Just a few weeks after Germany amended its rules on foreign direct investment (FDI) control, European Commission President Juncker announced a legislative proposal for, and the European Commission published a draft regulation dealing with, the screening by EU Member States of foreign takeovers and investments. In a nutshell, the Commission does not plan to create a centralised European body for the screening of foreign investment, like the Committee on Foreign Investment in the United States (CFIUS), but rather proposes a legal framework for the EU Member States, and in certain cases the Commission, to review foreign direct investments and take into account their individual situations (see Allen & Overy Client Briefing, “European Commission proposes common approach to foreign direct investment screening”, dated 15 September 2017).
Whilst the legislative procedure for a new European Regulation is just starting, the German rules have already taken effect. Key aspects of the amended German rules can be summarised as follows:
It is important to emphasise that Germany remains open to foreign investment. In line with past practice, corporate acquisitions by non-European purchasers can be prohibited only if they present a threat to the public order or safety of the Federal Republic of Germany. Generally, such interests may be relied on only if there is a genuine and sufficiently serious threat to a fundamental interest of society, which must always be determined in the individual case.
Nevertheless, the amended German legal framework presents non-European purchasers with a significantly more complex regulatory situation and with a more intense and time-consuming FDI screening process, all of which they will have to navigate.
For one thing, screening periods have been extended to allow the Commission and other EU Member States to comment on, and be given due consideration, in the German screening process. In practice, most of these extensions are not too significant because the relevant deadlines start running only after the file is complete. As the Ministry of Economic Affairs can always ask for additional information, it is in the hands of the Ministry to have the deadline start running again. However, if no clearance is applied for, the Ministry can open screening proceedings at any time up to five years after the signing of the relevant share or asset purchase agreement, potentially even leading to an order to unwind the relevant transaction years after completion. Whilst it has always been a risky strategy to proceed without the blessing of the Ministry, after the amendments this strategy has become even riskier.
Furthermore, the reach of governmental screening has been clarified by a number of examples, including operators of critical infrastructure and businesses producing software for the steering of critical infrastructure. These examples do not, however, incorporate all of the sectors mentioned in the proposed European Regulation. It cannot be ruled out that the Ministry of Economic Affairs will construe them in the light of the proposed European Regulation, where the notion of a threat to public order or safety is illustrated by examples ranging from critical infrastructure to critical technologies, critical inputs (natural resources) and data security.
In addition, it cannot be ruled out that the Ministry will take the aspect of reciprocity into consideration when deciding on clearing an FDI transaction, i.e. the German authorities could decide to screen a transaction stricter where the investor is based in a country with limited market access or where the proposed acquisition is funded by a foreign government or sovereign wealth fund.
Regarding investments in the defence sector, the reach of governmental screening has been extended. Non-German purchasers need FDI clearance not only when purchasing developers or manufacturers of weapons of war, tank engines and cryptography products, but also when the target business develops or manufactures goods subject to export control or machinery designed to produce such goods.
When issuing the legislative amendment in July 2017, the German government expected a modest increase in the number of foreign investment control filings. Now, two months later, it is becoming clear that significantly more filings have been submitted than expected, which is likely due to the increased complexity and uncertainties ingrained in the amended legal framework.
Against this background, non-European purchasers are well advised to analyse transaction risks early on and prepare their moves very thoroughly from a legal, political and communications point of view and consult with their legal advisors at an early stage of the proposed transaction to avoid any impediments resulting from the German FDI screening rules.
• Political initiatives for enhanced screening of foreign direct investment led to an amendment of the German rules on the control of foreign direct investment
After the takeover of KUKA, Germany’s iconic specialist in robotics, by Chinese Midea Group and the attempted takeover of Aixtron, an engineering business producing machinery for the manufacture of semiconductors, in mid and late 2016, the M&A activities of Chinese investors in Germany attracted attention at the highest political levels, leading to political initiatives for stricter control of foreign direct investment both at German and European levels.
