Public Funding of an Undertaking in a Closed Sector

Public funding of undertaking in a closed sector [legal monopoly] does not distort competition and therefore does not constitute State aid.

A legal monopoly has to conform with internal market rules.

Introduction

In July 2017, the Commission received a complaint by “C” [the complainant] alleging that Germany had granted State aid to two companies, RVV and Nordwasser, which supplied fresh water and treated waste water.

In Germany federal law specifies that the supply of water and the treatment of waste water are essential public services which fall within the responsibilities of the municipalities as a matter of local significance.

Nordwasser was founded in March 2015 as a separate legal entity governed by private law by Warnow-Wasser und Abwasserverband [WWAV] and Rostocker Versorgungs- und Verkehrs-Holding [RVV].

WWAV is a cross-municipal public entity and its members are the German town Hansestadt Rostock and the Zweckverband Wasser Abwasser Rostock Land consisting of 28 municipalities of the Landkreis Rostock. Under German law, the WWAV is the competent authority responsible for water and waste water services in the area of its members.

RVV is a state-owned entity subject to private law, whose single shareholder is Hansestadt Rostock. RVV is responsible, via various subsidiaries or shareholdings, for a broad range of municipal services such as water and waste water services, local public transport, municipal waste management.

WWAV and RVV are the only two shareholders of Nordwasser, with RVV holding 51% of the shares and WWAV 49%. All decisions are taken by a three-forth majority except for decisions on the use of Nordwasser’s earnings which require unanimity

In May 2018, WWAV amended its statute so as to prohibit for an unlimited period competition on and for the market for water and waste water services in the WWAV region. This amendment excluded competition by delegating those services to Nordwasser retroactively as of March 2015 when Nordwasser was founded.

Nordwasser become responsible, through a service contract, for the supply of water and waste water services and for the maintenance of the related infrastructure. The service contract covered a period of 20 years until 2038, with an automatic prolongation for 5 years unless one of the parties decided to terminate it with a two years’ notice.

In its assessment of the possible existence of State aid, the Commission examined several aspects of the contract between Nordwasser and WWAV. It concluded that competition was not distorted and therefore public funding did not constitute State aid [SA.48706].[1]

The exclusive right conferred to Nordwasser

The Commission assessed, first, the monopoly position of Nordwasser. It began by explaining that “(45) the fact that an in-house entity provides the services in question, such as Nordwasser in the present case, does not as such exclude a possible distortion of competition concerning the operation of water supply and waste water networks.”

Next, the Commission considered Germany’s argument that a valid legal monopoly excluded any distortion of competition, either for or in the market. “(46) Indeed, as set out in the Commission Notice on the Notion of Aid (“NoA”), a distortion of competition, and therefore the presence of State aid, can be excluded when each of the following conditions is met:

(a) a service is subject to a legal monopoly (established in compliance with EU law),

(b) the legal monopoly must exclude competition not only on the market, but also for the market, in that it excludes any possible competition between different entities to become the exclusive provider of the service in question,

(c) the service in question must not be in competition with other services, and

(d) if the service provider is active in another (geographical or product)market that is open to competition, cross-subsidisation must be excluded. This requires that separate accounts are used, costs and revenues are allocated in an appropriate way and public funding is provided for the service subject to the legal monopoly cannot benefit other activities.”

Then the Commission examined compliance with the four criteria listed above.

Existence of a legal monopoly, established in compliance with EU law

“(49) Such a legal monopoly exists where

– a given service is reserved by law or regulatory measures to an exclusive provider, with a clear prohibition for any other operator to provide such service (not even to satisfy a possible residual demand from certain customer groups);

– the decision to close a market must be taken by the competent public authorities or entity, in line with the national competency set-up;

– in doing so, the Member State or the competent public entity must act in compliance with EU law”.

The Commission confirmed that the relevant German law excluded all competition for and on the market and that local authorities were empowered to legislate on those matters. [paragraphs 50-65 of the decision]

The Commission noted that “(62) the public entity WWAV was entrusted by the municipalities to become the entity obliged by public law to carry out water and waste water services within the jurisdictional boundaries of its members.”

The Commission also checked whether the monopoly was established in compliance with EU law and, in particular, the single market freedoms.

