Investment control in Germany in the context of the European legal framework and its impact on M&A transactions

1. Introduction¹

The legal framework for investment control is advancing: After the provisions of German foreign trade law were strengthened at the end of 2018, the new Regulation (EU) 2019/452 of the European Parliament and of the Council of 19 March 2019 establishing a framework for the screening of foreign direct investments into the Union came into force on 10 April 2019. The regulation must be implemented from 11 October 2020, and its focus lays on the improvement of the cooperation between the EU Member States and the EU Commission. Although foreign direct investment contributes to economic growth in the Union by enhancing competitiveness, creating jobs and economies of scale, bringing in capital, technology, innovation and expertise and opening up new markets for the Union’s exports, and thereby supporting the objectives of the Investment Plan for Europe², there was an increasing desire for the establishment of a tool that ensures that investment from outside the EU actually corresponds to the EU’s interest.³

It did not take the German legislator long to react after Regulation (EU) 2019/452 came into force: On 8 April 2020, the Federal Cabinet initiated an amendment to the Foreign Trade and Payments Act [Außenwirtschaftsgesetz, AWG] and thus acted promptly upon the modifications of the European legal provisions (the “draft bill”).⁴
Both the number of foreign investments and the number of audit procedures conducted by the Federal Ministry of Economic Affairs and Energy (“BMWi”) had already gradually increased in recent years. Compared to 2017, the number of investment reviews has almost doubled. From 2018 to 2019, the number of cases reviewed rose from 78 to 107.⁵ This dynamic development requires every M&A advisor to be equipped to identify investment control notification requirements in cross-border transactions at an early stage and to conduct a risk assessment. This article aims to provide an overview of the current German and European provisions in order to meet this need.

2. Current situation in Germany

2.1 General restrictions on commercial transactions

The generally free movement of goods, services, capital, payments and other com-mercial transactions with foreign countries as well as the movement of foreign assets and gold between domestic residents (foreign trade) and the associated freedom of investment (see section 1(1) AWG) may be restricted in Germany, inter alia, to protect public security and order (section 4 AWG). The most significant restrictions for M&A in practice are country-related restrictions (embargoes, in particular e.g. the embargo on Iran and Russia), goods-related restrictions, person-related restrictions and the foreign investment review which this article elaborates.

2.2 Restrictions imposed by the Foreign Trade and Payments Ordinance

The movement of capital in form of M&A transactions is restricted by division 2 (examination of corporate acquisitions) of chapter 6 of the Foreign Trade and Payments Ordinance [Außenwirtschaftsverordnung] (“AWV”).
According to these provisions, the BMWi can examine whether a direct or indirect acquisition by non-European investors endangers public security or order in Germany. If it does, it can prohibit the acquisition or issue restrictions. However, prohibitions or restrictions may only be issued with the consent of the Federal Government.⁶

A situation quite frequently encountered in practice is the so-called cross-sectoral examination (Section 55 AWV et seq.).⁷ Any type of industry can be subject to the cross-sectoral examination. By way of example, section 55(1) sentence 2 nos. (1) to (6) AWV lists target companies which are operators of so-called critical infrastructures. Critical infrastructure sectors include energy, water, information technology and telecommunications, finance and insurance, health, transport and traffic, and food.⁸ In 2018, media companies have been added to the list.

(1) Scope/application threshold

The BMWi’s power to review and to issue prohibitions only applies to acquisitions of a domestic company or direct or indirect shareholdings in such a company by a non-EU resident.⁹ The term resident is defined in section 2(15) AWG. Accordingly, in the case of legal persons or partnerships, the residency is defined by their legal domicile or their headquarters.¹⁰
Formerly, the application threshold required an investment of at least 25% of the voting rights. However, the Twelfth Amending Ordinance to the AWV from 2018 narrowed this rule.¹¹ With regard to the examples listed in section 55(1) sentence 2, section 56(1) AWV significantly lowered the application threshold for affected investments, namely to 10%.¹² For other companies, the application threshold for cross-sectoral examination remained at 25%.

