The ECJ and Investment Control – Intensified Investment Screening

The European Court of Justice (ECJ) and the Commission very much influence the investment climate in Europe. They have been very successful in abolishing all kind of direct and indirect impediments to the free movement of people, goods, services and capital. However, the European Union has become much more than an economic community with legislation focusing on the elimination of trade barriers. In EU tax law, for example, there is no longer a focus on eliminating obstacles to free movement, but rather on the protection of the tax base and on fight against abuse. Generally, the ECJ is transforming itself into a constitutional Court concentrating on the development and protection of EU´s identity and values.[1]

Juliane Kokott, Advocate General at the European Court of Justice, discusses two developments in the area of investment law. This blog series features two posts by AG Kokott on (I) intensified investment screening and (II) on the ECJ-induced termination of intra-EU investment treaties, including some extraterritorial aspects.

This blog post is based on a speech originally delivered at the 2024 CELIS Forum on Investment Screening (CFIS) in Paris. The views and opinions expressed in this post are those of the author in her personal capacity. 

 

1. Introduction

Due to various crises, particularly Covid-19 and Russia´s war of aggression against Ukraine, keeping control of critical infrastructure within the EU (and not supporting hostile activities from outside the EU) has become an important topic. Competition law is generally unsuited to reach this aim. Free movement of capital prohibits "all restrictions on the movement of capital between Member States and between Member States and third countries".[2] Therefore, competition law enforcement must not discriminate against capital from third countries; probably it would thus be not so easy to favor “European champions”[3]. Moreover, M&A control only applies to mergers above certain thresholds.[4] Foreign Direct Investment (FDI) Screening is thus necessary to protect “security or public order at EU level”.[5]

 

2. Xella case

2.1 Judgment

The only judgment of the ECJ regarding foreign investment screening is Xella, from 2023. The Hungarian Minister for Innovation and Technology had blocked the proposed acquisition by Xella, a Hungarian company, of another Hungarian company which owned a quarry extracting gravel, sand and clay and which Hungary considered of strategic importance. The Hungarian company Xella was 100% owned by Xella Baustoffe GmbH, a German company, which is in turn 100% owned by Xella International SA, a Luxembourg company. The latter company is in turn indirectly owned by (LSF10 XL Investments Ltd, the ultimate parent company of the) Lone Star group registered in Bermuda(, the latter group belonging, ultimately, to J.P.G., an Irish national).

The Hungarian Minister had explained that it would be contrary to Hungarian national interests to allow a company with indirect Bermudan ownership to take control of a company which is active in the field of the extraction of construction aggregates.

Under the 2019 Screening Regulation, Member States may “screen foreign direct investments in their territory on the grounds of security or public order.” In defining public order, Members States may take account of the FDI´s effect on the supply of raw materials.[6]

However, the 2019 Screening Regulation only applies to “foreign direct investments into the Union”[7]. According to the ECJ, that limits its current scope of application to investments in the European Union made by undertakings constituted or otherwise organised under the laws of a third country.[8] Interestingly, the ECJ´s approach differs from the OECD benchmark definition of FDI[9] which covers direct and indirect investment relationships.[10] Accordingly, "the legal structures of related enterprises can consist of many enterprises linked through complex ownership chains."[11] What probably matters with regard to investment screening is the control, be it through direct or indirect ownership.

However, based on its narrow definition of “foreign direct investment”, the ECJ could solve the case only on the basis of the fundamental freedoms. It could not apply the 2019 FDI Screening Regulation in its current version, since the companies concerned by the takeover were established in the EU, even though indirectly controlled by the Bermudan company.

