Restrictions on M&A Transactions under German Foreign Investment Law - A Brief Guide
For many decades, Germany has consistently experienced significant inbound investment and it is widely recognised that foreign investment has been a considerable contributor to growth and prosperity in Germany. Investment from the US has always been strong and continues to account for a large share of foreign investment. More recently, cash rich strategic investors from China and India have increasingly looked at investment opportunities in Germany as have sovereign wealth, private equity, infrastructure and pension funds. While Chinese and Indian strategic investors often have a particular interest in businesses with a technology focus, many sovereign wealth funds tend to diversify and often invest in minority positions. Infrastructure and pension funds are usually looking to invest into steady income streams from assets that tend to be immune against or at least less affected by changes in the economic cycle.
Until 2004, Germany had no special legislation restricting foreign direct investment beyond general restrictions such as the need for antitrust clearance or regulatory requirements for investments in financial institutions which equally apply to investors from Germany, the European Union and elsewhere. In 2004, it was introduced that investors from countries other than the member states of the European Union (EU) and the European Free Trade Association (EFTA, i.e., Liechtenstein, Iceland, Norway and Switzerland) would need to notify the acquisition of a business manufacturing or developing war weapons or armaments or producing crypto systems admitted for the transfer of state secrets, unless the investor directly or indirectly acquires less than 25 per cent of the voting rights. The German government is authorised to restrict or prohibit the acquisition if it would affect significant security interests of the Federal Republic of Germany.
In the wake of supra-national discussions about the need for restrictions to foreign investment by sovereign wealth funds which resulted in guidelines by the Organisation for Economic Co-operation and Development (OECD), the International Monetary Fund (IMF) and the EU, and in light of the tools that are available to other countries that in principle share an open investment policy (such as the UK and the US), it was widely found that the restrictions limited to armaments and crypto systems were too narrow and required broadening.
As a result, the German Foreign Investment Act was amended in 2009. Since, the government may also restrict or prohibit acquisitions by investors from outside the European Union and the EFTA if the acquisition “jeopardises the public order or security” which shall require an “actual and sufficiently serious threat that affects a fundamental interest of the society”.
No doubt: the provision has a very generic character, and it may not surprise that it is sometimes difficult to render a clear cut assessment when we are - e.g., in large infrastructure transactions - faced with the question if a proposed acquisition could be restricted or prohibited under this legislation. To date, the German government has not made use of it to impose any restrictions, and it is therefore useful to shed some light on it and give guidance as to how the legislation is likely to be applied in practice:
On the one hand, the 2009 legislation is, unlike the 2004 legislation which covers producers of weapons, armaments and crypto systems only, deliberately not restricted to any specific sector. Its generic character rather intends to enable the government to review a large variety of acquisitions and to adapt its application to changes in the economy and the relevance of different industry sectors over time. On the other hand, there are various aspects limiting its scope. As mentioned above, only investors from outside the European Union and EFTA are covered, and as a result of the acquisition the investor must, directly or indirectly, acquire 25 per cent or more of the voting rights in the target company (which means that many minority investments by sovereign wealth funds will be outside the scope of the legislation). Also, in a circular the government emphasises that the legislation is intended to apply in very exceptional cases only and would not represent a change in attitude towards foreign investments. Further guidance can be taken from the European Court of Justice (ECJ). For purposes of interpretation of the term “public order and security”, the legislation refers to the equivalent term as used in the EC Treaty, and in relevant precedents the ECJ has ruled that member states may invoke the “public order and security” to ensure supply in a crisis in the areas of telecommunication, electricity, gas and petroleum. At the same time, the ECJ has pointed out that purely economic objectives or industrial policy would not qualify to pose a serious threat to the public order and security, and it would therefore not be sufficient to justify any restrictions with
- the restructuring of certain sectors;
- the enhancement of competitiveness of businesses or sectors;
- monetary interests of the government including the reduction of public debt;
- the support and development of capital markets and the desire to enhance individual ownership in stock of listed companies; or
- the general modernisation of the economy and the increase of productivity.
Apart from these guidelines, relevant factors are the person of the acquirer, its home country, its current business and future intentions. It may, for example, be a criterion if the investor’s home country is subject to an embargo or if the investor in its home country is engaged in the defence industry even if the proposed investment is in an unrelated sector. Another item to be considered is the competitive situation on the market in which the target business operates. The less competitive, the more likely it is that an investor could influence the supply with the relevant products or services.
While these criteria give some guidance and will, in the vast majority of cases, not justify any restrictions, there will sometimes remain uncertainty, in particular where large infrastructure assets in regulated markets with limited competition are concerned. Where relevant, it may be advisable to proactively seek a binding ruling from the government. In principle, the government has three months from the signing of a binding agreement on the acquisition to inform the acquirer that it wishes to commence investigations, and may within two months from receipt of all relevant information requested from the acquirer prohibit or restrict the transaction. In parallel, the Foreign Investment Act expressly enables an investor to apply for a clearance certificate by filing a description of the proposed investment, the acquirer and its business. Upon filing, the government has one month to decide on the issuance of such clearance certificate, and it must issue it if the proposed transaction would not threaten the public order or security. Such instrument provides some compensation for the level of uncertainty that the flexibility of the term “public order and security” involves.
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Nico Abel is a corporate partner of Norton Rose LLP and heads the corporate practice at the Frankfurt office. He specialises in complex mergers and acquisitions with a particular focus on transactions in regulated industries such as financial institutions and infrastructure.
Nico has wide experience of private and public company mergers and acquisitions, leveraged buy-outs, joint ventures, and corporate restructurings and has advised corporates and financial institutions on numerous transactions. His recent experience includes transactions in the financial institutions, energy and utilities, infrastructure and transport sectors.
Since 2007, JUVE, the leading German legal directory, ranks Nico among the Top Ten German M&A lawyers (age 40 and under). He is further mentioned by JUVE as a frequently recommended lawyer in M&A, Corporate and Private Equity. Chambers & Partners rank Nico as a leading lawyer in Private Equity. They quote clients as saying that he "knows how to get to the key point" when negotiating a deal and praise him for his “very commercial and pragmatic approach”. According to Legal 500 EMEA, Nico is “very responsive” and “great to work with”. Nico can be contacted on +49 69505 096 220 or by email at email@example.com