Economic Continuity in Recovery of Incompatible State aid

Lab test

The new owner of a company that received incompatible State aid may be liable to pay it back.

Introduction
 
Companies rarely escape from the obligation to repay incompatible State aid. Over the past decade or so, very few companies have successfully argued that they legitimately expected that the aid they received was compatible with the internal market. When a company buys another company which has obtained incompatible aid, the new owner cannot even claim that it considered the aid to have been granted legally and to have been compatible with the internal market. On 24 September 2019, the General Court ruled on an appeal against recovery of aid from the new owner of an aid recipient in case T‑121/15, Fortischem v European Commission.1 Fortischem appealed against Commission decision 2015/1826 that had ordered Slovakia to recover incompatible State aid from NCHZ [Novácké Chemické Závody]. After NCHZ obtained the aid it was sold to Fortischem. With the benefit of hindsight, Fortischem should have been more careful. But, as we will see, the General Court was also excessively harsh on Fortischem.NCHZ was a Slovak chemical company that entered into insolvency proceedings in October 2009. A Slovak law that came into force in December 2009 classified NCHZ as a “strategic company”. NCHZ was the only company subject to that law which required the insolvency administrator to continue the company’s operation and prevent collective dismissals. Consequently, the number of employees could not be reduced. This resulted in a steadily rising debt by NCHZ towards public bodies such as the social security administration.Eventually, in 2012, NCHZ was sold, via tender, to Via Chem which resold it on the next day to Fortischem, with the exception of immovable assets such as building and land. However, the immovable assets that were necessary for chemical production were at the same time leased to Fortischem.The Commission found that NCHZ owed EUR 4.8 million to various public bodies. That amount constituted incompatible aid that had to be recovered from Fortischem, the new owner of NCHZ.
Existence of State aidOne of the arguments of Fortischem was that no state resources had been transferred and no advantage had been conferred to NCHZ. It did not contest that the classification of NCHZ as a strategic company was imputable to the state, was selective and could affect trade.The General Court began its analysis by recalling the relevant principles in the case law:“(59) Only advantages conferred directly or indirectly through State resources or constituting an additional burden on the State are to be regarded as aid within the meaning of Article 107(1) TFEU. The very wording of this provision and the procedural rules laid down in Article 108 TFEU show that advantages granted from resources other than those of the State do not fall within the scope of the provisions in question”.“(61) The concept of ‘aid’ does not merely include positive benefits such as subsidies but also measures which, in various forms, mitigate the charges which are normally included in the budget of an undertaking and which, without therefore being subsidies in the strict meaning of the word, are similar in character and have the same effect”.

“(62) ‘State aid’, as defined in the Treaty, is a legal concept which must be interpreted on the basis of objective factors. For that reason, the EU Courts must, in principle, having regard both to the specific features of the case before them and to the technical or complex nature of the Commission’s assessments, carry out a comprehensive review as to whether a measure falls within the scope of Article 107(1) TFEU”.

Then the General Court noted that “(72) the application to an undertaking of rules derogating from the normal insolvency rules must be regarded as giving rise to the grant of State aid in two situations. In the first situation, it is established, in essence, that that undertaking has been permitted to continue trading in circumstances in which it would not have been permitted to do so if the normal insolvency rules had been applied. In the second situation, it is established, in essence, that that undertaking has enjoyed one or more advantages, such as a State guarantee, a reduced rate of tax, exemption from the obligation to pay fines and other pecuniary penalties or waiver in practice of public debts wholly or in part, which could not have been claimed by another insolvent undertaking in connection with the application of the normal insolvency rules.”

In the present case, the General Court found in paragraphs 73-79 of the judgment that NCHZ enjoyed an advantage because it was required to operate despite the fact that its debt to both private and public creditors was mounting.

The Court went on to reject Fortischem’s argument that the Slovak government had acted as a private creditor. “(85) The private creditor test requires that the conduct of a public creditor be compared to that of a private creditor in a situation as close as possible to that of the public creditor. Evidence may be required showing that the State’s decision is based on economic assessments comparable to those which a private creditor would have made”. No such evidence had been provided to the Commission.