The fundamental freedoms apply to cross border situations though, the ECJ has no jurisdiction on purely internal situations. The Xella case concerned a Hungarian company buying another Hungarian company. However, the fact that Xella, the acquiring company, formed part of a group of companies established, inter alia, in different Member States, introduces the necessary cross border element, according to the ECJ.[12]

Hungary thus prevented an EU company, on grounds of security and public policy, from acquiring a shareholding in a “strategic” resident company allowing it to exert a definite influence on the management and control of that company. This is clearly a restriction on the freedom of establishment of that EU company.[13]

The ECJ found no justification for that restriction, pointing also to the allegedly low market value of sand, gray or gravel that seems to underpin their lack of strategic importance.[14] Also, Hungary did not explain whether and how the indirect foreign ownership of the company operating the quarry represented a genuine and serious threat to the security of supply of gravel, sand and clay in Hungary.[15]

2.2 Opinion of AG Ćapeta

Important judgments of the ECJ are based on a previously published opinion of an Advocate General who is an independent member of the Court. Advocate General Ćapeta had previously advised the EJC that the 2019 FDI Screening Regulation was applicable. She underlines that the 2019 FDI Screening Regulation defines FDI as “investment of any kind by a foreign investor aiming to establish or to maintain lasting and direct links …”.[16] According to her, the investment process need not necessarily be conducted directly, but may be carried out indirectly (such as where a foreign investor acquires control over an EU company by acquiring its shares through another EU company).[17]

However, the ECJ exceptionally did not follow its AG insofar.

 

3. Reform of FDI Regulation

The proposed reform of the 2019 FDI Screening Regulation on the other hand adopts the same approach as Advocate General Ćapeta. It thus "remedies" the gap unveiled in the Xella - case covering the indirect acquisition of control over an EU target company by a foreign investor.[18]

Articles 206 and 207 TFEU though only confer competence to the Union in the area of “foreign direct investment”. Accordingly, FDI under the 2019 FDI Screening Regulation means “investment of any kind …aiming to establish or to maintain lasting and direct links between the foreign investor and the entrepreneur” or “undertaking to which the capital is made available”.[19] Insofar, the proposed amendment to the 2019 FDI Screening Regulation “remedies” the Xella-case insofar as it also covers the indirect acquisition of control over an EU target company by a foreign investor.[20] Therefore, the reform proposal is not only based on EU´s competence to regulate foreign direct investment, but also on Article 114 TFEU empowering the EU to “adopt the measures for the approximation of ... (Member State) provisions  … which have as their object the establishment and functioning of the internal market.”

Traditionally, this harmonization competence of the EU was used to eliminate trade barriers. However, according to the Commission´s broader understanding of its competences, differences in law termed regulatory fragmentation can also be obstacles to exercising the basic freedoms.[21] Taken literally, such an approach allows harmonizing the entire law of the Member States which would, however, be contrary to the principle of conferred competences, laid down in Article 5(2) TEU. According to this provision, “the Union shall act only within the limits of the competences conferred upon it by the Member States in the Treaties to attain the objectives set out therein. Competences not conferred upon the Union in the Treaties remain with the Member States.”[22]

In any case, the proposed inclusion of indirect third country investments seems to be in line with many FDI regimes at national level that already cover indirect acquisitions by foreign investors.[23]

Indirect foreign investments need to be “with foreign control”[24] under the proposed new FDI Regulation. Foreign control is more than “investments which enable effective participation in the management or control of a company”[25] which the FDI Regulation as it stands now requires for the screening of foreign direct investment. The OECD benchmark definition of FDI, for example, recommends 10% ownership only as the lower threshold for FDI.[26]

The question therefore remains how to define control. Theoretically “control” could be understood in a similar way as the ECJ understands it in EU competition law. For instance, in order to impute an infringement of Article 101 TFEU committed by a subsidiary to its parent company, the ECJ has acknowledged a (rebuttable) presumption of control of the subsidiary’s market conduct, where the parent company holds all or almost all of that subsidiary’s capital.[27]

Whether the Xella case would have been decided differently under the amended FDI Screening Regulation which would then include indirect foreign investment is doubtful. The regulation is EU secondary law, the fundamental freedoms applied by the ECJ in Xella are higher ranking primary law. Thus, the Screening Regulation cannot undermine the protection provided by those fundamental freedoms. On the other hand, in tax law, the ECJ did take account of newer anti abuse legislation (in particular the ATAD[28]) to interpret the fundamental freedoms more restrictively that before the adoption of that act.[29] In any case, it is not evident how the indirect foreign ownership of a company operating a quarry represents a threat to the security of supply of gravel, sand and clay.

