Client Alert

Better File than Sorry – Second Set of German FDI Screening Rules Imposes Strict Penalties, and Still More to Come

22 Jul 2020

Executive Summary

The second of three packages of proposed 2020 amendments to the German rules on control over foreign direct investments (FDI), effective on July 17, 2020, brings a scheme of severe civil and criminal penalties and lays the groundwork for broader and intensified scrutiny of FDI. The new rules, this time primarily entailing changes to the German Foreign Trade and Payments Act (AWG), supplement the first tranche of 2020 amendments to FDI screening in Germany that reflected the new public interest concerns related to the COVID-19 crisis and came into effect on June 3, 2020 (see our previous alert). The additional amendments effective now are a key element of the preparation of the German FDI control rules prior to the full applicability of Regulation (EU) 2019/452 establishing a framework for the screening of FDI (the “EU Framework Regulation”) on October 11, 2020. They enhance the enforcement side of German and EU FDI control, while a third (and likely final) set of 2020 amendments  expected in the next few weeks will, again, further broaden the scope of filing requirements and areas of potential in-depth screening.

Here are the core aspects of the most recent changes that investors need to be aware of in transactions involving German target companies:

  • The suspension of FDI transactions, i.e., the pending invalidity of any acquisition of shares or assets as agreed in a purchase agreement, is extended to all transactions subject to notification requirements. Such transactions may only be completed after being approved or deemed approved by the German Ministry of Economics and Energy (BMWi). The infringement of specific standstill obligations may lead to criminal prosecution and penalties, including hefty fines and imprisonment of up to five years.
  • The substantive test for the control of FDI has been adjusted. Instead of an “actual threat,” a “likely impairment” to security or public order has to be established in order to prohibit or restrict a transaction. This is a result of the EU Framework Regulation that suggests potential effects to assess when considering whether a specific investment is “likely to affect” security or public order.
  • Adjustments made to procedural deadlines provide for a clearer set of timelines, but do not necessarily reduce the overall duration of screening procedures, particularly not in complex cases. The general rule is two months for an initial review and another four months in case of in-depth screening. However, in complex cases, the timeline may be extended by up to three months (four months in the defense sector).

Severe Enforcement: Ban on Implementation of Transactions and Strict Penalties

Under the amended AWG rules, any implementation of a transaction that has a notification requirement remains invalid until being approved or deemed approved by the BMWi. Any non-compliance with applicable restrictions may lead to administrative and criminal penalties.

Ban on Implementation of All Transactions Subject to a Notification Requirement

Under the amended rules, any acquisition subject to notification requirements will be suspended for the duration of the review process. Until now, pending invalidity of investments before clearance was limited to particularly sensitive sector-specific transactions. Under the new rules, any implementation of a particularly security sensitive transaction subject to cross-sectoral control, for instance an investment in critical infrastructure, will be considered invalid until the transaction is cleared, or deemed to be cleared. An unconditional closing of the transaction will therefore no longer be legally possible.

The 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. In the future, the suspension of any acquisition of shares or assets implementing a purchase agreement will apply to a greater number of investments, as the scope of notification requirements is being further broadened. In addition to healthcare-related domestic companies included as part of the revision of the Foreign Trade and Payments Regulation (AWV), which became effective in June 2020, the German government plans to subject further sensitive industries and sectors to a notification requirement as identified by the EU Framework Regulation.

For acquisitions that do not trigger a notification requirement, however, the previous legal framework remains unchanged. Accordingly, those transactions will still be considered to be pending during the review period and can only be rendered void if the BMWi prohibits or restricts the transaction.

Standstill Obligations can be Enforced with Criminal Penalties

Transactions requiring notification are also subject to specific standstill obligations. Prior to FDI control clearance, the seller is not permitted to

  • Enable the acquirer to exercise voting rights, directly or indirectly;
  • Grant the acquirer the right to receive a claim for payment of profits or an economic equivalent; and
  • Provide or otherwise disclose to the acquirer certain company information of the target, (i) provided that such information relates to divisions or objects of the enterprise which are subject to the screening, or (ii) which the BMWi designates as important for the essential security interests of Germany.

