The ECJ’s Judgment in Xella – Judicial Cherry Picking?

By Alexia Crivoi, Vienna University of Economics and Business

 

Introduction

In the much-discussed Xella judgment of July 13 2023, the Court of Justice decided two things:

  • that the scope of the EU FDI Screening Regulation does not extend to ‘indirect FDI’, rejecting arguments relating to the company structure of an EU-based but foreign-owned investor (yet ultimately owned by an Irish national), and
  • that at the same time, the ownership structure of a foreign-held EU-based acquirer could serve as the ‘cross-border element’ bringing a ‘purely internal situation’ within the ambit of the EU free movement rules.

The Xella judgment has so far been mostly well received in scholarship, being for example described as ‘confirming orthodoxy’ here. Looking at the facts of the case, which have been summarised here and here, the outcome indeed seems overall reasonable. However, reading the Court’s conclusions above, a certain tension becomes apparent: when deciding whether the transaction falls within the ambit of the FDI Screening Regulation, the Court refuses to ‘pierce the corporate veil’ and does not attach any importance to the fact that Xella has foreign shareholders. However, when deciding whether the freedom of establishment applies, the Court relies precisely on Xella’s foreign ownership to establish the cross-border element necessary to render the freedom applicable. It is therefore fair to ask whether the Court is cherry picking in deciding when and when not to let the foreign ownership argument stand.

This contribution aims to put these prima facie conflicting approaches into perspective by analysing the Court’s arguments in Xella. Additionally, it explains why the Court is, despite the first look of things, not cherry picking, but instead follows its settled case law. Ultimately, it tries to find a way in which the Court could have arrived at the same result without sinking into the quicksand of internally inconsistent reasoning.

 

Not piercing the corporate veil: Xella as an EU company

The Court ruled that Xella is an EU company because of its incorporation under Hungarian law, rejecting arguments to the foreign origin of its ultimate owner (a Bermudan fund ultimately belonging to an Irish national).[1] The Court provides two arguments:

  • First, it recalls that it is the location of a company’s registered office, central administration or principal place of business that serves as the connecting factor with the legal system of a particular member state (MS).[2]
  • Second, the Court states that it does not follow from any provision of EU law that the origin of the shareholders of a company resident in the EU affects the company’s right to rely on Article 54 TFEU.[3]

Looking at the wording of Article 54 TFEU, the Court’s decision is without doubt the only reasonable outcome. Article 54 TFEU defines the companies and firms to which the freedom of establishment applies, naming only incorporation under the laws of a MS and a Union-link (by means of either the place of the company’s registered office, central administration, or its principal place of business) as relevant to determine the company’s ‘nationality’. As has been described in the literature, Article 54 TFEU follows the ‘structure theory’, as opposed to the ‘control theory’. Pursuant to the latter, the nationality of a company is determined by the nationality of its owners / controlling entity.[4] This approach has been confirmed by the Court ruling that the nationality of a company’s shareholders is irrelevant when invoking the freedom of establishment.[5]

However, after having ruled that the foreign origin of shareholders must be disregarded, the Court in Xella goes on to make an interesting addition specifying this is so ‘particularly since it is common ground that the ultimate owner of the group of which it forms part is an Irish national.’ This functional view might serve as an easy argument to affirm the applicability of the free movement rules, but at the same time it seems to undermine the Court’s case law rejecting the control theory. By referring to the EU nationality of the foreign group’s ultimate owner, the Court seems to link the applicability of free movement rules to the shareholders’ nationality after all, raising the question of whether the case would have been decided differently in the absence of an ultimate ownership by an EU national. A real departure from the structure theory however seems unlikely in light of the clear wording of Article 54 TFEU, leading thus to the conclusion that the Court was trying to deliver a functional argument which however entangled it in possibly inconsistent reasoning.