“(88) It follows from the Law on Strategic Companies and the decision of the Slovak State to confer the status of strategic company on NCHZ that the Slovak State’s sole objective was to avoid the negative effects of NCHZ’s ceasing to operate on the operation and competitiveness of the chemical industry as a whole in Slovakia, as well as the negative impact on employment in the region concerned which would endanger the Slovak economy.”

Was there State aid under normal insolvency proceedings?

The General Court also rejected the claim that the situation would have been the same had NCHZ been subject to the normal insolvency rules because there was no evidence that the administrator of NCHZ had considered how the normal insolvency rules could have applied.

“(119) Although, in the context of the market economy operator test, it is permissible to doubt the relevance of an ex post analysis in certain circumstances, the analysis required by [the Ecotrade, C‑200/97] judgment, which consists of determining whether NCHZ would have continued to operate, including in the event that the normal insolvency rules were applied to it, requires, by definition, a hypothetical ex post analysis. By virtue of the test established in that judgment, it is necessary to assess what, in all likelihood, would have happened if the Law on Strategic Companies had not existed.” This comparison was not possible because there was no “adequate and contemporaneous study”.

The General Court concluded that “(149) on account of the classification of NCHZ as a ‘strategic company’ by the Slovak authorities, it was required, first, to continue to operate, irrespective of any consideration of its economic situation and its capacity to honour its debts, in particular public debts, and secondly, to retain its staff, owing to the barrier to collective redundancies, thereby allowing it to continue to operate with an assurance provided to its customers and suppliers that it would do so until the end of 2010. At the same time, the application of the Law on Strategic Companies to NCHZ imposed the risk on some of its creditors, in particular the public creditors, that their claims would increase during the first insolvency period, that risk being unavoidable in the light of its financial position at the time of its classification as a ‘strategic company’. That risk moreover materialised during the first insolvency period, both for public creditors with pre-insolvency and post-insolvency claims and for those solely with post-insolvency claims.”

“(150) However, it cannot be considered that, in circumstances corresponding to normal market conditions, NCHZ could have obtained the same advantage as was made available to it, through State resources, within the meaning of the case-law cited in paragraphs 59 and 61 above. First, the market economy operator test was not applicable in the present case and in any event, it was not established that the first measure satisfied that test. Second, it cannot be concluded that the situation would have been the same if NCHZ had been subject to the normal insolvency rules and no additional burden had been placed on the public creditors”.


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Recovery

Fortischem argued that the Commission committed a manifest error of assessment in calculating the amount of the aid.

The General Court disagreed. “(181) The Commission did not err in finding that, in order to restore the previously existing situation, the amount of aid to be recovered had to correspond to the amount of the unpaid public liabilities during the period of application of the Law on Strategic Companies to NCHZ.”

“(182) By contrast, the applicant’s argument is based on a hypothetical ‘counterfactual scenario’ and a decision of the relevant committee to cease NCHZ’s operations at the start of the first insolvency period. However, the amounts to be repaid cannot be determined in the light of the various operations which could have been implemented in the absence of the measure which led to the granting of the aid and restoration of the previous situation does not entail reconstructing past events differently on the basis of hypothetical elements such as the choices, often numerous, which could have been made by the operators concerned”.

Economic continuity between NCHZ and Fortischem

The Commission decided that Fortischem was liable to pay back the aid that had been granted to NCHZ because there was “continuity” between NCHZ and the assets and operations acquired by Fortischem.

According to the General Court, “(207) the illegal aid must be recovered from the company which carries on the economic activity of the undertaking which initially benefited from the advantage associated with the grant of State aid and which retains the actual benefit thereof”.

