Control on foreign investment is subject to various legislation and reforms are regularly taking place. These reforms aim to respond to the evolution of cross-border dealmaking, as the global number of M&A transactions is increasing. In fact, 1,127 deals took place by May 2018, for an overall value of USD 384.4 billion. Europe led this great momentum, with 48.8 percent market share, as North America declined to USD 96.5 billion. These numbers remain beneficial, and the United States continues to take an active part in cross-border M&A transactions. In this respect, China was also active and remains the best dealmaker in Asia with 136 deals in the month of May 2018.
We are focused on these three regions in order to compare the legislation and legal evolution of the control on foreign investment in the United States, Europe (Germany, France, United Kingdom) and China.
2. Oversight of Cross-Border Dealmaking during the Trump Administration
2.1 Explaining CFIUS
The Committee on Foreign Investment in the United States (CFIUS) is an interagency committee made up of government officials led by the US Department of Treasury and includes representatives from the departments of Treasury, Defense, Homeland Security, Justice, Energy, Labor and State as well as other related agencies. All transactions that potentially involve a foreign entity acquiring control of a US entity may be reviewed by CFIUS to determine if such transaction would affect US national security interests. Parties to such transactions may voluntarily submit an application for CFIUS approval. If such parties do not voluntarily submit an application at the time of the transaction, CFIUS could still review the transaction on their own at any time, even years after the transaction has closed.
After the parties to a transaction have submitted an application to CFIUS, CFIUS will conduct a 75 day review of the transaction for risks to national security. If CFIUS does not approve the transaction during this review period, the parties to the transaction can withdraw from CFIUS review, modify the deal to address any potential concerns, or continue to push the transaction forward. Once CFIUS has conducted its review, it can submit a recommendation and report on the transaction to the president, at which point the president can approve, block or restrict the transaction.
Historically, a deal is rarely blocked over national security concerns. In fact, since CFIUS was created in 1988 to review foreign, inbound transactions and before President Trump took office, the sitting US president has only blocked four deals that failed to receive CFIUS approval. Part of this is due to the fact that most parties withdraw their application and voluntary walk away from the deal or restructure the deal if CFIUS does not approve the transaction within their review period.
2.2 Strengthening CFIUS under the Trump Administration
Under the Trump administration, a policy window has opened that might create a stronger, well-funded CFIUS charged with reviewing a wider array of transactions. First, foreign investment through acquisition, particularly from China, continues to stream into the United States. In 2018, CFIUS will review more than 200 transactions, more than a 25 percent increase from the previous record year. At the same time, funding for CFIUS has not kept pace, leaving the organization too overburdened to handle its current caseload. As a result, CFIUS review might take longer than its normal 75 days, causing further delays in time sensitive deals. Second, the Trump administration, with its “America First” agenda, has taken aim at immigration flows, trade agreements and now the free flow of capital. The administration sees CFIUS as a lever it can use to prevent foreign entities from taking over US industries or acquiring key intellectual property developed in the United States. Since President Trump took office, nine deals have fallen apart due to failure to obtain CFIUS approval.
Due to increased pressure on CFIUS to respond to market and policy trends, lawmakers are quickly mobilizing legislation that would enhance CFIUS’s capabilities.
2.3 Implementing FIRRMA
On August 13, 2018, President Trump signed into law the Foreign Investment Risk Review Modernization Act of 2018 (FIRRMA). The new law will make substantial changes to the current CFIUS regime. First, FIRRMA will give CFIUS authority to review a greater scope of transactions, including those involving infrastructure, critical technologies and sensitive personal data. Second, FIRRMA requires parties of certain transactions to file a CFIUS review (prior to FIRRMA, all CFIUS filings were voluntary). These transactions include those in which one of the parties is related to a foreign government, and in which the transaction involves critical infrastructure, technology or sensitive personal data. Third, FIRMMA gives CFIUS 90 days to review transaction: (1) a 45 day application review and (2) a 45 day investigation. In addition, FIRRMA provides for short-form declarations, in which parties to a transaction can file a 5-page application that CFIUS will review within 30 days. Lastly, FIRMMA imposes a mandatory filing fee: 1 percent of the value of the transaction or USD 300,000, whichever is less. US sellers to foreign entities and international investors should carefully review and consider contingencies to ensure that their transactions are not unnecessarily hindered by a stronger, more emboldened CFIUS.
