NOVEMBER 2023
Table of Contents
1. Screening of foreign direct investment within the Union: protection of essential interests or abuse of rights? (C-106/22, Xella Magyarország)
Nicolò Andreotti
2. The Court of Justice draws a line in the sand for foreign investment screening: ruling in Xella Magyarország C-106/22
Alberto Pérez
3. Reading the Xella judgment in its constitutional and institutional context
Thomas Reyntjens and Anna Jorna
4. Where Investment Screening and the Internal Market Meet – Xella Magyarország (C-106/22)
Trajan Shipley
5. ‘Time out’ for the EU cooperation mechanism in Austria due to Xella (C-106/22)
Judith Feldner and Felix Frommelt
6. The Xella Case: Screening FDIs is a matter of proportionality
Aldo Sandulli
Screening of foreign direct investment within the Union: protection of essential interests or abuse of rights? (C-106/22, Xella Magyarország)
by Nicolò Andreotti
Introduction
On 13th July 2023, the Court of Justice of the European Union handed down its judgment in case Xella Magyarország (C106/22). The case originated from a request for a preliminary ruling made by the Budapest High Court concerning the interpretation of Article 65(1)(b) TFEU (free movement of capital), read in conjunction with recitals 4 and 6 of Regulation (EU) 2019/452 establishing a framework for the screening of foreign direct investments into the Union (FDI Screening Regulation). The case offered the Court the opportunity to reflect for the first time on the scope of application of the FDI Screening Regulation, which authorises Member States to set up national screening mechanisms on the grounds of security or public order, and its interplay with the freedom of establishment.
The fact
Xella Magyarország is a Hungarian company which operates on the Hungarian construction materials market and is primarily engaged in the manufacture of concrete construction products. The company has a corporate vertical structure insofar as it was 100% owned by a German company, which was in turn 100% owned by a Luxembourg company. This latter company is indirectly owned by the ultimate parent company of the Lone Star group registered in Bermuda.
On 29 October 2020, Xella Magyarország concluded a sale agreement for the purpose of acquiring 100% of the shares in Janes és Társa, another company incorporated under Hungarian law which is active in the extraction of gravel, sand and clay. However, due to the fact that Janes és Társa is classified as a strategic company because of its activities, the Hungarian Minister for Innovation and Technology prohibited the transaction relying on the ground of national interest as provided for in Law No LVIII of 2020 on transitional provisions relating to the end of the state of emergency and to the pandemic crisis (the Vmtv).
Essentially, the Minister’s decision was based on two main elements. First, it classified Xella Magyarország as a foreign investor within the meaning of Paragraph 276(2) of the Vmtv because it is indirectly owned by a company registered in Bermuda. Second, it maintained that the security and foreseeability of the extraction and supply of raw materials were of strategic importance insofar as a serious disruption to the functioning of global supply chains could harm the national economy (para 23). According to the Minister, if Janes és Társa were to be indirectly owned by a foreign company, this would pose a longer-term risk to the security of supply of raw materials to the construction sector.
Xella Magyarország challenged the decision of the Minister before the Budapest High Court, arguing that that decision constituted arbitrary discrimination or a disguised restriction on the free movement of capital in light, inter alia, of Articles 54 and 55 TFEU, which afford, in parallel, the benefit of freedom of establishment to companies established
in the EU. It also argued that the lack of clarity of the concept of national interest, within the meaning of the Vmtv, was capable of breaching the fundamental principle of the rule of law (para 25).
That court, in turn, made the request for a preliminary ruling to the Court of Justice demanding, in particular, whether Article 65(1)(b) TFEU must be interpreted as meaning – having also regard to recitals 4 and 6 of Regulation 2019/452 and to Article 4(2) TEU – in the sense that it permits the laying down of rules such as those in Section 85 of the Vmtv, which empowers the Minister to examine (and, eventually, to prohibit) the acquisition of national strategic companies that may harm the Hungarian national interest, public security or public policy.
The judgment
The reasoning of the Court was essentially articulated into two main threads, one concerning the applicable EU legislation and the other concerning whether the national measure at stake constitutes an unjustifiable restriction to fundamental freedoms. As for the first aspect, the Court held that the acquisition at issue does not fall within the scope of the FDI Screening Regulation (para 29). According to the Court, the scope of Regulation 2019/452 is limited to investments in the EU made by undertakings constituted or otherwise organised under the laws of a third country.
In the Court’s eyes, Article 4(2)(a) and Article 9(2)(a) of the regulation, which prescribe that the ownership structure of the foreign investor may be taken into account as a factor of risk, cannot be applied since they expressly relate only to the ownership structure of the foreign investor, a concept which is limited to undertakings of a third country. It follows that the scope of the regulation is not extended to include investments made by undertakings organised in accordance with the laws of a Member State over which an undertaking of a third country has majority control (para 37).
As regard the second aspect, the Court noted that the case at issue concerned not the free movement of capital but, rather, the freedom of establishment. Xella Magyarország, even though it is part of a group of companies whose ultimate parent company is established in a third country, has the right to rely on the freedom of establishment guaranteed by the TFEU since it is connected to the legal system of a Member State and is therefore an EU company (para 47).
On the merits, the Court found that the national legislation concerned clearly constituted a restriction on the freedom of establishment of the company, in this case, even a particularly serious one (para 59). Turning to the question of whether the restriction is justifiable under an overriding public interest, the Court held that the security of supply to the construction sector as regards certain basic raw materials does not constitute such a public interest (para 69).
Implications of the judgment
As far as the application of the FDI Screening Regulation is concerned, the Court’s position seems questionable. First of all, one should recall the purpose of the FDI Screening Regulation, which is not to introduce a European FDI screening mechanism but, rather, to authorise Member States to introduce legislation that governs the screening of FDIs. In addition to this authorisation, the regulation establishes a framework of common standards that national screening mechanisms must comply with (for instance, the regulation provides that rules and procedures related to screening mechanisms shall be transparent and not discriminate between third countries). This framework of basic standards that States shall respect when setting up their screening mechanisms is of utmost importance to avoid abuses and/or infringement of the fundamental freedoms afforded by the EU treaties.
