From Niche To Standard? M&A Transactions Under Scrutiny By The German Foreign Direct Investment Regime - Inward/ Foreign Investment

The German federal government recently passed the 17th amendment to the Foreign Trade and Payments Ordinance (Außenwirtschaftsverordnung—AWV), which considerably expands the scope of foreign direct investment (FDI) screening in Germany. The new AWV rules apply to all transactions signed after May 1, 2021. This follows a general trend in the European Union (EU)—driven by the framework of the EU FDI Screening Regulation 2019/452—and in many other countries toward tightening screening and review of foreign investment. The expanded AWV scope will potentially affect all cross-border M&A activities directly or indirectly related to German assets or companies.

The most important aspect of the amendment is a significant expansion of the list of business areas for which an FDI notification to the German Federal Ministry for Economic Affairs is mandatory. In line with Germany's National Industry Strategy for protecting domestic key and future technology and the EU FDI Screening Regulation 2019/452, the list now also extends to key and future technologies, such as artificial intelligence, robotics, cybersecurity, aerospace, autonomous vehicles, and quantum and nuclear technology. In addition, the amendment introduces to the AWV several smaller changes that are likely to also contribute to stricter application of the German foreign investment control regime.

The German FDI Regime

The German FDI review process is broadly similar to the Committee on Foreign Investment in the United States (CFIUS) regime. The process is partly voluntary and partly mandatory, and distinguishes between cross-sector reviews and sector-specific reviews (for transactions affecting the defense and security sector).

Cross-sector regime. In principle, the cross-sector investment review regime (Sec. 55a AWV) applies to all direct or indirect acquisitions of at least 25% of voting rights or shares in, or assets of, a company resident in Germany by an investor located outside the EU or the European Free Trade Association (EFTA) region (i.e., Iceland, Liechtenstein, Norway and Switzerland). The regime applies regardless of the target's activities, the size of the transaction or the companies involved. Because the FDI regime captures indirect acquisitions, foreign-to-foreign transactions can be subject to German investment screening if the target business has a subsidiary, affiliate or permanent establishment (Betriebsstätte) in Germany.

A notification to the German Federal Ministry for Economic Affairs is mandatory if the acquired business is active in certain enumerated areas—including critical infrastructure and related software, telecommunications, cloud services, media, pharmaceuticals, and certain medical devices.

Even if the target is not active in one of these areas, the acquirer can make a voluntary notification to the Federal Ministry for Economic Affairs to receive a "safe harbor" letter (formal certificate of compliance—Unbedenklichkeitsbescheinigung, Sec. 58 AWV). Such a voluntary notification may be advisable in certain circumstances to obtain legal certainty. A safe harbor letter precludes the Ministry for Economic Affairs from initiating an ex officio review of a transaction, even after closing.

Sector-specific regime. Special rules, the sector-specific investment review (Sec. 60 AWV), apply to acquisitions in the defense and security sector. In this sector, any foreign (i.e., non-German) investor is subject to a mandatory filing requirement if it acquires more than 10% of a German company that is active in one of the listed specific defense- or security-related businesses.

Procedure. During the review period following a mandatory notification (under both the cross-sector and the sector-specific regimes), the parties may not close their transaction. This initial Phase I review can take up to two months, during which the Ministry for Economic Affairs can initiate an in-depth Phase II review. The timetable for a Phase II review ranges from an additional four to an additional eight months.

Importantly, as to procedure, the EU FDI Screening Regulation 2019/452 has recently established an EU-wide framework in which the EU Commission and the EU Member States can coordinate their assessments of foreign investments. This framework includes an obligation of EU Member States to notify other EU Member States and the EU Commission about all FDI notifications and review processes.

The New AWV: Expansion of Industry Sectors Subject to Mandatory Notification

Cross-sector regime. As explained, in the cross-sector review regime, a mandatory notification requirement applies only if the target operates in one of the business areas listed in Sec. 55a AWV. Consistent with the EU FDI Screening Regulation 2019/452, the amended AWV significantly expands this list—although it does not extend the filing obligation to all "critical technologies" and "dual use items" (see Annex I of EU Regulation 2009/428) as other EU Member States have done.