While the application threshold and the threshold for allocation of shares of 25% of the voting rights can be explained by reference to a blocking minority under corporate law and therefore a plausible (negative) influence on the management of the company affected, even in a company with many shareholders, this does not apply to a 10 % share of the voting rights, which is why the lowering was criticized by some.¹³

Although the 10% threshold only applies to the companies referred to in section 55(1) sentence 2 nos. (1) to (6) AWV, the non-exhaustive nature of this provision makes it prudent for legal advisors to adopt a careful approach and thus to conservatively assume a 10% application threshold. After all, it is at the BMWi’s discretion to extend the scope of the 10% application threshold to other areas which are not explicitly listed in section 55(1) sentence 2 nos. (1) to (6) AWV.¹⁴

(2) Threat to security and public order

The concept of danger to public security and order resulting from an acquisition is not to be confused with the terms within the scope of police law.¹⁵

Instead, the legal definition in section 5(2) AWG shall be used for reference. According to this definition, a state intervention in a company takeover requires an actual and sufficiently serious threat to a fundamental interest of society.¹⁶ This requires facts justifying the assumption that the investor’s influence will impair the security of supply to the population in the areas mentioned in section 55(1) sentence 2 AWV or that services provided by a company or knowledge of such services will be used in a manner detrimental to the Federal Republic of Germany.¹⁷ The BMWi reserves the right to individually examine further cases to assess whether they present a risk, particularly if none of the examples mentioned in section 55(1) sentence 2 AWV applies.¹⁸

(3) Cross-sectoral examination procedure

The cross-sectoral examination process comprises two stages.¹⁹

During a preliminary three-month period, the BMWi determines whether to open an examination procedure. In this case, the acquirer and the domestic company are notified in writing and all companies involved in the acquisition are requested to submit the documents required for the examination. It is advisable to comply with this request as soon as possible as the BMWi’s four-month review period following the preliminary ex-amination only begins once all the requested documents have been submitted, as per section 59(1) sentence 1 AWV.

The total review period may therefore be seven months or more. Since section 55(3) AWV was amended in 2017, this period no longer begins on the date the transaction is concluded, but when the BMWi obtains actual knowledge of the transaction, or in the case of public offers, when it obtains knowledge of the publication of the decision to submit an offer.

However, the examination procedure may not be opened later than five years after signing of the transaction documents (section 55(3) sentence 6 AWV).

According to section 55(4) AWV, acquirers must report transactions if they fall within the examples listed in section 55 (1) sentence 2 AVW.²⁰

It is also possible to apply for a certificate of non-objection in accordance with section 58(1) AWV. If the BMWi does not open an examination procedure within two months after receipt of this more comprehensive²¹ application, the certificate is deemed to have been granted. The certificate of non-objection certifies to the acquirer that there are no concerns with regard to public security or order. However, in the event that the BMWi opens an examination, the additional review period is also four months, so that the entire review can take at least six months.

(4) Legal consequences

Cross-sectoral acquisition transactions within the meaning of section 55(1) AWV are effective from the outset, but pursuant to section 15(2) AWG they are subject to the condition subsequent of prohibition by the BMWi during the examination procedure.
It must be assumed that these provisions will be narrowed to the detriment of the affected parties in the future: The revised version of section 15(3) AWG in the draft bill provides that the completion of any acquisition which is subject to reporting require-ments will be provisionally ineffective while the investment review is ongoing. This change provides another reason why it is highly advisable to inform the BMWi at an early stage of a potential affected transaction in order to avoid the risk of rescission for up to 5 years after the transaction was signed (see above).

3. Regulation (EU) 2019/452 (“FDI Regulation”)

The FDI Regulation constitutes a binding legal act in all Member States and must be fully implemented by the Federal Republic of Germany from 11 October 2020, cf. Art. 288(2) TFEU.

The FDI Regulation does not provide for full harmonisation of investment control. Alt-hough the new regulation establishes a framework for the screening of non-European investments into the EU, it does not introduce an independent review mechanism. Likewise, it does not determine which investments must be screened. The Member States remain responsible for maintaining, amending or adopting screening mecha-nisms (Art. 3(1) FDI Regulation). All Member States therefore remain competent for decisions on direct investments.²²

Instead, the new regulation focuses on the exchange of information and cooperation between the Member States and the EU Commission and between the Member States themselves.²³

3.1 Direct investments/ public security and order

The FDI Regulation also refers to direct investment into the Member States. Direct investment is defined as foreign investment that establishes lasting and direct links with an enterprise pursuant to Art. 2(1) FDI Regulation. However, unlike German foreign trade law, the EU Regulation does not set a shareholding threshold for direct investment and is therefore much broader in scope than the provisions of the AWV. The only exception relates to portfolio investments.²⁴ Even lasting and direct links with the target company are covered and even a mere “effective participation in the management or control”.²⁵

In order to fall within the scope of the FDI Regulation, direct investment must be likely to affect public security or order. This constitutes another major difference in compari-son to the national provisions in Germany and results in the extension of the transactions possibly covered by the law. The German laws, as seen above, require a real and serious threat.