In ruling out the possibility to expand the scope of application of the regulation to cover also investments made by EU undertakings controlled by an undertaking of a third country, the Court of Justice has significantly curtailed the relevance of the regulation, possibly exposing such companies to excessive restrictions only because they are controlled by foreign nationals.
It bears noting that, in its reasoning, the Court departed from the Opinion delivered by AG Ćapeta in the case. In her Opinion, the AG concluded that there is no obstacle to subsume a national FDI screening mechanism within the scope of the FDI Screening Regulation (para 38). Accordingly, for an investment to fall within the scope of the FDI Screening Regulation, the investment process need not necessarily be conducted directly but may be carried out indirectly. What matters is who ultimately acquires control over the EU undertaking in question (para 43).
To hold otherwise would imply that indirect FDIs could fall within the scope of the regulation only exceptionally, namely only if such investments do not reflect economic reality and circumvent the screening mechanisms and screening decisions (according to Article 3(6) of the regulation).
The position of the AG, if followed by the Court, could have struck a balance between the rights enjoyed by investors and the State’s necessity to screen foreign investments for public reasons. As the AG underscored, it should be clear that the screening of investments of third-country provenance carried out through an EU-based undertaking does not automatically imply that such an investment may be blocked without any further conditions.
In that regard, the AG pointed out that the FDI Screening Regulation itself already reflects the possible justifications to the restriction to the fundamental freedoms and, thereby, implicitly also the general criteria for assessing the proportionality of a restriction of a free movement right. If the rules relating to the internal market were not built into the FDI Screening Regulation and the national mechanisms authorised on that basis, the market freedoms available to all EU companies could be disproportionately burdened simply because of foreign shareholding in those companies (para 53).
Conclusion
In light of the above, the judgment of the Court of Justice could lead to a paradoxical effect. In negating the application of the FDI screening regulation to indirect investments, the judgement could augment abuses of screening activities by national authorities, thereby increasing uncertainty about the regulatory environment among foreign investors, which was precisely one of the situations that the regulation aimed to reduce.
Nicolò Andreotti is a Phd Student in international law at the University of Padua, Italy. His research focuses in particular on the interplay between international investment law and natural resources, as well as on the international law of the sea and EU law.
SUGGESTED CITATION: Andreotti, N., “Screening of foreign direct investment within the Union: protection of essential interests or abuse of rights? (C-106/22, Xella Magyarország)”, EU Law Live, 25/7/2023, https://eulawlive.com/op-ed-screening-of-foreign-direct-investmentwithin-the-union-protection-of-essential-interests-or-abuse-of-rights-c-106-22-xella-magyarorszag-by-nicolo-andreotti/
The Court of Justice draws a line in the sand for foreign investment screening: ruling in Xella Magyarország C-106/22
Alberto Pérez
On 13 July, 2023, the Court of Justice handed down its first judgment assessing the limits of the emerging national foreign investment screening mechanisms in the EU. This judgment constitutes a –second– reminder from EU institutions for national regulators in the recent years. Both the European Commission –and now the Court Justice– have recently vowed a powerful message to ensure that the fundamental freedoms enshrined in TFEU are respected in this (re-)nascent area of the law.
The setting of this case involves a local quarry of gravel, sand and clay located in Lázi, Hungary, operated by Janes és Társa, a Hungarian company. The transaction involved the acquisition of the entire capital share of Janes by Xella Magyarország, another Hungarian company that acquires about 90% of Janes’ output and produces concrete construction products.
The Hungarian Minister for Innovation and Technology prohibited the acquisition under its domestic foreign direct investment screening legislation. The Minister classified Xella as a ‘foreign investor’ because it is it is indirectly owned by a Bermudan company –even though the latter is ultimately owned by an Irish national–. In addition, Janes qualified as a ‘strategic company’ and the transaction was vetoed since it would ‘pose a longer-term risk to the security of supply of raw materials to the construction sector’ having regard to its market share in that region and the increasing proportion of domestic-owned companies in this industry (para. 24.). In a prior Op-Ed, Nicolò Andreotti includes a comprehensive summary of the facts leading to this judgment.
The Court of Justice provided useful guidance in terms of scope of application of EU rules to national foreign direct investment screening mechanisms and substantive assessment of decisions to prohibit transaction under such screening. We will examine both issues in turn.
Does the FDI Regulation apply to direct foreign investment?
The Court of Justice declares that investments directly carried out by an EU investor generally falls outside the scope of the FDI Regulation (2019/452). This literal interpretation of the scope of the FDI Regulation (supported by the Commission) is at odds with the position adopted by the Advocate General Ćapeta. In her Opinion for this case, the conclusive factor for the application of the FDI Regulation lies on the ultimate person who acquires control over the EU undertaking (para. 43 of the Opinion). The Italian Government supported this view, since for instance an indirect investment by third-country may be a relevant factor to determine whether FDI is likely to affect security or public order (Article 4(2) (a) of the FDI Regulation).
The position finally adopted by the Court of Justice may be based on two decisive elements. It is true that this specific case did not amount to a ‘foreign investor’ regardless of the criterion used to identify it. Both the direct investor (Xella) and the ultimate indirect investor (an Irish individual, who controls the Bermudan holding company) were EU investors. In addition, the Court of Justice may be concerned that a broader interpretation of the term ‘foreign investor’ may serve as a
basis to apply national foreign investment screening to EU investors, on the sole basis that part of their shareholders are not EU nationals (para. 46 of the Xella Judgment). The Court of Justice recalls that the only exception coined in the FDI Regulation triggering a see-through is aimed at preventing ‘artificial arrangements that do not reflect economic reality and circumvent the screening mechanism’ (recital 10 and Article 3(6) of the FDI Regulation).
