By Janosch Wiesenthal, University of Lüneburg
Due to its geo-economic orientation, both politicians and legal scholars usually perceive investment screening as a field being at the mercy of political interests. The “Kleo Connect” case confirms that this traditional perception still holds true. In addition, it also reveals that investment screening mechanisms might be used to different ends, namely as a public law protective shield in corporate disputes. Furthermore, the constellation illustrates the lack of an expropriation provision in the context of investment screening.
Lesson 1: Investment Screening at the Mercy of Political Interests
Due to China’s rapid rise in the global economy and the associated fear of a sell-off of strategically important domestic companies to financially powerful competitors form the Far East, as well as its political agenda, the European Union, under pressure from some Member States, issued a regulation on the screening of foreign direct investment (hereinafter: EU-Screening Regulation) more than four years ago now. It allows Member States to screen transactions involving third country entities seeking to acquire a controlling participation in a domestic company on grounds of public policy and public security.
The Member States immediately availed themselves of the EU-Screening Regulation’s authorisation to adopt (stricter) rules on the screening of foreign direct investment by either introducing new mechanisms, or significantly tightening the existing ones. If the screening procedure under such a mechanism determines that a foreign direct investment is likely to impair public policy or public security (often equated with “national security”), the authorities may issue orders and, if necessary, prohibit a transaction altogether. Some Member States have made use of these powers and prohibited certain transactions, particularly from China.
Some time ago, no one would have even given a thought to such an instrument with such far-reaching possibilities, let alone having the force to prohibit capital flows, while free trade was still praised everywhere. In this respect, investment screening emblematises a change in international economic relations. Instead of liberal cooperation States are focusing on the regulation of investment and trade, especially with regard to “systemic rivals” such as China.
This change, which has been accelerated by multiple global crises, also manifests itself in the Kleo Connect case. In 2018, the German Federal Ministry of Economic Affairs and Climate Action (hereinafter: the Ministry) authorised Chinese investors Shanghai Spacecom Satellite Technologies and CED (hereinafter: Chinese investors) to acquire from Eighty Leo the majority of shares (53%) in the German satellite company Kleo Connect GmbH. The authorisation was granted in the form of a certificate of non-objection, cf. Section 58 Foreign Trade and Payments Ordinance (hereinafter: FTPO). Such certificate can be applied for, if the target company does not fall under the cases regulated under Section 55a FTPO and the Ministry did not initiate a screening procedure ex officio. The transaction concerning the acquisition of shares in the Kleo Connect GmbH, a German limited liability company that wants to establish satellite communications services through a corresponding network, had met these conditions. In granting the certificate of non-objection, the Ministry confirmed that it has no public policy or security-related concerns regarding the acquisition of the said shares and that the parties may complete the transaction.
However, recently the Ministry appeared more than just concerned when, following an ex officio screening procedure, it prohibited the “acquisition” of further shares by the Chinese investors, according to several media reports. At first glance, one might be tempted to ask: Why the turnaround? Obviously, the Chinese investors already have a majority stake in the Kleo Connect GmbH and the Ministry did not have any objections previously. The Ministry’s shift in thinking can, among other things, be attributed to the changed perception of foreign direct investments from the Far East. Capital flows from China are no longer perceived as a boost for the national economy but rather as a threat. In practice this became clear at the latest with the media-effective prohibitions in the cases of Siltronic , Heyer Medical and Elmos. In its “Strategy on China” from July, the German government cautiously formulated this change in perception.
On top of that, all the major geo-economic actors are now indirectly involved in the Kleo Connect case trying to pull the strings. In addition to China (with multiple of its state-related firms being interested in the technology) and Germany (or the EU), the United States of America are also part of the game. This is because the frequencies required for the satellite network are provided by a Liechtenstein company (Trion Space AG), whose main shareholder sold its shares to the American company Rivada. The telecoms company is owned by Declan Ganley who has worked extensively for the United States government, in particular the Department of Defense. As a result of the sale to Rivada, Trion cancelled the frequency license agreement with Kleo Connect preventing the Chinese investors from having access to the core of the project. It is important to note that this decision was taken with the help of votes from Eighty Leo representatives, as Kleo Connect holds a stake in Trion Space AG. Thus, every actor seems to be trying to gain control for himself or at least prevent another from doing so. Investment screening procedures serve as ideal means to prevent the control of other actors over strategic assets and strengthening one’s own.
