Stricter rules for foreign direct investment

An overview of the changes and their possible practical impact on transactions

On July 12, 2017, the German government amended the provisions on foreign direct investments under the German Foreign Trade and Payments Ordinance (Außenwirtschaftsordung – the “Ordinance”). Under these provisions the Federal Ministry for Economic Affairs and Energy (the “Ministry”) has the option to review whether a foreign company poses a hazard to public order or security. The amendment has two main effects: firstly, the groups of companies whose acquisition will in future be subject to a reporting requirement or strict industry-specific provisions are specified and expanded. Secondly, the periods for the two-stage review process will be changed. This will have a quite considerable impact on the M&A practice.

Special rules for certain target companies

First, special rules are issued for companies which contribute to infrastructure deemed to be critical. These include companies in the energy, IT and telecommunications, transport, health, water, food and finance/insurance sectors. These business areas are being extended in particular to companies which produce industry-specific software for companies in these sectors, certain cloud computing providers and companies dealing with telematics infrastructure.

Foreign acquirers of such domestic companies are now subject to a reporting requirement. They must report relevant transactions to the Ministry in writing. By way of introducing a corresponding definition of the term “public order and security” the regulator states that such transactions are capable in principle of jeopardising the public order or security. This definition appears to be a clarification only, since such acquisitions were previously treated as sensitive as well.

The stricter industry-specific rules to date for the defence and IT security industry are also expanded. Previously, this only covered companies manufacturing specially listed military weapons, specially designed engines or transmissions for driving combat tanks or certain IT security products. Now these rules also apply to the manufacturers of other defence equipment for reconnaissance and support. Here, too, a reporting requirement is stipulated. Besides this, the Ministry can prohibit transactions in this area or issue orders alone without the consent of the Federal Government.

Extension of time periods

There are also amendments to the time periods for the review procedure: previously, the Ministry had three months to initiate a review on its own motion after the purchase agreement was concluded. Now the start of this three-month period depends on when the Ministry obtained knowledge of the transaction. In the future, ultimate certainty will only exist after expiry of the newly introduced five-year cut-off period after conclusion of the purchase agreement. From now on, companies will probably more often seize the opportunity to gain legal certainty as soon as possible by applying for a clearance certificate.

The timetable for the review will also change considerably, going by the wording of the order: previously, the Ministry had one month after receiving an application for a clearance certificate to initiate formal examination proceedings. This period has now increased to two months. For the second review phase, there is now a period of four months instead of two after receipt of complete documentation. Also, the four-month period is suspended if the Ministry conducts contract negotiations with those involved, e.g. to explore how to guarantee public order and security from the perspective of the Ministry. The proceedings are thus not ultimately time-limited – even in theory.

Impact on the M&A practice

The revision of the Ordinance will thus certainly have an impact on the M&A practice: in the last 12 months alone, we have seen a change in the treatment of applications for clearance certificates on the part of the Ministry. For instance, virtually none of the reported transactions have been approved simply after the end of the one-month period or by issuing of a clearance certificate within this period; usually further documents are requested for the initiation of formal review proceedings. We can only hope that this will change due to the extension of the first review phase to two months. In practice, the impression has frequently arisen that the second review phase was initiated solely to extend the time needed for the first preliminary review and not because a full scope review was necessary to exclude any reservations about public order and security. If the Ministry now has more time for review in the first phase, this may lead to the dropping of the phase 2 review in less security-related economic sectors, and thus the duration of reviews in certain cases will be shorter than under the old rules.

If the Ministry enters the second review phase, this involves considerable effort for those involved: for example, following the General Order by the Ministry dated 2 September 2013 (Federal Gazette AT 6/9/2013 B1), extensive documentation on the acquirer structure, annual and group financial statements and possibly the business strategy of the acquirer are to be submitted along with the purchase agreement. The fact that these documents must be submitted in German language means significant time is required for translation. Also, in practice further information is required, for instance regarding the influence of the target company on the market, on the future of the locations in Germany, on the future collaboration between acquirer and target company and possibly on the technological lead of the target company or its R&D activities.

Although the period for review in phase 2 has now been increased from two to four months, in practice there remains the hope that the actual decisions of the Ministry will not in fact be delayed, as it is still the case today that the corresponding review period only starts once the complete documentation is received. However, it is solely at the discretion of the Ministry to judge when this documentation is complete. In this respect, reviewing a company acquisition can already take longer now than the two-month period provided for by law, because the Ministry often requests further documents or raises further questions.

Particularly in auction processes with a set of bidders falling within the scope of the Ordinance, the new rules will be influential. Vendors will have to plan in much more time between signing and closing of the transaction. This extension will increase uncertainties in the process, which in turn can lead to lower valuations. From the acquirer’s viewpoint as well, things will be more complicated. For example, the interplay with other transaction elements, such as the provision of third party financing (normally involving fees), will become harder to plan. There is also the question of whether it makes sense to submit many more documents when applying for the clearance certificate, or to already have them translated at this early stage. This may seem like a drawback for foreign investors who fall within the Ordinance’s rules, but for the M&A advisory practice it will still be possible, via better process organisation, to minimise the de facto impact of the revision of the Ordinance, at least in the areas deemed not to be particularly relevant to security by this revision.