In Germany, the investment climate remains liberal in principle. Nevertheless, since 2016, German foreign investment control has continuously toughened, and the German Federal Government has become increasingly sensitive about protecting key technologies, industries and know-how.
Several transactions involving, in broad terms, critical infrastructure, telecommunication networks and advanced technologies have been cleared only after lengthy investigations, and were subject to strict compliance remedies.
According to the BMWi, almost all of the cases in which security concerns were identified in 2019 and 2020 were resolved through contractual arrangements.
In addition, triggered by the EU Screening Regulation and the COVID-19 pandemic, the German regulatory framework has—once again—undergone substantial expansive revisions throughout the past year, adding to the complexity and scope of the review process.
THE REGULATORY FRAMEWORK
The German rules on foreign direct investment are set out in the German Foreign Trade and Payments Act (Außenwirtschaftsgesetz; AWG) and the German Foreign Trade and Payments Ordinance (Außenwirtschaftsverordnung; AWV). The regulatory framework is broadly structured as follows:
- The competent authority is the Federal Ministry for Economic Affairs and Energy (Bundesministerium für Wirtschaft und Energie—BMWi), which involves other federal ministries and government agencies depending on the target activities
- The German foreign direct investment regime is partly mandatory, and partly voluntary. In essence, the activities of the target and the "nationality" of the direct or indirect investor determine the process and whether there is a filing obligation
- For all foreign direct investments that are subject to the mandatory regime, the investment threshold is 10 percent (shares or assets), and the transaction is subject to a standstill obligation until clearance
- For all other foreign direct investments, the investment threshold allowing for a review is 25 percent, and there is generally no equivalent standstill obligation
- The review timeline includes an initial review period of two months. To the extent the BMWi decides to initiate a full review, a subsequent in-depth review of four months from the full documentation (subject to suspensions and extensions)
- The material review criterion to be applied by the BMWi is whether the foreign direct investment results in a probable impediment to the public order or security (öffentliche Ordnung oder Sicherheit) of the Federal Republic of Germany
SCOPE OF REVIEW AND TYPES OF DEALS REVIEWED
The activities of the target and the nationality/origin of the investor determine the scope and intensity of the review process.
Regarding certain highly sensitive industries such as arms and military equipment, encryption technologies and other key defense technologies such as reconnaissance, sensor and protection technologies, investments of at least 10 percent (voting rights in an entity or assets constituting a business) by any foreign (i.e., non-German) investor are subject to a mandatory, so-called "sector-specific" review.
Any other type of investment may only be scrutinized by way of a so-called cross-sectoral review that applies if the investor is based outside the EEA/EFTA. When reviewing foreign investments, the BMWi takes a broad view and looks at all entities in the entire "acquisition chain" from the direct acquirer to the ultimate parent, and also to shareholders such as limited partners.
Whether a review is mandatory or voluntary further depends on the target's activities. In particular, the review is mandatory if a non-EU/EFTA investor acquires 10 percent or more of a domestic target that:
- Operates "critical infrastructure" (as legally defined in great detail) or develops and modifies software specifically for such "critical infrastructure"
- Has been authorized to carry out organizational measures pursuant to the Telecommunications Act or produces or has produced the technical equipment used for implementing statutory measures to monitor telecommunications and has knowledge about this technology
- Provides cloud computing services and related infrastructure
- Holds a license for providing telematics infrastructure components or services
- Is a company of the media industry which contributes to the formation of public opinion via broadcasting, telemedia or printed products and is characterized by particular topicality and breadth of impact
- Provides services which are needed to ensure the trouble-free operation and functioning of state communication infrastructures
- Develops or manufactures personal protective equipment
- Develops, manufactures or markets essential medicines, including their precursors and active ingredients
- Develops or manufactures medicinal products within the meaning of medicinal product law which are intended for diagnosis, prevention, monitoring, predicting, forecasting, treating or alleviating of life-threatening and highly infectious diseases
- Develops or manufacturers in vitro diagnostics within the meaning of medicinal product law which serve to supply information about physiological or pathological processes or conditions or to stipulate or monitor therapeutic measures relating to life-threatening and highly infectious diseases
For any other type of target, a filing is voluntary, and the BMWi may initiate ex officio proceedings, where a non-EU/EFTA investor acquires 25 percent or more of a domestic target.
The BMWi is entitled to review all types of acquisitions; i.e., share deals and asset deals. The calculation of voting rights held in the target company will take into account certain undertakings that may be attributed to the ultimate owner, such as an agreement on the joint exercise of voting rights. In order to prevent circumvention, the AWV provides more details on how to calculate and attribute acquired voting rights.
