Germany intends to tighten the rules for foreign direct investments

In the midst of the Corona crisis the German government introduces a draft bill to overhaul the foreign direct investment rules for investments in German companies made by non-EU and non- EEA investors.

In December 2018, the German government already introduced new thresholds for the review and lowered the foreign investment review procedure to reaching or exceeding 10% or more of the voting rights in a critical company namely those operating a critical infrastructure (see here.)

The new draft bill has been in the public domain since early 2020 and the Federal Ministry of Economics and Infrastructure conducted a consultation with the public. Now, the Federal Government has endorsed the draft and the start of the legislative procedure is to be expected soon. As the draft bill reflects some changes introduced by the EU Regulation establishing a framework for the screening of foreign direct investments into the Union (Regulation (EU) 2019/452, EU FDI Screening Regulation), one can expect that the changes should enter into force in October 2020 when the EU Regulation takes effect as well.

New Substantive Test

The current review test is based on the criteria of public order and security which are terms stemming from EU law and which are not finally decided in the EU courts as the Court of Justice of the European Union indicated that the concept of public policy may vary from one country to another and from one era to another (Case C-36/02, - Omega, para 31). The current test requires that public order or security is actually endangered by the acquisition being reviewed.

This test will be lowered - in line with the requirements of the EU FDI Screening Regulation - to public order or security is expected to be impaired by the acquisition. This lowered substantive test will give the reviewing authority a much broader discretion for review. Therefore, interventions are more easily possible and will likely occur more often in the future.

In addition, the review of public order and security is broadened to cover also the potential impact on other EU Member States or projects and programmes of union interest. This change is brought by the EU FDI Screening Regulation which foresees a cooperation mechanism for the Member States and the EU Commission. In the current form that may mean that a transaction could be prohibited solely on the grounds and impact of the transaction in a different Member State.

Overall, such a lowered test can be expected to lead to more interventions in the future. To this extent the Federal Minister of Economics told the press that currently the security of supply with medical protection gear is one of the major concerns, i.e. cases where the security of supply for the German market may be at stake. Currently this could be applied if a transaction could deprive the German market of access to certain crucial medical equipment, devices, etc. However, one would need an indication that the acquirer is planning to reroute needed products to other territories.

New Prohibition to Implement

In addition, the intended changes foresee the introduction of a prohibition to implement similar to merger control proceedings for transactions which will trigger a notification requirement – currently reaching or exceeding 10% of the voting rights in a critical company.

The draft law foresees in this regard:

• The purchase agreement pertaining to a transaction triggering a
  notification requirement will be subject a condition subsequent or
  resolving condition that the competent authority does not prohibit
  the transaction; i.e. the effects of the purchase agreement will
  cease with a prohibition.

• The legal or factual implementation of the transaction triggering a
  notification requirement is prohibited for as long as the transaction
  has not been cleared or not prohibited within the procedural
  timeframes; i.e. all legal acts are invalid during the review
  procedure.

Furthermore, the prohibition to implement is supplemented with prohibitions of specific acts to clarify where factual acts may implement a transaction. During the review procedure and with a clearance or the lack of prohibition within the procedural timeframes, the following is prohibited:

• Exercising of the voting rights by the acquirer;
• payment of dividends to the acquirer;
• providing or disclosing sensitive information related to the company
  to be acquired to the acquirer insofar as this information relate to
  the business activities which may affect public order and security
  interests of Germany; and
• providing or disclosing information related to the company to be
  acquired to the acquirer if the competent authority issues a
  respective order.

Violations of these specific prohibitions can be met with imprisonment of up to 5 years or a penalty of up to €500,000 in case of negligent violations.

The issue with the current wording of the prohibition to implement relates to the specific prohibition on disclosure of information as the wording of this prohibition is rather broad. The legislative material indicates that the prohibition aims at such information which represent critical know how and technology and, therefore, commercial or other customary information which the investor obtains in the course of a due diligence exercise to assess the viability of the investment should not be encompassed.

Still the wording of the law leaves room for interpretation and given the potential consequences of imprisonment, this changed law will have to be reflected in the planning of future M&A transactions.

Future Changes

For the time being, the thresholds for the cross-sector review remain unchanged; i.e. acquisition of 10% of the voting rights in a critical company and 25% of the voting rights in all other companies. However, the Federal Ministry of Economics and Infrastructure already announced that in a second step further adjustments will be made which will most likely concern the subject matter of the review. In this regard a definition of critical technology will be introduced and companies engaged with such critical technology will be subject of the notification requirement of the 10% threshold. The fields of critical technology have been identified as artificial intelligence, robotics, semiconductors, biotechnologies and quantum and nuclear technologies, but the details remain unclear.

See our coronavirus (COVID-19) feature for more information generally on the possible legal implications of COVID-19.