Reading the ECJ’s Xella judgment in its constitutional and institutional context

In the recent Xella Magyarország case (C‑106/22), the European Court of Justice (‘ECJ’) ruled that Hungary had infringed the freedom of establishment by prohibiting a foreign-owned Hungarian company from acquiring another Hungarian company under its foreign direct investment (‘FDI’) screening mechanism. This contribution will focus on the broader constitutional and institutional context in which the Xella judgment was handed down. Constitutionally, the ECJ at first sight seems to have done nothing more than confirm orthodoxy. But a closer look at the dramatis personae reveals an interesting angle to the judgment. The Xella judgment is also a reminder for—if not an instruction to—the European Commission, which may have work to do as guardian of the Treaties. Firms have a few tools at their disposal to help the Commission fulfil this mandate, especially if their transaction is subject to the EU Merger Regulation No 139/2004 (‘the Merger Regulation’).

Facts and outcome of the Xella case

Under its FDI screening mechanism, the Hungarian Minister for Innovation and Technology prohibited Xella's acquisition of Janes és Társa Kft on national interest grounds. The Minister considered that Xella, a Hungarian company indirectly owned by a company registered in Bermuda, qualified as a foreign investor and that the target company, whose main activity was the extraction of gravel, sand and clay, was a strategic company. The acquisition would, so the Minister argued, undermine the national interest and pose a long-term risk to the security of supply of raw materials to the construction sector, particularly in the target company's region. 

Xella challenged the Minister's decision before the Budapest High Court, arguing that it violated its rights under the free movement of capital. That Court then asked the ECJ for a preliminary ruling on the compatibility of the Hungarian FDI screening mechanism with EU law, in particular with Regulation 2019/452 and the free movement of capital. 

The ECJ first identified the applicable EU law. In that regard, it held that the acquisition in question did not fall within the scope of Regulation 2019/452. That Regulation is limited to foreign direct investment, i.e. investment in the EU made by undertakings constituted or otherwise organised under the laws of a third country, hence not when one EU company is acquiring another EU company, even if the acquirer is owned by third-country investors.

The ECJ then held that the applicable EU fundamental economic freedom in this case is the freedom of establishment, since the national legislation intended to apply only to ‘those shareholdings which enable the holder to exert a definite influence on a company’s decisions and to determine its activities’. The ECJ further held that Xella, as an EU company, could rely on that freedom regardless of the origin of its shareholders.   

On substance, the ECJ found that the national legislation constituted a particularly serious restriction of the freedom of establishment. The ECJ further found that this restriction was not justified by an overriding reason relating to the public interest, since the alleged loss of the supply of raw materials to the construction sector did not constitute a genuine and sufficiently serious threat to a fundamental interest of Hungary’s society.

Xella in its constitutional context: construing the cross-border element broadly

The freedom of establishment has always circumscribed how Member States can screen and control inbound investment from firms that are based in other Member States. In principle, if a firm from Member State A wants to acquire control over a firm in Member State B, it should be free to do so. Member State B can only restrict the investment in order to protect an overriding reason of public interest. For instance, in the Vivendi case (C‑719/18), Italy tried to block a hostile bid from a French company for Mediaset, a leading Italian media company, by alleging that the combination of the two companies would reduce media plurality. While the ECJ recognised that media plurality is an overriding public interest, it held that the concrete measures taken by Italy were disproportionate and that Vivendi should therefore be allowed to buy Mediaset.

So, at first sight, there is nothing new to the Xella case as far as EU free movement law is concerned. But the precise structure of the underlying transaction reveals an interesting angle.

The entity that was sold is Janes és Társa, a Hungarian entity, which has a Hungarian parent. The Hungarian entity that made the acquisition is Xella Magyarország Építőanyagipari Kft. This latter entity is owned by Xella Baustoffe GmbH, a German company, which is 100% owned by Xella International SA, a Luxembourgish company. The Luxembourgish company is in turn indirectly owned by LSF10 XL Investments Ltd, which is the ultimate parent company of the Lone Star group registered in Bermuda, the latter group belonging ultimately to J.P.G., an Irish national.

This dramatis personae shows that the underlying transaction actually seems to be a ‘purely internal situation’, as also noted by the ECJ (Xella, para 51). There was no investment from Member State A into Member State B. One Hungarian entity bought another Hungarian entity. This point is significant because in the absence of an EU cross-border element free movement rules do not normally apply (Xella, para 50). The ECJ nonetheless granted protection under the freedom of establishment rules in this case, reasoning as follows:

‘However, the fact that the acquiring company forms part of a group of companies established, inter alia, in different Member States, even if those companies do not appear to play any direct role in the acquisition concerned, constitutes a relevant foreign element . . . .’ (Xella, para 52).

Constitutionally, the ECJ’s favourable interpretation of what constitutes a sufficient cross-border link is arguably the most innovative aspect of the Xella judgment, which otherwise does not do much more than confirm the orthodoxy that free movement law constrains the way in which Member States can screen and control inbound investment, as the above Vivendi judgment, among many other judgments, also shows.