At a European level, a group of members of the European Parliament (from Germany, France and Italy) called on the European Commission to provide a set of instruments for (i) cases where the investor is domiciled in a country where outbound investment is subsidised by the government, distorting competition for the target business, and (ii) where the investor’s home country restricts market access for European investors so that they cannot compete fairly with domestic businesses. According to this initiative, the existing rules on foreign investment control were to be extended to investments in strategically important sectors such as energy, transport, telecommunications, health and water. The European Commission announced that it would examine the effectiveness of EU policies to safeguard key technologies and ensure reciprocity of market access. On 13 September 2017, in view of the exclusive competence of the EU in the area of commercial policy, the European Commission presented a draft regulation designed to create an enabling framework for EU Member States to adopt or maintain a review mechanism for foreign direct investment.
At a German level, at the request of the Free State of Bavaria, the upper house of parliament (Bundesrat) adopted a resolution entitled “Foreign investment – securing technological sovereignty”. The upper house considered it appropriate that (i) control and prohibition options should be fixed on the principle of reciprocity, i.e. foreign direct investors based in countries whose markets are not freely accessible to foreign investors should be subject to stricter screening, and (ii) foreign direct investments should be prohibited if not primarily driven by market economy considerations. The upper house expressly asked the Federal Government to examine how the loss of industrial core competencies and key technologies can be counteracted by amending the Foreign Trade Regulation (Außenwirtschaftsverordnung; FTR) or other instruments.
On 12 July 2017, the Federal Government amended the FTR, following the upper house’s request only in part – the topic of reciprocity of market access was not addressed. The amendments became effective on 18 July 2017.
Key elements of the German Foreign Investment Control Regime
• There are two regimes of German investment control: (i) sector-specific investment review for the defence sector; and (ii) cross-sector review for all other sectors
Under the FTR, the Ministry of Economic Affairs (the Ministry) enjoys authority to review investments made by non-European investors in a German business, provided that the foreign investor acquires directly or indirectly more than 25% of the voting rights in such German business. The FTR distinguishes between two review regimes, a regime for review in all sectors but defence and cryptography (Sec. 55 et seq. FTR), and a regime for investments in defence and encryption businesses (Sec. 60 et seq. FTR).
Cross-sector investment screening and current amendments
Scope of application
• Scope of application clarified by a non-exhaustive list of examples of sensitive businesses, with particular emphasis on critical infrastructure
• Anti-circumvention rule addressing potential illegitimate bypassing of the screening procedure
Under the rules on cross-sector investment screening, the Ministry has authority to examine whether the direct or indirect acquisition of 25% or more of the voting rights in a German company by a non-European investor presents a threat to the public order or safety of the Federal Republic of Germany (Sec. 55(1)1 FTR).
The terms of public safety and order originate from the fundamental freedoms enshrined in the Treaty on the Functioning of the European Union and from case law of the European Court of Justice (ECJ). As clarified in ECJ case law, EU Member States enjoy discretion in determining public policy and public security requirements in the light of their national needs, but those public interests cannot be determined unilaterally by the EU Member States without any control by the institutions of the EU and must be interpreted strictly; they may be relied on only if there is a genuine and sufficiently serious threat to a fundamental interest of society. Restrictions to fundamental freedoms must not be misapplied so as to, in fact, serve purely economic ends. ECJ case law recognises that the secure supply of goods and services in strategically important sectors such as telecommunications and electricity, railways, port operations and merchant shipping even in the event of a crisis is a matter of public safety and order.
Under the amendments to the FTR, the notion of public safety and order has been significantly refined by a non-exhaustive list of examples of particularly sensitive business areas, especially in relation to critical infrastructure (Sec. 55(1)2 FTR).
