Foreign Direct Investment (FDI) screening mechanisms must respect fundamental freedoms: A Case built on Clay, Sand (and Gravel)

Weak cases sometimes make good law. On 13 July, the ECJ in Case C-106/22 held that:

• Except in specific circumstances, the EU FDI Screening Regulation 2019/452 does not apply to acquisitions by EU-based purchasers; and
• FDI screening measures which restrict fundamental freedoms can only be justified if they address a genuine and sufficiently serious threat (and the Hungarian authority’s decision in this case did not meet this test).

Hungarian FDI authority’s decision

The case seemed weak from the outset: in 2020, Hungary’s FDI authority blocked the acquisition of a local quarry by Xella Magyarország, the Hungarian affiliate of a Germany-based building materials group that has an indirect ownership structure spanning the globe (from Luxembourg and Bermuda to the US and Ireland). The transaction was blocked on the basis that the target’s activities (the extraction of gravel, sand and clay) related to critically important raw materials. The quarry had a national market share of 0.52%, and 90% of its production was already supplied to the purchaser (Xella) pre-transaction. The authority considered Xella to be foreign because not all entities in its control structure were based in the EU.

Purchasers established in the EU are not foreign, irrespective of the identity of their shareholders

The ECJ ruled that subsidiary companies established and registered in an EU Member State have the status of (intra) EU investor, even if they have indirect or ultimate controlling shareholders in non-EU jurisdictions. Except in cases of circumvention, direct or indirect non-EU ownership of EU-established companies is irrelevant for the purposes of the Screening Regulation and the case law on fundamental freedoms “since the status of an EU company is based, under Article 54 TFEU, on the location of the registered office and the legal order of which the company is incorporated, and not on the nationality of its shareholders”. This renders the EU FDI Screening Regulation, with all of its information exchange and multilateral consultation between EU Member States and the European Commission, inapplicable to all such cases of indirect non-EU ownership. It also means that EU subsidiaries of third-country holdings are entitled to the full protection of EU law (special rules may apply in relation to the military sector).

Restrictions of fundamental freedoms must meet high test

The ECJ’s press release emphasises that the prohibition of the transaction on national security grounds clearly constitutes a restriction on freedom of establishment, “which is, moreover, a particularly serious restriction”. The Court stresses that its longstanding case law on how restrictions of fundamental freedoms can be justified also applies to FDI screening measures. Indeed, such restrictions can only be applied to proven cases of “genuine and sufficiently serious threat to a fundamental interest of society”. The judgment therefore confirms that the ECJ jurisprudence that led to the demise of investment control regimes like “golden shares” in the early 2000s is still good law in this “new world” of de-risking. Vague justifications based on “purely economic grounds, such as, in particular, the promotion of the national economy or its proper functioning” are not sufficient. Or, in the Court’s own words, “the objective of ensuring the supply of gravel, sand and clay to the construction sector at the regional level cannot justify a restriction on the freedom of establishment”.

Impact on national screening mechanisms (“look through”)

Like Hungary, many Member States’ FDI regimes look at an investor’s control structure when assessing its nationality. But the judgment clarifies that the EU FDI Screening Regulation does not, as a matter of principle, apply to the review of such constellations. According to the ECJ, “look through” is only warranted in cases of circumvention - which it has traditionally defined narrowly.

Irrespective of the above, restrictive measures applied by national FDI authorities that limit fundamental freedoms are subject to the high standards set by the ECJ decades ago, i.e. they must be required to counter a genuine and sufficiently serious threat to a fundamental interest of society. It seems questionable whether the breadth of sectors which some Member States subject to mandatory screening satisfy this test.

With this precedent, FDI in Europe may become a little less the quarry of government arbitrariness.

Please contact us or your usual contact in our Antitrust, Competition and Trade team if you would like to discuss this update further. To read more about other antitrust developments, refer also to our Global antitrust in 2023: 10 key themes report.