Xella in its institutional context: how firms can help the Commission fulfil its mandate as guardian of the Treaties

Private enforcement of free movement rules is not the only constraint on Member States that unduly restrict inbound investment. The Commission also has an important role to play.

Article 17 TEU enlists the Commission as ‘guardian of the Treaties’. The Commission is to check that the Member States comply with Union law. Article 258 TFEU confers it with the power to commence an infringement procedure if it finds that a Member State has legislation or an administrative practice that is contrary to Union law.

An infringement procedure presupposes that the Commission has become aware of a potential breach of Union law. Firms have an essential role to play here. They can proactively provide the Commission with information about a Member State’s law and practice and present their views on why they think EU law has been infringed. The Commission provides guidance on the recommended procedure for firms to follow and has committed to keeping complainants abreast of developments in their complaint (see here and here). A complainant cannot, however, oblige the Commission to act (Star Fruit v Commission, para 11).

The primary purpose of infringement procedures is to ensure that Member States give effect to EU law in the general interest, not to provide individual redress. The Commission therefore focuses its resources on systemic issues. We are not saying that the recent expansion of investment screening mechanisms in the Member States, which is well documented (UNCTAD Investment Policy Monitor, February 2023), is a systemic issue. But if a certain Member State uses its new powers consistently to block transactions in a particular sector or transactions entered into by firms that are not politically palatable to the powers that be, perhaps the Commission will consider that an infringement procedure is the appropriate course of action.

Another difficulty which the Commission faces when bringing an infringement procedure is speed. The procedure first involves a lengthy engagement process with the Member State concerned through informal contacts/requests for information, a letter of formal notice, and a reasoned opinion. Only then may the Commission refer the case to the ECJ, which will decide whether there has been a violation of EU law.

Firms can help the Commission to accelerate this procedure significantly if their transaction was cleared by the Commission under the Merger Regulation and subsequently blocked by a Member State on non‑competition grounds.

Article 21(2) and (3) of the Merger Regulation prohibits Member States from applying their national legislation to mergers that have an EU dimension, subject to the exception set out in Article 21(4) which allows Member States to take appropriate measures to protect certain legitimate interests. Three specified interests are always legitimate: public security, plurality of the media, and prudential rules. ‘Any other public interest’ can also be protected, but the Commission must give its prior approval. When a Member State does not request authorisation from the Commission or tries to cloak a certain interest it wants to protect as one of the three recognised interests, the Commission can commence an infringement proceeding against it for violating Article 21 of the Merger Regulation.

In a rare Full Court judgment, the ECJ confirmed that the Commission does not need to follow the procedure set out in Article 258 TFEU in this type of situation (Portugal v Commission, C‑42/01). Instead, after due engagement with the Member State concerned, the Commission can adopt a decision in which it concludes that there has been a violation of the Merger Regulation. The ECJ justified this approach, among others, based on the requirements of the business world for speed.

The Commission’s practice shows that it can indeed act rather quickly in these types of situations. The recent VIG/Aegon CEE transaction, an insurance deal, is a good illustration. Hungary vetoed the transaction on national security grounds on 6 April 2021. After the Commission cleared the transaction on competition grounds on 12 August 2021 (Case M.10102), it adopted a separate decision under Article 21(4) of the Merger Regulation on 21 February 2022, ordering Hungary to withdraw its veto (Case M.10494). The Commission’s decision shows that the merging firms played an important role in providing it with information and arguments to reach the conclusion that Hungary’s veto was unjustified.

Concluding thoughts

The Xella judgment shows that the EU’s fundamental freedoms can provide firms whose transaction was blocked following an investment review with individual redress through the courts of the Member States, with guidance from the ECJ if needed. Firms can count on a favourable interpretation of what constitutes a cross-border link following the ECJ’s judgment in Xella.

As guardian of the Treaties, the Commission can also take enforcement action if it considers that there is a systemic issue in a Member State. However, information asymmetries and lengthy procedures can make such cases tough to bring. Firms therefore have an important role to play to assist the Commission in its mandate. Successful enforcement action by the Commission may not help those firms change the outcome of past or even current transactions. But firms which are repeat players and, for whatever reason, are at risk of being caught in the crosshairs of a foreign investment review have a strong interest in becoming assistant‑guardians of the Treaties. It is no coincidence that Xella Magyarország is ultimately owned by funds advised by Lone Star, a prolific global deal-doer.

Thomas Reyntjens is a legal secretary (référendaire) at the Court of Justice of the European Union and a DPhil candidate at the University of Oxford, Brasenose College.

Anna Jorna is a legal secretary (référendaire) at the Court of Justice of the European Union.

All views expressed in this contribution are their own.

A previous version of this blog post was published on EU Law Live: https://eulawlive.com/op-ed-reading-the-xella-judgment-in-its-constitutional-and-institutional-context-by-thomas-reyntjens-and-anna-jorna/