Germany significantly lowers threshold to veto deals; FDI screening mechanism at the European level is coming soon
1. Legal developments and changes in Germany
On December 19, 2018, the German Goverment passed an amendment to its foreign direct investment regime that increases its powers to investigate and block foreign direct investments in the defense sector, in critical infrastructures, including the media industry, and in certain other civil technologies that are relevant to security, such as IT-security. The amendments will enter into force in January 2019.
This is the second significant reform of the German foreign direct investment rules within one and a half years. Germany already tightened restrictions on foreign direct investments in July 2017 by expanding the competences of the German Federal Ministry of Economic Affairs and Energy to review whether a foreign direct investment jeopardizes public order or security of the Federal Republic of Germany and by significantly extending the review periods. As expected, those reforms caused a significant increase in notifications of transactions to the Ministry and led to much more formal review procedures. In August 2018, the French company Manoir Industries, controlled by the Chinese Yantai Taihai Group, withdrew its bid for Leifeld Metal Spinning AG after the German government, was about to block the deal. Leifeld Metal Spinning AG is a German machine tool manufacturer specialized in high-strength materials for the aerospace, energy, automotive and potentially also for nuclear industries. It would have been the first implementation of Germany's foreign direct investment rules to veto an M&A transaction. Another remarkable case that became public shortly before the Leifeld case was a transaction concerning the German grid operator 50Hertz. The German government prevented the State Grid Corporation of China from buying a 20 percent stake in 50Hertz by directing the state development bank Kreditanstalt für Wiederaufbau (KfW) in Frankfurt to buy this stake and potentially resell it later.
The new amendments are in line with the stricter control of foreign direct investments in Germany. They considerably expand the competences of the Ministry to examine the acquisition of German companies by foreign investors through lowering the pick-up threshold for review from 25 percent stake in a German company to 10 percent for certain sensitive industries. This new threshold of 10 percent applies to
- The sector-specific review of foreign direct investments in the defense sector, including military key technology such as specific sensor technology, and for IT security products relevant for state security;
- The cross-sector review of foreign direct investments in
- "Critical infrastructures" such as certain facilities in a range of sectors, including energy, water supply, information technology and telecommunications, finance and insurance, health, transport and traffic as well as food, providing that they reach a certain scale
- Developers of software for the operation of such "critical infrastructures"
- Companies involved in the field of telecommunications
- Providers of certain cloud computing service
- Activities in telematics infrastructure
- Companies in the media industry that contribute to the formation of public opinion using broadcasting, tele media or printing units and that are distinguished by their timeliness and broad impact.
The media industry has been newly included in the above list of sensitive industries in order to safe-guard freedom of press, freedom of reporting and pluralism of media.
Foreign direct investments of 10 percent or more in these sensitive industries have to be notified to the Ministry.
2. Impact on M&A transactions
The lowered threshold opens up the possibility for the Ministry to review even more transactions in sensitive sectors than before and is in line with the increasing "awareness" trend of German investment controls policy. More foreign acquisition projects will be in the scope of the Ministry and can only be closed with a corresponding delay, as the review process can last for half a year or even longer. It also must be considered that the period for the review process will be suspended as long as the Ministry is negotiating contractual provisions to ensure public order or security, or essential security interests of Germany with the parties.
The long review periods and increased administrative effort must be taken into account by foreign investors for acquisitions of at least 10 percent of the voting rights in a German company if the target's activity falls within the above-mentioned sensitive sectors. Applications for Clearance Certifications become an even more important tool for transactions in order to avoid legal uncertainty for up to five years. Risks relating to conditions imposed by the Ministry and the worst-case scenario of a prohibition should be regulated in the Sale and Purchase Agreement.
Another issue to be considered is that the periods for the antitrust review are very likely to differ from the periods for the review under foreign direct investment rules.
3. Increased complexity and time lag for transactions in future; what are we expecting at the European level?
At the same time, reform projects at the European level will have a further significant impact on the M&A practice in Germany and other EU member states. Currently, there is no comprehensive framework at EU level for the screening of foreign direct investments on the grounds of security or public order. This will change very soon. A new EU Regulation establishing a framework for screening of foreign direct investments by the Commission and the member states will come into force in a couple of months; its application however is likely to start 18 months following the entry into force.
The new EU Regulation provides for factors that may be taken into consideration by the member states or the Commission in determining whether a foreign direct investment is likely to affect security or public order. Accordingly, they may consider the potential effects of the foreign direct investment on, inter alia:
- Critical infrastructure whether physical or virtual, including energy, transport, water, health, communications, media, data processing or storage, aerospace, defense, electoral or financial infrastructure, sensitive facilities and investments in land and real estate, crucial for the use of such infrastructure
- Critical technologies and dual use items as defined in Article 2.1 of Regulation (EC) No 428/2009 (Dual-Use Regulation), including artificial intelligence, robotics, semiconductors, cybersecurity, quantum, aerospace, defense, energy storage, nuclear technology, nano-technologies and biotechnologies
- Supply of critical inputs, including energy or raw materials, as well as food security
- Access to sensitive information, including personal data, or the ability to control such information
- The freedom and pluralism of the media
It also has to be noted that the new EU Regulation provides that state ownership or significant state funding of the acquiring entity is an important factor for assessing the proposed investment. This may in particular affect foreign direct investments by Chinese investors.
The new EU Regulation will give the Commission wide-ranging powers to screen foreign direct investments likely to affect projects and programs of EU interest. This includes in particular projects and programs involving a substantial EU funding or established by EU legislation regarding critical infrastructure, critical technologies or critical inputs (e.g. Horizon 2020, Galileo & EGNOS or European Defence Industrial Development Programme). Since most critical infrastructure, notably cross-border projects, is subject to EU legislation and there is significant EU funding for many critical technologies, the Commission will in effect have the power to review or even influence the prohibition of a wide range of foreign direct investments. Once the Commission has received the information requested from the member state, the Commission would have in general 35 calendar days to submit its recommendation; the deadline may be longer if additional information is needed. At the conclusion of its review, the Commission would issue a recommendation to the member state in which the investment is planned or has been completed. Although the proposed EU Regulation states that the final decision rests with the member state concerned, the member state must "take utmost account" of the Commission's recommendation and must justify any decision not to comply with the issued recommendation.
The new EU Regulation also provides for a "cooperation mechanism" between the Commission and the member states in national screening procedures as well as in cases where a foreign direct investment is not undergoing screening but a member state considers that this investment is likely to affect its security or public order or where the Commission considers that the investment is likely to affect the security or public order in more than one member state. In such cases, the Commission is empowered to issue an opinion and other member states may provide comments. In general, comments or opinions have to be addressed to the member state where the foreign direct investment is planned or has been completed no later than 35 calendar days after receipt of certain relevant information; other deadlines are possible in certain exceptional cases and constellations where additional information is needed.
Besides, the new EU Regulation encourages member states to set up a screening mechanism with respect to foreign direct investments taking into account the functioning, experiences and best practices of mechanisms already in place. However, the decision whether to set up such screening mechanism, or to screen a particular foreign direct investment remains the sole responsibility of the member state concerned.
The upcoming cooperation mechanism between member states and the Commission as well as the Commission's powers to screen foreign direct investments likely to affect projects and programs of EU interest will require additional time and resources in M&A transactions.Foreign Direct Investments in Germany but also in other member states will become even more complex and will have to be prepared very carefully.
For more information on FDI in Germany see our previous Client Alert dated July 31, 2017.
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