In this connection, it pointed out as a preliminary point, that “(66) Member States, whether at national, regional or local level, are not free to impose monopolies on any activity they choose. Such a restriction of the market freedom provisions must always be justified by reference to strong public policy arguments and be in line with EU law.”

“(67) More specifically, the Commission recalls that a valid legal monopoly must be set up in accordance with the market freedoms. Standing case law qualifies state monopolies or measures with a similar effect as an infringement of the freedom of services or goods. Nonetheless, such restrictions may be justified if certain conditions, expounded by the Court of Justice, can be satisfied. According to these decisions, the restrictions must be justified by imperative requirements in the general public interest, be suitable for achieving the objective which they pursue and not go beyond what is necessary in order to attain it. Furthermore, they must be applied without discrimination.” [At this point the decisions cites several judgments of the Court of Justice on cases concerning internal market freedoms.]

“(68) The Court of Justice considers that infringements can be justified for reasons of public health, pursuant to Art. 52/56/62 TFEU [concerning establishment, provision of service and movement of capital], or over-riding requirements. While arguments in that respect (e.g. public health, hygiene and environmental protection) might not be evident in many cases, they are in the case at hand.”

“(69) The provision of water and waste water services, as governed by European legislation, is considered to be of a special kind based on public policies to ensure public health and a high level of hygiene as well as a high level of environmental protection”.

“(70) The Commission notes that, under German federal law water supply and waste water services are declared essential public services (Aufgaben der Daseinsvorsorge) which have to be offered by legal entities governed by public law. They are, in compliance with EU legislation, an obligation of a special kind which falls on local municipalities to guarantee appropriate handling.”

“(71) The Commission has already recognised the special and strategic nature Member states attribute to water and waste water services in its case practice. It is of utmost importance that water and waste water services are offered at a high standard, all the more in view of the fact that the all households and companies connected to one single network would be affected and suffer from any shortcomings, just to mention public health and environmental risks associated with untreated sewage.”

The Commission concluded that the relevant German law could be qualified as “(72) as over-riding reasons in the meaning of standing case law.”

Then it went on to assess whether the measures in question were proportionate.

“(74) In accordance with the case law, it lies within the discretion of the Member States to decide on the degree of protection which they wish to afford to public health and on how that protection is to be achieved, as long as the conditions of proportionality and non-discrimination that apply to them are satisfied. In particular, for a measure to be in line with the market freedoms, the Court requires that the measure under assessment is appropriate, i.e. that it genuinely reflects a concern to attain the objective pursued in a consistent and systematic manner. Standing case law has outlined that in order to assess whether national legislation is proportionate, it is necessary to determine the level of protection desired by the respective Member State and whether there are less restrictive means of achieving the same level of protection.”

The Commission also noted that “(76) the mere fact that a Member State (or an entity of the same Member State but competent for a different geographical region) has opted for a system of protection which differs from that adopted by another Member State or geographical region, cannot affect the assessment of the need for and proportionality of the relevant provisions. Those provisions must be assessed solely by reference to the objectives pursued by the competent authorities of the Member State concerned and the level of protection which they seek to ensure.”

“(78) The Commission notes that the monopoly adopted by the German authorities, that is by the WWAV, is non-discriminative, since it excludes competition for national and European providers alike. In the context of direct awards for service concession contracts, the Court of Justice has indeed ruled that in case private shareholders are considered by the public authorities, which are to set up a semi-public in-house provider, the tendering procedure concerning the shareholding shall be consistent with the principles of free competition, transparency and equal treatment. However, the Commission notes that the entities founding Nordwasser as an in-house provider have not foreseen private shareholders and that there is no obligation which would have required them to do so. Therefore, the Commission concludes that the establishment of the legal monopoly complies with the relevant standards and legal requirements expounded by case law.”

On the basis of the above analysis, the Commission concluded that the “(79) legal monopoly was in line with the market freedoms, since the objective of protecting public health through the provision of a high level of water and waste water services were pursued in a proportionate and non-discriminative manner.”

