EXECUTIVE SUMMARY

Effective June 3, 2020, the screening of foreign direct investments (FDI) has been expanded in Germany, with a first tranche of new rules primarily affecting the healthcare sector. Drivers for the amendments are the EU Framework Regulation that took effect in April 2019 and will be fully applicable on October 11, 2020, and the COVID-19 pandemic situation, in line with the EU Commission’s guidance issued on March 25, 2020. However, certain newly introduced provisions apply to all business sectors, as will be the case with further amendments that are expected in the next few months. The expansion of FDI control schemes reflects a broader trend across a number of EU Member States and globally.

Here is what non-EU investors should have on their radar for transactions involving entities in Germany and other EU Member States:

• Effective immediately, the German government must be notified about certain investments in German companies active in the healthcare sector and in other critical infrastructures. As suggested by the EU Framework Regulation, the German government may now also specifically assess whether the foreign investor is controlled by, or receives significant (more than marginal) funding from, a government of a non-EU country.
• In the coming months and as of October 11, 2020 at the latest, the standard of screening will be significantly lowered. Currently, the German government needs to demonstrate that there is an “actual threat” to general public interests (security or public order). Under the new rules currently being discussed by the German parliament, the substantive test will be whether an FDI is “likely to affect” security or public order.
• The expected further amendments will bring additional notification requirements, particularly for minority investments of 10%, to a number of so-called “sensitive” business sectors. As foreseen in the EU Framework Regulation, FDI in, for instance, data-driven businesses, critical technologies and businesses involving dual-use items may trigger notification obligations. Such acquisitions will be suspended for the duration of the review. The parties will be prohibited from closing the deal prior to clearance. German authorities may enforce severe penalties for violations.
• Other EU Member States (e.g., Spain and France) have also introduced new or amended provisions to enable their governments to screen FDI more broadly. Member State governments are implementing the new cooperation mechanisms and procedures for the exchange of information that will be applicable on October 11, 2020. For investments involving EU interests or affecting potential national security concerns of more than one Member State, investors need to take the extended review periods into  account for their deal timelines.

DUE TO COVID-19, STRICTER RULES FOR FOREIGN INVESTMENTS ARRIVE SOONER THAN PLANNED

On October 11, 2020, the EU framework for the screening of foreign direct investments will become fully applicable. EU Member State governments have begun to amend their FDI screening statutes to align with the EU Framework Regulation (EU Regulation No. 2019/452) adopted in March 2019 (see our previous alert). The German government has started legislative proceedings to amend statutory rules and regulations accordingly until October 2020.

The COVID-19 pandemic has accelerated the development of more strict and coordinated foreign investment screening on the national and European levels. In reaction to the outbreak of COVID-19, the European Commission issued guidelines to ensure a strong EU-wide approach to foreign investment screening (“EU Guidelines”). The German government split up the process to amend the Foreign Trade and Payments Regulation (Außenwirtschaftsverordnung or AWV) that was already under way, and adopted certain provisions to better protect healthcare related businesses by way of urgent amendment proceedings.

EU GUIDELINES TO PROTECT CRITICAL EUROPEAN ASSETS AND TECHNOLOGY

The EU Guidelines, published on March 25, 2020, urge the Member States to make full use of tools available to them to protect against the selling off of critical infrastructures and technologies. As 13 Member States currently do not have FDI screening mechanisms available, these governments are encouraged to set up full-fledged control regimes. The EU Commission notes that, particularly in situations of public health emergencies, an acquisition could result in a threat to the security or public order of a Member State.

The EU Commission clarifies that the EU Framework Regulation applies to all sectors of the economy and is not subject to any thresholds. It emphasizes that the need for screening may depend on the strategic importance of the target rather than the value of the transaction.

In the EU Commission’s view, even portfolio investments may threaten public order or security. Although a threat may be less likely in such a scenario because the investor generally does not gain control or other effective influence over the target, a minority investment could still be a concern if the investor obtains a so-called qualified shareholding under national company law.

The EU Commission also reminds that, in view of the principle of free movement of capital, restrictions of foreign investments need to be justified by legitimate general public interests. Purely economic objectives are generally insufficient, while public health, financial stability and other fundamental public interests may provide a basis to block or restrict certain acquisitions.

GERMAN OVERHAUL AFFECTS A BROAD RANGE OF SECTORS AND INCREASES SCRUTINY

FDI screening in Germany is governed by the Foreign Trade Act (Außenwirtschaftsgesetz or AWG) and the respective underlying regulations (AWV). Revisions to both instruments are under way, in addition to the most recent amendments of the AWV that came into effect on June 3, 2020.

COVID-19 Triggered Amendment to the German Foreign Trade Regulation Effective June 3, 2020

The urgently adopted amendment to the AWV is intended to maintain a functioning healthcare system in Germany by expanding the list of companies that are particularly relevant for public order or security, and to establish that where acquisitions by non-EU investors of 10% or more of a company’s voting rights are proposed, the German government must be notified. So far, the list only includes operators of critical infrastructures, companies developing software to use critical infrastructures, companies in the media industry and a limited number of other sensitive businesses.