2.4 Fallout of Reform
Such legislation has a clear goal: limiting China’s ability to take control of key industries in the United States. Enacting such legislation to accomplish this goal, however, could have significant collateral damage. The legislation could potentially transform CFIUS into a bureaucratic monster, stalling much-needed foreign investment. In such a situation, foreign capital might find alternative jurisdictions in which to invest, putting US industries at a significant disadvantage. Not only could this increase the price of financing for US companies, but it could also impact current US investors, particularly hedge funds, that tend to invest alongside foreign investors and governments.
3. An Update on Foreign Investment Control in Germany
The German government recently tightened regulations on foreign investments in Germany in order to restrict non-EU/foreign acquisitions of German companies in certain industries. On July 18, 2017, an amendment to the German Foreign Trade and Payments Ordinance (Außenwirtschaftsverordnung or GFTPO) came into effect. It specified critical industries, introduced obligations to notify the authorities, and extended applicable review periods, among other things. This amendment is part of a recent political trend towards stricter control of foreign investments, triggered in particular by Chinese efforts to acquire German companies such as KUKA, Osram, AIXTRON, 50Hertz and Leifeld Metal Spinning.
In order to protect public order and security, the Federal Ministry for Economic Affairs and Energy (Bundesministerium für Wirtschaft und Energie, or BMWi) may review acquisitions of German companies by foreign investors. The review may result in restrictions, or, in the worst case, prohibition of an acquisition. The GFTPO distinguishes between cross-sectoral reviews and sector- specific reviews in explaining the details of the review procedure.
3.1 Cross-Sectoral Reviews
A cross-sectoral review may be conducted if the investor is located outside the European Union and if the European Free Trade Association (EFTA) region, and the investment comes under the scope of German foreign trade law. The latter is the case if the investor acquires direct or indirect participation of at least 25 percent of voting rights in a German company. This includes voting rights of third or intermediate holding companies in which the investor holds at least 25 percent of the voting rights and voting rights of other shareholders with whom the investor agreed on the joint exercise of voting rights.
Acquisitions through EU/EFTA-resident companies that were set up in order to circumvent these rules (not necessarily exclusively) may also be reviewed. According to the most recent amendment, acquisitions via EU/EFTA based companies without a considerable independent business activity or a permanent presence in the form of premises, personnel or asset base are now regarded as a manifestation of such circumvention.
The latest amendment introduces examples of German companies whose acquisition may threaten public order or security:
- Operators of critical infrastructure (particularly in the sectors of energy, transport, water, information technology and telecommunications, finance, insurance and health)
- Developers of software serving the operation of critical infrastructure
- Certain companies in the area of telecommunications and surveillance technology
- Certain companies in the area of cloud computing
- Certain companies in the area of telematics
The BMWi must be notified in writing about acquisitions within the scope of the aforementioned example industries, according to the new rules. The BMWi may conduct an in-depth review only if it notifies the acquirer and the target within three months from the day it becomes aware of an acquisition, or, at the latest, five years from the conclusion of the acquisition agreement. The legal uncertainty deriving from the BMWi’s five-year deadline to initiate an in-depth review (and potentially prohibit the acquisition) can only be avoided by combining the required notification with a request for a certificate of non-objection.