It can therefore be argued that the prohibition of the acquisition of shares by Chinese investors in the case of the Kleo Connect GmbH stems (also) from a changed (foreign) policy situation and indirect influences of geo-economic superpowers. It is thus a prime example for investment screening being at the mercy of (geo-)political interests.
Lesson 2: Investment Screening as a Public Law Protective Shield in Corporate Disputes?
The investment screening procedure, which led to the prohibition, was presumably triggered by the provisional end of a corporate feud between Eighty Leo and the Chinese Investors. It began when the Chinese investors brought in a Chinese manufacturer for the construction of the satellites that were needed to build the planned global communication system. Eighty Leo apparently suspected that the Chinese investors were only after the German technology and wanted to extract it via the manufacturer. As a result, Eighty Leo attempted to force the Chinese investors out of the project by means of preliminary injunctions, while the Chinese investors countered that using the same tool.
However, this strategy was not the only means by which both parties tried to gain full control over the project. Eighty Leo and the Chinese investors attempted to collect each other’s shares pursuant to Section 34 (2) of the Act on Limited Liability Companies (ALLC). According to this provision, a shareholder’s shares may be collected, i.e. destroyed, if the articles of association of the limited liability company provide for it. Several media outlets and Kleo Connect itself confirmed (cf. press release) that Kleo Connect‘s articles of association contain a provision that allows shares to be collected for good cause. Such good cause may consist of the unauthorised actions of Eighty Leo‘s representatives in connection with the termination of the frequency licence agreement and the appointment of a new board of directors at the Trion Space AG (cf. Munich I Regional Court, 16 HK O 3831/22).
According to a Juve report, a shareholder resolution concerning the collection of Eighty Leo’s shares was successful. As a result of this collection, the shareholder’s shares and the associated rights are destroyed. At the same time, the shares of the remaining shareholders, in the case of Kleo Connect those of the Chinese investors, increase ipso iure (cf. Altmeppen, GmbHG § 34 para. 98 et seq.). This increase in controlling stake brought the Ministry onto the scene, which – according to a media report – had been notified by Eighty Leo itself. Based on this the Ministry examined the increase in shares held by the Chinese investors. Eighty Leo’s strategy, assuming correctness of the media report, follows the innovative idea that the collection of its shares constitutes an acquisition pursuant to Section 55 (3) FTPO, which the Ministry can examine and, if need be, prohibit. This raises an important legal question, whether a compulsory collection of shares pursuant to Section 34 (2) ALLC also constitutes an “acquisition” within the meaning of the FTPO (cf. on the issue Nehring-Köppl, Paradigmenwechsel im Außenwirtschaftsrecht, p. 137 (142); on the term as such, Hellmann, NKart 2023, 342 (343 et seq).; Becker, Die Investitionskontrolle im Außenwirtschaftsrecht, p. 146).
As the legislator has not further defined the term “acquisition” contained in Section 55 FTPO, it must be determined on the basis of interpretation (wording, purpose, system and history) whether a compulsory collection falls also under the said provisions.
The wording initially points neither in one direction nor the other. To the extent that reference is made to the fact that the acquisition in Section 55 FTPO presupposes a legal transaction (a compulsory collection of shares does not presuppose a legal transaction), this fails to convince. Under German civil law, an acquisition can take place both through a legal transaction and on the basis of statutory provisions. In literature, some authors therefore assume that Section 55 FTPO also covers statutory acquisitions (cf. Nehring-Köppl, Paradigmenwechsel im Außenwirtschaftsrecht, p. 137). Additionally, the term acquisition actually refers to the material transfer agreement (Verfügungsgeschäft) and not the contractual transaction imposing an obligation (Verpflichtungsgeschäft), cf. Hellmann, NZKart 2023, 342 (343). Thus, an acquisition concerns both the contractual transaction imposing an obligation, but also the material transfer agreement. Furthermore, the wording of the provision does not require the acquisition to be for value. As a consequence, the “free of charge” compulsory collection may be covered. Ultimately, a reference to an allegedly required active participation of the seller does not lead any further (in this sense however, Nehring-Köppl, Paradigmenwechsel im Außenwirtschaftsrecht, p. 142), as the term “acquisition” does not provide any information as to whether such activity may be required at all. Once again, reference can be made to the statutory acquisition, which regularly takes place without any major involvement on the part of the former owner.
