Legal development

The Court of justice judgment in Xella

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    The Court of justice judgment in Xella – a reminder that FDI regulations must comply with the fundamental freedoms guaranteed by EU law


    The Court of Justice of the European Union has ruled that national FDI regulations must respect the fundamental freedoms guaranteed by EU law, including when companies established in the EU are ultimately controlled by non-EU entities.

    Introduction – the facts

    On July 13, 2023, the Court of Justice of the European Union (the Court) issued a judgment concerning the application of Member State (Hungary) rules on foreign direct investments (FDI rules).

    The case concerned the acquisition by a Hungarian company (Xella Magyarország Építőanyagipari Kft., Xella Hungary) of another Hungarian company which owned a quarry containing sand, clay, and gravel (the acquisition).

    The Hungarian authorities had blocked the acquisition claiming that (i) Xella Hungary should be treated as a foreign company because it was ultimately owned / controlled by a private equity fund registered in the Bermudas and (ii) it was contrary to the Hungarian national interest to allow such a company to acquire one active in the extraction of construction aggregates.

    That decision was challenged before the Fővárosi Törvényszék (Budapest High Court) which requested a preliminary ruling. The Budapest High Court asked whether the Hungarian FDI rules were compatible with (i) Article 65(1)(b) of the treaty on the functioning of the European Union – the Treaty (on the free movement of capital within the EU) and (ii) the EU FDI rules i.e., Regulation (EU) 2019/452 (the FDI Screening Regulation).

    In response, the Court provided a helpful reminder of the importance of the basic principles of EU law (particularly the fundamental freedoms guaranteed by the Treaty) when assessing the compatibility of FDI rules with EU law. The Court also emphasized that the compatibility of FDI rules with EU law cannot simply be presumed because EU law imposes strict limits on Member States' ability to review and, more importantly, block investments by EU-based companies.

    Recently, the Commission found that Hungary's veto of AEGON's Hungarian subsidiaries' acquisition by an Austrian company breached Article 21 of the EU Merger Regulation (EUMR). Under this article, the Commission has exclusive competence to review concentrations with a Union dimension. Member States may not to apply their national laws to these transactions. Member States can only take appropriate measures to protect legitimate interests if those measures are compatible with EU law and are communicated to the Commission (with limited exceptions).

    However, the Court's judgment in Xella has much broader implications. It is not restricted to transactions vetted and authorized by the Commission under the EUMR. The Court judgment applies to all transactions in relation to which FDI regimes are enforced, including where measures are imposed which fall short of a prohibition but render the investment in the target less attractive.

    An EU based company does not cease to be an EU company just because it is owned or controlled by a foreign investor

    The first important take-away from the Court's judgment relates to the ability of EU/EEA Member States to treat companies registered and located in the EU as non-EU companies because they are ultimately owned or controlled by non-EU entities.

    This is important because non-EU-entities do not necessarily benefit from the fundamental freedoms enshrined in the Treaty, such as the freedom of establishment. The Hungarian authorities had treated Xella Hungary as a non-EU company because it was controlled by a fund based in the Bermudas.

    The Court stressed, in this regard, that the national origin of a company's shareholders does not affect the right of such company to rely on, e.g., the freedom of establishment. This is because, under EU law, the status of an EU company depends on the location of its registered office and the legal order according to which incorporated, not the nationality of its shareholders.

    According to the Court, this meant that Xella Hungary could rely on the freedom of establishment guaranteed by the Treaty to challenge the legality of the measures imposed on it by the Hungarian authorities via their FDI rules.

    This is an especially important reminder that, in principle, companies based in the EU, which are owned or otherwise controlled by non-EU investors, will benefit from the protection of the provisions relating to the basic EU freedoms in the same way as EU companies controlled or owned by EU investors.

    This finding does not necessarily call into question EEA Member States' ability to treat acquisitions made by non-EU investors via EU companies differently from those by EU-controlled companies (e.g., by requiring notification of acquisitions of small non-controlling stakes by such companies while such filings are not requested from companies controlled by EU entities). The Court recognized that an acquisition by EU companies controlled by non-EU investors may require a more careful review. The Court cited, for instance, situations in which "the foreign investor is directly or indirectly controlled by the government, including state bodies or armed forces, of a third country" or in which an EU based entity was used to circumvent Member State FDI rules1.

    However, except in a specific and narrow set of circumstances, if a company is registered in the EU, it will benefit from the fundamental freedoms of the EU Treaties, independently from the origin of its shareholders or controlling entities. Therefore, limits placed on such a company's ability to invest in other EU companies will have to be justified and proportionate within the meaning of the Court's existing case law.

    Member States' FDI rules may only impose restrictions on investments made by EU based companies if such restrictions are justified and proportionate

    As indicated above, the Budapest High Court had queried the compatibility of the Proposed Transaction's prohibition with EU law, specifically the rules on free movement of capital e.g., Article 65(1)(b) TFEU. The Court was quick to note that the Transaction concerned the outright acquisition of the target and thus would have allowed Xella to establish itself the field of the target's business in Hungary. Therefore, the prohibition decision constituted, in effect, an impediment to the freedom of establishment rather than free movement of capital.