Exclusion of competition not only on the market, but also for the market

“(81) Secondly, according to the NoA, the Commission must assess if the legal monopoly excludes not only competition on the market, but also for the market, in that it excludes any possible competition between different entities to become the exclusive provider of the service in question. In case a contract is awarded through a competitive procedure, there is competition for the market.”

“(82) The German authorities have confirmed that WWAV entered into a contract with Nordwasser based on an in-house set-up. Thus, no competitive procedure took place to choose the future exclusive provider of the services in question amongst potential competitors.”

“(83) As evident in the rulings in INPS and Arriva Italia, the Court of Justice considers that, as a general rule, following recital 188 NoA, a legal monopoly cannot be established merely based on the fact that the relevant authorities decided to enter into a contract by means of a direct award, unless they were required to award the operation of the services in question exclusively to one undertaking by legislative or regulatory measures. Only in such a case, based on legislative or regulatory measures, one could consider that there was no competition for the market. In case the relevant authorities retain the right to tender out the services in question, one cannot conclude that competition was excluded for the market.”

The judgment in the INPS case [C-659/17] was reviewed here on 13 August 2019

https://www.lexxion.eu/en/stateaidpost/aid-to-providers-of-local-services-through-exclusive-contracts-can-still-affect-cross-border-trade/

The judgment in the Arriva Italia case [C-385/18] was reviewed here on 14 January 2020

https://www.lexxion.eu/en/stateaidpost/exclusive-rights-and-legal-monopolies/

“(84) The Commission notes that, WWAV as the responsible entity to organise water and waste water services has put, […], a self-binding commitment in place concerning the direct contract to Nordwasser. This decision is explicitly spelled out in the byelaw enacted by the WWAV, […], which states that the association shall not permit any third party to operate or set up a service network for the public supply of water or waste water services in its territory.”

“(86) Moreover, the abovementioned Court rulings do not specify that the law or regulatory measure would need to be established by a different authority or at a different level than the contracting authority, […] more specifically, the Court has not stated or implied in a general way that legal monopolies cannot be established at regional or municipal level. In fact, the question which level or authorities would have been competent to enact measures to exclude competition for the market was not touched upon at all in either case. On substance, the Court has also not assessed a set-up similar to the case at hand, where a municipality would enjoy autonomy (as granted to it by the Constitution) in the organisation of certain services, including the possibility to impose certain obligations on itself, such as setting up a legal monopoly by means of a Satzung.”

“(87) Hence, the Commission considers that competition for the market was successfully excluded and concludes that the second criteria is fulfilled.”

No competition with other services

Thirdly, according to the NoA, the service in question must not be in competition with other services.

The Commission found that “(89) in the present case, there are no other services that would be in competition with the provision of water and waste water services in the relevant geographical area. The Commission has in various cases found that water and waste water infrastructure can be deemed a natural monopoly, as high investment costs would make its replication prohibitively expensive.”

“(90) The Commission therefore concludes that the third criterion is also fulfilled, as the service is not in competition with other services.”

No cross-subsidisation

“(91) Fourth, according to the NoA, a legal monopoly does not prevent the operator from conducting other activities than the ones in question. However, in such a case, the Commission recalls that cross-subsidisation must be excluded by allocating costs and revenues of different activities separately so that public funding provided for the service subject to the legal monopoly cannot benefit other activities.”

“(92) The German authorities have demonstrated that Nordwasser has a separate accounting system in place as a means to exclude cross-subsidisation. In addition, Nordwasser’s activities, which are not related to the provision of water and waste water services are of ancillary nature and minor from an economic point of view.”

Conclusion

“(94) In view of the above, the market for water and waste water services is not open for competition. As a result, there is no need to examine the other cumulative conditions for the existence of State aid within the meaning of Article 107(1) TFEU. The Commission therefore reaches the conclusion that the measure in question (the remuneration paid to Nordwasser) does not constitute State aid pursuant to Article 107 (1) TFEU.”

Shareholding structure of Nordwasser and possible indirect aid to RVV

The next aspect of the case that was assessed by the Commission was whether the institutional relationship between Nordwasser and RVV and WWAV led to leakage of State aid.

“(95) In order to assess whether the legal set-up and agreements in place between RVV and WWAV concerning the shareholding structure and split of profits generated by Nordwasser constitutes State aid as described above, the Commission considers it appropriate to assess first if, based on the shareholding agreement between RVV and WWAV concerning Nordwasser’s profits, RVV benefits from an economic advantage through state resources.”