The expanded list now also includes:

• Developers and manufacturers of personal protective equipment;
• Developers and manufacturers of medical products (drugs, etc.) essential for ensuring the provision of health care to the population or which place such products on the market or hold a corresponding drug license;
• Developers and manufacturers of medical devices intended for the diagnosis or treatment of life-threatening and highly contagious infectious diseases;
• Developers and manufacturers of in vitro diagnostic tests to detect infectious agents; and
• Service providers that are necessary to ensure the continuity and functioning of state communications infrastructure.

The new rules further clarify that asset deals are also included in the scope of the German FDI screening regime. This was already the case, but the government clarified its established practice.

As suggested by the EU Framework Regulation, under the revised German AWV provisions, another consideration, inter alia, is if the investor is directly or indirectly controlled by the government of a third country, which includes other state bodies or armed forces. The new rules further specify that control in this context can exist based on ownership, or by way of funding by the government or other state entities or armed forces, if such funding exceeds an insignificant (marginal) level, which however is not further specified.

Proposed Upcoming Changes Will Impact Additional Sectors

The German government also introduced draft amendments to the AWG and is preparing further changes to the AWV. The proposed provisions currently subject to the parliamentary or ministerial legislative processes are supposed to align the German rules with the EU Framework Regulation and include the following:

• The substantive test of screening will become less stringent. In the future, the standard introduced by the EU Framework Regulation will apply, i.e., the assessment of whether an investment is “likely to affect security or public order.” It will replace the current test of the German control regime, under which an “actual threat” needs to be shown by the government to restrict any investment. The screening will thus entail an element of prediction. The German government notes that this will only emphasize the predictive nature of the already existing screening mechanism. However, it also notes that “eventual” or “potential” threats can be taken into consideration under the proposed rules. Future decision-making practice, and likely also court rulings, will show if and to what extent the revised substantive test will actually change the approach while also maintaining the objective of the EU to generally remain one of the most open markets for foreign investments.
• Under the proposed rules, not only the public order or security of Germany, but also “of another Member State” will be subject to the investment screening. Moreover, the potential effects on “projects or programs of Union interest” shall be taken into account. Through the EU-wide consultation process, Member States can comment on any threat to their public order or security. The EU Commission may produce an opinion on issues in several Member States or in relation to projects or programs of EU interest. An impact on the timeline, especially for investments involving entities of the target company in multiple EU Member States, needs to be expected.
• Whereas previously only the acquisition of enterprises engaged in the development or manufacturing of military equipment or products with IT security functions was covered, in the future, enterprises which are or were previously engaged in the modification or use of such equipment or products can also be screened. Such prior activities of the enterprises shall be sufficient to require an investigation if the target still has knowledge of or access to the security-critical technology.
• Any acquisition subject to notification requirements will be suspended for the duration of the review process. An unconditional closing of the transaction will therefore no longer be legally possible. This will apply to a greater number of business sectors than is currently the case. Further, in addition to healthcare related businesses, the German government plans to subject other industries and sectors to notification requirements, in particular those already identified by the EU Framework Regulation (e.g., data-driven business sectors, semi-conductors, aerospace, critical technologies, businesses involving dual-use items, AI, robotics and cybersecurity). For acquisitions that do not trigger a notification obligation, however, the previous legal framework remains unchanged.
• If notification is required, the newly introduced penalty prohibitions prevent the parties to the acquisition from creating a fait accompli during the ongoing screening. Prior to FDI control clearance, the parties are not permitted to

• (1) enable the acquirer to exercise voting rights directly or indirectly,

  (2) grant the acquirer the right to receive a claim for payment of profits or an economic equivalent, or

  (3) provide or otherwise disclose to the acquirer certain company information of the target, provided that such information relates to divisions or objects of the enterprise which are subject to the screening.

• In case of non-compliance with the notification requirements and other obligations under the amended rules, administrative and criminal penalties may be imposed. The proposed amendments are designed to enhance the effectiveness of the German FDI control regime by closing existing gaps that allow parties to proceed with the implementation of an investment while the government is still conducting its investigation.

IMPACT ON INVESTMENTS IN EU-BASED TARGET COMPANIES

With the full applicability of the EU Framework Regulation as of October 11, 2020, non-EU investors face considerable changes in the screening of their investments in EU-based target companies.

These developments not only concern the timeline for screening procedures due to the cooperation mechanism implemented by the EU Framework Regulation, the scope of covered critical or sensitive business sectors will be considerably expanded as well. The German Ministry of Economics, the competent authority that conducts the screening process for targets based in Germany, will have additional leeway in its decision-making. Similarly, under the new provisions introduced in Spain at the end of March 2020 and in France effective April 1, 2020, other EU Member States have adopted laws and regulations to comply with the EU Framework Regulation, and further national governments will follow these paths.

Transactions involving a number of EU-based companies in different EU Member States will require a multijurisdictional analysis to identify notification requirements and related obligations in order to ensure compliance with FDI control rules in the same way that investors are already used to under merger control rules.

[View source.]