It is important to note that the inapplicability of the FDI Regulation does not mean that Member States are precluded from enacting foreign indirect investment mechanisms at all. This atypical Regulation (‘a kind of a platypus’, as described by AG Ćapeta) does not force Member States to enact domestic FDI screening legislation nor does set uniform FDI screening mechanism rules. For those Member States willing to screen foreign direct investment screening mechanism, the FDI Regulation sets a framework of common standards and certain cooperation duties with other Member States and the Commission. The very FDI Regulation acknowledges that it does not prejudice the right of Member States to derogate from the free movement of capital as provided for in Article 65(1)(b) of the TFEU and notes that several Member States have already put in place such alternative measures. National foreign indirect investment screening is not per se prohibited under EU law, but subject to the Treaty rules on fundamental freedoms as we will see below.
Substantive appraisal of national FDI decisions under TFEU fundamental freedoms
Having discarded the FDI Regulation, the Court then assesses whether the prohibition to acquire Janes by Xella resulted in a breach of the fundamental freedoms of the Treaty. In this case, the relevant rules are the ones governing the freedom of establishment and not the ones on freedom of capital, since the transaction enabled the investor to exert a definite influence on the target’s decisions and to determine its activities.
The Court then applies its traditional test to consider that the breach of Xella’s fundamental freedom of establishment is unjustified. It qualifies the restriction as ‘particularly serious’ (para. 70 of the Judgment) and recalls that the substantive test to justify a restriction on grounds of public policy or public security is ‘only if there is a genuine and sufficiently serious threat to a fundamental interest of society’ (para. 66 ibid.). On this basis, the Court considers several factors to call into question that the test has been met, such as the local scope of the activities of the target, the nature of the input (which is not to be profitably sold far away from the extraction point) and the existing contractual relationship whereby Xella already acquires almost of the output of Janes.
Conclusions
The Court of Justice sends two relevant messages in Xella. First, the FDI Regulation does not serve as a EU endorsement to review or prohibit investments by EU companies for the mere reason that they are indirectly controlled by non-EU investors. Member States may still implement such additional screening measures on indirect foreign investment, to the extent that they comply with fundamental freedoms of the TFEU.
Second, the substantive assessment under national foreign investment screening mechanisms is not subject to pure political discretion. Fundamental freedoms –either of establishment, for investments resulting in the acquisition of control over the target, or of capital movements, for the rest of the investments– remain fully applicable to any indirect or direct inbound investment in EU companies. It should be noted that the latter in principle is applicable to non-EU investors as well, subject to the exceptions provided for in Articles 64 and 65 of the TFEU.
This is particularly relevant in jurisdictions which apply their investment screening mechanisms also to EU investors. Spain provisionally applies its FDI screening mechanism inter alia to EU investors acquiring more than 10% of the
voting rights of a Spanish company, provided that either the transaction value exceeds EUR 500 million in Spain or it involves a company listed in any Spanish stock exchange. It was originally set to expire on 31 December 2021, but has been extended several times and the last amendment extended its scope of application until 31 December 2024.
An additional layer of review of national FDI authorities exists for transactions for which the European Commission has jurisdiction under the Merger Regulation (139/2004). In its recent Decision on 21 February 2022 (M.10494 – VIG / AEGON CEE), the Commission found Hungary to have infringed Articles 21 of the Merger Regulation and 49 of the TFEU by prohibiting Vienna Insurance Group AG (VIG) acquisition of AEGON Hungary and therefore unduly interfering with the Commission’s exclusive competence to decide on a concentration with a Union dimension.
Finally, it should be noted that the direct effect of the provisions of the TFEU on fundamental freedoms enable national courts to review national FDI authorities decisions. This may give rise to greater caution on whether prohibition or remedies decisions are justified by ‘a genuine and sufficiently serious threat to a fundamental interest of society’ and do not go beyond what is necessary to address such threat. A line in the sand drawn (again) for upcoming foreign investment review in the EU.
Alberto Pérez is an EU & Competition law associate at an international law firm.
SUGGESTED CITATION: Pérez, A.: “The Court of Justice draws a line in the sand for foreign investment screening: ruling in Xella Magyarország C-106/22”, EU Law Live, 26/7/2023, https://eulawlive.com/op-ed-the-court-of-justice-draws-a-line-in-the-sand-for-foreigninvestment-screening-ruling-in-xella-magyarorszag-c-106-22-by-alberto-perez/
Reading the Xella judgment in its constitutional and institutional context
Thomas Reyntjens
and Anna Jorna
The facts and outcome of the Xella Magyarország case (C-106/22) as well as the Court of Justice’s findings on Regulation 2019/452 have been summarised elsewhere on EU Law Live, so those aspects do not need to be recalled here. This contribution will focus on the broader constitutional and institutional context in which the Xella judgment was handed down. Constitutionally, the Court at first sight seems to have done nothing more than confirm orthodoxy. But a close look at the dramatis personae reveals an interesting angle to the Court’s judgment. The Xella judgement is also a reminder for – if not an instruction to – the European Commission, which may have work to do as guardian of the Treaties. Firms have a few tools at their disposal to help the Commission fulfil this mandate, especially if their transaction is subject to the Merger Regulation 139/2004
Xella in its constitutional context: construing the cross-border element broadly
The freedom of establishment, the fundamental economic freedom at play in Xella, has always circumscribed how Member States can screen and control inbound investment from firms that are based in other Member States. In principle, if a firm from Member State A wants to acquire control over a firm in Member State B, it should be free to do so. Member State B can only restrict the investment in order to protect an overriding reason of public interest. For instance, in the Vivendi case (C-719/18), Italy tried to block a hostile bid from a French company for Mediaset, a leading Italian media company, by alleging that the combination of the two companies would reduce media plurality. While the Court of Justice recognised that media plurality is an overriding public interest, it held that the concrete measures taken by Italy were disproportionate and that Vivendi should therefore be allowed to buy Mediaset.
So, at first sight, there is nothing new to the Xella case as far as EU free movement law is concerned. But the precise structure of the underlying transaction reveals an interesting angle.