“(96) The Hansestadt Rostock, a German municipality, is RVV’s only shareholder, hence RVV is 100% publicly owned. The Commission notes that RVV is a set-up as a holding company. Through its operative subsidiaries, it is active in numerous activities, several of which can be considered economic activities.”

“(97) Against this background, the Commission concludes that any measures in favour of RVV have to be examined for State aid implications, as they may provide RVV with a potential competitive advantage. More specifically, RVV must be considered as a recipient of State aid in case state resources are allocated to the undertaking in a way that does not correspond with market terms.”

“(98) As a matter of principle, if the State is able, by exercising its dominant influence over a public undertaking, to direct the use of its resources in order, as occasion arises, to finance specific advantages in favour of other undertakings, these resources are considered state resources.”

At this point the decision cites an article on the State Aid Uncovered blog that reviewed case C-150/16, Fondul, concerning transfer of state resources. Unfortunately, the link in the decision is not correct. The article was published here on 6 June 2017

https://www.lexxion.eu/en/stateaidpost/transfer-of-state-assets-between-state-owned-companies/

“(99) The Commission notes that in this case, only public authorities (municipalities) exercise supervision over the management of RVV, […] Against this background, RVV’s public owner – Hansestadt Rostock – is able, by exercising its dominant influence over it, to direct RVV’s profits gained based on the split of profits concerning Nordwassser, in order, as occasion arises, to finance specific advantages in favour of other undertakings, which are part of RVV holding structure.”

“(100) Accordingly, the allocation of profits at the level of RVV must be considered as State resources.”

“(101) The Commission notes that when Nordwasser was set up, RVV held 51% of the shares, WWAV 49%. The latter was entitled to 20% of the profits, RVV to 80% of them.”

“(102) Such a distribution of profits, which does not correspond to the shareholding structure, is not in line with the behaviour of two independent entities, which set up a jointly owned subsidiary in free competition, unless the shareholder, which is entitled to more profit than its corresponding shareholding, bears a higher risk (e.g. being the only shareholder to absorb losses) or contributes with additional assets to the newly established subsidiary so that the other, independent shareholder of the said subsidiary would accept such deviated profit allocation under conditions of free competition. The Commission did not receive any evidence by the German authorities that this holds true for RVV.”

“(103) Accordingly, the Commission is of the view that, in principle, an allocation of 80% of Nordwasser’s profits to RVV as 51% shareholder could convey an economic advantage on RVV. Based on the indicators concerning imputability laid down in case law, in view of the 100% public ownership of RVV, the actual dominant influence and involvement of Hansesstadt Rostock and the private law status of RVV, this advantage must be considered as imputable to the state.”

“(104) However, the German authorities confirmed that this disproportionate allocation of Nordwasser’s profit was amended by its shareholders before Nordwasser became operational on 1 July 2018.”

“(105) By aligning the allocation of Nordwasser’s profits to the corresponding shareholdings of RVV and WWAV, the shareholders agreed to a profit allocation that independent companies would establish in free competition.”

“(106) This amendment of the profit allocation became effective before Nordwasser started its operations on 1 July 2018. A company cannot distribute its profits before it has generated them through its operations. Nordwasser was in a position to do so only after it started operations on July 2018. At this point in time, based on the revised shareholding structure, RVV was only entitled to a share of profits to an extent which independent companies would established in free competition.”

The Commission also noted that Nordwasser was neither economically, nor legally in a position to distribute profits before 1 July 2018. Therefore, no advantage was conferred to RVV before June 2018.

“(112) The Commission therefore reaches the conclusion that the measure in question (shareholding structure) does not constitute State aid pursuant to Article 107 (1) TFEU.”

Overall conclusion

Since the public funding of Nordwasser did not affect trade and distort competition and RVV did not receive any advantage, the Commission concluded that no State aid had been granted.


[1] The full text of the Commission decision can be accessed at:

https://ec.europa.eu/competition/state_aid/cases1/202131/273180_2302910_239_2.pdf


Photo by Ivan Bandura 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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