Foreign investment in a German company operating in one of the following sectors may, but does not necessarily have to, be considered as a threat to public order or safety:
Operator of a Critical Infrastructure as defined by the Act on the Federal Authority for Information Security (Sec. 55(1)2 no. 1 FTR)
Critical infrastructures within the meaning of the Act on the Federal Authority for Information Security (Gesetz über das Bundesamt für Sicherheit in der Informationstechnik; the BSI-Act) are facilities, systems or parts thereof belonging to the (i) energy, (ii) information technology and telecommunications, (iii) transport and haulage, (iv) health, (v) water, (vi) nutrition, and (vii) financial and insurance sectors, and which are of significant importance for the functioning of the community because their failure or impairment would result in significant supply shortages or threats to public safety.
According to a regulation issued by the Federal Ministry of the Interior (Verordnung zur Bestimmung Kritischer Infrastrukturen nach dem BSI-Gesetz; the BSI-Regulation), facilities and systems qualify as critical infrastructure if they ensure the supply of at least 500,000 individuals in the energy, water, nutrition and information technology and telecommunications sectors. The Ministry assumes that there are 2,000 operators of critical infrastructure in Germany, among them 750 operate within the water, energy, nutrition and telecommunication sectors.
Development or modification of industry-specific software for the operation of Critical Infrastructures (Sec. 55(1)2 no. 2 FTR)
This industry-specific software for the operation of Critical Infrastructures is defined in an exhaustive list in Sec. 55(1)3 FTR. The list includes, inter alia, (i) software for power plants and network control technology in the energy sector, (ii) software for control and automation technology for facilities in the water supply sector, (iii) software for operating systems or systems for voice and data transmission or data storage in the information technology and telecommunication sectors, (iv) software for cash supply, card-based payment transactions, conventional payment transactions, the transfer of cash and the settlement of securities and derivatives transactions in the finance and insurance sector, (v) software for the operation of a hospital information system and the distribution of prescription medicines in the health sector, (vi) software for the transport of passengers and goods by air, rail, sea, waterway transport, road transport and local public transport in the transport sector, and (vii) software for food supply in the nutrition sector.
Operator entrusted with organisational measures in accordance with Sec. 110 of the Federal Telecommunications Act (Sec. 55(1)2 no. 3 FTR)
This provision covers domestic operators of communication systems providing publicly available telecommunications services.
Operator providing cloud computing services (Sec. 55(1)2 no. 4 FTR)
This provision covers domestic operators of cloud computing services transferring a certain data volume per annum (according to Annex 4 of the BSI-Regulation).
Owners of approvals for components or services of the telematics infrastructure (Sec. 55(1)2 no. 5 FTR)
Telematics infrastructure means a platform connecting the various stakeholders of the German statutory health insurance funds system (doctors, patients, insurance companies etc.), allowing these stakeholders to exchange personal data according to the Social Security Code V (Sozialgesetzbuch V).
Technically speaking, the list of examples of particularly sensitive business areas has not broadened the interpretation of the terms of “public safety and order”. If, in the past, the acquisition of a business active in one of the sensitive areas had to be screened, it would have been possible to block the acquisition based on concerns of public safety or public order. This notwithstanding, the non-exhaustive list includes cases which, in fact, would not have been considered a threat to public safety or order in the past. Therefore, based on the amendments, the administrative practice of the Ministry may be expected to change.
The Ministry may also screen cases beyond the non-exhaustive list. However, domestic businesses in the automotive, chemical and engineering sectors will usually not have the necessary strategic importance to justify a prohibition of the acquisition (even though, in practice, it can be observed that the Ministry requests rather detailed information on the activity of the target in these sectors once a transaction has been notified).
However, it cannot be ruled out that the proposed European Regulation will have an impact on how the terms public order and public safety will have to be interpreted going forward. The proposed regulation lays out another non-exhaustive list of examples of particularly sensitive industry sectors (Article 4 Draft Regulation). In addition to critical infrastructure, such list contains critical technologies (including artificial intelligence, robotics, semiconductors, technologies with potential dual use applications, cyber security, space or nuclear technology), critical inputs (supply with natural resources), and sectors with access to, or the ability to control, sensitive information. Therefore, if the proposed European Regulation is adopted (possibly even before this is the case), the acquisition of businesses might be subject to screening pursuant to the FTR.
