guardrail compliance. We should avoid NSA terms that could be interpreted as evidence of unresolved national security risks that might give the Commerce Department pause in evaluating a CHIPS application.
B. CHIPS Act Application Planning
1. Defer Formal Application. VPI should defer any formal CHIPS application until after CFIUS clearance has been obtained and the transaction has closed. This approach avoids the complications of overlapping regulatory processes and allows VPI to present a complete and transparent application to the Commerce Department.
2. Begin Preparatory Work. Notwithstanding the recommendation to defer the formal application, VPI should begin preparatory wo