National Interest and Freedom of Establishment: The CJEU’s Judgment in Xella
In its judgment[1] published on 13 July 2023, the Court of Justice of the European Union (CJEU) ruled that Hungary’s decision to prohibit an investment by a foreign-owned Hungarian company aiming to acquire a Hungarian company violated the freedom of establishment. The prohibition involved the use of the novel foreign direct investment (FDI) screening mechanism and had the declared purpose of ensuring the predictability and security of the supply of raw materials to the construction sector. The Hungarian authorities framed this decision as necessary for protecting national interest, an even more elusive concept than the already broad security and public order used in the FDI Screening Regulation.[2]
Investment screening mechanisms, providing a wide margin of discretion for authorities, are susceptible to potential misuse. The Court’s ruling emphasizes the need for any restrictions imposed on the freedom of establishment to be exceptional, narrowly interpreted, and backed by an overriding public interest. These expectations must be adhered to even in cases in which Member States act in their self-interest, in the context of a global pandemic, basing their actions on emergency regulation aimed specifically at combating the negative effects of the pandemic on the local economy. According to the judgment, derogations must not be misapplied for purely economic purposes.
While EU institutions have shown their ability and willingness to scrutinize unilateral measures of Member States in the context of investment screening, the efficiency of the proceedings remains questionable. The lengthy review process and ongoing legal proceedings can undermine business interests, casting doubt on the effectiveness of remedies against investment screening decisions and their impact on immediate objectives.
Investment Screening x2
Hungary adopted its national security investment screening mechanism while the EU Regulation[3] was still in the works. Act LVII of 2018 on controlling foreign investments violating Hungary’s security interests was later amended a number of times, among others, to bring it in line with the Regulation.
Pursuant to the challenges brought to the fore by the Covid-19 pandemic, the Hungarian Government adopted a set of measures aimed at redressing the economy. Among these were measures to control the inflow of FDI in order to safeguard sectors of the economy considered strategic. Act LVIII of 2020 concerning the transitional rules and epidemiological preparedness related to ending the state of emergency established a new screening mechanism that would work in parallel to the one established by Act LVII of 2018. Titled measures necessary for the economic protection of companies established in Hungary, Chapter 85 of Act LVIII of 2020 set up a screening mechanism with the broader aim of protecting Hungary’s economic interests in strategic economic sectors. The mechanism was initially established in response to the state of emergency resulting from the pandemic but was subsequently reactivated due to the Russian aggression against Ukraine.[4]
Case C-106/22 stems from the application of this latter mechanism, as shown below.
The Case at Hand
Xella Magyarország Kft (“Xella”), a manufacturer of concrete construction products, is a company with an ownership structure that follows through Germany, to Luxembourg, to the US and Bermuda, and ultimately to an Irish national. Xella made a bid to take over the Hungarian company Janes és Társa Kft., active in the extraction of gravel, sand, and clay, an activity which triggers the application of the mentioned screening mechanism.
According to its obligations under Act LVIII of 2020, the investor notified the transaction. The authority competent under these rules, the Minister of Innovation and Technology, prohibited the transaction invoking national interest. The Budapest High Court annulled that decision, ordering that a new procedure be conducted.
In the second procedure, the Minister once again decided to prohibit the transaction and elaborated on its stance. It argued that Xella was indeed a foreign investor under the applicable law, that the target company’s activities were of strategic importance, and that the “pandemic clearly showed that serious disruption to the functioning of global supply chains could occur in a short period of time, with negative repercussions that could harm the national economy.”[5]
The building materials market in Hungary was hit by severe price hikes during the pandemic, due to supply chain inefficiencies, which––at least in part––explains this stern decision of the Minister.[6] According to the CJEU Judgment, the Minister pointed to the fact that this market sector was dominated by foreign-owned Hungarian producers, and the planned takeover would result in additional “longer-term risk” to the security of the supply of such raw materials. The effects would be even more severe in the region where the target company operates, as it has a market share of just over 20%.[7] The Minister also added that “the acquisition by a foreign owner of a strategic company would reduce the proportion of domestic-owned companies, which could harm the ‘national interest’, in the broad sense.”[8]
Xella appealed the Minister’s decision in front of the Budapest High Court, arguing that it “constituted arbitrary discrimination or a disguised restriction on the free movement of capital.” The investor also pointed out that “the lack of clarity of the concept of ‘national interest’, within the meaning of [the applicable law], was capable of breaching the fundamental principle of the rule of law.”[9] Keen observers of this field may recognize this as a recurrent critique, as investment screening mechanisms allow for a considerable scope of discretion for authorities, rendering this instrument susceptible to potential misuse.
