Foreign investment control has become a key factor in M&A deals and 2020 has been an eventful year. A large number of economies have introduced foreign investment control regimes or tightened their existing rules. Now it appears that it is time to make use of them: this week Germany has not only prohibited a planned acquisition by Chinese investors, but the entire draft prohibition decision has been leaked. This allows first-hand insights into the government’s stance towards Chinese investment and sends a strong signal to parties of international deals involving German target companies.
On Wednesday, December 2, 2020, the German Federal Government prohibited the acquisition of communications technology company IMST GmbH by the Chinese investor Addsino Co. Ltd, a subsidiary of the Chinese state-owned defence group China Aerospace and Industry Group Co. Ltd (CASIC).
The prohibition decision of the German government
A prohibition decision under German foreign direct investment (FDI) laws is not only rare – this is only the second – but more importantly, it is normally kept confidential and not published. It was therefore very surprising that only a day after the Federal Government said “no in the IMST case”, a copy of that decision made its way around the community of FDI advisors in Germany. It is unprecedented that a decision of the German Ministry of Economics (Bundeswirtschaftsministerium – BMWi) reaches the public by way of an – intentional or unintentional – leak. While this casts a poor light on the administrative process of the German government, the text of the decision allows for insights into the thinking of the government as regards Chinese investment in Germany.
The target IMST is active in research and production the area of radio systems, chip design, antennas and EDA software. It also has key know-how in the fields of satellite/radar communication and 5G technology that is also relevant for military applications. Hence, the BMWi’s main concern was that the acquisition endangered the supply to the German Armed Forces. The flipside of this concern was the supply of armament to China as a non-allied country. Specifically dangerous in the cocktail of concerns was the fact that the target company IMST engages in the area of 5G technology:
- The BMWi has been focussing on 5G technology and other key technologies for the future development for a long time. In the present case the BMWi has found that IMST’s technology can be used for building the German 5G network, which is viewed as critical infrastructure. The most serious concerns for the prohibition are based on the know-how IMST has in the field of satellite/radar communication and 5G, and the fact that the potential acquirer is a Chinese state-owned defence company.
- In line with recent experience, the BMWi has also found the security of supply to the German Armed Forces to be a major concern – even if the target company is only indirectly part of the supply chain. IMST has been part of the supply chain for relevant applications in the past. Especially, the target has developed a key component for the German earth observation satellite TerraSAR-X whose data the Federal Ministry of Defence has used to calculate a highly accurate 3D elevation model for military purposes.
- The decision further emphasises that IMST has acquired parts of its know-how through significant public funding received from the German state. Funding made up ca 40% of IMST’s revenue in the last years and the BMWi invoked this as a basis for its conclusion that IMST’s activities relate to Germany’s “technological sovereignty” that should not be “sold out”.
- Another important point is the BMWi’s assessment regarding export controls: The BMWi has considered the previous application for export control licences relating to products caught under the regulations – even if not used – as sufficient to conclude that the target fell into the scope of the (military) sector-specific FDI procedure. The decision states that it is not required that the target is currently active in the development or production of goods falling under the scope of FDI review. It is sufficient that the company has developed or produced the relevant goods in the past and still has the corresponding means of production and the necessary know-how available.
The parties unsuccessfully tried to rebut the BMWi’s concerns and even offered remedies to mitigate the concerns. The BMWi rejected this offer and stated that there was no alternative to prohibition. This is an approach rarely used before, as mitigation agreements are very common in German FDI procedures and allowed to address a variety of concerns in previous transactions.
The decision sets out how the BMWi dealt with the seller’s arguments that a prohibition would affect their protected rights to divest their own business. While the constitution guarantees this right, the government did not consider a prohibition unproportionate. It held that it was likely that there would be alternative investors outside of China.
The decision follows a number of reforms and a substantial tightening of German rules on FDI in the past years. Three reforms have come into effect only this year. The German FDI rules allow the BMWi to investigate whether the acquisition of a German domestic company by a foreign investor poses a threat to “essential security interests” or “public order or security” of Germany.
This is not the first decision of the Federal Government to prohibit a deal under German FDI rules and not the first one to involve a Chinese investor either: Already in 2018 the Federal Government voted to veto the acquisition of Leifeld Metal Spinning AG by Chinese investor Yantai Taihai Corporation. At that time, however, the parties had already abandoned the transaction before the prohibition decision was made, while the IMST deal was still alive.
The scope of IMST’s activities is relevant in view of the ongoing reform process of German FDI rules: The German government is currently working to introduce “critical technology” into the catalogue of activities subject to mandatory FDI review. The BMWi refers explicitly to the EU FDI Framework Regulation (EU) 2019/452 (available here), which has recently taken full effect and on which the term is based. The term focusses on technologies considered vital for future development and is likely to include 5G technology. However, the scope of the term is wide and it has proven difficult to limit its definition, as the government is working on striking the right balance between the free market principle and national security and public order.
The decision also provides more guidance on the definition of Germany’s essential security interests. The BMWi has, in particular, clarified that such interests relate to the military and the supply of the armed forces, but also the provision of technologies to armed forces of a non-allied third country. While the acquirers suggested mitigation measures, these were not deemed appropriate and sufficient by the BMWi for not preventing the loss of know-how to China.
Finally, the decision explains that the seller could have found alternative buyers which would not raise similar concerns. The governments mentions expressly financial investors as alternative acquirers, suggesting that these would not trigger comparable security concerns. For private equity investors, this may serve as an important argument in future deal negotiations.
The parties in the IMST case will probably take legal action to the German administrative courts, which would yet be another unprecedented step under the German FDI regime. If there is a legal review of the prohibition decision, it would for the first time test the wide interpretation of the law by the German government in the last few years and would possibly provide welcome clarifications.
Key Takeaways for parties to transactions in Germany
For parties to a transaction involving a German target company, the IMST case is a reminder to keep the follow questions in mind when assessing the probability of a prohibition or a need of a mitigation agreement:
- Is the buyer a Chinese State-owned entity or somehow indirectly affiliated with the Chinese State?
- Is the target company active in the field of critical technology, including any relationship with 5G networks?
- Does the target play a role for the security of supply to the German Armed Forces – even if the target company is only indirectly part of the supply chain?
- Does the target have any sales to or cooperation with security agencies such as the Federal and State police? The BMWi stated that IMST would no longer be a reliable partner if under Chinese control.
- Did the target receive significant public funding? The extent of the funding IMST received was seen as proof that IMST’s activities are of great public importance (e.g. technological sovereignty).
- Did the target apply for export control licenses in the past that related to items classified in critical categories? Even past exports may serve as proof of sensitive activities.
Finally, parties to transactions subject to German FDI screenings need to be aware and cautious that leaks may not be excluded. This will not strengthen the trust parties put in the process, including in the negotiation of mitigation agreements.