The amended GFTPO extends the procedural deadlines. A certificate of non-objection is now deemed to be granted if the BMWi does not launch an in-depth review within two months from the request (compared to one month previously). The acquisition may be restricted or prohibited within four months (compared to two months previously) after a full set of documents requested by the BMWi for the purpose of the in-depth review has been submitted. Moreover, this review period shall be suspended as long as the BMWi enters into negotiations with the parties concerned.
3.2 Sector-Specific Reviews
In order to protect German security interests, special rules apply when target companies operate in sensitive security areas (in particular the defense sector) and are acquired by foreign investors (including EU-resident investors) or German companies which were set up in order to circumvent the rules on foreign investments.
These special restrictions apply to the acquisition of the direct or indirect participation of 25 percent or more of the voting rights in manufacturers and developers of the following:
- War weapons
- Specially-designed engines and gearboxes for military- tracked armored vehicles
- Products with IT security features that are used for processing classified government information
- Certain products which fall within the scope of special foreign trade regulations
The last category is new and focuses on military technology.
The procedural deadlines for review have also been extended. If the BMWi does not initiate an in-depth review procedure within three months (compared to one month previously) from the receipt of the investor’s obligatory written notification, the acquisition shall be deemed to have been approved. In the event that a review procedure is opened, the acquisition may be restricted or prohibited within three months (compared to one month previously) after the full set of requested documents has been submitted. Again, this review period shall be suspended as long as the BMWi enters into negotiations with the parties concerned.
3.3 Additional International Aspects
The amended GFTPO does not result in a material restriction on foreign investments in German companies. However, the extended application area, new notification requirements, and, in particular, extended review periods, require that foreign investors deal with these restrictions proactively and early in the process.
Potential development of similar initiatives at the EU level also must be taken into account. At the request of several governments and members of the EU parliament, the European Commission currently reviews EU politics regarding the protection of key technologies and reciprocity of market access.
Finally, the acquisition of German companies frequently results in the indirect acquisition of business activities in other countries, such as the United States, which have their own foreign investment control. The Committee on Foreign Investment in the United States, for example, played a decisive role regarding the failed acquisitions of AIXTRON SE and the LED division of the Dutch Philips group by Chinese investors.
4. Review of Certain Foreign Investments by the French Authorities
While foreign investments in France are generally unregulated, Article L. 151-3 of the French Monetary and Financial Code provides that certain foreign investments are subject to the prior approval of the Ministry of Economy. Such investments are those that (i) participate in the exercise of public authority; (ii) relate to activities likely to affect public order, public security or national defense; or (iii) relate to the research, production or commercialization of weapons, ammunitions, powders and explosive substances.
In order to fall within the scope of the prior approval regime, the following conditions relating to the nature of the investment must also be met: the foreign investor acquires more than 33.33 percent of the share capital or voting rights of a French company (or, if the foreign investor is based in the European Union, a majority of the voting rights); or the foreign investor acquires all or part of a French company’s branch of activity.
4.1 Sensitive Sectors
In order to improve visibility on the applicability of the foreign investment regulation, Article R153-2 of the Monetary and Financial Code provides a list of “sensitive sectors” falling within the scope of the prior approval regime. They include inter alia private security services, equipment designed to intercept communications, cryptology, goods and technology with dual applications, gambling (excluding casinos), businesses certified for national defense and businesses under contract to supply research or equipment to the French Ministry of Defense or its subcontractors.
A Decree dated May 14, 2014, added new sensitive sectors, such the safety and the continuity of the supply of water, electricity, gas, hydrocarbons and any other source of energy and the operation of transport services and telecommunications, as well activities related to “the protection of public health”.
The French government is currently discussing the possibility to further extending the list of sensitive sectors to include artificial intelligence, data, nanotechnologies or financial infrastructures.