 

Conclusion

The ECJ is a strong player in the field of investment law. As to investment screening, it has interpreted the term foreign direct investment, a precondition for applying the foreign investment screening regulation narrowly as covering only “undertakings constituted or otherwise organized under the laws of a third country”, and not where a company organized under the laws of a Member States is controlled by a company from a third country. Therefore, the Union legislator is now trying to fill the perceived gap by amending the 2019 FDI Screening regulation.

 

 

 

[1] E.g. ECJ, judgments of 16.2.2022 – C – 156/21 – Hungary/EP and Council, ECLI:EU:C:2022:97, no. 232 and C – 157/21 – Poland/EP and Council, ECLI:EU:C:2022:98, no. 264; pending case C-769/22, Commission/Hungary, 7th plea of the Commission invoking the values of Art. 2 TEU as self-standing and judiciable. K. Lenaerts/J. Gutiérrez-Fons, Epilogue. High Hopes: Autonomy and the Identity of the European Union, in: J. Lindebohm/R. Wessel (eds.), The Autonomy of EU Law, Legal Theory and European Integration, 2024, European Papers www.europeanpapers.eu ISSN 2499-8249 Vol. 8, 2023, No 3, pp. 1495-1511: the principle of autonomy as a powerful instrument to promote liberal values in- and outside the EU.

Description of the ECJ´s innovative approach and agenda-setting at M. Mandujano Manriquez/T. Pavone, Follow the leader. The European Commission, the European Court of Justice, and the EU´s rule of law revolution, in: Blauberger/Naurin/Sedelmeier/Wunsch (guest eds.), Journal of European Public Policy, Special Issue: The Multi-level Politics of COunterin Democratic Backsliding, 2024, https://doi.org/10.1080///13501763.2024.2336125, “(1) establishes a novel legal basis under EU primary law for ROL (rule of law) enforcement; (2) creates a novel legal principle to guide ROL enforcement; (3) makes these innovations bite for the forst time by sanctioning a state for infringing a novel ROL legal basis or principle.”

[2] Art. 63 TFEU.

[3] Cf. EU’s Incoming Competition Head Pushes for Policy Shift to Support ‘European Champions, CPI Competition Policy International, 19.9.2024; P. Droessler, The Return of the European Champion?, Antitrustpolitics.com, A blog about the intersection of antitrust, foreign investment control, politics, and everything in between, 31.5.2024; Levy/Little/Mostyn, European champions – Why politics should stay out of EU merger control, Concurrences, 2019, 23 ff.

[4] Cf. also ECJ, judgment of 3.9.2024 - joined cases C‑611/22 P und C‑625/22 P - Illumina/Grail

[5]Expl. memo. to European Commission, Proposal of 24.1.2024 for a Regulation on the screening of foreign investments in the Union and repealing Reg. 2019/452, COM((2024)) 23 final.

[6] Art. 4(1) Regulation 2019/452; opinion Ćapeta of 30.3.2023, C-106/22, nos. 82 f. – Xella.

[7] Art. 1(1) Regulation 2019/452.

[8] Sa ECJ, judgment of 13.7.2023, C-106/22, no. 32 – Xella.

[9] In tax law, the ECJ even integrates subsequent commentaries to the OECD model treaties when interpreting EU legislation, cf. judgm. of 26.2.2019 - joined cases C - 115/16 (N Luxembourg 1), C - 118/16 (X Denmark), C -119/16 (C Danmark I) and C - 299/16 (Z Denmark), nos. 90 et seq., ECLI:EU:C:2019:134.

