by Andrea Zulli, Partner
The mandatory and suspensory notification system under the new EU Foreign Subsidy regime (“FSR”) enters into force today, 12 October 2023.
The FSR has been on the radar for several months now, but for the latecomers to the party, the FSR aims at levelling the playing field in the EU internal market by addressing distortive foreign (i.e. non-EU) subsidies granted to companies active in the EU. By doing this, the FSR addresses a perceived regulatory gap in the EU not covered by existing rules on State aid, which only regulate subsidies by EU governments. In the context of M&A transactions, the FSR aims to assess – and, where appropriate, address – the effects that foreign subsidies can play in M&A deals involving companies active in the EU (e.g., a foreign subsidy granted to a buyer directly facilitating a deal).
It is worth noting that notifiable M&A transactions signed since 12 July 2023, but not closed by today, require FRS clearance to be implemented or face (potentially significant) financial fines.
What are the key practical implications of the FSR on M&A transactions?
1.The FSR brings an additional – third – layer to the assessment of M&A deals, with the consequence that qualifying deals now have to be evaluated under merger control, foreign direct investment, and FSR rules.
The focus of the FSR mirrors that of the EU merger control regime (“EUMR”), namely transactions leading to a change of control on a lasting basis – such as mergers or acquisitions – and those concerning the creation of a full-function joint venture (“JV”).
2. The FSR requires a mandatory and suspensory filing for large M&A transactions meeting applicable notification thresholds. These are that:
- (a) at least one of the merging companies, the target company, or the JV (i) is established in the EU, and (ii) generates a consolidated aggregate EU turnover of at least EUR 500 million (the turnover threshold); and
- (b) the merging companies, the acquirer(s) and the target company, or the JV parents and the JV were granted combined aggregate financial contributions of more than EUR 50 million from third countries in the preceding three years (the financial contribution threshold).
The notion of foreign financial contributions is wider than the concept of State aid and more complex. Here it suffices to say that the FSR does not define the notion of financial contributions but simply provides a non-exhaustive illustrative list including (a) “capital injections, grants, loans, loan guarantees, fiscal incentives, the setting off of operating losses, debt forgiveness, debt to equity swaps”, (b) “tax exemptions or the granting of special or exclusive rights without adequate remuneration rescheduling” and (c) “the provision of goods or services or the purchase of goods or services”. Financial contributions can be direct or indirect.
A ‘third country’ includes any non-EU central government, public authorities, and certain public – and, under very specific circumstances, even private – entities.
With regard to private equity funds, foreign financial contributions include not only those that are received by the portfolio companies, but also those that are received by the general partner from the limited partners. And, like under the EUMR, if a private equity group operates via various funds (e.g. PE Fund I, PE Fund II, PE Fund III, etc.), the whole private equity group – including all its funds – is most likely to have to be taken into account.
Finally, the European Commission (“Commission”) can request the prior notification of a deal that does not meet the above thresholds at any time before such a deal is implemented if it suspects that foreign subsidies may have been granted to the parties in the preceding three years. This means that the Commission has, in theory, an almost unlimited jurisdiction since it is entitled to call in almost any deal if it wishes to review it (and let’s hope that it will use this power wisely by only calling in below-thresholds deals that are problematic from a substantive perspective). And bear in mind that when a deal is called in, the suspension obligation kicks in.
3. The FSR creates an additional substantive risk for deals falling winthin its scope. In order to approve a deal under the FSR, the Commission will, from a substantive perspective, assess whether:
- (a) a foreign financial contribution amounts to a foreign subsidy (namely whether it confers a benefit to the recipient and is limited, de jure or de facto, to one or more companies or industries); and
- (b) a foreign subsidy gives rise to a distortion on the EU internal market. The FSR sets out and vague and general notion of a distortive foreign subsidy – i.e., a distortive foreign subsidy is “deemed to exist where a foreign subsidy is liable to improve the competitive position of an undertaking in the internal market and where, in doing so, that foreign subsidy actually or potentially negatively affects competition in the internal market” – supplemented by a non-exhaustive illustrative list of most likely distortive foreign subsidy (as well as, for completeness, a list of most likely unproblematic foreign subsides and de minimis foreign subsidies). In the context of its assessment, the Commission “balance[s] the negative effects of a foreign subsidy in terms of distortion in the internal market[…] against the positive effects on the development of the relevant subsidised economic activity on the internal market, while considering other positive effects of the foreign subsidy such as the broader positive effects in relation to the relevant policy objectives, in particular those of the Union.”
In the event of an adverse finding, the Commission may conditionally approve the deal on the basis of remedies offered by the parties. It is worth noting that the FSR provides a non-exhaustive illustrative list of commitments that may, where required, be offered by the parties
4. The FSR must be factored in the transaction agreements. In particular, a condition precedent clause (“CP”) must now take into account the FSR on qualifying deals. The language – in particular in terms of risk allocation – can be expected to be very similar to that already used for merger control. For example, in the context of an acquisition, a “hell or high water” CP will likely continue to have the usual obligations on the purchaser(s) with the main difference being its wider scope in order to cover both merger control and FSR. It can also be expected that the language concerning the risk of the Commission calling in a below-threshold deal is likely to be similar to that currently used to address the risk an Art. 22 referral under the EUMR.
Strong cooperation between the parties, in the context of regulatory filings, is common in merger and joint venture agreements so no major difference is expected concerning the FSR. In the context of acquisitions, the level of cooperation between the purchaser(s) and the target concerning regulatory filings may instead significantly vary on a case by case basis. With regard to FSR, a strong level of cooperation should be expected in most cases, since it is the target that is best placed (to say the least) to identify its indirect financial contributions, its overall financial contributions that are foreign as well as those that amount to foreign subsidies and that may have distortive effects on the EU internal market.
Specific FSR Reps&Warranties/Indemnity may also be appropriate in cases where there is a material risk that the target is unable to provide accurate/complete information on the foreign financial contributions received in the preceding three years.
5. Compliance with the FSR is essential for qualifying deals. The Commission can impose fines up to 10% of the parties’ aggregate turnover if they, inter alia, fail to notify a notifiable transaction and/or “gun jump” it. A similar fine can be imposed on parties that circumvent or attempt to circumvent the notification requirements (the FSR includes a specific provision prohibiting the parties to “arrange financial operations or contracts to circumvent the notification requirements”). Therefore, failure is not an option…
6. Hostile takeovers face additional challenges. From the purchaser’s perspective, it is going to be extremely hard – if not almost impossible in particular with regard to indirect financial contributions – to precisely determine the foreign financial contributions received by the target in the preceding three years only on the basis of publicly available information. Accordingly, a reasonable course of action in such cases should be to engage in pre-notification discussions with the Commission and potentially make a precautionary FSR filing, given that the Commission would be able to send RFIs directly to the target. From the target’s perspective, the FSR – like the EUMR – may well offer a potential defence against the hostile takeover, albeit a successful one may well negatively impact the target’s ability to carry out future deals successfully under the FSA.
In conclusion, the FSR clearly increases the (already significant) regulatory burden on the parties in the context of qualifying M&A deals, but many uncertainties remain over how much of an impact it will have in practice. Only time will tell…