The teleological interpretation provides significantly more evidence as to whether a compulsory collection falls under the term acquisition in Section 55 FTPO. Under the provision the term acquisition should cover transactions that increase the possibility of foreign investors exerting influence in domestic companies (which may result in potential threats to public order and security). It is evident that transactions that are completed without an underlying legal transaction imposing an obligation, as in the case of inheritance, create a more imminent risk to public policy and security than those which do not. The acquirers can make use of the rights attached to their stakes in the company without further ado. Such understanding finds support in Section 56 FTPO, which links the acquisition of a stake to the voting rights providing the foreign investors with (decisive) influence over domestic companies. Thus, if the foreign acquirer obtains (additional) influence, the screening mechanism should, according to the purpose of the provision, apply. Since the collection of a shareholder’s shares results in an automatic increase of the remaining shareholders’ stake, including the associated voting rights (see above), it may exceed the thresholds under Section 56 FTPO and trigger the screening mechanism. Therefore, from a teleological perspective, the “acquisition” under the FTPO also covers the collection of shares pursuant to Section 34 (2) ALLC.
Further support for such a broad interpretation may be found in the normative system of the law. The fact that Section 55a (4) and Section 55 (1b) FTPO refer to a “legal transaction governed by the law of obligations” does not change this. Section 56 FTPO, which is fundamentally decisive for any acquisition triggering the screening procedure (cf. Section 55(1), (1a), (2) and (3) FTPO), always requires an “acquisition” of stake, linked to the voting rights. In addition, Section 4 Foreign Trade and Payments Act (FTPA), which is to be concretised by the FTPO allows the Ministry to restrict both “legal transactions” and “actions”. However, if the Ministry can even restrict actions, i.e. actual processes, then it must (in theory) also be able to review them. Anything else would simply make no sense.
Finally, the legislative history also indicates that the “acquisition” in the FTPO does not always have to be linked to a contractual obligation. The explanatory memorandum to the law (on the introduction of the cross-sectoral screening procedure) states, with reference to the predecessor provision of Section 55a FTPO: “The provision refers to any contract under the law of obligations the purpose of which is the acquisition of […] voting rights […].” (cf. BT-Drs. 16/10730, p. 13). It follows from this that the legislator was primarily thinking of contracts under the law of obligations for investment screening, since these are probably the most frequently chosen instrument for transferring voting rights in practice. Nonetheless, this does not mean that the screening procedure is limited to cases concerning legal transaction under the law of obligations. The legislator makes it abundantly clear that the factor triggering the screening is the acquisition of voting rights (“the purpose of which is the acquisition of […] voting rights […]”).
Thus, the purpose, the normative system and the legislative history indicate that every acquisition of voting rights should be covered by the term “acquisition”, irrespective of the underlying event.
In the Kleo Connect case, the collection of Eighty Leo’s shares increases the stake of the Chinese investors. Thus, the collection falls under the definition of acquisition in Sections 55 (in connection with Section 56 FTPO). As the acquisition of the voting rights exceeds the threshold of Section 56 (2) no. 3 case 3 FTPO, the Ministry can initiate an investment screening procedures. The prohibition of the acquisition of further shares by the Chinese majority shareholder in Kleo Connect, suggests such an interpretation by the Ministry, as otherwise it would not have been allowed to carry out a screening procedure at all.
Since the collection of shares falls under the term acquisition, the Ministry’s prohibition also reveals a new corporate law dimension of investment screening. It can apparently also be used indirectly as a “protective shield” under public law by domestic companies in order to defend themselves against undesired partners.
Lesson 3: A Missing Expropriation Provision?
Despite the prohibition, the Chinese investors still hold the majority of shares in the Kleo Connect GmbH. Although the risk of an impairment of public policy and public security seems to be averted for the time being (due to the lack of frequencies), the question arises as to how to deal with cases in which an impairment only becomes apparent after clearance or the granting of a certificate of non-objection.
In these cases, similar to the Aixtron case, the Ministry may consider cancelling the original clearance or certificate of non-objection, both indisputably representing administrative acts. General administrative law provides a possibility for such cancellation in the form of withdrawal (Section 48 Administrative Procedure Act) and revocation of an administrative act (Section 49 Administrative Procedure Act). The distinction between the two legal bases depends on whether the original administrative act was adopted lawfully or unlawfully.
