CJEU Xella: Limits of Investment Screening

What the CJEU Xella judgment decided

In the CJEU Xella judgment of 13 July 2023 (C-106/22), the Court of Justice of the EU held that the freedom of establishment precludes a national investment screening mechanism from prohibiting an acquisition by a company resident in a Member State, which belongs to a group established in several Member States but is ultimately controlled from a third country, on the ground that the acquisition harms or risks harming the national interest in security of supply of gravel, sand and clay to the construction sector, particularly at local level.

The Court found that the risk relied on did not concern a fundamental interest of society that could justify a restriction on grounds of public policy or public security.

The CJEU Xella ruling is the Court's first substantive judgment on national foreign direct investment (FDI) screening since the EU FDI Screening Regulation (EU) 2019/452 began to apply. It confirms that screening decisions affecting acquisitions by EU-based investors must comply with the fundamental freedoms, that public security derogations are interpreted strictly and that economic objectives cannot justify restrictions. For investors in Germany, whose screening regime under the Foreign Trade and Payments Ordinance also covers indirect acquisitions through EU subsidiaries of non-EU parents, the judgment sets important limits.

The facts of the case

Xella Magyarország, a Hungarian company producing concrete construction products, wanted to acquire 100% of Janes és Társa, a Hungarian company operating a quarry producing gravel, sand and clay, which was classified as strategic under Hungarian law. Xella Magyarország was wholly owned by a German company in a group whose ultimate parent was registered in Bermuda and ultimately belonged to an Irish national.

The Hungarian minister responsible for screening prohibited the acquisition, classifying Xella Magyarország as a "foreign investor" because of its indirect ownership by the Bermuda company and arguing that ownership by a third-country entity posed a long-term risk to the security of supply of raw materials to the regional construction sector. Xella challenged the decision before the Budapest High Court, arguing that it infringed EU law, which referred questions to the CJEU by decision of 1 February 2022.

The reasoning of the CJEU Xella ruling

The Court first examined which freedom applied. Because the Hungarian legislation targeted acquisitions giving the investor decisive influence over the target, the freedom of establishment under Article 49 TFEU was relevant rather than the free movement of capital. Xella Magyarország, a company incorporated in Hungary and part of an EU-based group, could rely on that freedom, even though its ultimate parent was established in a third country.

The Court then held that the FDI Screening Regulation did not apply to the case, because the acquirer was an undertaking established in the EU and the transaction was not an investment from a third country within the meaning of the Regulation; the Regulation only addresses investments from within the Union in cases of artificial arrangements that circumvent screening. The Hungarian mechanism therefore had to be assessed directly under the Treaty.

On justification, the Court recalled that derogations on grounds of public policy and public security must be interpreted strictly and can only be invoked where there is a genuine and sufficiently serious threat to a fundamental interest of society.

They cannot serve purely economic ends. The objective of ensuring security of supply of construction raw materials at local level did not meet that threshold. The mere fact that the acquirer was ultimately owned by a third-country company did not by itself establish a threat. The prohibition was therefore incompatible with the freedom of establishment, and the national court had to draw the consequences.

Investment screening in Germany after the CJEU Xella ruling

German screening under the Foreign Trade and Payments Act (AWG) and the Foreign Trade and Payments Ordinance (AWV) applies to acquisitions by non-EU acquirers (Unionsfremde), including indirect acquisitions through EU subsidiaries. Under § 55(1) AWV, the Federal Ministry for Economic Affairs and Energy can examine whether the acquisition of a domestic company by a non-EU acquirer, directly or indirectly, is likely to affect public order or security of Germany, another Member State or projects of Union interest. Under § 55(2) AWV, acquisitions by EU-resident acquirers can also be examined where there are indications of an abusive arrangement or circumvention transaction designed to avoid screening.

The CJEU Xella ruling is relevant to German practice because many acquisitions in Germany are made by EU-based subsidiaries of non-EU groups. Where such an acquirer relies on the freedom of establishment, a restriction of the acquisition must be justified by a genuine and sufficiently serious threat to a fundamental interest.

In sensitive sectors, such as critical infrastructure, defence and certain technologies, the ministry will usually be able to identify such interests. In other sectors, and for restrictions based mainly on economic or industrial-policy considerations, the judgment strengthens the position of acquirers. It also confirms that the mere fact of non-EU ultimate ownership is not enough; the authority must show how the specific acquisition creates a risk.

