In the context of MuMAC 2020, we reported on a trend that in recent years has developed into something like a never-ending story: the continued expansion in scope and further tightening of Germany’s foreign investment control regime. The 17th Amendment Ordinance to the Foreign Trade and Payments Ordinance dated 27 April 2021, which entered into force on 1 May 2021, adds another chapter to this story. It was meant to be the last one – at least for the time being. However, further amendments are already in preparation for autumn 2021.
Following various amendments to Germany’s investment control regulations in recent years, profound changes eventually occurred in 2020, when the first amendment act of the German Foreign Trade and Payments Act (AWG) entered into force on 17 July 2020 (the Amendment Act). The purpose of the Amendment Act was to adapt the existing German legal framework to the requirements of the European Foreign Direct Investment (FDI) Screening Regulation (Regulation (EU) 2019/452 of 19 March 2019) and to further tighten the investigation and control regime for foreign investments in German target companies. The changes were accompanied by unexpected shifts induced by the COVID-19 pandemic, which also led to amendments to the Foreign Trade and Payments Ordinance (AWV).
The reforms of 2020 and 2021 left the general structure of German investment control law unchanged: namely, the distinction between the cross-sectoral review (Sec. 55 seq. AWV) and the sector-specific review (Sec. 60 seqq.). The cross-sectoral review regime continues to be directed to non-European Union (EU)/European Free Trade Association (EFTA) investors and is linked in principle to the acquisition of 25% of the voting rights in a German company. The sector-specific review applies to all non-German investors, irrespective of whether they are from the EU/EFTA or from any other country.
Although the distinction between the two central review areas was maintained, the reforms substantially changed the previous regime. In addition to the inclusion of European security interests in national investment control, the new regulations from 2020 inter alia brought about the following important aggravations:
Threshold for interventions. The threshold for the enactment of restrictive measures was significantly lowered. Under the old version of Sec. 5 (2) Sentence 2 AWG it was necessary for the issuance of orders or the prohibition of a transaction, respectively, that the foreign investment posed “an actual and sufficiently serious threat” to public order or security. Under the revised Sec. 5 (2) AWG, it is now sufficient that public order or security is “likely to be impaired”. Furthermore, the explanatory memorandum to the Amendment Act indicates that under the new rules, a threat to public order or security no longer requires that the acquisition under scrutiny endangers “fundamental interests of society”. Instead, a relevant impairment of public order and security may in the individual case already be established even if there is “no specific connection to the fundamental interests of society”. This means a tightening of the previous standard as applied on the basis of European law.
New categories of notifiable transactions. In light of the Covid-19 pandemic, the catalogue of transactions which must be notified to the Federal Ministry for Economic Affairs and Energy (BMWi) was expanded to capture case groups relevant for maintaining a functioning health care system, namely, transactions in the area of certain personal protective equipment, essential pharmaceuticals, medical devices and in-vitro diagnostics.
Expanded application of 10% review threshold. Notifiable transactions in these newly added categories are also subject to the 10% threshold for review which had been introduced only recently for notifiable transactions in the cross-sector area (instead of the 25% threshold applicable to other transactions in the area of cross-sector review).
Standstill orders. Another significant amendment concerns the extension of standstill orders (i.e., pending invalidity of transactions). Prior to the Amendment Act, only those contracts that concerned investments in the area of sector-specific review were (temporarily) invalid until the conclusion of the review process. Since the Amendment Act, all notifiable legal transactions are (temporarily) ineffective from the time they are executed until the conclusion of the review proceedings. This means that transactions that are subject to the cross-sector review which concern, inter alia, critical infrastructure, specific software for infrastructure, media companies essential for the formation of public opinion and health care only become valid if the transaction is cleared at the end of the review process (or deemed cleared).
Gun-jumping. The extension of the standstill provisions was accompanied by the introduction of various criminal and regulatory offences, similar to the ban on gun-jumping under cartel law. The respective sanctions are intended to ensure that the purpose of the investment review is not thwarted by completion of the transaction prior to clearance or by any premature exchange of security-relevant information.
2. 17th amendment ordinance to the Foreign Trade and Payments Ordinance
Pursuant to the BMWi, the 17th AWV completes the revision of German investment control law and its full integration into the new EU legal framework, which began in 2020. This assessment suggests that the legislator is not planning any (substantial) further changes to foreign trade law for the time being. In essence, four changes are noteworthy:
Further categories of notifiable transactions. The new AWV introduces a substantial number of additional case groups which are subject to the notification requirement under the provisions of the cross-sectoral review (Sec. 4 (1) no. 4, Sec. 5 (2) AWG and Sec. 55 to 59 AWV) bringing the list from 11 to a new total of 27 case groups.
Transactions concerning investments in respective companies by non-EU investors with regard to which the legislator, in line with the EU Screening Regulation, assumes an increased likelihood for an impairment of public order or security must not only be notified to the BMWi upon signing, but also are subject to the standstill regime. Luckily, the German government did not take the new case groups directly from the EU Screening Directive, but made some effort to define them more clearly and narrowly. Many case groups remain rather vague, however, and should be defined more precisely.
Previously, cross-sectoral review of corporate acquisitions focused on critical infrastructures, including telecoms and the energy sector. The new case groups mainly introduce various areas of emerging technologies deemed likely to affect public order or security, as well as companies that extract critical raw materials and ores, and companies relevant for food security. Examples in the field of emerging technologies include, inter alia, the following case groups in Sec. 55 a (1) AWV:
- Certain artificial intelligence applications that can be misused for misinformation or observation purposes (no. 13);
- Unmanned motor vehicles and aircraft with automated or autonomous driving or navigation functions (No. 14), e.g., self-driving cars, drones and air taxis;
- Semiconductors and optoelectronics (no. 16);
- IT security products (or material components of such products) in the field of cyber security (no. 17);
- Goods and essential components of quantum information technology and quantum communication (no. 20).