In the case of Kleo Connect, the adoption was probably lawful, meaning that Section 49 Administrative Procedure Act (APA) would form the correct legal basis for a cancellation. As a favourable administrative act that does not “provide for a one-time or a continuing payment of money or a divisible material benefit”, the Ministry needs to revoke the certificate of non-objection pursuant to Section 49 (2) APA. In order to rely on the provision, there must be a reason for a revocation under Section 49 (2) APA and the deadline under Section 49 (2) sentence 2 APA in conjunction with Section 48 (4) APA must be met. In investment screening procedures, the subsequent change in circumstances (no. 3) and the prevention of serious harm to the common good (no. 5) may be considered as grounds for revocation. In the case of Kleo Connect, the (intended) cooperation with Chinese manufacturers for the satellite construction may have led to a subsequent change in circumstances that would have entitled the Ministry “not to issue the administrative act” (and the failure to revoke “would be contrary to the public interest”). As consequence, the material requirements for a reason for revocation pursuant to Section 49 (2) sentence 1 no. 3 APA may therefore have been met in the Kleo Connect case. However, pursuant to Section 49 (2) sentence 2 in conjunction with Section 48 (4) APA, the authority, in this case the Ministry, only has one year after becoming aware of the facts to revoke the administrative act, e.g. the authorisation. It is doubtful whether this deadline would have been met by a revocation in September, as the “circumstances” in the Kleo Connect case date back several years.
If the deadline has expired, the authority can no longer revoke (or even withdraw) a formerly issued authorisation or certificate of non-objection. It is true that the authority must first become aware of the (subsequent) change in circumstances in order for the one-year period to begin to run (thus, the provision provides some room). However, as the most recent decisions of the Berlin Administrative Court on investment screening proceedings have shown, deadlines are not at the disposal of the parties, meaning that the room for manoeuvre will likely be very small, if not non-existent. The court underlined this in several respects by emphasizing the great importance of such procedural aspects (cf. Jonas Fechter, Taking due process seriously – The Administrative Court of Berlin doubles down on FDI procedural rules). Thus, due to this very strict interpretation the Ministry might very well miss the deadline. In this case, it would no longer be able to intervene despite any possible adverse effects on public policy and security.
If one considers the high importance of the protected goods, public policy and security, the result seems difficult to accept. While acquirers need legal certainty in order to dispose of their assets, potential threats to public policy or security may only arise later in time. Thus, the Ministry needs to be equipped of means to react promptly to such changes, even if, under certain circumstances, the deadline may already have expired. In this respect, it may be necessary to create a special provision on (retrospective) intervention in order for the Ministry to react to subsequent changes of circumstances, which are not compatible with its decisions taken in the past. An expropriation provision could, for example, provide such a possibility to react. According to experts in the field (such as Prof. Dr. Christoph Herrmann) the idea of taking the investors stake in a domestic company had been already discussed when the national screening framework was about to be amended against the background of the EU-Screening Regulation. Back then, the legislator rejected this idea even though the wording of Art. 2 no. 3 and 4 EU-Screening Regulation (“unwinding”) might (probably) be wide enough for Member States to include expropriation in a Member State’s screening mechanism. Nevertheless, one should note that introducing an expropriation provision is nothing uncommon in foreign trade law. Other areas such as the Energy Supply Security Act, already include the possibility of expropriation (Section 18). Interestingly, the legislator introduced this provision only after having adopted the law (cf. BT-Drs. 20/1501, p. 1) as a result of a change in thinking (which in itself was due to international developments in the energy sector). In light of cases like Kleo Connect, the government should maybe reconsider the introduction of an expropriation provision in the field of investment screening (especially since the white paper of the Ministry on a potential reform does not suggest anything similar). After all, the Ministry would then not have to permanently “keep an eye” on formerly issued authorisations in order to not miss the deadline. This could have a resource-saving effect.
Ultimately, the Kleo Connect case may therefore have also revealed that investment screening mechanisms lack an expropriation provision. Thus, the Ministry should not prematurely disregard the consideration of such a provision in its current reform plans.
 Strictly speaking, this was not a prohibition in the traditional sense (Section 59 (3) No. 1 FTPO). Due to a lack of time to review important documents, the Ministry was not able to take a decision in good time, meaning that the Federal Financial Supervisory Authority’s acceptance period expired and the acquisition could not be completed. In terms of its effects, however, this non-decision was similar to a prohibition.
 The Administrative Court of Berlin just recently declared the prohibition unlawful, see <https://www.berlin.de/gerichte/verwaltungsgericht/presse/pressemitteilungen/2023/pressemitteilung.1386057.php>.