The entity that was sold is Janes és Társa, a Hungarian entity, which has a Hungarian parent. The Hungarian entity that made the acquisition is Xella Magyarország Építőanyagipari Kft. And now, gentle reader, bear with us: this latter entity is owned by Xella Baustoffe GmbH, a German company, which is 100% owned by Xella International SA, a Luxembourgish company. The Luxembourgish company is in turn indirectly owned by LSF10 XL Investments Ltd, which is the ultimate parent company of the Lone Star group registered in Bermuda, the latter group belonging ultimately to J.P.G., an Irish national.
This dramatis personae shows that the underlying transaction actually seems to be a ‘purely internal situation’, as also noted by the Court of Justice (Xella, para. 51) – there was no investment from Member State A into Member State B. One Hungarian entity bought another Hungarian entity. This point is significant because in the absence of an EU crossborder element free movement rules do not normally apply (Xella, para. 50). The Court nonetheless granted protection under the freedom of establishment rules in this case, reasoning as follows:
‘However, the fact that the acquiring company forms part of a group of companies established, inter alia, in different Member States, even if those companies do not appear to play any direct role in the acquisition concerned, constitutes a relevant foreign element […].’ (Xella, para. 52).
Constitutionally, the Court’s favourable interpretation of what constitutes a sufficient cross-border link is arguably the most innovative aspect of the Xella judgment, which otherwise does not do much more than confirm the orthodoxy that free movement law constrains the way in which Member States can screen and control inbound investment, as the above Vivendi judgment, and many other judgments, also show.
Xella in its institutional context: how firms can help the Commission fulfil its mandate as guardian of the Treaties
Private enforcement of free movement rules is not the only constraint on Member States that unduly restrict inbound investment. The Commission also has an important role to play.
Article 17 TEU enlists the Commission as ‘guardian of the Treaties’. The Commission is to check that the Member States comply with Union law. Article 258 TFEU confers it with the power to commence an infringement procedure if it finds that a Member State has legislation or an administrative practice that is contrary to Union law.
An infringement procedure presupposes that the Commission has become aware of a potential breach of Union law. Firms have an essential role to play here. They can proactively provide the Commission with information about a Member State’s law and practice and present their views on why they think EU law has been infringed. The Commission provides guidance on the recommended procedure for firms to follow and has committed to keeping complainants abreast of developments in their complaint (see here and here). A complainant cannot, however, oblige the Commission to act (Star Fruit v Commission, para. 11).
The primary purpose of infringement procedures is to ensure that Member States give effect to EU law in the general interest, not to provide individual redress. The Commission therefore focuses its resources on systemic issues. We are not saying that the recent expansion of investment screening mechanisms in the Member States, which is well documented (UNCTAD Investment Policy Monitor, February 2023), is a systemic issue. But if a certain Member State uses its new powers consistently to block transactions in a particular sector or transactions entered into by firms that are not politically palatable to the powers that be, perhaps the Commission will consider that an infringement procedure is the appropriate course of action.
Another difficulty which the Commission faces when bringing an infringement procedure is speed. The procedure first involves a lengthy engagement process with the Member State concerned through informal contacts/requests for information, a letter of formal notice, and a reasoned opinion. Only then may the Commission refer the case to the Court of Justice, which will decide whether there has been a violation of EU law.
Firms can help the Commission to accelerate this procedure significantly if their transaction was cleared by the Commission under the Merger Regulation and subsequently blocked by a Member State on non-competition grounds.
Article 21(2) and (3) of the Merger Regulation prohibits Member States from applying their national legislation to mergers that have an EU dimension, subject to the exception set out in Article 21(4) which allows Member States to take appropriate measures to protect certain legitimate interests. Three specified interests are always legitimate: public security, plurality of the media, and prudential rules. ‘Any other public interest’ can also be protected, but the Commission must give its prior approval. When a Member State does not request authorisation from the Commission or tries to
cloak a certain interest it wants to protect as one of the three recognised interests, the Commission can commence an infringement proceeding against it for violating Article 21 of the Merger Regulation.
In a rare Full Court judgment, the Court of Justice confirmed that the Commission does not need to follow the procedure set out in Article 258 TFEU in this type of situation (Portugal v Commission, C-42/01). Instead, after due engagement with the Member State concerned, the Commission can adopt a decision in which it concludes that there has been a violation of the Merger Regulation. The Court justified this approach, among others, based on the requirements of the business world for a need for speed.
The Commission’s practice shows that it can indeed act rather quickly in these types of situations. The recent VIG/ Aegon CEE transaction, an insurance deal, is a good illustration. Hungary vetoed the transaction on national security grounds on 6 April 2021. After the Commission cleared the transaction on competition grounds on 12 August 2021 (Case M.10102), it adopted a separate decision under Article 21(4) of the Merger Regulation on 21 February 2022, ordering Hungary to withdraw its veto (Case M.10494). The Commission’s decision shows that the merging firms played an important role in providing it with information and arguments to reach the conclusion that Hungary’s veto was unjustified.
Concluding thoughts
The Xella judgement shows that the EU’s fundamental freedoms can provide firms whose transaction was blocked following an investment review with individual redress through the courts of the Member States, with guidance from the Court of Justice if needed. Firms can count on a favourable interpretation of what constitutes a cross-border link following the Court’s judgment in Xella.
As guardian of the Treaties, the Commission can also take enforcement action if it considers that there is a systemic issue in a Member State. However, information asymmetries and lengthy procedures can make such cases tough to bring. Firms therefore have an important role to play to assist the Commission in its mandate. Successful enforcement action by the Commission may not help those firms change the outcome of past or even current transactions. But firms which are repeat players and, for whatever reason, are at risk of being caught in the crosshairs of a foreign investment review have a strong interest in becoming assistant-guardians of the Treaties. It is no coincidence that Xella Magyarország is ultimately owned by funds advised by Lone Star, a prolific global deal-doer.