In Front of the CJEU
The Budapest High Court filed a request for a preliminary ruling seeking guidance on the screening mechanism’s compatibility with EU law. The CJEU first looked at whether the acquisition and the national legislation fell under the scope of the FDI Screening Regulation. It concluded that the acquisition itself falls outside the scope of the Regulation, as does the part of the Hungarian legislation according to which screening rules apply to undertakings registered in Hungary or in another Member State.[10] Significantly, the Court refrained from delving into the intricacies of assessing whether this mechanism diverged from the FDI Screening Regulation due to its implementation during a state of emergency, and its expressly stated objective of safeguarding national interest, rather than security or public order as stipulated by the Regulation. Indeed, this legislative instrument has been notified to the Commission and appears on the list published on the Commission’s website.[11]
Relying on the facts of the case, and invoking EU law and previous jurisprudence, the Court retained that Xella is an EU company and thus has the right to “rely on the freedom of establishment guaranteed by the TFEU.”[12] Although the Court recognized that the transaction was confined to a single Member State, it maintained that Xella’s ownership structure, being part of a group of companies, as shown earlier, “constitutes a relevant foreign element” for the admissibility of assessing the matter under the regulations pertaining to freedom of establishment.[13]
Analyzing the screening mechanism’s use in this case, the Court reiterated that “Member States are still, in principle, free to determine the requirements of public policy and public security in the light of their national needs.” However, it pointed out that any derogations from a fundamental freedom enshrined in the TFEU will come under the control of the EU institutions, such that “public policy and public security may be relied on only if there is a genuine and sufficiently serious threat to a fundamental interest of society.” According to the Court, “derogations must not be misapplied so as, in fact, to serve purely economic ends.”[14] Relying on previous case-law, the Court did not consider that the stated objective of the Minister’s decision to safeguard the supply of the raw materials to the construction sector was anchored in a “genuine and sufficiently serious threat to a fundamental interest of society.”[15]
The Court retained that the bulk (90%) of the production of the target company was already being bought up by Xella, with only about 10% being used by other local companies. It noted that the low market value of raw materials, and the comparatively significant transportation costs make it highly unlikely that these will leave the local market. In the Court’s view, this meant that the prohibition was not suitable for achieving its objective.[16]
Final Thoughts
This is the second significant case in which EU institutions censored an investment screening decision of the Hungarian authorities. The first case regards the acquisition of AEGON Group’s Hungarian subsidiary by Vienna Insurance Group.[17] Both cases demonstrate the ability and willingness of EU institutions to step in and scrutinize unilateral measures of Member States, even in cases where the declared objective of national authorities is to safeguard security or public order, or––as in this case––national interest.
The Court clarified once again that any restrictions that Member States may impose on the rights stemming from the fundamental freedom of establishment, must be done in exceptional circumstances, and the derogations must be interpreted narrowly. The judgment once again confirms that despite the broad margin of discretion investment screening mechanisms accord to Member States’ authorities, any decision under these novel mechanisms must adhere to EU law, and must be backed by an overriding public interest.
Nevertheless, in both cases, we may observe that the sluggishness of these proceedings does not impede the utilization of screening mechanisms to achieve immediate objectives. In the above case, the transaction remains suspended due to the ongoing legal proceedings in front of the national courts. Although the legislation governing the screening mechanism stipulates accelerated proceedings before national courts, appeals are restricted to matters of due process. The review process by EU institutions (15 months in the present case) may take longer than what a business transaction may tolerate. Ultimately, the inefficiency of these proceedings will undermine business interests. From the investor’s point of view, the timing of this judgment may render its impact insignificant.
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[1] Judgment of 13 July 2023, Xella, C-106/22, ECLI:EU:C:2023:568.
[2] Regulation (EU) 2019/452 of the European Parliament and of the Council of 19 March 2019 establishing a framework for the screening of foreign direct investments into the Union.
[3] Regulation (EU) 2019/452 of the European Parliament and of the Council of 19 March 2019 establishing a framework for the screening of foreign direct investments into the Union.
[4] See Government Decree 561/2022 (XII. 23.).
[5] Judgment, paragraph 23.
[6] There have been other interventions specifically in this area as well, which have caught the attention of the European Commission, see Press Release 14 July 2023: Building materials: Commission decides to refer Hungary to the Court of Justice of the European Union for violations of the freedom of establishment, https://ec.europa.eu/commission/presscorner/detail/en/ip_23_3527
[7] Judgment, paragraphs 23–24.
[8] Judgment, paragraph 24.
[9] Judgment, paragraph 25.
[10] Judgment, paragraphs 29–34.
[11] See List of screening mechanisms notified by Member States: https://policy.trade.ec.europa.eu/enforcement-and-protection/investment-screening_en
[12] Judgment, paragraphs 42, 45–48.
[13] Judgment, paragraphs 52, 56.
[14] Judgment, paragraph 66.
[15] Judgment, paragraphs 67-69.
[16] Judgment, paragraphs 72-74.
[17] An analysis of the case can be found here: Kovacs, Balint, Facilitating and Scrutinizing National Security Measures: Analysis of an Investment Screening Case in the European Union (June 10, 2023). Available at SSRN: https://ssrn.com/abstract=4475471
