Protection of secrets in defence M&A and industrial transformation

The defence sector: expanding industry with specific regulatory requirements 

In view of recent political and economic developments, the defence industry in Germany has undergone dynamic growth. Production demand is rising, public spending in the defence sector is becoming more reliable and private investors are discovering new opportunities to finance defence projects. In addition, defence companies are beginning to expand and invest, which is also leading to an increase in M&A activity in the defence industry. 

Investments in the defence industry, i.e. the acquisition of a defence company, are subject to specific legal and regulatory requirements which, especially for investors who have no experience in this sector, may come as a surprise and may require adjustments to the usual standardised M&A procedures. The same applies to companies that wish to enter new business areas in the arms industry through transformation processes in the production or service sector. Even in the case of these mostly internal structural changes or business expansions, new regulatory requirements are becoming increasingly important and must be taken into account in order to create the conditions necessary to operate in the defence sector. 

Requirements for protecting secrets make due diligence more difficult procedures in the defence sector 

When investing in the defence industry, typically in M&A projects, it often comes as a surprise at the outset that the target company normally handles secret information (for example, in the production process). The M&A transaction must therefore comply with German confidentiality regulations. Since the disclosure of such information is either prohibited or at least strictly regulated, even typical M&A due diligence procedures become quite difficult. Depending on the classification level of the information ("confidential", "secret" or even higher), different procedures must be followed before such information may be disclosed in a data room. These procedures include certain "personal requirements" (i.e. training, confidentiality obligations or even approvals by authorities) for the persons entrusted with examining the information (representatives of the parties, lawyers), but also "material requirements" regarding the possibility of disclosing the information (i.e. IT and/or facilities for protecting the information). If the investor is a foreign/non-German company, the question also arises as to whether confidential information may be transferred abroad. 

Transformation processes require personnel and material adjustments to protect secrets 

When a company undertakes a transformation project, it quickly becomes clear that requirements for protecting secrets impose both personnel and material demands that usually require significant changes to the structure and processes of a company. For example, personnel-related protection of secrets requires adjustments to employment contracts, the establishment of special new functions (such as that of a security officer), combined with new reporting lines and responsibilities. Material requirements for protecting secrets often necessitate important changes that only become apparent during the process – from changes to the IT structure to adjustments to the premises in order to be able to work with classified information in-house. 

Detailed legal knowledge and practical experience as the key to success 

All of these transaction issues require specific legal expertise and practical experience to make the project a success. Security protection in Germany follows clearly defined principles that run through all regulations – in particular the Directive on Classified Information, the German Security Screening Act and the Manual for the Protection of Secrets in the Economy. These principles ensure that classified information is only processed by authorised persons, in secure rooms and under controlled conditions. Approvals are granted by specific departments of various authorities. Legal advisors must have detailed knowledge of the regulations and should at least be familiar with the approval procedures or, better still, know the employees involved personally in order to ensure that the transaction or successful transformation proceeds quickly and smoothly.