Thomas Reyntjens and Anna Jorna are legal secretaries (référendaires) at the Court of Justice of the European Union. Thomas is also preparing a DPhil (PhD) thesis at the University of Oxford, and he was previously a lawyer in Brussels and London. Anna previously worked in a law firm in Brussels.
All views expressed in this contribution are, naturally, their own.
SUGGESTED CITATION: Reyntjens T., and Jorna, A.,: “Reading the Xella judgment in its constitutional and institutional context”, EU Law Live, 14/9/2023, https://eulawlive.com/op-ed-reading-the-xella-judgment-in-its-constitutional-and-institutional-context-by-thomasreyntjens-and-anna-jorna/
Where Investment Screening and the Internal Market Meet – Xella Magyarország (C-106/22)
Trajan Shipley
Introduction
The European Union (EU) has recently started to calibrate its traditional openness to foreign trade and investment by becoming more assertive and pursuing its own ‘strategic autonomy’. In its effort to achieve this, the EU has adopted numerous measures under its common commercial policy (CCP).
Among those instruments is the Foreign Direct Investment Screening Regulation (FDI Screening Regulation). This Regulation sets minimum requirements for Member States to enact their own FDI screening legislation and enables EUwide cooperation on the European Union’s understanding that the FDI Screening fully falls within the CPP and it is for the EU to decide on this matter. Even if based under the CCP, when the instrument is applied to real-world situations, EU internal market provisions also come into play. The application of both internal market rules and instruments developed under the CCP has important practical consequences for market operators regardless of whether they are based in the EU, as the standards of investment protection available to them in specific situations is related to what internal market freedom(s) they are entitled to.
The judgment in Xella Magyarország (C-106/22) illustrates these considerations. The case concerned the application of a national FDI screening mechanism to the acquisition of an EU-based company by another EU-based company ultimately controlled by a non-EU undertaking. The legal question was whether the FDI Screening Regulation applies to such an investment. The Advocate General and the Court of Justice did not agree on how to answer that question. Prior contributions to this symposium have focused on the consequences of this judgment for FDI screening and the broader constitutional and institutional implications. This Op-Ed will examine from an internal market dimension and attempt to draw practical consequences in the context of FDI screening.
The judgment in Xella
The facts of the case have already been summarised in this symposium. In her Opinion, Advocate General Ćapeta advised the Court to find that the FDI Screening Regulation applied to the present case. She also reasoned that national FDI screening mechanisms and individual screening decisions should comply with internal market law, which would require an assessment of whether they constitute justifiable restrictions of fundamental freedoms (in particular, the free movement of capital).
However, the Court of Justice found otherwise, ruling that as a matter of principle, the FDI Screening Regulation does not apply to investments made by EU companies. Importantly, it held that, in principle, the freedom of establishment applies because the investment would enable the acquiring company to exercise ‘a definite influence’ on the target company. Therefore, the acquiring company (formally an EU company) could rely on this freedom despite its international corporate structure to contest the screening. Moreover, the Court further held that the objective of ensuring security of
supply could not justify in the present case a restriction to this freedom because the factual scenario did not concern a ‘fundamental interest of society’, nor did it give rise to a ‘genuine and sufficiently serious threat’.
Applicability of the FDI Screening Regulation
The Advocate General’s reasoning in favour of the applicability of the FDI Screening Regulation was premised on the fact that a ‘direct investment’ falls within the scope of internal market rules, in addition to the CCP. This does not contradict the Court’s approach. The difference related to the interpretation of the regulation itself. The Advocate General took an expansive view by reference to the purpose of the regulation, concluding that it does not discriminate between different structures of investment. Therefore, ‘indirect investments’ would fall under the scope of that regulation even in intraEU situations (i.e. acquisitions of an EU company by another EU company ultimately controlled by a foreign investor).
By contrast, the Court opted for a narrower interpretation of the regulation, limiting its applicability to investments in the EU made by non-EU companies. It explained that while the regulation allows taking into account the ownership structure of foreign investors in assessing the investment’s potential risks to public order or security, that does not extend the regulation’s scope so as to include investments formally made by EU companies. The only possibility to apply the regulation to those investments would be in circumvention attempts under Article 3(6) thereof, which was not found to be the case here. Therefore, no application of national FDI screening mechanisms to intra-EU investments falls within the scope of the FDI Screening Regulation, regardless of the international corporate structure of the EU acquiring company.
Interplay of internal market and CCP provisions
By finding the freedom of establishment (to which only EU companies are entitled to) as the relevant freedom in intra-EU screening, the Court brings intra-EU situations exclusively into an internal market framework where no FDI screening may take place. This also renders the non-EU nationality of the shareholders of an EU company an irrelevant criterion for the purposes of FDI screening. The Advocate General’s proposal to include ‘indirect investments’ within the scope of the FDI Screening Regulation to screen ‘who ultimately acquires control over the EU undertaking in question’ could only work by considering the free movement of capital as the relevant market freedom, as both EU and non-EU companies benefit from that freedom (unlike the freedom of establishment).
The Court’s message is clear: internal market law cannot be disregarded by an instrument developed under the CCP. The difficulty lies in discerning which situations fall under each competence. In relation to the specific area of foreign direct investment, this is a particularly difficult task, as by definition, internal market law applies to situations falling within the notion of foreign direct investment. The Court has now clarified in Xella that in the context of FDI screening, intra-EU investment is exclusively an internal market issue, while investments conducted by non-EU investors will be subject to the application of CCP instruments in the light of the free movement of capital. However, as duly noted by Thomas Reyntjens and Anna Jorna in their Op-Ed, the narrowness in the Court’s approach to the applicability of the FDI Screening Regulation is compensated by a broad notion of the required cross-border element for free movement provisions to apply.
The Xella case illustrates how, as new trade and investment policy instruments adopted by the EU under the CCP are applied, they will often be pulled into contexts where their application will clash with internal market rules. In some cases, the consequence will be that these instruments do not apply to situations where under a CCP logic perhaps they
should, as would be the case of ‘indirect investments’. However, the takeaway from Xella is that in intra-EU situations, there is no room for applying instruments developed under the CCP, even in light of new geopolitical realities. Rather, the relevant situations must be examined under an internal market lens.