Asset deals require a comparable test for the respective asset values, whereby 25 percent/10 percent of the total assets of the acquired business are deemed relevant—in essence deals that "substitute" the acquisition of a stake above the relevant threshold.
PROCESS CONSIDERATIONS AND TIMELINE
All transactions subject to a mandatory review must be notified to the BMWi.
All transactions that require filings are subject to a "standstill obligation." In particular, it is prohibited to allow the acquirer to directly or indirectly exercise voting rights, distribute profits to the acquirer or grant the acquirer access to certain sensitive data before clearance has been or is deemed to be granted.
In addition, the purchase agreement (also under the voluntary regime) is subject to the condition subsequent (auflösend bedingt) of a prohibition, and (only under the mandatory regime) any closing steps are provisionally void (schwebend unwirksam) until clearance.
The review timeline is two months for the initial review that decides whether to open a formal review, which then lasts for another four months starting upon receipt of all necessary documentation. The BMWi has broad discretion in formal review cases regarding the point at which filings are complete so that statutory deadlines are triggered.
The BMWi can extend the formal review period of four months by another three months (or four months, in exceptional cases). The period available to conduct the formal review measures is suspended in case of additional information requests, and for as long as negotiations on mitigation measures are conducted between the BMWi and the parties involved. Such considerations outside the official review timeline can have a significant impact on the overall transaction timetables.
Even if the transaction does not trigger a mandatory filing, foreign investors often decide to initiate the review process by voluntarily submitting an application to the BMWi for a non-objection certificate (Unbedenklichkeitsbescheinigung) in order to obtain legal certainty. After complete submission of the application, the BMWi has two months to decide whether to issue the certificate or open the formal review procedure. Upon expiration of this period, the non-objection certificate is deemed to have been issued if no review procedure has been opened.
POWERS AND SANCTIONS
In order to safeguard public order or security, the BMWi may—in conjunction with other ministries—prohibit transactions or issue "instructions" (taking the form of mitigation measures or "remedies").
Clearances subject to "remedies" (such as compliance commitments in the form of a trilateral mitigation agreement between ultimate acquirer parent, target and the German Federal Government) have become a common form of resolving issues. For acquisitions included in the cross-sectoral review procedure, the imposition of mitigating measures require the approval of the German Federal Government.
To enforce a prohibition, the BMWi can in particular prohibit or restrict the exercise of voting rights in the acquired company, or appoint a trustee to bring about the unwinding of a completed acquisition at the expense of the acquirer.
Breaches of the standstill obligation or against orders by the BMWi are subject to criminal sanctions: imprisonment up to five years or criminal fines. Negligent violations are considered an administrative offense, punishable with an administrative fine of up to €500,000.
Any BMWi decision can be challenged before a German court. However, this is often not a practical option for the parties (timing, publicity), and the German Federal Government enjoys broad discretion as to what constitutes a probable impediment to public order or security.
RECENT REVISIONS OF THE REGULATORY FRAMEWORK
Following the reduction of the investment threshold from 25 percent to 10 percent and the expansion of the review to certain activities in the media-sector in 2018/2019, the German regulatory framework has undergone severe revisions throughout the past year.
The most relevant developments are:
- Expansion of the review to a number of health-related activities (primarily triggered by the COVID-19 pandemic)
- Lowering of the assessment criterion from "threat" to "probable impediment" to public order and security
- Stronger scrutiny regarding structure, origin and past conduct of investors
- Formal clarification of the generally accepted interpretation that the review also applies to asset deals
- Introduction of a standstill obligation for all notifiable transactions
- Introduction of criminal sanctions for breaches of standstill obligation and administrative orders,
- harmonization of review timelines
- Establishment of a national contact point for European coordination
RECENT DEALS REVIEWED BY THE BMWI
Since 2016, the number of deals reviewed by BMWi each year has continuously increased. From January 2016 to December 2018, 185 transactions were subject to BMWi investment reviews, of which 75 acquisitions were attributed directly or indirectly to a Chinese acquirer. In 2018, 78 transactions were reviewed by the BMWi, almost double the 41 reviews in 2016. From 2018 to 2019, the numbers continued to rise significantly, to 106 cases, with the complexity of the review cases also increasing.
According to the BMWi, almost all of the cases in which security concerns were identified in 2019 and 2020 have been resolved through contractual arrangements, which are becoming the tool of choice, especially in deals perceived critical for the German healthcare system.