As a side note, concluding that Xella as an EU company may invoke the freedom of establishment does not rule out that the FDI Screening Regulation, via legislative amendment, could cover such indirect FDI as ultimately foreign. In principle, it could possibly also not prevent the Court from reviewing restrictions towards a foreign-held EU company in a different manner than in exclusively intra-EU scenarios. This, however, seems to have been settled for now, since the Court decided to apply the same justification-test in Xella as in purely intra-EU cases.

 

Finding the cross-border link: Xella as an EU-based, but foreign-held company

For the freedom of establishment (or any other fundamental freedom, for that matter) to apply, it is necessary that the underlying situation falls within the scope of Union law, meaning the situation must have some cross-border dimension. Invoking a fundamental freedom is not possible in purely internal situations confined within a single MS.[6] Since the case at hand concerns the acquisition of a Hungarian company by another Hungarian company, one could think of the situation as purely domestic.

However, the Court argues that the cross-border ownership structure of Xella provides a relevant foreign element.[7] This outcome is overall consistent with the Court’s settled case law characterised by the Court’s readiness to find a cross-border element even in situations that seem to be purely domestic.[8] Even more so, it is entirely in line with the Court relying on a company’s foreign ownership to prove the cross-border link,[9] an approach that has already rightly been criticised in scholarship.[10]

Admittedly, it is highly probable and reasonable that the foreign origin of Xella’s shareholder does play a role. However, the cross-border link cannot reasonably be based on the mere fact that the corporate structure features an element of foreign ownership, regardless of the ultimate owner’s nationality. A cross-border dimension could much rather stem from the potential impact Xella’s economic activities could have – by virtue of its foreign corporate structure – on the internal market, such as, for example by engaging in cross-border trade within the Xella Group, or by being part of a group taxation scheme alongside other group subsidiaries.[11]

Furthermore, it can be argued that the national legislation applicable in the case at hand, the Vmtv, covers in principle both EU- and HU-based investors, meaning it could represent a restriction to the freedom of establishment in a case where it would be applied to a company from another MS than Hungary. This would allow the Court to interpret Articles 49 and 54 TFEU and their effect on the Hungarian screening provision by relying on the potential future effect the national legislation may have when applied to a non-Hungarian EU company.[12]

 

Conclusion

While the outcome in Xella is overall in line with the Court’s caselaw (and thus indeed ‘conforms orthodoxy’), the Court seems to be brushing off the question of the cross-border dimension by relying precisely on the argument it chose to reject in its answers to the first part of the question. By doing so, its reasoning becomes internally inconsistent. This could have been avoided if the Court found a more substantiated explanation for affirming the cross-border element and based its assumption thereof on something else than the mere existence of a foreign corporate structure.

 

[1] Case C-106/22 Xella Magyarország [2023], para 37.

[2] Case C-106/22, para 45; Case C-167/01 Inspire Art [2003], para 97.

[3] C-106/22, para 46.

[4] Ulrich Forsthoff, ‘Artikel 54 AEUV. Gleichstellung der Gesellschaften’ in Eberhard Grabitz, Meinhard Hilf and Martin Nettesheim (eds), Das Recht der Europäischen Union (79. EL C.H.Beck 2023), para 22 noting this is the overall prevailing view.

[5] Case C-221/89 Factortame II [1991], para 30.

[6] Case C-391/20 Boriss Cilevičs [2022], para 31 and the cited caselaw; Case C-106/22, para 50.

[7] C-106/22, para 56.

[8] Cf Joined Cases C-340 and C-341/14 Trijber [2015], paras 40-2.

[9] Case C-108/96 Mac Quen [2001], para 16; Case C-79/01 Payroll [2002], para 25.

[10] Forsthoff (n 4), para 22.

[11] Cf Case C-106/22 Opinion of AG Capeta, para 63 and see para 64 for another possible ‘connecting factor’.

[12] Cf Joined Cases C-340 and C-341/14, paras 40-2, where the Court allowed invoking the freedom of establishment in a purely domestic situation on the sole ground that the state measure in question could impede the future exercise of that freedom by a national of a Member State other than the one taking the measure; see Case C-106/22 Opinion of AG Capeta, para 62.

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