Conclusion
The Court’s judgment in Xella signals that the basic tenets of internal market law may not be altered by recent trade and investment instruments developed under the CCP. This applies in particular to the availability all market freedoms for established EU companies, regardless of their international corporate structure. Equally, it also applies to its wellestablished test to justify restrictions to the internal market.
In practical terms, this means that where foreign direct investment into the EU is structured in a way that includes an EU presence, it will be able to benefit from more substantive standards of protection under EU internal market law. Specifically concerning FDI screening, foreign investors conducting an investment through an EU subsidiary may in principle not be subject to FDI screening by other Member States.
Trajan Shipley is a lawyer in Brussels, Belgium. His practice focuses on EU and international trade law.
SUGGESTED CITATION: Shipley, T.,: “Where Investment Screening and the Internal Market Meet – Xella Magyarország (C-106/22)”, EU Law Live, 22/9/2023, https://eulawlive.com/op-ed-where-investment-screening-and-the-internal-market-meet-xella-magyarorszag-c-10622-trajan-shipley/
‘Time out’ for the EU cooperation mechanism in Austria due to Xella (C-106/22)
Judith Feldner and Felix Frommelt
Advocates General do not often write about animals in their opinions. In the Opinion in C-106/22, Xella, AG Ćapeta referred to a ‘kind of a platypus, a strange creature’ in order to describe the nature of the FDI Screening Regulation 2019/452. The AG points out that, in contrast to other regulations, it neither ‘impose[s] binding rules’ and does not ‘introduce a common foreign direct investment screening mechanism’, nor does it oblige ‘Member States to introduce legislation that governs the screening of foreign direct investments’. Instead, the FDI Screening Regulation ‘merely authorises’ them to do so and provides for some common standards that those (to be) established national screening mechanisms must meet. The FDI Screening Regulation only provides for a partial harmonisation of the Member States’ screening mechanisms, resulting in some cases to non-congruent definitions of ‘foreign direct investments’ at the national and EU level.
Therefore, in Xella (for a summary of the facts see here) the Court of Justice – arguably adopting a rather favourable interpretation of what constitutes a sufficient cross-border link as pointed out by Reyntjens and Jorna – had to clarify which foreign direct investments are in fact caught by the FDI Screening Regulation and thus must be forwarded by the Member States to the so-called EU Cooperation mechanism. Against this background, Member States having a diverging understanding of foreign direct investments are now not only facing the issue that their national screening mechanism must adhere to the Treaty rules on fundamental freedoms, but also how to deal with the procedural implications of the Xella judgment. Austria is a particular good example to highlight these implications as under the Austrian Investment Control Act (‘ICA‘) the EU cooperation mechanism is (or better has been) an integral part of any investment control proceedings.
In our opinion, the issue of whether or not to get the European Commission and other Member States involved via the EU cooperation mechanism must be resolved by adhering to the primacy of EU law until the national legislator amends the procedural provisions of the ICA.
‘Foreign direct investments’ according to Xella
The Court of Justice clarified that the concept of foreign direct investments under the FDI Screening Regulation covers only ‘investments aimed at a lasting and direct holding’ by a foreign investor, i.e. an undertaking constituted or otherwise organised under the laws of a third country. Consequently, the FDI Screening Regulation does not apply to investments made by undertakings registered in a Member State over which an undertaking registered in a third country has a majority control (so-called ‘indirect’ foreign investment). The only exception are cases of ‘circumvention’, meaning investments within the EU by means of artificial agreements that do not reflect economic reality to circumvent the screening mechanisms, where the investor is ultimately owned or controlled by a natural person or an undertaking of a third country.
As a result, the Court of Justice confirmed the European Commission’s position that only ‘direct’ foreign investments are relevant under the FDI Screening Regulation, thereby dismissing the AG’s view that ‘indirect’ foreign investments
are also included. Against this background, the question arises which procedural implications Xella has, in particular with regard to the EU cooperation mechanism, for Member States whose respective FDI regimes encompass ‘direct’ and ‘indirect’ foreign investments. Austria is one of those Member States.
Investment control proceedings in Austria
The ICA provides for an authorisation requirement if a foreign person (i.e. a natural person without EU citizenship or citizenship of an EEA state or Switzerland, or a legal entity with its registered office or headquarters outside the EU, the EEA and Switzerland) invests in an Austrian target undertaking active in one of the sensitive areas listed in the annex to the ICA. In contrast to the FDI Screening Regulation, the ICA catches all direct and indirect acquisitions of, the acquisition of a certain amount of voting right shares in, controlling influence over or substantial assets of an Austrian target undertaking. Therefore, the definition of ‘foreign direct investments’ under the ICA encompasses ‘direct’ and ‘indirect’ foreign investments.
This broad understanding of ‘foreign direct investments’ and the procedural approach adopted by the Austrian legislator that the national FDI proceedings only start after the EU cooperation mechanism has ended, result in a threefold division of FDI proceedings in Austria: The application for authorisation does not start the national proceedings, but merely means that the Austrian FDI authority initially checks whether the mandatory information is provided. No deadline applies in this respect. Subsequently, the Austrian FDI authority forwards the application to the EU cooperation mechanism. The EU cooperation mechanism takes 35 calendar days (if no comments or requests for further information are issued) and only after that Phase 1 of the Austrian FDI proceedings begin. Phase 1 may take up to one month. Within this period, the Austrian FDI authority has to decide whether to issue the authorisation or to initiate an in-depth investigation (Phase 2). Phase 2 proceedings, although relatively rare, may last up to two months in which the investment is either authorised unconditionally or under remedies or – as ultima ratio – prohibited.