The notification requirement now applies also to businesses active in the following sectors, among others (for a list of all areas, see Sec. 55a(1) AWV):

the operation of satellite systems;
the manufacture/development of products related to artificial intelligence;
the manufacture/development of products related to automated/autonomous vehicles or unmanned drones;
the manufacture/development of industrial robots; the manufacture/development of certain semiconductors;
the manufacture/development of certain types of IT-security equipment/systems;
the operation of an air carrier and the manufacture/development of aerospace goods or technologies;
the manufacture/development of certain goods related to nuclear technology;
the manufacture/development of goods based on quantum technologies;
the manufacture/development of goods for additive manufacturing (3D printing);
the manufacture/development of goods designed for the operation of wireless or wireline data networks;
the manufacture/development of smart meter gateways;
the extraction, processing or refining of critical raw materials or ores as defined by the EU;
the manufacture/development of goods based on secret intellectual property rights; and
the owning of agricultural land of more than 10,000 hectare.

In contrast to the sector-specific regime and to industry areas that were already captured by the notification requirement in the cross-sector regime, a notification of acquisitions of businesses active in the newly added sectors is only required if the acquired shareholding crosses an ownership threshold of 20% (rather than 10%) (Sec. 56(1) (No. 2) and Sec. 55a(1) (No. 8-27) AWV).

Sector-specific regime. The AWV also expands the scope of the sector-specific mandatory filing regime. Under the amended regime, all military equipment as defined in the German Export List (Ausfuhrliste), rather than only a few individually listed items as under the past regime, is now within the scope of the sector-specific review (Sec. 60(1) (No. 1) AWV).

The New AWV: Other Noteworthy Changes

The 17th AWV amendment introduces several additional changes that are likely also to contribute to stricter application of the German foreign investment control regime.

The amended AWV now also captures transactions where the acquired shareholding does not reach the relevant thresholds but the acquirer nevertheless acquires a degree of influence that equals the influence of a 10%, 20% or 25% shareholder because of a board representation that exceeds what is consistent with the level of shareholding or contractual veto rights over strategic business or personnel decisions (Sec. 56(3) and Sec. 60a(2) AWV).
The amended AWV explicitly confirms the Federal Ministry for Economic Affairs' current practice of deeming increases in shareholdings by an existing shareholder subject to German FDI review. However, the AWV amendment clarifies that such shareholding increases are subject to review only if certain newly introduced thresholds (20%, 25%, 40%, 50% or 75%) are met (Sec. 56(2) and Sec. 60a(2) AWV). Under the amended AWV, the Federal Ministry for Economic Affairs may also make a clearance decision subject to the condition that future shareholding increases must be notified, even if the increase would not bring the shareholding above the newly introduced thresholds (Sec. 58a(3) and 60a(2) AWV).

Implications for Businesses

In contrast to the recent increase of revenue thresholds in German merger control, which will result in fewer merger control notifications in Germany, the AWV amendment will increase the number of transactions that must be notified under the German FDI regime. The German government expects a significant increase of FDI cases, in part because—as the government acknowledges—the increased complexity of determinations of whether a notification is required or not will result in some transacting parties deciding to notify in an abundance of caution. A new dedicated subdivision in charge of AWV reviews is expected to be established at the Federal Ministry for Economic Affairs to handle the additional caseload.

Accordingly, and particularly given that all EU Member States will be required to notify the EU Commission and other EU Member States of any pending FDI reviews, transaction parties must pay close attention to the AWV regime. Both foreign investors and domestic businesses will need to navigate potential deal risks with FDI screening regimes in Germany and throughout the EU and prepare for potential substantive reviews. Companies should consider analyzing the potential for a foreign investment review, in particular in Germany (and elsewhere in the EU), as a standard check in M&A transactions directly or indirectly related to Germany.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.