4.2 Review Process
If a foreign investor determines that its investment in France requires the prior approval of the Ministry of Economy (i.e., the investment falls within one of the “sensitive sectors” and meets the conditions relating to the nature of the investment), the investor should send a request for approval to the Ministry of Economy (Treasury Department) setting out the basic structure of the transaction and providing basic information about the investor (including its ultimate beneficiary). The request is usually sent after the signing of the acquisition contracts, but before the transaction’s closing. Once the Treasury Department is satisfied that it has been provided with all relevant information, a two-month review period will start. In the absence of a response from the Treasury Department at the end of the two-month period, prior approval is deemed to be granted.
If the foreign investor is not sure that its investment requires prior approval, it may submit a ruling request to the Treasury Department as to the applicability of the foreign investment regulation to its investment. The Treasury Department should answer within two months. The absence of response within this two months period does not constitute an approval of the investment.
It is difficult to assess whether many investments have been blocked by the French authorities over the years due to the fact that the review procedure and its outcome are confidential. However, it is clear that the French authorities leverage foreign investment regulation by conditioning their prior approval to certain specific commitments aiming at ensuring that the contemplated investment does not jeopardize French national interests. These commitments are requested from the foreign investor for a limited time-period (typically 2 to 8 years, depending on the circumstances) and may include: maintaining research and development capacities and related intellectual property in France, complying with obligations under procurement contracts entered into with public entities, or maintaining jobs in France.
In practice, a commitment letter is entered into between the foreign investor and the Treasury Department. Although there is limited room for negotiation, the foreign investor can often convince the Treasury Department to eliminate unreasonable or unnecessary commitments.
In case the Treasury Department refuses to approve the foreign investment, the foreign investor can appeal the decision before the administrative courts within two months of its notification. The possibility to obtain the nullity of the Treasury Department’s refusal decision is somewhat limited by the fact that the administrative courts can only rule against the Treasury Department in the case of blatant mistake.
Failure to comply with the foreign investment regulation can lead to three types of sanctions.
First, the investment realized without the proper prior approval of the Treasury Department can be considered null and void.
Secondly, the parties may be forced to abandon the investment, modify the structure of the investment, or return to the status quo ante at their own expense.
Finally, criminal sanctions may be imposed on the investor, including imprisonment for up to five years (very unlikely in practice) or a fine of up to twice the amount of the investment.
The French government is currently considering modifications to these sanctions, including flexible fines that can be adapted to the relevant circumstances and the possibility to suspend the foreign investor’s voting rights in the French company.
4.4 Practical Recommendations
In order to ensure that the foreign investment regulation does not excessively delay the closing of a transaction, foreign investors can follow a few practical recommendations.
The applicability of the foreign investment regulation must be assessed as early as possible and, at the latest, during the due diligence process. It is important to engage the seller in this discussion. If the activity falls within one of the sensitive sectors, the seller may have had to obtain the prior approval of the French authorities when it acquired the French company.
While it is possible in most cases to determine with enough certainty whether the relevant investment falls within the scope of the foreign investment regulation, some transactions are in the grey area. In such cases, foreign investors should consider seeking a ruling.
Foreign investors seeking prior approval from the French authorities should be as open and forthcoming as possible in terms of providing information on their business and corporate structure. The information requested by the French authorities is usually not overly intrusive. Providing all the requested information from the outset will speed up the process and build goodwill and confidence.
Finally, it is recommended that foreign investors engage with the Treasury Department by meeting in person to explain their strategy, with the objective of comforting the French authorities. They should not be shy when negotiating the commitment letter, as it is normal practice, keeping in mind that certain commitments are likely to be non-negotiable.
5. Reform of the Approach of the United Kingdom to Foreign Investment on Grounds of National security
In October 2017, the UK government published a consultation document outlining reforms designed to strengthen its powers to investigate acquisitions and certain types of investment in UK assets on national security grounds. The consultation followed a UK government review of its policies, which concluded that they did not meet the standards applied in comparative G7 nations and were insufficient to protect national security effectively.