[10] OECD Benchmark Definition of Foreign Direct Investment Fourth Edition, 2008, Chapter 3 Main Concepts and Definitions of Foreign Direct Investment, e.g. p. 49, No. 122.

[11] OECD Benchmark Definition of Foreign Direct Investment Fourth Edition, 2008, Chapter 3 Main Concepts and Definitions of Foreign Direct Investment, p. 50, no. 127.

[12] ECJ, judgment of 13.7.2023, C-106/22, no. 52 – Xella.

[13] ECJ, judgment of 13.7.2023, C-106/22, no. 59 – Xella.

[14] ECJ, judgment of 13.7.2023, C-106/22, nos. 63 ff. – Xella; but see judgment of 26.9.2024 - C - 387/22 - Nord Vest Pro Sani Pro, ECLI:EU:C:2024:786, no. 64 concerning the construction sector in Romania: "considerations linked to the objective of combatting systemic risks faced by a Member State in a sector of particular importance for its development, such as, in the present case, the construction sector, in order to ensure the viability, even the continuity, of that sector, do appear to be overriding reasons in the public interest capable of justifying a restriction on the fundamental freedoms guaranteed by the FEU Treaty."

[15] Cf. Opinion Ćapeta of 30.3.2023, C-106/22, no. 88 – Xella.

[16] Opinion Ćapeta of 30.3.2023, C-106/22, nos. 42 ff. – Xella.

[17] Opinion Ćapeta of 30.3.2023, C-106/22, no. 43 et seq. – Xella.

[18] Cf. Art. 2 of the Proposal of 24.1.2024 for a Regulation on the screening of foreign investments in the Union and repealing Reg. 2019/452, COM (2024)) 23 final.

[19] Art. 2 Ziff. 1 Regulation 2019/452.

[20] Cf. Art. 2 of the Proposal of 24.1.2024 for a Regulation on the screening of foreign investments in the Union and repealing Reg. 2019/452, COM (2024)) 23 final

[21] Expl. memo. to European Commission, Proposal of 24.1.2024 for a Regulation on the screening of foreign investments in the Union and repealing Reg. 2019/452, COM (2024)) 23 final, p. 10.

[22] S.a. German Federal Constitutional Court/BVerfG, order of 23.7.2024 - 2 BvR 557/19 – Achmea – nos. 54 et seq.

[23] E.g. Germany § 56 AWV;____________; cf. also OECD Benchmark Definition of Foreign Direct Investment, 4^th Edition 2008, p. 88; Lübbig/Salaschek, Screening-VO (Verordnung (EU) 2019/452) und primärrechtliche Grundlagen, no. 75, in: F. Röhling/R. Stein, Recht der Investitionskontrolle, 2024.

[24] Art. 2 of the Proposal of 24.1.2024 for a Regulation on the screening of foreign investments in the Union and repealing Reg. 2019/452, COM((2024)) 23 final

[25] Art. 2 Ziff. 1 Regulation 2019/452.

[26] OECD Benchmark Definition of Foreign Direct Investment, 4^th Edition 2008, p. 127; s.a. Lübbig/Salaschek, Screening-VO (Verordnung (EU) 2019/452) und primärrechtliche Grundlagen, no. 66 - 70, in: F. Röhling/R. Stein, Recht der Investitionskontrolle, 2024.

[27] ZB C- 595/18 The Goldman Sachs Group / Commission

[28] Council Directive (EU) 2016/1164 of 12 July 2016 laying down rules against tax avoidance practices that directly affect the functioning of the internal market.

[29] Cf. e.g. pre - ATAD ECJ judgments of 11.3.2004 – C-9/02 - Lasteyrie du Saillant, ECLI:EU:C:2004:138; of 12.9.2006 - C - 196/04 - Cadburry Schweppes with post ATAD ECJ judgments of 26.2.2019 - C - 581/17 - Wächtler, ECLI:EU:C:2019:138; of 26.2.2019 - joined cases C‑116/16 und C‑117/16 - T - Danmark, ECLI:EU:C:2019:135.