European Court of Justice rules that foreign investment screening cannot be used as a protectionist tool within the EU
8 min read
The European Court of Justice (“ECJ”) has ruled that Hungary’s foreign investment screening law is incompatible with EU law, in particular the freedom of establishment enshrined in Article 54 TFEU. In striking down a protectionist measure, however, the ECJ raised several points of interest for FDI screening within the EU.
Within the European Union (EU), foreign direct investment screening based on national security considerations is primarily a national competence. Each Member State applies its own legislation to screen foreign investments. The EU, through the EU FDI Screening Regulation (Regulation (EU) 2019/452),1 plays an important role in setting up a cooperation mechanism between EU countries and the European Commission, and a supporting role in screening investments from third countries. The recent Xella Magyarország judgement provides a rare but interesting instance of an ECJ ruling in this area.2
The ECJ's decision comes as a response to a request for a preliminary ruling from the Budapest-Capital Court in Hungary. The Hungarian court sought guidance on whether a Hungarian law, allowing the Minister of Innovation and Technology to prevent foreign investors, including EU-based companies under “majority control” by third-country investors, from acquiring "strategic" Hungarian companies,3 was compliant with the EU FDI Screening Regulation and with EU law in general.
In this case, Xella Magyarország, a Hungarian company ultimately owned by an Irish national but part of a group of companies based in Bermuda, aimed to acquire all shares of Janes és Társa, a Hungarian company involved in mining raw materials like gravel, sand, and clay. The Hungarian Minister blocked the transaction, citing concerns about the “security of raw material supply to the construction sector” and its impact on the “national interest”.4
The ECJ found that the Hungarian national screening law on foreign direct investments as interpreted in the case at hand is incompatible with EU law, in particular the freedom of establishment. The judgement has implications for FDI screenings within the EU.
Key points of the judgment
a) Clarification of the scope of application of the EU FDI Screening Regulation
The ECJ found that the EU FDI Screening Regulation does not apply to investments made by companies registered in an EU Member State which are controlled by a third country investor.
Reading the EU FDI Screening Regulation narrowly, the ECJ held that the EU FDI Screening Regulation’s scope of application is “limited to investments in the European Union made by undertakings constituted or otherwise organised under the laws of a third country.”5 The Hungarian measure at issue, which captures not only investments from third countries, but also investments which “are made by undertakings registered in Hungary or in another Member State over which an undertaking registered in a third country has “majority control””,6 therefore falls beyond the EU FDI Screening Regulation’s narrow scope.
In so holding, the ECJ did not follow the Advocate General’s Opinion, who had suggested that the Hungarian measure should fall within the scope of application of the EU FDI Screening Regulation. Indeed, Advocate General Ćapeta had argued that the very rationale behind the EU FDI Screening Regulation was to target foreign investment which could endanger or threaten the EU’s public policy or security.7 This reasoning should apply, she argued, regardless of the form, or structure, which the foreign investment takes (i.e., regardless of whether the investment is direct, or indirect through the acquisition of shares by another EU undertaking).8
b) Clear message that EU Member States cannot use FDI screening as a protectionist tool
The ECJ further stated that in light of the Hungarian measure’s ability to capture intra-EU FDI, it must be assessed under the Treaty on the Functioning of the EU (“TFEU”) rules on free movement, in particular the freedom of establishment enshrined in Art. 54 TFEU.9
The ECJ found that the measure at hand constitutes a particularly serious restriction to the freedom of establishment, as it prohibits an EU company from acquiring a stake in a “strategic” resident company, on grounds of security and public policy.
According to the ECJ, Hungary did not provide sufficient justification for this restriction on the basis of overriding reasons of public interest. The ECJ confirmed that such reasons must be interpreted strictly and cannot be based on purely economic motivations.10 In particular, the ECJ asserted that the objective of ensuring supplies of construction materials does not represent a “fundamental interest of society” for the purposes of justifying a restriction of Art. 54 TFEU.11 Moreover, the ECJ considered that the acquisition of Janes és Társa by Xella Magyarország is equally unable to raise a “genuine and sufficiently serious threat” (which would generally have been sufficient for the purposes of justifying a restriction to the freedom of establishment).12
This finding confirms the ECJ’s strict review of restrictions of fundamental freedoms, as well as the limited leeway that exists for justifying restrictions of such freedoms. This is particularly the case where the measure at issue is protectionist in nature.
