Rethinking Production Capacity: Your Path Into The Security And Defence Industry – With Solid Legal Support Every Step Of The Way

Market entry: Your chance to unlock economic opportunities

The German automotive industry is facing its biggest crisis in decades. The impact of this crisis extends beyond car manufacturers, hitting suppliers along the entire supply chain.

At the same time, the security and defence industry in Germany and Europe is seeing a huge influx of capital. For many affected businesses, branching into this dynamic sector could be an opportunity to put existing, currently unused capacity to profitable use.

Entering the security and defence industry can be economically attractive but involves significant – though not insurmountable – legal challenges. We would like to give you an overview of these challenges and the advisory services we offer to support you in making this strategic decision.

Project planning and corporate structure

It is generally a good idea to establish a separate business unit for the production and distribution of goods for the defence industry. You could, for example, spin off an existing company and transfer production capacity to the new business unit. Production often requires specific expertise that your company may not yet possess. If this is the case, you could consider operating the business unit as a joint venture with a company that is already familiar with the requirements of the security and defence industry.

This raises various questions in terms of corporate law. To ensure the proper arrangement of corporate structures, we strongly recommend that any contracts between partners are carefully drafted. It may be necessary to conduct due diligence to safeguard your legal position.

Antitrust regulations must also be taken into account. If any large systems houses are involved in a joint venture, you will need to make sure there is no infringement of antitrust law.

Luther offers extensive antitrust expertise and is here to assist you in structuring the corporate framework of your new business unit.

Tax law aspects

When organising the business unit, particularly when choosing its legal form, tax considerations are of course also relevant, as the taxation of partnerships (particularly limited partnerships) is subject to different rules than the taxation of corporations (particularly limited liability companies and public limited companies). As a full-service law firm, we have been providing tax law advice for many years and support our clients in developing the most tax-efficient solution.

Financing and ESG

Entering the security and defence industry is often capitalintensive. In addition to transaction and organisational costs, there are costs associated with retrofitting production facilities. For suppliers to the automotive industry who are considering branching into this sector, (external) financing options are therefore particularly relevant.

In the context of financing, the question often arises as to whether investments in the security and defence industry are sustainable in terms of ESG compliance. This is important as certain funds will only invest if this sustainability prerequisite is met. While this matter has not been conclusively resolved, there are a growing number of voices arguing that investment in the security and defence industry may indeed be considered sustainable, at least under certain circumstances. The European Commission recently issued a statement on this matter.

Investments involving foreign investors must also comply with investment control regulations, as the Federal Ministry for Economic Affairs may prohibit such investments under some circumstances.

Another point to bear in mind is that, under Section 60(1) of the German Foreign Trade Ordinance (Außenwirtschaftsverordnung), investments in the security and defence sectors made by foreign nationals who are citizens of EU member states also fall under the scope of investment control regulations and may therefore be blocked by the Federal Ministry for Economic Affairs. As such, the provisions of investment control legislation should be reviewed wherever there is foreign involvement.

Luther will assist you in identifying the best financing options for your needs. We possess a wealth of experience in all stages of financing.

Preparatory measures: Product development and supplier integration

To successfully enter the security and defence industry, the company in question must decide what (and for whom) it wants to manufacture by identifying which products its customers need. One option is to reach out to companies in the security and defence industry to secure a place in their supplier pool. In addition, the order advisory offices run by the chambers of industry and commerce in the German federal states can put suppliers in touch with defence companies upon request.

In the security and defence industry, the requirements that a manufacturing company must meet depend to a large extent on the specific product manufactured and its stage within the value chain.

Specific technical requirements for the product and its manufacture, particularly any necessary certifications, may come from a wide variety of DIN standards (e.g. DIN EN 9100 or DIN 2303), ISO standards and, in some cases, specific standards set by the armed forces, such as the Bundeswehr's technical requirements or technical delivery conditions.

NATO has set out its technical requirements for products in the Allied Quality Assurance Publications (AQAP), some of which correspond to DIN and EN standards. The Bundeswehr often follows these NATO requirements and incorporates them into the contract as binding product specifications.

The standards mentioned do not, however, replace the product requirements laid down in the supply contract. The terms of the contract are therefore crucial to the supplier relationship. Through negotiation and the drafting of contracts, you can generally influence the technical requirements your product must meet. Our experts in commercial and distribution law can provide you with comprehensive support throughout this process. Should mandatory legal requirements apply to your products, our specialists in commercial and distribution law and product compliance have the necessary expertise to minimise potential liability risk.