Freedom of establishment or free movement of capital?

The distinction between the two freedoms matters in screening cases. The free movement of capital under Article 63 TFEU also applies to capital movements between Member States and third countries, whereas the freedom of establishment protects only EU nationals and companies. A non-EU investor acquiring a controlling stake directly in an EU company generally cannot rely on the freedom of establishment, and its position under the free movement of capital is limited where the legislation targets controlling acquisitions. By contrast, an EU-incorporated subsidiary of a non-EU group can rely on the freedom of establishment when it acquires a controlling stake, as the CJEU Xella case shows.

This has structural consequences. Investors from outside the EU who make acquisitions through genuinely established EU subsidiaries may benefit from stronger protection under EU law than if they acquired directly. Screening authorities, for their part, can respond by examining whether the EU structure reflects economic reality or is an artificial arrangement designed to circumvent screening. German law expressly allows such examination under § 55(2) AWV, and the substance of holding companies, such as their staff, premises and decision-making, becomes important evidence.

Procedure and mitigation in Germany

German screening distinguishes between sector-specific review for acquisitions in defence-related and certain IT security sectors and cross-sectoral review for all other sectors, with mandatory notification and a standstill obligation for acquisitions of targets in listed critical sectors once the relevant voting rights thresholds are reached. The ministry can clear an acquisition, impose conditions, conclude a public-law agreement with the parties or, as a last resort, prohibit it with the consent of the federal government. In practice, most cases are cleared, and many concerns are addressed through mitigation measures, such as commitments on security of supply, data access, local management or the protection of sensitive technology.

After the CJEU Xella ruling, acquirers that can rely on the freedom of establishment have a stronger basis to argue that restrictive measures must be proportionate and limited to addressing genuine and sufficiently serious threats. Procedural rights, such as the right to be heard and access to the reasons for concerns, should be used actively. Decisions can be challenged before the administrative courts, although the timetable of transactions often makes negotiated solutions more practical than litigation.

Reform context: EU and German legislation

The European Commission proposed in January 2024 a revision of the EU FDI Screening Regulation that would require all Member States to have screening mechanisms, set minimum sectors, strengthen cooperation and address investments by EU entities controlled from third countries more explicitly. In Germany, the government has been working on a dedicated Investment Screening Act to replace the AWG/AWV provisions. Investors should check the current status of both reforms before structuring transactions. Whatever the new rules provide, they will have to respect the limits drawn by the Court in the Xella case for restrictions affecting EU-based acquirers.

Transaction documents and risk allocation

Investment screening affects the structure and documentation of transactions. Purchase agreements should include screening clearance as a condition precedent where a filing is mandatory or advisable, with long-stop dates that take into account the review periods and possible extensions. The parties should agree who prepares the filing, how information about the acquirer's ownership is provided, and how far the buyer must go in accepting mitigation measures. Reverse break fees or other risk-allocation mechanisms may be appropriate where screening risk is significant.

Sellers in competitive processes increasingly evaluate bidders' screening risk as part of deal certainty, which can disadvantage bidders with non-EU ownership even where their EU structures would allow them to rely on the freedom of establishment. A well-prepared screening analysis, ideally shared with the seller, helps to counter that disadvantage. Where the target operates in a sector that the ministry regards as sensitive, early informal contact with the ministry can clarify concerns before signing.

Practical steps for investors

• Map the ownership chain and identify any non-EU ultimate controllers.
• Assess whether the target's activities fall within sensitive sectors that trigger mandatory filings or cross-sectoral review.
• Document the economic substance of EU holding companies to rebut any allegation of artificial arrangements.
• Prepare arguments on the absence of a genuine and sufficiently serious threat, and consider mitigation measures that address specific concerns.
• Plan timelines and conditions precedent for screening procedures, including possible extensions of review periods.

How TRW & Co helps

We advise investors, sellers and targets on foreign investment screening in Germany and the EU. We assess filing obligations, prepare notifications and applications for clearance certificates, negotiate mitigation measures with the Federal Ministry for Economic Affairs and Energy and challenge restrictive decisions. Our work connects with our foreign investment control and M&A practices; see also our notes on the Investment Screening Act reform and the FDI filing checklist. Please contact us to discuss your transaction. This briefing is general information and not legal advice.