Target companies falling under case groups 1 to 7 are subject to the low threshold of 10% of the voting rights. With regard to case groups 8 through 27, the applicable threshold triggering the notification requirement is 20%, rather than the 10% threshold that the initial ministerial draft of the 17th AWV had proposed. Target companies in need of a new investor may consider such relaxation to be good news. Venture capital investors typically aim for a stake of more than 10% in start-ups, usually between 10% and 25%. A participation threshold of 10% would have therefore significantly hindered such investments. From the point of view of safeguarding public order and security, the non-application of the low 10% threshold also seems reasonable, since stakes of less than 25% typically do not grant substantial opportunities for influence in a company.
Redefinition of control. The 17th AWV introduces a broader understanding of the term “acquisition of control”. For the first time since the introduction of the rules on investment control reviews, an event other than the acquisition of voting rights may trigger the applicability of the screening regime. According to the new rules, it is sufficient for the investor to acquire a share of voting rights below the relevant threshold if such acquisition comes with “additional seats or majorities in supervisory bodies or in the management”, the “granting of veto rights in strategic business or personnel decisions” or the “granting of rights over information within the meaning of Sec. 15 (4) sentence 1 no. 3 AWG”.
The new concept allows for an extension of the protection regime to a larger number of transactions, but at the same time leads to a loss of legal certainty for the parties to a transaction, as the criterion of “other significant participation in control” leaves more room for interpretation than linking the application of the review procedures to certain thresholds of voting rights. In practice, considerations made in the context of merger control clearances where there is also the criterion of “acquisition of competitively significant influence” (Sec. 37 (1) no. 4 of the German Act against Restraints of Competition) may help. However, in that regard parties also often consult with the German Federal Cartel Office prior to having legal certainty. In the context of the foreign direct investment regime, this could mean that the number of applications for certificates of non-objection increases, or, where this is not possible, such as in case of a notification requirement pursuant to Sec. 55a (4) sentence 1 AWV, that the authorities are at least consulted more often.
In addition to the previously existing provisions on the attribution of voting rights, e.g., as a result of shareholdings or voting agreements, an attribution between investors can now be derived from additional circumstances. For several state investors from the same country investing in parallel, attribution can be presumed (Sec. 56 (4) sentence 3 AWV); this presumption may be regarded as another tool to review more transactions from China.
Increasing the level of voting rights and atypical control. Since the new AWV entered into effect, an investor that already holds voting rights in a company (and the initial investment of which has been cleared) may become subject to a (further) review in case of any additional acquisitions of voting rights, provided that such acquisitions meet or exceed certain thresholds contained in Sec. 56 (2) AWV (20%, 25%, 40%, 50% and 75%). This means that every additional share purchase may trigger the scope of the review regimes again. The concept of “other significant participation in control” also applies here.
Expansion of sector-specific review. The new AWV expands the sector-specific review (Sec. 4 (1) no. 1, Sec. 5 (3) AWG and Sec. 60 to 62 AWV) to all acquisitions of companies which develop, manufacture, modify or have de facto control over certain listed military technology and equipment. Since May 2021, all military equipment within the meaning of Part 1 Section A of the Export List is covered. All foreign investments in such companies must be notified if voting rights of 10% or more are acquired. In line with previous provisions, the notification requirement and screening regime applies regardless of whether the investor is from the EU or any non-EU country. In relation to companies that supply manufacturers of military goods, the new AWV substantially increases the number of notifiable transactions – the ministerial draft amendment ordinance estimated a doubling of cases.
3. Assessment and outlook
The 17th amendment of the AWV was meant to bring the reform of the German foreign investment control regime to a (provisional) conclusion. This seems unrealistic. The BMWi will evaluate the effectiveness of the new regulations and the associated efforts and expenses for both enterprises and authorities by mid-2022. Also, further amendments are already in preparation, which shall (presumably) enter into force in September 2021. In the course of adopting AWG and AWV to the new Dual-use-Regulation (Regulation (EU) 2021/821 of 20 May 2021), investment control law will be modified once again: E.g. an exemption from the standstill orders will be introduced for stock exchange transactions/public takeovers via sec. 15 (5) AWG.
The latest amendments continue the story line of expansion of the German investment control regime’s scope and generally allow the BMWi to review more transactions. This is due in particular to the introduction of new notification obligations (e.g., in the health sector and in emerging technologies), lower thresholds for screening transactions and an extended definition of the terms control/influence. The latest statistics give a foretaste of what is to come: In 2020, 160 investments into German target companies by foreign investors were reviewed. In comparison, 106 review procedures took place in 2019, 78 in 2018 and 66 in 2017. This means that the number of review procedures is steadily increasing. The latest changes in law will exacerbate this trend. However, it may be considered as good news that the BMWi reports that almost all 2020 cases where it identified relevant security risks could eventually be remedied through the conclusion of mitigation agreements.
With its focus on companies active in the field of future technologies, the 17th AWV certainly has an impact on venture capital transactions, as more transactions fall under the thresholds lowered from 25% to 10% or 20%. This also affects (mid-cap) private equity investors that seek minority investments in matured but not yet fully developed companies. When setting up and carrying out their due diligence processes, such investors (as well as any other investors) should make sure that the involved parties take into account the applicable regulations on gun-jumping. Non-compliance with such regulations can result in severe sanctions, including criminal liability not only for target companies, but also for sellers and investors.
Investors should be prepared to identify notification requirements early in the transaction process. Sellers – particularly in auction processes – should, when evaluating potential bidders, consider their nationality and potential security concerns they might raise.