However, the German national laws may soon be aligned with the FDI Regulation. The draft bill provides that in the future, the term “likely to affect” public security and order will be sufficient as a criterion to justify a review.²⁶ In this event, taking investment control measures would be much easier for authorities, which would ultimately lead to a stricter legal frame.

In order to determine whether a foreign direct investment is likely to affect public secu-rity or order, Art. 4 FDI Regulation provides extensive screening mechanisms and ex-amples that must be taken into account when interpreting the terms public security and order.

3.2 Cooperation mechanisms

Although the screening of foreign (non-EU) direct investment is still within the compe-tence of each Member State (in Germany, the BMWi in accordance with sections 55 ff. AWV), the interests of other Member States will increasingly influence national proce-dures due to the focus on the new cooperation mechanisms which were introduced in Art. 6 ff. of the FDI Regulation.

The regulation distinguishes between two different cases: On the one hand, Art. 6 FDI Regulation contains cooperation mechanisms in relation to screening procedures car-ried out by a Member State. On the other hand, Art. 7 FDI Regulation relates to cooperation mechanisms in cases where a direct investment has taken place without screening by the competent Member State (i.e. by the BMWi in Germany).

(1) Cooperation mechanism for transactions undergoing screening, Art. 6 FDI Regulation

Direct investments that are undergoing screening by an individual Member State must be notified by the Member State to the EU Commission and the other Member States pursuant to Art. 6(1) FDI Regulation. The scope of the information obligation is governed by Art. 9 FDI Regulation.²⁷

After no more than 15 calendar days, other Member States or the Commission must inform the Member State undertaking the screening whether they intend to provide comments or opinions, see Art. 6(6) FDI Regulation. According to Art. 6(3) FDI Regu-lation, the Commission will issue an opinion if it considers that a foreign direct investment is likely to affect public security or order in more than one Member State. The actual comments or opinion must then be sent to the state undertaking the screening within 35 days of receipt of the notification of the direct investment.

The state undertaking the screening must give due consideration to the comments and the opinion. If a foreign direct investment is likely to affect projects or programmes of the Union´s interest,²⁸ Art. 8(2)(c) FDI Regulation additionally augments the state’s screening obligation by requiring it to take utmost account of the Commission’s opinion.
Overall, while this does not establish an obligation to decide in favour of the opinion or the comments, it does result in Union´s interests becoming a standard of review of its own within the BMWi’s examination.²⁹ They could even be the crucial factor in a discre-tionary decision.³⁰ In this respect, the draft bill so far provides that, when interpreting the undefined legal term “public security and order”, the public security and order of another Member State of the European Union as well as projects or programmes of Union interest must be taken into account (Section 5(2) AWG (see above, paragraph 1.2.2), section 4(1) no. 4 AWG as amended).

In addition, it is unclear how the time limits which need to be incorporated in the national rules affect the German procedure. Since, as set out above, pursuant to section 59(1) sentence 1 AWV, the BMWi has the power to prohibit a transaction or to issue re-strictions to the acquirer within a period of four months from receipt of all requested documents, the BMWi should have sufficient time after receipt of the comments or an opinion within 35 days to balance all interests and reach an appropriate decision.³¹ The same conclusion applies to the non-objection certificate within the meaning of section 58(1) AWV. As set out above, according to this provision, the non-objection certificate is deemed to have been granted after two months if the BMWi does not open an exam-ination procedure within this period. If all periods of the cooperation mechanism are ful-ly utilized, the BMWi will receive the relevant comments and opinions from the Com-mission or other Member States within 35 days. This leaves a bit less than a month for the examination of the application for a certificate of non-objection. After extending the period until the non-objection certificate is deemed granted from one to two months in 2017, a further extension of the period should be avoided in the interests of transaction security and expediency. In the few ambivalent cases, the BMWi can open an exami-nation which will extend the relevant periods.

(2) Cooperation mechanism for transactions not undergoing screening, Art. 7 FDI Regulation

The obligation to cooperate does not cease to apply in cases where the target country of the transaction would generally not carry out a review. According to Art. 7(1) FDI Regulation, a Member State which considers that a transaction planned or even com-pleted in another Member State which is not undergoing screening in that Member State affects its public security or order, may submit comments to that Member State. The EU Commission is equally entitled to this.

In accordance with Art. 7(6) FDI Regulation, the time limit for the other Member States is also 35 calendar days from receipt of the information on the transaction. If the Commission’s opinion follows comments from other Member States, the Commission has an additional 15 calendar days to issue the opinion. The period for the submission of opinions or comments cannot exceed 15 months from the signing of the transaction, in accordance with Art. 7(8) FDI Regulation.

