Focus on foreign subsidies distorting the internal market – new notification obligation for acquisitions

EU legislation on foreign subsidy control entered into force in January this year, following its adoption last December, while its provisions apply from 12 July 2023 and the notification obligation for major concentrations and public contracts will apply from 12 October 2023. Below is a summary of some of the practical implications of the FSR for M&A transactions.

Purpose and means of the FSR

The declared aim of the FSR is to eliminate the distortive effects of subsidies from outside the EU so that businesses can compete on a level playing field when acquiring companies and participating in EU public procurement procedures. In many cases, it has been a problem that subsidies from non-EU countries have put some companies in a better position on the EU market and given them an unfair advantage. Until now, there was no EU instrument to control subsidies from non-EU countries. The FSR is intended to fill this regulatory gap by providing the Commission with new investigative tools to examine and, where necessary, redress the distortive effects of foreign subsidies granted to companies doing business in the EU.

The scope of the FSR covers all economic activities within the EU, in particular mergers, acquisitions, public contracts, but also any other economic activity.
Enforcement of the FSR falls within the exclusive competence of the Commission, which can use a variety of instruments to counteract the distortive effects of subsidies granted from outside the EU:

a) from October 2023, prior notification of major mergers or public procurement with financial support from non-EU countries will be mandatory if certain thresholds are met; and

b) the Commission will have a general investigative tool for all other market situations, as well as for smaller mergers and public procurement bids, under which the Commission may open ex officio investigations on its own initiative and require notifications from the undertakings concerned.

The main aspects of the FSR affecting transactions are highlighted below.

Which concentrations are subject to the notification obligation?

For the purposes of the FSR, the same transactions as in the EU Merger Regulation (Regulation (EC) No 139/2004 (hereinafter "EUMR"), i.e. the acquisition of direct or indirect control of all or parts of one or more undertakings, a merger or the creation of a full-function joint venture, are considered to be concentrations.

A concentration must be notified to the Commission if the following thresholds (a turnover threshold and a financial subsidy threshold) are both met:

1. at least one of the merging undertakings, the target or the joint venture is established in the Union and generates an aggregate turnover in the Union of at least EUR 500 million; and

2. the following undertakings were granted combined aggregate financial contributions of more than EUR 50 million from third countries in the three years preceding the conclusion of the agreement, the announcement of the public bid, or the acquisition of a controlling interest:

i. in the case of an acquisition, the acquirer or acquirers and the acquired undertaking;

ii. in the case of a merger, the merging undertakings;

iii. in the case of a joint venture, the undertakings creating a joint venture and the joint venture.

However, according to the Commission's guidance on certain provisions of the FSR, the above turnover threshold may not be met in the case of a newly created joint venture (greenfield joint venture), as the newly created entity does not yet have turnover.

Please note that the FSR also empowers the Commission to examine on its own initiative (ex officio) transactions below the notification thresholds which have not yet been implemented, if it suspects that foreign subsidy may have been involved in the transaction, and to subject such transactions to a detailed investigation where appropriate.

Foreign subsidy is also a broad term: it includes any financial instrument provided directly or indirectly by a non-EU country. For example, capital injections, non-refundable grants, interest-free loans, unlimited guarantees, loan guarantees, fiscal incentives, operating loss compensation, preferential tax treatment, debt relief, tax credits, the granting of special or exclusive rights without adequate compensation, the provision of goods or services, the acquisition of goods or services, etc.

The FSR classifies foreign subsidies into several categories based on the likelihood of market distorting effects:

1. The first category includes those subsidies that are most likely to distort the internal market. This includes subsidies that directly facilitate a merger, aids to firms in difficulty, unlimited guarantees, export financing other than OECD Arrangement on Officially Supported Export Credits, and foreign subsidies that give an undue advantage in a public procurement procedure.

2. The second group includes foreign subsidies that are unlikely to distort the internal market and the total amount of which does not exceed EUR 4 million over three consecutive years.

3. Subsidies of the third type do not, as a general rule, distort the internal market. Examples include aids to restore the damage caused by natural disasters or exceptional occurrences and aids which do not exceed the amount of aid which could be considered de minimis under EU State aid rules for three consecutive years.

Notification procedure and consequences of failure to notify

The notification must be made by the parties to the merger or, in the case of a joint acquisition of control, by the parties acquiring joint control, and in all other cases by the acquiring undertaking after the conclusion of the agreement, the announcement of the public bid or the acquisition of the controlling interest, but before the implementation of the concentration.The parties concerned may also report the proposed transaction prior to the conclusion of the agreement if they can demonstrate their good faith in concluding the agreement resulting in the concentration.

The notification must be submitted to the Commission using the form set out in the Annex to the FSR Implementing Regulation (Commission Regulation (EU) No 2023/1441). In addition to basic information on the transaction, the notification must provide detailed information on the nature of the financial subsidy and its impact on the internal market.

If the Commission finds that the foreign subsidy granted for the concentration distorts the internal market, it may (i) accept commitments offered by the undertakings concerned provided that they fully and effectively remedy the distortion of the internal market, (ii) impose redressive measures to remedy the distortion (such as repayment of the foreign subsidy received, divestment of certain assets, reduction of capacity or market presence, access to certain infrastructure, prohibition of certain market conduct, etc. ), or (iii) prohibit the concentration.

Notifiable concentrations may not be implemented before Commission clearance.

In the event of missed notification or premature implementation of a concentration, the Commission may impose fines on the undertakings concerned of up to 10 % of the total turnover achieved in the previous financial year.

Some of the practical implications of the FSR for M&A transactions

It follows from the above that compliance with the FSR will impose an additional burden on the parties involved in M&A transactions, on top of the existing EU and national merger control and FDI-type control regimes.

For this reason, it is necessary for the companies concerned and their advisors to identify the foreign subsidies received and the extent of such support during the planning and due diligence stages of the transaction. The requirements under the FSR should also be reflected in the transaction documents, for example, the contract should provide for the notification and clearance of the transaction under the FSR by the Commission as a condition precedent for closing the transaction, or the sharing of risks arising from the FSR between the parties.

As the identification and provision of data and information necessary for the Commission's procedure and the preparation of a complete merger notification depend on the continuous cooperation between the parties and their advisors, it is also recommended that any breach of this obligation of cooperation by the parties and its consequences should be addressed in the transaction documents.

A further difficulty for the parties is that the FSR procedure and the existing national and EU merger control regimes apply in parallel (e.g. the Commission may have to examine and clear a merger in two different procedures, or the competition authorities of the member states may have to conduct their own merger control procedures in parallel with the Commission's FSR investigation). Therefore, different decisions may be taken on the same transaction, which could easily make it impossible to plan and implement transactions in a timely manner. The parties should also consider whether there is a real risk of ex officio intervention in transactions below the thresholds and should also look at the history of the target company's compliance with the FSR requirements.

Due to the new European rules on foreign subsidy control, parties to M&A transactions must now consider the FSR requirements and the resulting risks, preferably from an early stage in the planning of their transaction – otherwise they could face severe sanctions.