The judgement states loud and clear that a protectionist measure taking the form of national FDI screening legislation will amount to an unjustifiable restriction of the fundamental freedoms protected under EU law. While Member States can keep screening EU foreign investments, the ECJ makes it clear that any restrictions resulting from such screening must be limited to measures targeting a “genuine and sufficiently serious threat to a fundamental interest of society”. The ECJ goes on to find that “purely economic ends” cannot provide a sufficient justification. Given that “economic sovereignty” has become a key driver for FDI screenings in the EU, it could be practically difficult in some instances for national authorities to draw a clear line between legitimate economic considerations in terms of national security on the one hand and protectionist (i.e., purely economic) measures on the other.
The judgment’s approach could suggest that third-country investors in EU companies will benefit from free movement rules enshrined in the TFEU, and that they will not be caught by the EU FDI Screening Regulation once they engage in second or third investments with their now-EU company. The EU FDI Screening Regulation would apply only at the point of first entry of an investment into the EU. Such a generous interpretation may create an incentive for third-country investors to direct their first investments into Member States which have a more flexible approach of FDI screening, or even to set up a local vehicle for future acquisitions. However, the primary competence for screening foreign investments lies at the national level. As such, national screening authorities retain the right to screen any foreign investment, including intra-EU FDIs – as long as an intervention is justified by genuine grounds of public policy, public security or public health. (That being said, national courts typically grant the screening authorities substantial discretion in this space, and the time it takes to annul an FDI prohibition often makes appeals against such vetoes unfeasible in the first place). What the Xella judgement does reiterate, however, is that intra-EU FDIs fall within the protective scope of the EU free movement rules. It will be relevant to follow how national screening authorities will implement this approach, especially in situations where the (principally EU-based) investor still has a nexus with third countries, as was the case in the transaction giving rise to the Xella Magyarország judgment.
1 Regulation (EU) 2019/452.
2 Case C‑106/22, Xella Magyarország Építőanyagipari Kft. v Innovációs és Technológiai Miniszter, EU:C:2023:568
3 Articles 276, 2777 and 283 of the veszeyhelyzet megszűnésével összefüggő átmeneti szabályokról és a járványügyi készültségről szóló 2020. EVI LVIII. törvény (Act No. LVIII of 2020 on the transitional rules relating to the end of the state of emergency and to the epidemiological alert situation), of 17 June 2020 (Magyar Közlöny 2020/144).
4 Case C‑106/22, Xella Magyarország Építőanyagipari Kft. v Innovációs és Technológiai Miniszter EU:C:2023:568, para. 24.
5 Case C‑106/22, Xella Magyarország Építőanyagipari Kft. v Innovációs és Technológiai Miniszter EU:C:2023:568, para. 32.
6 Case C‑106/22, Xella Magyarország Építőanyagipari Kft. v Innovációs és Technológiai Miniszter EU:C:2023:568, para. 33.
7 Opinion of Advocate General Ćapeta delivered on 30 March 2023(1) in Case C‑106/22 Xella Magyarország Építőanyagipari Kft.v Innovációs és Technológiai Miniszter, EU:C:2023:267, para. 45.
8 Opinion of Advocate General Ćapeta delivered on 30 March 2023(1) in Case C‑106/22 Xella Magyarország Építőanyagipari Kft.v Innovációs és Technológiai Miniszter, EU:C:2023:267, para. 43.
9 Case C‑106/22, Xella Magyarország Építőanyagipari Kft. v Innovációs és Technológiai Miniszter EU:C:2023:568, para. 41.
10 Case C‑106/22, Xella Magyarország Építőanyagipari Kft. v Innovációs és Technológiai Miniszter EU:C:2023:568, para. 64
11 Case C‑106/22, Xella Magyarország Építőanyagipari Kft. v Innovációs és Technológiai Miniszter EU:C:2023:568, para. 69
12 Case C‑106/22, Xella Magyarország Építőanyagipari Kft. v Innovációs és Technológiai Miniszter EU:C:2023:568, para. 71
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