Based on the recent and planned AWG and AWV revisions, the BMWi expects the numbers to rise by approximately 40 cases per year over the coming years. In addition, the BMWi expects an additional 130 cases per year from other European authorities based on the EU cooperation and notification scheme. The BMWi expects to issue written opinions in a significant number of these cases.
Only one veto by the BMWi has become public since 2018: In July 2020, the German Federal Government vetoed Chinese Vital Material Co.'s proposed acquisition of PPM Pure Metals GmbH, part of the French Recylex group and a manufacturer of metals used in semiconductors and infrared detectors, including for military applications. The deal was vetoed despite PPM having had filed for insolvency just two months earlier.
Other noteworthy interventions were:
- In July 2018, the German Federal Government had decided to prevent the acquisition of a 20 percent stake in the power grid operator 50Hertz by a Chinese investor by arranging for an investment by the state-owned Kreditanstalt für Wiederaufbau (KfW), because it did not have jurisdiction to block the deal under the then pertinent FDI regime. The German Federal Government officially confirmed that the acquisition by KfW was aimed at protecting critical infrastructure for energy supply in Germany
- In August 2018, the BMWi—for the first time—threatened to veto a Chinese inbound transaction. In the end, the Chinese investor dropped its attempt to acquire German toolmaker Leifeld ahead of an expected veto. This decision would have been the first prohibition of a transaction under the German investment control regime
In contrast, in February 2020, the BMWi cleared the acquisition of German locomotive manufacturer Vossloh by Chinese train manufacturer CRRC.
Triggered by the COVID-19 pandemic, the BMWi announced in June 2020 that the KfW will acquire 23 percent in CureVac, a biopharmaceutical company that focuses on developing vaccines for infectious diseases such as COVID-19 and drugs to treat cancer and rare diseases, in order to avoid its potential acquisition by any foreign investor.
TRENDS IN THE REVIEW PROCESS
The current market climate is characterized by the BMWi's substantially increased awareness and persistent efforts toward enhanced scrutiny, including regarding a potential use of key technologies, in military applications.
The overall number of approved transactions shows that the investment climate in Germany remains liberal for the majority of transactions. The recent clearance of the CRRC/Vossloh transaction is a clear sign that Germany generally continues to welcome foreign direct investment, including investment from the People's Republic of China.
However, there is also a clear trend towards the use of "remedies" to mitigate security concerns. In particular, trilateral mitigation agreements between the ultimate acquirer parent, target and the German Federal Government have become a common form of resolving issues—and appear to be the new standard in health-related transactions. In the same vein, the German investment in CureVac may be seen as another step toward increasing scrutiny in the healthcare sector. In fact, the BMWi justified its decision based on German security interests.
HOW FOREIGN INVESTORS CAN PROTECT THEMSELVES
Parties to M&A transactions—whether public or private—should carefully consider the risk of foreign investment control procedures typically starting at the front-end of the due diligence process. Given the potential for considerable FDI review risks, it may be appropriate for the parties to initiate discussions with the BMWi even before the signing and/or announcement of a binding agreement.
From an investor's perspective, regulatory conditions and covenants relating to the regulatory review process serve to protect the acquirer from having to consummate a transaction under circumstances in which the German Federal Government has imposed regulatory conditions or mitigation measures that would change the nature of or the business rationale behind the proposed transaction.
Contractual undertakings intended to protect the acquirer from these risks may take the form of regulatory material adverse change clauses and/or covenants that specify the level of effort that the investor must expend in order to obtain the necessary regulatory approval.
- It remains unknown whether the implementation of the European screening mechanism, which came into force in October 2020, the overall number of deals approved shows the continuous openness of Germany towards foreign direct investments
- The German Federal Government announced that it will expand further the list of critical activities subject to notification obligation based on the EU Screening Regulation. The list will probably include companies active in the field of artificial intelligence, robotics, quantum technology and biotechnology, and may expand to other areas included in the EU Dual Use Regulation
- It remains unknown whether the implementation of the European screening mechanism, which will come into force in October 2020, will further extend the duration of investment control procedures in Germany, perhaps because of a coordination with other EU Member States or the European Commission. But with the expansion of the list of critical activities, a significant number of additional transactions need to be filed and reviewed. Staff at the BMWi has been beefed up insufficiently to meet the increased demand, which is expected to result in further delays of reviews conducted by the BMWi
- The German Federal Government understands that review duration is a problem, but (apart from a reduction of the initial review period to two months) has not done anything substantial about review duration yet
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