Xella’s implications for Austria
As the ICA also applies to ‘indirect’ foreign investments, the question arises what effect the different scope of the FDI Screening Regulation has on the timing of the national procedure. The ICA provisions do not provide for a restriction to ‘direct’ foreign investments. Therefore, the EU cooperation mechanism would also have to precede Phase 1 of the national proceedings in cases of ‘indirect’ foreign investments, although the FDI Screening Regulation does not apply to such cases. Such approach, however, would simply contradict the Xella judgment.
Yet, according to settled case law the primacy of Union law must be observed, which means that directly applicable EU law ‘render[s] automatically inapplicable any conflicting provision of current national law’ (Simmenthal C-106/77, para. 17). Consequently, the Austrian FDI authority must not forward foreign direct investments that fall within the scope of the ICA but are not subject to the scope of the FDI Screening Regulation to the EU cooperation mechanism. Instead, Phase 1 of the Austrian FDI proceedings must begin immediately after receipt of the application for authorisation (cases of circumvention being the only exception in this regard).
The result for Austria is that two different proceedings will exist in the future:
• foreign direct investments that fall within the scope of the ICA and FDI Screening Regulation will be forwarded to the EU cooperation mechanism and the Austrian FDI proceedings start only after the EU cooperation mechanism has ended, and
• in cases of foreign direct investments that fall within the scope of the ICA but are not caught by the FDI Screening Regulation (namely ‘indirect’ foreign investments) the Austrian FDI proceedings begin immediately after receiving the application for authorisation without triggering the EU cooperation mechanism.
However, the FDI Screening Regulation does not provide an answer to the question what happens, if an authority forwards an ‘indirect’ foreign investment case to the EU cooperation mechanism although the FDI Screening Regulation is inapplicable. It remains to be seen how the European Commission intends to deal with such cases – the initiation of infringement proceedings being the extreme, but rather unlikely and also, in our view, not preferable response. The ongoing evaluation of the FDI Screening Regulation would be the perfect opportunity to address this topic.
Conclusion
Although the ‘platypus’ FDI Screening Regulation received some necessary clarifications through the Court of Justice, the Xella judgment added another layer of complexity for Member States that have diverging definitions of foreign direct investments, resulting in different scopes of application for national law and the FDI Screening Regulation. The FDI Screening Regulation therefore remains an exotic animal. Although, in our view, this issue can be rather easily resolved by going back to the roots of EU law and abiding the principle of primacy of EU law, this divergence in the crucial definition of foreign direct investment may also have procedural implications as demonstrated by the example of Austria.
Speaking of animals, how the European Commission has to deal with foreign direct investments that are forwarded to the EU cooperation mechanism although the FDI Screening Regulation is inapplicable remains the elephant in the room and cannot be resolved for the time being. The FDI Screening Regulation does simply not address this situation.
Judith Feldner and Felix Frommelt are Austrian based lawyers regularly advising international clients in FDI and competition law matters.
SUGGESTED CITATION: Feldner, J., and Frommel, F., “‘Time out’ for the EU cooperation mechanism in Austria due to Xella (C106/22)”, EU Law Live, 11/10/2023, https://eulawlive.com/op-ed-time-out-for-the-eu-cooperation-mechanism-in-austria-due-to-xella-c106-22-by-judith-feldner-and-felix-frommelt/.
The Xella Case: Screening FDIs is a matter of proportionality
Aldo Sandulli
The insightful comments already published in EU Law Live on the Xella Magyarország case (Court of Justice, Second Chamber, 13 July 2023, C-106/22, Xella Magyarország Építőanyagipari Kft. v. Innovációs és Technológiai Miniszter) [2] allow me to come straight to the points that I would like to expand on.
I. Firstly, the Xella judgment shows that it may be necessary to reconsider Regulation (EU) 2019/452 on the foreign direct investment screening mechanism, particularly in relation to the definition of foreign investment.
The Court’s decision provides a restrictive interpretation of foreign direct investment. It confines the scope of Regulation (EU) 2019/452 to investments regarding strategic national interests made by undertakings incorporated, or at least organised, in accordance with the law of a third country. This does not mean Member States may not introduce further restrictions concerning ‘indirect’ foreign direct investment, but these can only be considered lawful if they do not conflict with EU fundamental freedoms.
For the Court of Justice, the Hungarian Regulation, which also extends the exercise of special powers to companies registered in Hungary or another Member State where companies registered in a third country hold a majority vote, falls outside the scope of the Regulation mentioned above. This is true unless the intention to circumvent the control mechanism on foreign direct investment laid down by the Regulation is demonstrated, as stated in Recital 10, but this was not the case here.
Hence, contrary to the Advocate General’s recommendations, the Court of Justice chose not to apply the Regulation. Instead, it advocated for a test based on the freedom of establishment rather than the free movement of capital.
All this suggests that there is room for a revision of the content of the 2019 Regulation mentioned above. But Alexia Crivoi has already addressed this point in her recent Long-Read in the Weekend Edition, to which we can refer.
II. Secondly, the judgment highlights that some Member States, notably France, Spain, and Italy, have instituted foreign direct investment controls that exceed the scope of both the European regulations and those of other Member States.
The Court of Justice has unequivocally stated that substantive assessment under national foreign investment screening mechanisms cannot be a matter of purely political discretion. The fundamental freedoms – of establishment, for investments involving taking control of the target, or capital movements, in the case of other types of investments –remain fully applicable to any indirect or direct inward investment in EU companies. It also clarifies that, in principle, these freedoms also apply to non-EU investors, subject to the exceptions in Articles 64 and 65 TFEU.
This is particularly significant for jurisdictions that also apply their investment control mechanisms to EU investors, such as, for example, the Italian (Decree-Law No. 21 of 15 March 2012, as amended), French (loi 2019-486, of 22 May 2019, PACTE), and Spanish (Real Decreto 671/2023, of 4 July, sobre inversiones exteriores) regulations.
III. In particular, the Court of Justice’s decision dwells at length on the subject matter of the Regulation, although, in my
opinion, the most important part of the judgment concerns the objective and substantive aspects. An important facet of the Court’s judgment is that it establishes, on the one hand, the proportionality of the measure to be taken and, on the other, the fulfilment of the obligation of adequate reasoning in order to demonstrate the just extent of the power exercised by the government. In practice, an adequate and serious threat to national strategic interests must be found to justify restricting foreign direct investment.