Under the current regime, except where a business falls within the special public interest regime (which applies to defense contractors or companies holding confidential defense material under licence), powers under the UK Enterprise Act 2002 (Enterprise Act) do not permit UK governmental intervention at all on national security grounds where the turnover of a UK business is less than GBP 70 million, or where the merger results in a combined share of supply of particular goods or services above 25 percent of the market. These thresholds therefore exclude from UK government scrutiny transactions involving small but highly-specialized businesses, and investments where the investor has no pre-existing presence in the market. In addition, the current regime under the Enterprise Act does not address investments in critical infrastructure projects (such as newly built nuclear plants) or the transfer of individual assets such as high-tech machinery and intellectual property.
In effect, up until now, the UK government has had little power to investigate (let alone prevent) small scale foreign investment in national security sensitive assets or large-scale foreign investment in critical infrastructure. To illustrate, there have only been seven instances of the UK government invoking an intervention on national security grounds since 2002.
5.1 Setting up
Regulation On March 15, 2018, the UK government announced its response to its consultation and on May 14, 2018, new regulations came into effect in relation to small scale investment in specific industries. The existing GBP 70 million turnover and 25 percent combined market supply tests in the Enterprise Act will not apply to activities in three sectors:
- The development or production of items for military use or items having both a military and civilian application;
- The design and maintenance of aspects of computing processing hardware; and
- The development and production of quantum technology.
For these sectors, the turnover threshold drops to GBP 1 million and the share of supply threshold is met where the target enterprise alone has a 25 percent share in the market. These provisions, therefore, give the UK government power to scrutinize very small transactions and those where the acquiring (or investing) party is new to the UK market. However, they are restricted to particular industry sectors.
5.2 Aim of Government
In relation to the broader reforms outlined in October 2017, the UK government has not yet published its response to its consultation. However, in its consultation, the UK government expressed an intention to expand its existing powers in the Enterprise Act beyond the media, defense and banking public interest regime to enable it to unilaterally prescribe and scrutinize a broader range of investments on national security grounds, citing as a minimum the civil nuclear, defense, telecommunication and transport sectors as well as the emergency services and government. The UK government also expressed an intention to introduce a concept of “significant influence” to enable it to scrutinize transactions resulting in a foreign investor acquiring more than a 25 percent interest in an entity or equivalent transaction structures amounting to a foreign investor having significant influence or control of, or unrestricted access to, a UK business or UK assets.
While the United Kingdom has traditionally had the lowest barriers to foreign investment amongst the G7, the line of travel in terms of UK government policy is clear. Investment in critical defense, technology and national infrastructure in the UK will increasingly come under scrutiny. These changes, coupled with the UK reclaiming national competition oversight from the European Union following Brexit, will mean that in the future many more UK deals that would otherwise not require UK regulatory consent will increasingly require it.
6. China’s National Security Review on Acquisition of Chinese Companies by Foreign Investors
The national security review was first introduced by the Provisions on the Acquisitions of Chinese Enterprises by Foreign Investors issued by Chinese government in 2006 and then repeated in Article 31 of China’s Anti- Monopoly Law in 2007. However, the Chinese legislations had not provided any operational mechanism for national security review until China’s State Council published a notice in March 2011 detailing the national security review procedure for the acquisition by foreign investors of domestic Chinese companies (NSR Notice), which was further clarified by the implementation rules issued by the Ministry of Commerce (MOFCOM) in August 2011.
For the first time, the NSR Notice and the MOFCOM implementation rules set the national security review mechanism to review and potentially reject acquisitions of Chinese companies by foreign investors where such acquisitions could affect national security, economic stability, social order, or research and development capabilities relating to key technologies. It applies to acquisitions in a wide range of industry sectors in China.
National security review covers the following major industry sectors:
- National defense industry, including military industry enterprises and military industry supporting enterprises; enterprises located near key and sensitive military facilities; and other entities that have an impact on national defense security. Any acquisition of an interest (which need not be more than 50 percent or a controlling interest) in any of these businesses will be subject to national security review.