These rules may lead to legal uncertainty in practice: If the BMWi had knowledge of the transaction (and therefore the five-year period pursuant to section 55(3) sentence 1 AWV does not apply, see above), the question arises as to how the BMWi shall react after the expiry of the three-month period pursuant to section 55(3) sentence 1 AWV, which cannot be extended. Assuming that the BMWi is informed of the transaction (which will be the case for most relevant transactions), and it concludes that German interests are not endangered, it will not open an examination within the three-month period. In this event, no comments from other European countries could be taken into account, should they be issued afterwards. This is because under current law, the BMWi cannot reopen the procedure.

However, one will be led to the conclusion that the three-month period is redundant in these cases, as the obligation under the FDI Regulation to take account of the com-ments and the opinion is binding in Germany pursuant to Art. 288 TFEU³², as laid out above. It can therefore not be excluded that reopening the procedure will be deemed possible.³³ A practical solution would be for the BMWi to notify the other Member States without undue delay pursuant to Art. 9 FDI Regulation, of a relevant transaction of which it has acquired knowledge but which it does not wish to examine, in order to be able to respond to any comments or opinions within the three-month period, should they be submitted.

In order to achieve legal certainty for transactions, the legislator is urgently required to adapt the existing provisions.³⁴ The draft bill announces further adaptations and amendments to German investment review law within the scope of the Foreign Trade and Payments Ordinance.

(3) Exchange of information and confidentiality

According to Art. 9(1) FDI Regulation, Member States must ensure that the information required by other Member States and the Commission to examine the facts is made available. Art. 9(2) FDI Regulation stipulates which information is included. Art. 9(2) requires disclosure of the ownership structure of the investor (including information on the ultimate, i.e. beneficial investor with its equity ownership), the products, services and business transactions of the foreign investor and the target company, the main countries in which business transactions are to be carried out, the financing of the investment and the source of the financing. It remains to be seen how much detail needs to be provided to meet the individual requirements. Comprehensive disclosure obliga-tions could require the disclosure of confidential information and business secrets. In cases of doubt, close cooperation with the BMWi should be sought at an early stage if critical business secrets may be affected.

4. Conclusion

The BMWi will still have the final say in deciding whether a transaction is authorized or prohibited, but the review process is expected to become more complex and time-consuming. In particular, the cooperation mechanism at European level will have an impact on the duration of national investment control procedures and therefore on the duration of the affected transactions. Advisors and investors should take this into ac-count when planning transactions. There is also a risk that applications for a non-objection certificate may lead to examination proceedings being opened, simply because opinions and comments from other Member States or the EU Commission can-not be sufficiently considered due to the short period of time until the non-objection cer-tificate is deemed granted. However, this will likely remain an exceptional case, so that a general extension of the review period until the non-objection certificate is deemed granted is not necessary.

A positive effect results from the fact that Art. 4 FDI Regulation (determining whether public security or order is affected) assists with the interpretation of the essential but broad legal term of public security and order. It can be assumed that the examples included in Art. 4 FDI Regulation must also be considered when applying the German AWV, thereby leading to increased legal certainty. ³⁵
The provisions of the FDI Regulation lead to an exchange of highly confidential information among a large number of people. This is a challenge for M&A transactions in which confidentiality is typically highly valued. There are various technical solutions to ensure that the group of people who receive confidential information is kept limited. It would be desirable to either grant the affected parties a legal right to sufficient protection of their legitimate interest in confidentiality or at least to ensure sufficient transparency about the measures taken to protect confidentiality.
Where there is a risk that the transaction may be affected by a foreign trade provision, it is advisable to report the transaction early in order to obtain legal certainty as quickly as possible. The structural disadvantage of foreign investors compared to European investors in competing for the acquisition of a European company has increased. It remains to be seen how this will affect important non-European investments.

There is a need for further harmonisation between the German investment control provisions and the FDI Regulation. It would be desirable if, the current draft bill and the announced revision of the AWV were used for this purpose in the further legislative procedure.
However, according to the announcement by the Minister of Economic Affairs, Peter Altmaier, they will be used to tighten the “very liberal” foreign trade law to account for German security interests. In the legislative procedure that has now been initiated, the experiences related to the Corona pandemic will also play a role. It remains to be seen to what extent the changes announced will affect future M&A transactions. In any case, a significant increase in screening procedures can be assumed.³⁶