This part of the decision (converging on this point with the Advocate General’s Opinion) sets precise standards from the objective and procedural point of view. Considering the distinction articulated in the judgment, there may be room for further reflection on whether a proportionality check of varying intensity might be contemplated depending on whether the party interested in the acquisition is simply a foreign investor or an EU entity controlled by a third-country company.
Furthermore, the Court’s reasoning with regard to the proportionality of the measure adopted by governments in the exercise of extraordinary powers is also likely to have a knock-on effect on the orientation of national courts. In Italy, for example, there is much debate as to the nature of government measures when it imposes a veto or introduces prescriptions and/or conditions. The Court of Justice’s decision appears to lean in the direction of disassociating the deliberation of the Council of Ministers from being solely a political act. Instead, it advocates for imposing a set of procedural and principled constraints on the government’s actions since, if the measure must be proportionate and sufficiently motivated, subsequent judicial review cannot be unduly restricted. A thorough judicial review, as the Hungarian case also shows, serves as a necessary buffer against ‘political discretion’ on the one hand and as an expedient guarantee for Euro-EU economic principles and freedoms on the other.
However, even when analysing the judgment from the subjective point of view, one necessarily returns to the objective and substantive aspects.
Are the only foreign direct investments eligible for screening those operated directly by a company from a country outside the Union, or is domestic screening of ‘indirect’ foreign direct investments also admissible?
According to the Court, the case falls under the rules of the internal market and must be settled in accordance with the principle of freedom of establishment, which means that Xella is, in its own right, an EU company, and Regulation (EU) 2019/452 does not apply. This is a straightforward and correct solution in terms of the legal exegesis of the Treaties.
However, the question arises as to where the boundary lies between the rules governing the Euro-EU market, the safeguarding of national security, and the strategic need for a supply of essential raw materials to the Member States. In this respect, the objective element is once again crucial in determining whether a genuine and sufficiently serious threat exists to a fundamental public interest.
It follows, therefore, that the screening of foreign direct investment is undoubtedly a highly political and discretionary decision but one that remains subject to a proportionality check as far as the exercise of power is concerned.
IV. What might the consequences of the Xella judgment be?
The ruling certainly provides some valuable pointers for the 2019 Regulation update.
However, it is not a foregone conclusion that the Member States that have implemented a particularly stringent foreign direct investment screening discipline may witness a partial relaxation of the regulations. This is mainly because the concrete reality and the regulatory data, at both European and national levels, are heading in entirely different directions.
Suffice it to recall the stalemate affecting the World Trade Organisation following the pandemic and Ukrainian crises and consider the extension of the BRICS countries to include six new countries.
But it is primarily the decisions made in the United States and the United Kingdom that indicate such a direction.
On 9 August 2023, President Biden issued an Executive Order limiting investments by US companies in China, with specific regard to semiconductors, microelectronics, artificial intelligence, and quantum information technology, in order to safeguard military defence and national security. This is yet another sign of decoupling between the US and China, a separation into two opposing blocs. The decision has aroused widespread debate and led to heated criticism, both within the US business sphere, notably from Big Tech and investment funds, as it places severe constraints on investment in regions of particular importance to the technology industry and at the political level, where, on the contrary, it is considered too timid and ineffective in countering Chinese military interests.
As for the European Union, intending to achieve strategic autonomy within the next few years, the European institutions adopted the new semiconductor regulation in late July 2023. The goal is to double the indigenous production of semiconductors by 2030, thus increasing it from 10 to 20 per cent of the global market. In terms of the Union’s strategic autonomy, the key concept is that of technological sovereignty, and this will inevitably clash with the traditional principles concerning the functioning of the market and its freedoms as we have come to understand them.
Consideration must also be given to recent measures in the Western area concerning the control of foreign subsidies as a safeguard for its economic borders against non-EU companies distorting the European market. It is widely known that the State Aid Temporary Framework, adopted in 2020 at the Union level at the height of the Covid-19 pandemic, was answered by the aggressive US green subsidy plan, the Inflation Reduction Act (IRA), and, across the English Channel, the UK Subsidy Control Act. These interventions were further countered by the new temporary Euro-Union framework, designed to stimulate business investment for a sustainable recovery and address the energy crisis. And on 14 December 2022, Regulation (EU) 2022/2560 was adopted. It concerns foreign direct and indirect subsidies for third-country companies benefiting from public funding and operating on the continent with a competitive advantage over European companies, which are required to comply with the rules prohibiting any State aid that might distort competition.
If we add to this the common defence strategies adopted by the European Union over the past year on the subject of common security, especially regarding technological infrastructure (e.g., Space Strategy for Security and Defence – SSSD, focusing on space infrastructure for cybersecurity), it becomes apparent that the screening of foreign direct investment will only expand in the years ahead.
This is due to the increasingly evident and extensive interventions of the public authorities to protect national industry, and not only in Europe, while issues relating to national defence and security on the one hand, and the market and freedom of economic initiative on the other, are becoming more indissolubly intertwined.
It is no coincidence that the topic of economic security is evolving and assuming an increasingly central role in Europe too: a statement that, until very recently, would have been considered an oxymoron.
[1] See the Op-Eds in this Symposium by N. Andreotti; A. Pérez; T. Reyntjens and A. Jorna; T. Shipley; J. Feldner and F. Frommelt, , as well as the Long Read by A. Criovi in the Weekend Edition nº 158.
Aldo Sandulli is Full Professor of Administrative Law, Department of Law, Luiss University.
SUGGESTED CITATION: Sandulli, A.; “The Xella Case: Screening FDIs is a matter of proportionality”, EU Law Live, 19/11/2023, https:// eulawlive.com/op-ed-the-xella-case-screening-fdis-is-a-matter-of-proportionality-by-aldo-sandulli/