In addition, according to the proposed European Regulation, it is permissible for foreign investment control carried out by the EU Member States to take into account whether the investor is directly or indirectly controlled or significantly funded by the government of a non-European country (Article 4 Draft Regulation).
As regards the anti-circumvention rule, the amendments specify (in line with the prior administrative practice) that it constitutes a sign of circumvention if the purchaser of record does not have significant domestic substance or no permanent presence in the form of premises, personnel or equipment in Germany (Sec. 55(2)2 FTR).
• Mandatory notification requirements for investments in critical infrastructure
• Possibility to combine notification with application for certificate of non-objection
Before the amendments took effect, investors in businesses outside the defence sector were not required to notify proposed acquisitions to the Ministry. The purchaser had the choice to apply for a certificate of non-objection (Unbedenklichkeitsbescheinigung) to receive clearance for the acquisition. Under the amended FTR, the signing of a share purchase agreement relating to a direct or indirect acquisition of a German company in one of sectors outlined above must be notified in writing to the Ministry (Sec. 55(4) FTR). There is no deadline for the notification. But since the notification triggers the three-month period during which the Ministry can ex officio start a screening of the transaction parties have a vital interest to notify the Ministry as soon as possible. Apart from the fact that the three-month period does not start, there are no administrative sanctions in the case that the purchaser fails to notify the Ministry. In particular, the notification is no statutory closing condition to the acquisition. Further, there is no statutory requirement that the purchaser must combine the notification with an application for a certificate of non-objection.
However, from a practical perspective, we advise combining the notification with the application for a certificate of non-objection for two reasons: (i) an application for a certificate of non-objection reduces the deadline for the Ministry to launch a screening from three to two months; and (ii) a mere notification to the Ministry regarding a relevant acquisition without a reasoned written application can especially create suspicion at the Ministry and trigger an extensive investigation that might delay the closing of the transaction significantly.
• Unless notified by the purchaser, the Ministry may start the screening process within five years after signing
• Notification of the transaction to the Ministry, or knowledge of the transaction that the Ministry gains from other sources, triggers a three-month screening period
• The Ministry has authority to prohibit an acquisition, or impose conditions, within four months (previously: two months) after receipt of the complete documentation. The period starts running only when the file is complete, i.e. in practice the screening process may be longer
• Requests for information may be addressed to all parties to the transaction (previously: only to the purchaser)
• If and as long as the Ministry and purchaser are negotiating, the screening period is suspended
Under the amended FTR, the Ministry can launch a screening of the acquisition in its own initiative within three months after becoming aware of the signing of the share or asset purchase agreement or, in the case of a public bid, after becoming aware of the announcement of the bid. In most cases, the Ministry will become aware of the transaction because of the purchaser’s filing. If the purchaser chooses not to apply for clearance, the Ministry may start the screening process within five years after the signing of the share or asset purchase agreement (Sec. 55(3) FTR). Consequently, without a filing, the purchaser will have legal certainty no earlier than five years after signing.
This is a fundamental change in approach. Under the previous regime, the Ministry had authority to start screening acquisitions only within three months after signing, regardless of whether or not the Ministry had become aware of the transaction. The screening periods as extended allow the Commission and other EU Member States to comment on, and be given due consideration in, the German screening process. Such extension may be seen to anticipate the implementation of a European cooperation mechanism between the EU Commission and the EU Member States as foreseen in the proposed regulation. Under such cooperation mechanism, the competent authority of the EU Member State concerned must inform the Commission and all other Member States within five business days after commencement of an investment screening to allow for the submission of non-binding statements on the acquisition within 25 business days or, if extended, a longer period of time (Article 8 Draft Regulation).
The Ministry has authority to prohibit an acquisition, or impose conditions, within four months (previously: two months) after receipt of the complete documentation (Sec. 59(1) FTR;) (previously: two months). However, it is in the hands of the Ministry to determine whether or not the documentation is complete; if it turns out during the process that certain information is missing, the Ministry may request the submission of such information at any time – and the screening period starts running again upon submission of the requested information.
