The German government has proposed a new draft bill reforming the current foreign direct investment (“FDI”) regime, which is likely to have a significant impact on all M&A transactions involving acquisitions of 10% or more of the voting rights in German companies active in “critical infrastructures” and “critical technologies” by any non-EU investors. Under the revised regime, such transactions will automatically be subject to a period of suspension until clearance is granted.

Background

Upon publishing a Ministerial draft on 30 January 2020, the German government started a legislative process to change the FDI regime embedded in the German Foreign Trade Act (“Außenwirtschaftsgesetz – “AWG”). Recently, the Federal Ministry of Economics and Technology (Bundesministerium für Wirtschaft und Energie – “BMWi”) presented the draft bill of 31 March 2020.

The main purpose of the legislation is to align the German FDI regime with EU Regulation 2019/452/EU (the “EU FDI Regulation”), adopted in March 2019 and based on a joint initiative of Germany, France and Italy. The EU FDI Regulation came into force on 11 April 2019 and will take full effect as of 11 October 2020. Further, the draft bill incorporates new rules to reflect certain practical enforcement experiences of the German authorities.

While the current FDI reform in Germany has been in the making for a while now, the events surrounding the present Covid-19 pandemic places the amendments into a wider perspective of tightening FDI developments at EU and Member State level in Europe.

We summarize the key amendments of the draft bill below:

Lowering of the review standard

Under the draft bill, in order to intervene in a transaction, the government must assess whether a proposed transaction is likely to affect public order or security. This amends and lowers the pre-existing review standard under which the government is required to make an assessment of whether a proposed transaction poses a threat to public order.  According to the BMWi’s explanatory memorandum provided in the draft bill, this amendment aligns the AWG with the review standard of the EU FDI Regulation, and aims to better address the forward looking nature of FDI screenings.

Broadening of the scope of mandatory filing obligations to “critical technologies”

Under the current German FDI regime, mandatory filing obligations exist for the acquisition of 10% or more of the voting rights in companies active in:

• (mainly) the defense sector (the, so-called, sector-specific examination); and
• the operation of “critical infrastructures” and similar activities (part of the cross-sector examination). Critical infrastructure includes facilities, equipment or parts thereof in the sectors of energy information technology and telecommunications, transportation and traffic, health water, nutrition, and the finance and insurance industries. Similar activities may relate to the development or modification of software for critical infrastructure, the monitoring of telecommunications, the provision of cloud computing services, telematics infrastructure or social services and to the media industry.

It is understood that the amendment of the AWG will be accompanied by amendments to the Foreign Trade Ordinance (Außenwirtschaftsverordnung – the “AWV”). The AWV cements the enforcement powers laid down in the AWG. The German government has already announced that the amendments of the AWV will include an extension of mandatory notification obligations regarding acquisitions of 10% or more of the voting rights in German companies active in the areas of “critical technologies” such as artificial intelligence, robotics, semiconductors, biotechnology and quantum technology.

Extension of the prohibition to implement transactions (“suspensory effect”)

The current German FDI regime prohibits the implementation of a transaction only for sector-specific examinations (i.e. in the defense space). The draft bill proposes to extend this prohibition to all transactions for which a mandatory filing obligation is established. Therefore, in the future the validity of all transactions falling within the scope of the sector-specific examination (i.e. mainly transactions concerning defense-related activities) and all transactions involving “critical infrastructures” and “critical technologies” will be suspended pending FDI control clearance.

In order to safeguard public order or security during the suspension period, the draft bill also implements a strict prohibition on providing the potential investor with “critical” information, i.e. information that is sensitive with respect to the FDI-purpose of protecting public order and security. We note that the explanatory memorandum states that the usual commercial due diligence should “typically” not be restricted by this provision. It will also be prohibited to grant the potential investor any voting rights (directly or indirectly) or rights to receive dividends (or other profit sharing rights) during the suspensory period.

Any breach of the prohibitions set out above may be punished with imprisonment for up to five years or a fine.

Conclusion

The draft bill will significantly enhance the enforcement powers of the BMWi. Among other things, the bill introduces a suspension period for all transactions that are subject to a mandatory filing obligation and lowers the review standard to allow the German authorities to intervene in a transaction based  on a mere likelihood that it may affect public order and security.

In addition, the introduction of a suspensory effect will have a major impact on M&A transactions concerning “critical infrastructures” and “critical technologies” and involving all non-EU buyers, where automatic suspension will now apply for the first time. This may  be particularly unexpected for transactions involving “critical technology”, which also become newly subject to FDI review generally.