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/