Any violation of the above-mentioned standstill obligations, may lead to administrative and criminal penalties. Penalties include imprisonment of up to five years for intentional infringements and hefty administrative fines of up to EUR 500,000, even for negligent behavior.

Tougher Substantive Control over Foreign Direct Investments in the EU

Under the amended AWG rules, the standard of screening is aligned with the EU Framework Regulation. Until now, the German government needed to demonstrate that there is an “actual threat” to security or public order. Due to the alignment, the assessment will now be whether an investment is “likely to affect security or public order.” The BMWi announced in a press release that critical corporate acquisitions may now be examined “more proactively.” However, only future decision-making practice and court rulings will show if and to what extent the revised substantive test will actually change the screening approach.

Under the amended rules, not only the public order or security of Germany, but also “of another Member State” will be subject to the investment screening. In addition, the potential effects on “projects or programs of Union interest” will be taken into account. If the acquisition of a domestic target is likely to affect security or public order beyond Germany, the BMWi will need to cooperate with the affected stakeholders and share information among Member State governments. An impact on the timeline of screening procedures, especially for investments involving entities of the target in multiple EU Member States, needs to be expected.

It is worth noting, however, that the new substantive test, although becoming effective at the level of the AWG, still needs to be implemented in the corresponding regulation, the AWV, before becoming applicable. Amendment of the AWV will be part of the third amendment package expected to become effective in autumn 2020. Until then, by the letter of the law, the “old” substantive test requiring a “threat to security or public order” remains applicable.

Introduction of Uniform Screening Time Limits

The BMWi now has two months to formally open a screening procedure after obtaining knowledge that the parties concluded a purchase agreement. Until now, the BMWi’s deadline for opening formal proceedings was three months, so the amendment constitutes a considerable reduction. The two-month time limit also still applies where the parties to a transaction apply for a letter of non-objection.

However, the deadline for the BMWi to conduct and terminate its formal proceedings is extended for particularly complex cases. Generally, the BMWi has to issue a prohibition or restriction order within four months after the parties provide all necessary information. It may, however, extend the examination period for up to three additional months if the case proves to be factually or legally difficult. Under certain circumstances, e.g., if the transaction affects defense-related interests of Germany, the BMWi may extend proceedings by another month. Also, under specific circumstances, the deadline may become indefinite (since the clock may be stopped), as already foreseen under the prior rules. The new deadlines will only apply to transactions which the government first gained knowledge of after July 17, 2020.

The Introduction of the Contact Point at the BMWi

As intended by the EU Framework Regulation, the amended AWG includes the establishment of a “National Contact Point.” The BMWi will fulfill this function, which is essential for the new European cooperation mechanism. Pursuant to the EU Framework Regulation, the National Contact Point is responsible, inter alia, for

  • Notifying the EU Commission and other EU Member States of any FDI that is being screened in Germany, as well as providing comments on FDI in other EU Member States if security or public order concerns arise from its perspective and serving as contact in case of opinions or comments issued by the EU Commission or other Member State governments; and
  • Requesting information from other Member States on FDI in their territories, as well as collecting information on FDI and, upon request, providing such information to contact points of other EU Member States.

Further Adjustments to the EU Framework Regulation and its Impact on Investors

A third package of amendments tightening FDI screening in Germany is still being discussed. It is expected to come into force by the time the EU Framework Regulation takes effect on October 11, 2020. The proposed further amendments will bring additional notification requirements to a number of so-called “critical technologies” including, e.g., artificial Intelligence, robotics, semiconductors, biotechnology and quantum technology. As under the current regime, minority investments of 10% or more in these sensitive areas will be subject to control.

Similarly, other EU Member States are currently adopting tighter regulation of FDI. When envisaging targets within the EU, investors must be aware of the potentially extended number and duration of FDI screenings.

Alexander Eisenfeld has contributed to the drafting of this client alert.

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