    However, the principles adopted by the Court in its judgment are, in our view, equally applicable to measures restricting free movement of capital in the EU - such as those restricting or prohibiting the acquisition of minority shareholdings (rather than an outright acquisitions).

    The Court readily found that FDI rules can constitute obstacles to the freedom of establishment. In this case, the obstacle was especially serious as it prevented Xella exercising the freedom of establishment.

    However, the notion of what constitutes an obstacle to a fundamental freedom is broad and would likely also include the imposition of a notification obligation, especially if accompanied by a stand-still obligation and/or heavy fines for violations. We tend to think that most, if not all, FDI regimes in place in EEA Member States could be viewed as creating obstacles to the fundamental freedoms protected by the Treaty.

    The Court further noted that, according to its case law, limits on EU companies' ability to invest in other companies in the EU/EEA can be compatible with EU law only if they pursue "an objective in the public interest or the guarantee of a service of general interest".

    The Court stressed that such exceptions should be interpreted restrictively, and Member States cannot determine the scope and modalities of their FDI regimes unilaterally without oversight from the EU institutions. Member States must demonstrate that the FDI rules are necessary to protect "a fundamental interest of society" against a "genuine and sufficiently serious threat".

    The Court noted that that limits on investments in activities or public services in the petroleum, telecommunications, or energy sectors could be justified due to the importance of such products and services for the general interest.

    However, in this case, the target company only produced basic raw materials (gravel, sand, and clay). Therefore, the Court very much doubted whether the need to guarantee access to such products could justify the restrictions in the present case, especially since the Hungarian authorities prohibited the acquisition outright (a measure which resulted in a "particularly serious" restriction on the freedom of establishment).

    The Court added that Xella already purchased 90% of the target's output prior to the Proposed Transaction thus making it difficult to argue that the Proposed Transaction would put at risk the supply of basic raw materials to the market at large.

    The Court therefore concluded that the prohibition of the acquisition by the Hungarian authorities infringed the EU law provisions concerning the freedom of establishment.

    Conclusions and take-aways

    FDI regimes have flourished in the EEA after the EU institutions warned Member States that they did not have sufficiently effective FDI regimes in place to protect strategic sectors of their economy from acquisitions by non-EU investors, especially investors controlled or subsidised by foreign governments.

    However, the FDI regimes which have been adopted following this "call to arms" have often resulted in filing obligations which:

    (i) cover investments made by EU companies including, but not exclusively, those ultimately controlled by foreign investors and thus falling squarely within the scope of the prohibition on measures limiting the exercise, by EU companies, of the fundamental freedoms guaranteed by the EU Treaties;

    (ii) require notifications of acquisitions in in sectors or concerning targets which appear prima facie not to be strategic.

    (iii) require notification of operations or transactions which do not seem prima facie to entail a risk for the public security or public interest of the Member State concerned. (for example, those regimes which require notification of the acquisitions of small stakes that do not amount to acquisition of a target, or which require notifications of internal restructurings that only involve EU-based companies.)

    In addition, Member States have sometimes imposed prohibitions or extensive conditions when less intrusive or restrictive measures could have been imposed.

    It remains to be seen whether companies will now challenge measures adopted by EEA Member States on the basis of their FDI regimes more frequently. Challenges will likely remain sporadic as companies may prefer to simply comply with filing obligations (even if potentially incompatible with EU law) rather than embark on lengthy legal proceedings.

    However, the Court's judgement clearly requires national courts to review the compatibility of measures imposed by Member States on the basis of their FDI regulations when challenged by the affected companies.

    National courts, which have sometimes argued for wide Member State discretion in application of their FDI rules, should remember that the Court has made it clear that exceptions which allow obstacles to the freedom of establishment or the free movement of capitals to be tolerated should be interpreted restrictively. National courts must exercise their power of judicial review in a rigorous manner to ensure this principle is respected. This is likely to require more preliminary references to the Court so that the case-law regarding the permitted measures develops into a solid set of guidelines which, hopefully, Member States will consider when updating and amending their FDI rules.


    1. For instance, the Italian government blocked the acquisition of Verisem, a seed producer, to Syngenta arguing that Syngenta should be treated not as a Swiss Company which could also benefit from the fundamental freedoms but as a Chinese state-owned entity. The Italian Council of State (Administrative Supreme Court) confirmed the veto stressing the risk for the Italian economy linked to the nature of the buyer (i.e. the Chinese government). Such arguments may be more difficult to make in the future.

    The information provided is not intended to be a comprehensive review of all developments in the law and practice, or to cover all aspects of those referred to.
    Readers should take legal advice before applying it to specific issues or transactions.


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