Protection of secrets and classified information

Depending on your specific contractual relationship with your customers, you may encounter classified information and need to ensure that it is kept secure. We will work with you to develop legally sound solutions.

That is why we will support you in meeting the requirements of the German Security Clearance Act (Sicherheitsüberprüfungsgesetz). If employees or bodies within your company come into contact with classified information as a result of you entering the security and defence sector, security clearance for the employees concerned must be obtained according to the Security Clearance Act. There are very few exceptions to this requirement.

Our IP/IT and commercial and distribution law teams can advise you on matters relating to the protection of secrets.

Your employment law briefing for the defence sector

Entering the security and defence industry brings with it new challenges in terms of employment law. With many years of expertise in employment law specific to the defence sector, Luther is your one-stop shop for pragmatic, tailored advice. One thing to bear in mind in the security and defence industry is that maximum, uncompromising security is required in both production and logistics, particularly when working with external third parties. Whether you are a company in the supply or logistics sector, we can advise you on all employment law matters when setting up a new business unit or adapting an existing one within the security and defence industry – ranging from potential transfers of operations involving mandatory staff transfers to the specific requirements for new hires subject to security clearance. Working with you, we define tailored security requirements for employees (e.g. criminal record checks, background checks), develop tiered security concepts depending on proximity to the end product and establish processes for the ongoing verification, documentation and enforcement of these requirements, ensuring that your HR compliance remains legally sound and practical even within the highly sensitive defence sector. We also ensure that collective labour law –and your works council's rights to codetermination in particular – are incorporated in a practical manner from the outset, for example in the event of operational changes, so that your move into and work within the defence sector goes smoothly and with minimal conflict. If you are working closely with a defence client, it is also crucial to establish the right contractual framework with your client. From service contracts to temporary employment contracts: we will develop a legally sound yet efficient employment law solution that factors in the specific security requirements for your workforce.

Supply chain, quality management and contract drafting

In practice, effective supply chain management often means establishing a quality management plan. You should strongly consider putting such a plan in place.

This is necessary to ensure that your products meet the contractual requirements, as your customer may bind you to a quality management plan through contractual provisions. If procurement is linked to a NATO order, such a quality management plan is mandatory. The Federal Association of the German Security and Defence Industry (BDSV) has provided a number of "golden rules" that can serve as a guide when drafting contracts. We would be happy to assist you with the specifics of implementing these rules.

A second field in which potential risks must be avoided is the drafting of your contracts – both with your customers and your suppliers. As experienced advisors in commercial and distribution law, industrial construction, and public procurement and its contractual frameworks, we possess the expertise to avoid pitfalls and steer clear of complications. We identify red flags in contract drafts, work with you to draw up tailored counterproposals and support you in negotiations with your contractual partners. Obtaining legal counsel on these matters is strongly recommended, as the financial consequences of disadvantageous terms can be severe. Because security of supply is paramount in the security and defence industry, suppliers must often guarantee the supply of spare parts for 20 years or more. This means you will need to negotiate and agree on appropriate compensation in return for long-term contractual supply obligations. It is also important that you are familiar with the relevant contractual terms of the Bundeswehr, as these may become part of your obligations through subcontractor chains or supply chains.

Export controls: War weapons, dual-use items and catch-all clauses

Depending on the specific details of your project, you may find yourself subject to the provisions of the German War Weapons Control Act (Kriegswaffenkontrollgesetz) or the legislation governing the export of weapons and dual-use items.

We have the expertise necessary to overcome any legal hurdles in these cases, too.

Car manufacturers looking to produce certain military vehicles, for example, must be prepared to comply with the provisions of the War Weapons Control Act.

Other legislation that may be relevant in specific cases includes the Dual-Use Regulation, which covers certain civilian goods with potential military applications, and the German Foreign Trade Ordinance (Außenwirtschaftsverordnung), which is particularly relevant for certain exports.

Public procurement

One area of law that plays no role in the automotive industry but is central to the security and defence sector is public procurement law. If you operate as a supplier or even as a direct contractor in the defence sector, you will need to consider public procurement requirements. Those who are well positioned here will have better economic prospects. After all, errors in the procurement procedure could potentially cost you the contract.

With our many years of expertise in public procurement law, representing both public clients and bidders, we provide targeted, pragmatic guidance through the process. We offer training to ensure your purchasing team is well prepared and support you throughout the procurement procedure.

We always hit the mark

We provide comprehensive advice on all relevant legal matters within the security and defence industry – from corporate and tax structuring to financing, product-related compliance, employment law and contract drafting.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.