- Other sensitive industries as specifically listed out by MOFCOM, including important agricultural products, important energy and resources, important infrastructure, important transport service, key technology and major equipment manufacturing. Any acquisition of actual control of businesses in these sensitive industries will be subject to security review.
6.2 Review Authorities
MOFCOM is responsible for the preliminary security review of M&A transactions by foreign investors. If MOFCOM determines that an M&A transaction falls within the scope of the security review, it will forward the case to the Ministerial Panel, a joint panel consisting of representatives of the National Development and Reform Commission, MOFCOM and other relevant government authorities for substantive and final review.
6.3 Three Ways to Initiate the Review
(i) Voluntary Filing: The foreign investor involved in an M&A transaction that may be subject to security review can voluntarily file an application for preliminary review with MOFCOM;
(ii) Referred Reporting: The local MOFCOM will report the transaction to MOFCOM and require the foreign investor to file an application for preliminary review with MOFCOM if it finds that an M&A transaction is subject to security review.
(iii) Request by Third Parties: Concerned government authorities, national industrial associations, competitors and upstream and downstream enterprises can submit a request to MOFCOM to conduct a security review if they believe that an M&A transaction falls within the scope of security review.
6.4 Review Process and Timeline
(i) Pre-filing Consultation (non-binding)
Before filing a formal application for security review with MOFCOM, foreign investors may request a prefiling consultation regarding the procedural issues relating to the proposed M&A transaction. However, this is not a mandatory procedure, and the result of the consultation does not have any binding effect and cannot be relied on as the basis for making a formal application.
(ii) Preliminary review by MOFCOM (15 working days)
After the official filing of an application for security review, MOFCOM shall provide written notification to the applicant within 15 working days as to whether the proposed M&A transaction will be submitted for review by the Ministerial Panel. During this time, the M&A transaction shall be put on hold, and the local MOFCOM shall not approve the M&A transaction. If the applicant has not received any response from the MOFCOM after the 15-day period, the applicant can proceed to implement the M&A transaction without considering national security issues.
If MOFCOM notifies the applicant that review is necessary, MOFCOM will forward the application to the Ministerial Panel within five working days for final determination of whether the transaction falls within the scope of security review.
(iii) Review by the Ministerial Panel
(a) General review process (30 working days): by way of soliciting written opinions from related departments or organizations. If there is no problem, a favorable decision will be issued; if one department raises concerns on this transaction, it will initiate the Special Review Process.
(b) Special review process (60 working days): a substantive review process, including evaluation process and collective decision processes. If no consensus can be reached at this stage, this matter will be submitted to State Council for final decision (no time limitation for this final decision).
(c) Decisions: if the Ministerial Panel concludes that an M&A transaction has exerted, or is likely to exert, a major impact on national security, then it is required to order MOFCOM (and other relevant departments) to either terminate or modify the transaction appropriately. Unlike merger control decisions, there is no obligation for the Ministerial Panel to publish conditional approvals or prohibitions. Decisions resulting from a national security review may not be administratively reconsidered or litigated.
(d) Non-compliance: if the Chinese government has national security concerns about a transaction that is not submitted for approval, parties could be subject to sanctions or mitigation measures, including a requirement to divest the acquired Chinese assets.
With the implementation of the security review system in China, foreign investors intending to engage in acquiring Chinese businesses in sectors that fall within the above scope will now need to consider whether the contemplated transaction will be subject to national security review. It is advisable for foreign investors to take a proactive approach here, given the fact that there are two other involuntary ways to initiate the review, i.e., the third party whistle report and the referral reporting by the local MOFCOM. Even before the formal filing, it is advisable to make pre-filing consultations with MOFCOM to assess the risk exposure here at an early stage.
The international cross-border dealmaking enterprise should keep in mind the current foreign investment control regulation in the home country of its target or even the jurisdictions of the subsidiaries of its target, in order to not be surprised during the process of the transaction. This is even truer in times of increasing protectionism.