Investing in the German Defence Sector - Investment Control Law: Stricter Scrutiny in the Era of the ‘Zeitenwende’

For investors in the German defence sector, foreign direct investment (FDI) control proceedings pose one of the most significant hurdles due to Germany’s well-established FDI regime. The Federal Ministry for Economic Affairs and Energy (BMWE) reviews the acquisition of German companies by foreign investors to prevent threats to public order or security. The Federal Ministry of Defence (BMVg) and the German intelligence agencies are closely involved in every FDI procedure relating to defence interests. The BMVg alone employs 16-17 officials responsible for FDI control. In the defence sector, this scrutiny is particularly stringent and has been noticeably tightened due to the new security landscape.

The defence sector falls under the strictest level of FDI review, what is referred to as sector-specific review (sektorspezifische Prüfung). This level of review is triggered, inter alia, when a foreign investor (including EU-based investors) acquires at least 10% of the voting rights in a company that develops, manufactures, modifies, actually possesses, or has access to goods covered by Part I Section A of the German Export List (Ausfuhrliste). This includes virtually all essential military goods, from weapons and tanks to military software, including input products for such goods when they are specifically designed for military purposes. The review can also be triggered by past activities if the company retains knowledge about the underlying technologies (including through employees). 

There are very detailed rules in relation to ownership for indirect acquisitions. In practice, many indirect investments trigger review even where the effective participation in the German company is less than 10%. This is because the authority considers investments on a non-diluted basis. E.g. a 10% investment in a company that in turn holds 10% in a sensitive German target may be subject to mandatory screening because the authority considers it to be a 10% investment in the German target (even though, mathematically, it accounts for only 1% of the German target’s value).

The acquisition is subject to a mandatory notification to the BMWE and a standstill obligation, meaning that the transaction cannot be closed until it is cleared. Certain pre-closing acts, including sharing security-sensitive information, are punishable under criminal law.

Over the last few years, the BMWE has started to apply a more risk-sensitive interpretation of the law:

1. Broader Understanding of Security: The BMWE and the BMVg examine whether an investment would negatively affect the supply security or the defence capabilities of Germany’s armed forces, the Bundeswehr, including by increasing reliance on other countries (particularly non-EU countries). The potential loss of German knowhow is another key factor in the review. This may also relate to technology that is not currently used for defence applications but could be used for that purpose by the military of third countries. The protection of supply chain-related and technical information has also become a larger focus of the review process. 

2. Strong Differentiation Based on Investor Origin: The investor's nationality and ownership structure play a decisive role. While investors from the EU, NATO, or "like-minded" countries (e.g. Australia and Japan) continue to have a better chance of clearance, acquirers from other jurisdictions, especially those with suspected state influence, are subject to tougher scrutiny. Historically, China has been the focus of this review. However, investors from other countries are also increasingly subject to a more detailed assessment when there is a (perceived) possibility of state influence over the investor. This includes investors from countries that have been considered close allies for decades. 

3. Mitigation Tools: Outright prohibitions of transactions remain the exception (partly because many transactions that would be prohibited are never concluded by the Parties out of precaution or are abandoned during the FDI process if they meet government resistance). Instead, the BMWE uses unilateral orders (Anordnungen) or bilateral public law contracts (öffentlich-rechtliche Verträge) to safeguard Germany's security interests. Such measures can involve extensive obligations for the investor, such as (i) guaranteeing the supply to the Bundeswehr under specific conditions, (ii) ring-fencing sensitive technology and appointing a security officer, (iii) a commitment to maintain production capacities and R&D sites in Germany under the control of a German company, as well as (iv) restricting the flow of information to the foreign parent company. However, the BMVg is generally sceptical of measures that aim to prevent the loss of knowhow, particularly for investors that they do not trust (for example, because they are affiliated with a third country), which is why this mitigant is rarely approved.

4. Longer and More Complex Review Procedures: While the average duration of a German FDI review has decreased over the last few years, the process for complex cases has become noticeably more demanding. The BMWE and the BMVg ask in-depth questions about the target company's technology, the investor's strategy, and the entire supply chain. Today, investors must plan for a significantly longer transaction timeline from the outset (often six months or more, and in some cases 12-18 months, particularly if complex negotiations of public law contracts are involved). 

For foreign investors in the German defence sector, early and strategic engagement with investment control is essential. Even before signing a deal, the target company's activities should be carefully analysed and a clear strategy for the review process should be developed. Proactively addressing potential security concerns and offering tailored mitigation measures can be crucial for the success of a transaction.

In this blog series, we explore key regulatory opportunities and challenges shaping investments in the German and European defence sector, providing critical insights for our clients. You can find the previous posts on public funding and BMWE 's guidance on drones and loitering munitions here.