Whereas the responsibility for the filing and submission of information rests on the purchaser, the Ministry has authority to request further documents from all parties directly or indirectly involved in the acquisition (Sec. 57 sentence 3 FTR). In contrast to past practice, this includes the target business and may become relevant where the purchaser is unable to collect the information in question (e.g. information on the target business). Therefore, it may happen that the start of the four-month period is significantly delayed if additional information is requested.
The expiration of the four-month screening period is suspended if the Ministry enters into negotiations with the purchaser regarding contractual provisions guaranteeing the public safety or order of the Federal Republic of Germany (Sec. 59(2) FTR). This might delay closing even further.
In light of the changes to the screening procedure, foreign investors should factor in more time for the closing of their transactions.
Certificate of non-objection
• Period for the Ministry to grant certificate of non-objection was extended from one to two months
• Certificate of non-objection becomes even more relevant to achieve legal certainty
A foreign investor can apply for a certificate of non-objection to obtain legal certainty regarding the proposed acquisition. Therefore, in many share or asset purchase agreements the parties agree on a condition to closing that the Ministry grants a certificate of non-objection – including the seller’s obligation to support the purchaser within the clearance procedure and to provide him with all information and documents as requested by the Ministry.
When applying for the certificate, the purchaser must describe the acquisition, the purchaser and the assets to be acquired as well as the main features of the business that the purchaser and the target are conducting. After the receipt of the application, the Ministry has two months (previously: one month) to decide whether to issue the certificate or start the screening of the transaction. If the period expires without the Ministry reacting, the clearance certificate is deemed to be issued (Sec. 58(2) FTR).
We expect that certificates of non-objection will become even more important in future transaction practice. This is mainly because without a filing the Ministry can launch a screening procedure at any time during the five-year period after signing.
Legal consequences of a prohibition
• Risk of unwinding a closed transaction is borne by the purchaser
• Public law contract as an instrument to avoid a prohibition
If the Ministry prohibits an acquisition that has already seen its closing, the Ministry may still (i) prohibit or restrict the purchaser in the exercise of its voting rights in the target company, or (ii) appoint a trustee with the mission to unwind the transaction at the expense of the purchaser (Sec. 59(3) FTR).
The amended FTR clarifies that a prohibition of the notified transaction may be avoided by entering into a so-called public law contract (öffentlich-rechtlicher Vertrag) with Germany (Sec. 59(2) FTR). The obligations and the commitments that the purchaser has to accept under such a contract depend on the circumstances of the transaction. However, a purchaser should consider that it may come to negotiations with the Ministry and that such negotiations may have material effects on the timeline to closing.
Sector-specific Investment review and current amendments
Scope of application
• Broader scope of application for the screening of defence-related investments
• Anti-circumvention rule has been refined
Under the sector-specific screening regime, the Ministry has authority to examine whether essential security interests of the Federal Republic of Germany are at risk if a non-German purchaser directly or indirectly acquires a domestic business or a shareholding of more than 25% of the voting rights in a domestic company if such business or company (i) manufactures or develops goods within the meaning of Part B of the War Weapons List (Kriegswaffenliste), (ii) manufactures or develops specially designed engines or gearboxes for tanks or other armoured military vehicles, or (iii) manufactures products with IT security functions designed to process classified information or components essential for the IT security function of such products.
The sector-specific screening regime as amended requires the screening of foreign investments in companies manufacturing or developing certain goods listed on the German Export List (Ausfuhrliste); (Annex 1 to the FTR) (Sec. 60(1) no. 3 and 4 FTR). These goods include, without limitation, fire control systems, weapon sighting devices, target acquisition equipment, special armour or protective equipment, sensor integration equipment, space crafts and their components, specialised equipment for military training (simulators etc.), diving devices, robots, nuclear energy production equipment or laser equipment, in each case specially designed for military use.