“(208) According to the case law, in order to assess whether such economic continuity exists, the following factors may be taken into consideration: the purpose of the transfer (assets and liabilities, continuity of the workforce, bundled assets), the transfer price, the identity of the shareholders or owners of the acquiring undertaking and of the original undertaking, the moment at which the transfer was carried out (after the start of the investigation, the initiation of the procedure or the final decision) and, lastly, the economic logic of the transaction […] The EU Courts have stated that the Commission was not required to take into account all of the above factors, as is demonstrated by the use of the expression ‘may be taken into consideration’”.

“(209) As regards the sale price, although the market price criterion is one of the most significant, it is not a sufficient criterion for a finding that there is no economic continuity”.

The problem with having several indicators is that, without price being the decisive one, the outcome of any assessment on the basis of those indicators becomes difficult to understand and impossible to predict.

“(210) In addition, according to the case-law, where the undertaking which received the unlawful aid is insolvent and a company has been created to continue some of the activities of the insolvent undertaking, the pursuit of those activities may, where the aid concerned is not recovered in its entirety, prolong the distortion of competition brought about by the competitive advantage which that company enjoyed in the market as compared with its competitors. Accordingly, such a newly created company may, if it retains that advantage, be required to repay the aid in question. That is the case, in particular, where it acquires the assets of the company in liquidation without paying the market price in return or where it is established that the effect of that company’s creation is circumvention of the obligation to repay the aid, which applies, in particular, if the payment of a market price is not sufficient to cancel out the competitive advantage linked to receipt of the unlawful aid”.

Then the Court embarked on an analysis of each of the indicators mentioned above and arrived at the conclusion that there was continuity in the activities of NCHZ before and after it was acquired by Fortischem.

The Court also concluded that although NCHZ was sold via a competitive tender, the price paid by the highest bidder was not a market price because the tender procedure allowed bidders to match higher bids ex post.

“(230) It must be noted that the Commission stated in recital 141 of the contested decision that the conditions of the 2011 tender procedure gave precedence to participants willing to accept the commitments, which could indicate that the price proposed in a tender without commitments could be higher than the price proposed by the successful participant.” “(231) It is nevertheless true that, as the Commission stated in recital 139 of the contested decision, one of the factors that ensures that the highest price is achieved in a tender procedure is the uncertainty concerning the price proposed by the other tenderers. A tender procedure which allows certain tenderers to change the price that they propose entails a risk, first, that those who are able to amend their tender may seek not to propose the highest price at which they have assessed the undertaking offered for sale, while waiting to see if it is necessary to increase their offer, and, on the other hand, that those who cannot amend their tender seek to propose a price which is also lower than the highest price at which they have assessed the undertaking offered for sale, or decide not to tender, considering that they might in any event be eliminated by a tenderer willing to accept the commitments.” “(232) Accordingly, it cannot be ruled out that the conditions laid down by the 2011 tender procedure providing for the possibility of altering the sale price proposed could have had an impact on the sale price, in the sense that it would not have been the highest possible price.”

This conclusion of the General Court is logically incorrect. It could have been correct if only some bidders could revise their offers, but not if all bidders had the possibility to revise their offers. Moreover, as explained below, in order to be able to revise a previous offer, a bidder had to be the highest bidder that had accepted the commitments.

This is the condition in the tender procedure, as described in paragraph 18 of the Commission decision: “The rules of the tender stipulated that, if the highest bid were from a bidder not undertaking the commitments, the highest bidder who did take them over would have the possibility to match the highest bid.”

Now, all bidders could choose whether to accept or not the required commitments. If it is not known beforehand who would accept or not accept commitments and if only the highest bid with commitments could match the highest bid without commitments, each bidder would quote the highest price they could afford to pay, because only in this way they could get the chance to match a competing bid. In a two-stage procedure, the highest bid wins and the highest bid is the highest price any bidder is willing to offer. Moreover, even if the commitments reduced the value of the assets sold, bidders would still quote the highest price they could afford to pay without accepting commitments because only that strategy would ensure that they could not be outbid by another company that was willing to accept the commitments.

