Effective June 3, 2020, the screening of foreign direct investments (FDIs) has been expanded in Germany with a first tranche of new rules primarily affecting the healthcare sector. This expansion of the FDI control scheme reflects a broader trend across a number of EU member states and globally. It is also a first step of a more extensive revision of German FDI control that will come into force during the course of this year.

Non-EU private equity investors should have the following on their radar for investments involving entities in Germany:

• Effective immediately, the German government must be notified about investments of 10% (or more) in German companies active in the healthcare sector and in other critical communication infrastructures.
• In its assessment of FDIs, the German government may now specifically take into consideration whether the foreign investor is controlled by, or receives significant funding from, a government of a non-EU country.
• In the coming months, and as of October 11, 2020 at the latest, FDI assessment rules will be further amended and include:
  • An extended list of businesses that utilize transactions that require notification to the German government.
  • Changes in the test for FDI control that will make assessments less predictable.
  • Public order or security of other EU member states will become relevant in addition to German national security interests.
    • Suspension of acquisitions of sensitive businesses will occur during the FDI review period and prohibit the closing of transactions.

Amendments include an extended scope and increased scrutiny of FDIs

FDI screening in Germany is governed by the Foreign Trade Act (Außenwirtschaftsgesetz or AWG) and the respective underlying regulations (AWV). The most recent amendments of the AWV came into effect on June 3, 2020. Significant amendments include:

1. Notification of the German government is required for certain investments in German companies active in the healthcare sector and in other critical communication infrastructures. Up until June 3, 2020, investments of 10% (or more) of a company’s voting rights in (i) operators of critical infrastructure, (ii) companies developing software to use critical infrastructures, (iii) companies in the media industry, and (iv) a limited number of sensitive businesses required notification to the German government. The expanded list now also includes:

• Developers and manufacturers of personal protective equipment;
• Developers and manufacturers of medical products (drugs, etc.) that are essential for ensuring the provision of health care to the population or which place such products on the market or hold a corresponding drug license;
• Developers and manufacturers of medical devices intended for the diagnosis or treatment of life-threatening and highly contagious infectious diseases;
• Developers and manufacturers of in vitro diagnostic tests to detect infectious agents; and
• Service providers that are necessary to ensure the continuity and functioning of state communications infrastructure.

2. The new FDI regime contains additional considerations to assess whether a transaction poses an actual threat to security or public order in Germany. Such new considerations are, inter alia, used to determine whether the investor is directly or indirectly controlled by the government of a third country, which includes other state bodies or armed forces. The new rules further specify that control in this context can exist based on ownership, or by way of funding, by the government or other state entities or armed forces if such funding exceeds an insignificant (marginal) level, which is not further specified.

3. In cases of non-compliance with the notification requirements and other obligations under the amended rules, administrative and criminal penalties may be imposed.

Outlook – Proposed upcoming changes will further expand FDI screening

Further amendments to the rules on FDI control are already under way. The German government also introduced draft amendments to the AWG and is preparing further changes to the AWV. The proposed provisions are supposed to align the German rules with the EU Framework Regulation (EU Regulation No. 2019/452) and include the following:

1. An expanded list of business sectors subject to FDI screening:

• The German government plans to subject other industries and sectors to notification requirements, particularly those already identified by the EU Framework Regulation (e.g., data-driven business sectors, semi-conductors, aerospace, critical technologies, businesses involving dual-use items, AI, robotics, and cybersecurity).
• Whereas previously only acquisitions of enterprises engaged in the development or manufacturing of military equipment or products with IT security functions were covered, in the future, enterprises which are or were previously engaged in the modification or use of such equipment or products will also be screened. Such prior activities of the enterprises shall be sufficient to require an investigation if the target still has knowledge of, or access to, the security-critical technology.

2. The standard for the substantive test of screening will become less stringent and, as a result, less predictable. In the future, the standard introduced by the EU Framework Regulation will apply, i.e., assessment of whether an investment is “likely to affect security or public order.” It will replace the current test, under which an “actual threat” needs to be shown by the government to justify intervention. The German government notes that “eventual” or “potential” threats can be taken into consideration under the proposed rules. Future decision-making practice, and likely also court rulings, will show if and to what extent the revised substantive test will actually change the approach while also maintaining the objective of the EU to generally remain one of the most open markets for foreign investments.

3. Under the proposed rules, not only investments that may affect the public order or security of Germany, but also “of another EU Member State” will be subject to FDI screening. Moreover, the potential effects on "projects or programs of Union interest" shall be taken into account. An impact on the timeline, especially for investments involving entities of a target company in multiple EU member states, needs to be expected.

4. If notification is required, the newly introduced penalty prohibitions prevent the parties to the acquisition from creating a fait accompli during the ongoing screening. Prior to FDI control clearance, the parties are 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, or
• provide or otherwise disclose to the acquirer certain company information of the target, provided that such information relates to divisions or objects of the enterprise which are subject to screening.

Impact on investments in EU-based target companies

With the full applicability of the EU Framework Regulation effective as of October 11, 2020, non-EU investors face considerable changes in the screening of their investments in Germany, and also EU-based, target companies:

1. Private equity investors should have their FDI implications assessed early on in their transactions to be able to evaluate the consequences for the deal and its timing. Because other EU member states will also adopt their own new rules on FDI screening to align with the EU Framework Regulation, transactions involving a number of EU-based companies in different EU member states will require a multijurisdictional analysis to identify notification requirements and related obligations in order to ensure compliance with FDI control rules in the same way that investors are accustomed  to under the current merger control rules.

2. The German Ministry of Economics, the competent authority that conducts the screening process for targets based in Germany, will have additional leeway in its decision-making under the proposed new rules. Private equity investors will have to deal with a degree of uncertainty until future decision-making practice, and likely also court rulings, will allow a more reliable upfront assessment of FDI implications. The transaction documents will also have to reflect this uncertainty and the parties will have to negotiate the consequences of different outcomes of the FDI review.

3. Given the proposed suspension of consummation of transactions during the FDI review, private equity investors will have to factor in a time gap between signing and closing until the FDI review is completed. In the months following the introduction of the new rules, the review will probably take longer until processes and resources are fully adapted.

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