According to a new anti-circumvention rule (Sec. 60(2) 1 FTR), it is an indication of circumvention where a domestic purchaser, except for its holding of the target company, either has no significant business activities in Germany or no permanent presence in the form of premises, personnel or equipment in Germany.
• Screening period was extended to three months (previously: one month)
• Requests for information may be addressed to all parties to the transaction (previously: only to the purchaser)
• If and as long as the Ministry and purchaser are negotiating, the screening period is suspended
Any acquisition subject to sector-specific screening must be notified to the Ministry. The notification must explain the proposed transaction, the purchaser and the domestic target to be acquired as well as the main features of the business areas of the purchaser and the target company (Sec. 60(3)2 FTR).
The Ministry shall clear the proposed transaction if there are no reasons speaking against it from the point of view of essential security interests of the Federal Republic of Germany. Clearance by the Ministry is a statutory closing condition. A transaction is deemed to be cleared if the Ministry (i) does not start the screening within three months of receipt of the notification (previously: one month), or (ii) does not prohibit the transaction or imposes conditions within three months (previously: one month) after receipt of the complete documentation (Sec. 62(1) FTR). For purposes of the screening, the Ministry may request all parties directly or indirectly involved in the transaction to submit further documents (Sec. 57 sentence 3 FTR).
If the Ministry starts negotiations with the purchaser regarding contractual provisions designed to guarantee the security interests of the Federal Republic of Germany, expiration of the screening period is suspended for the duration of such negotiations (Sec. 62(2) FTR).
If such negotiations cannot address the raised objections in terms of the essential security interests of Germany, the Ministry can prohibit the purchaser from closing the acquisition or issue instructions.
Summary and outlook
• Early risk assessment will be necessary more than ever before
• Too early to forecast whether amended FTR will result in more prohibitions and restrictions of foreign direct investments
• Higher number of applications and screenings expected
• Certificate of non-objection may become even more relevant
The amended FTR reflects a change in attitude that the Ministry has applied during the past twelve months and codifies part of the current administrative practice. The extension of the screening periods anticipates a possible implementation of a cooperation mechanism on foreign direct investment review between the European Commission and the EU Member States, as suggested in the proposed European Regulation.
The amended German legal framework presents non-European purchasers with a more complex situation than it has before. Non-European purchasers are well advised to analyse transaction risks early on and prepare their moves very thoroughly from a legal, political and communications point of view.
Given the mandatory notification requirements of the acquisition of targets in the sector of critical infrastructure under the cross-sector investment review, investors will have to assess early on whether their transactions fall under the scope of the FTR.
It remains to be seen whether the amended FTR will result in the Ministry screening acquisitions that it has not looked at in the past. In addition, the proposed European Regulation suggests extending the screening of non-European direct investments to businesses in the sectors of critical technology, natural resources and data security. In light of this wide range of sectors, the Ministry might have the power to initiate screenings of transactions in a similarly wide area in the future. But irrespective of these non-exhaustive lists, the Ministry will still decide on a case-by-case basis whether an acquisition actually constitutes a threat to public order or safety.
In light of the above, precautionary measures will be more important than before. We expect that certificates of non-objection will be increasingly used in future transaction practice. We believe that this is because an application reduces the deadline for the Ministry to launch a screening from three to two months and a mere notification to the Ministry regarding a relevant acquisition without a reasoned written application can especially create suspicion at the Ministry and trigger an extensive investigation that might delay the closing of the transaction significantly.
But even the quick application for a certificate of non-objection will not guarantee a fast closing of a corporate acquisition by a non-European investor. Two months after the amended FTR has taken effect, it has become clear that significantly more filings have been, and will be, submitted to the Ministry than originally expected. This results in the delay in the processing of applications for the certificate of non-objection. Further, in light of the proposed European Regulation, the Ministry might no longer be able to issue a certificate of non-objection until the time limits for submitting comments under the proposed cooperation mechanism have expired.