The General Court would have been right in its conclusion if the tender procedure took place in multiple stages until all but one bidder were eliminated. Then all bidders would have an incentive to start at lower offers and then progressively match higher offers. In this case, the winner would be the bidder who could match the offer of the second highest bidder and the winning bid would not be the highest price the winner would have been willing to offer. But this was not the case with the sale of NCHZ.

The problem with the formula of economic continuity

The General Court stated that the incompatible State aid had to be repaid by the eventual company that “retain[ed] the actual benefit” of the initial State aid, if it “retain[ed] that advantage”. [Paragraphs 207 & 210 of the judgment]. Therefore, in order to recover aid from a successor company it is first necessary to establish whether the advantage has been passed on from the initial recipient or whether the advantage has been retained by the initial recipient.

Assume a company is worth 100, receives aid of 30 and then immediately afterwards it is sold. The value of the company is 130. If the price paid by the buyer is 130, then the buyer obtains no advantage. Where has the aid gone? It passed through the beneficiary company to former owner – the seller. In this case, no aid is passed on to the buyer and no aid is retained by the beneficiary company.

Assume now that the company that receives the aid is in debt. Its worth is minus 20. Aid of 30 raises its worth to plus 10. The buyer pays 10 to acquire the company. Where has the aid gone? Now the situation is more complex and depends on the liability of the seller. If the seller is not liable for the debt of the company, then 20 has gone to creditors and 10 has gone to the seller. The creditors are not “indirect” beneficiaries of the aid. They are only “secondary beneficiaries” [for an explanation of the important difference between indirect and secondary beneficiaries see paragraph 116 of the Commission’s Notice on the Notion of State aid]. Therefore, the company itself has benefited from 20 of aid that eliminated its debt. This has to be recovered from the company. The other 10 has to be recovered from the seller. If the seller is liable for the debt of the company, then the aid relieves the seller from its fiduciary obligations and therefore all of the aid of 30 has to be recovered from the seller.

Perhaps these are easy cases. The Commission has invented the concept of economic continuity in order to prevent Member States from evading recovery by transferring companies or breaking them up. So it is necessary to find out how advantage is passed on when a company is transferred or broken up.

As the examples above imply, when a company is simply transferred, the advantage stays with the company. Neither the old, nor the new owner extract any value out of the company. The recovery has to take place from the company that received the aid in the first place. If the company cannot pay back the aid then it will have to be liquidated. If the new owner assumes also obligations towards the liabilities of the company, then the new owner may have to pay back some or all of the aid and compensate some or all of the creditors.

When a company is broken up and its assets are sold individually, the company still continues to exist as a legal person. The proceeds from the sale of the assets are kept in the company or are used to compensate creditors. The creditors are secondary beneficiaries so no aid needs to be recovered from them. If no creditors are paid off, then cash is simply accumulated in the company. The fact that the assets have been sold off is irrelevant. They have been converted to cash that remains with the company.

In conclusion, we see that as long as the direct aid recipient continues to exist as a legal person, it must be the one who has to repay the aid. The only exception is when value is extracted from the company when it is sold to a new owner.

The complicated formula of economic continuity used by the Commission only makes the whole situation vague and unpredictable.

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 1 The full text of the judgment can be accessed at: http://curia.europa.eu/juris/document/document.jsf;jsessionid=BDDCD1AEA801DB3988F8D224CD9A24FB?text=&docid=218119&pageIndex=0&doclang=EN&mode=lst&dir=&occ=first&part=1&cid=250522.

[Photo by Louis Reed on Unsplash]

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About

Phedon Nicolaides

Dr. Nicolaides was educated in the United States, the Netherlands and the United Kingdom. He has a PhD in Economics and a PhD in Law. He presently holds positions at the College of Europe and the University of Maastricht. He has published extensively on European integration, competition policy and State aid. He is also on the editorial boards of several journals. Dr. Nicolaides has organised seminars and workshops in many different Member States, and has acted as consultant to several public authorities.

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