Perhaps the most important aspect of the compatibility of State aid with the internal market is the presence of incentive effect. That is, the aid is capable of changing the behaviour of the recipient. If it does not, then public money is wasted because it has no effect on what happens on the market anyway.
In principle, in order to determine whether aid has an incentive effect, it is first necessary to establish what the recipient would do without the aid. This is the counterfactual scenario, which must be included with convincing evidence, in any notified measure to the European Commission.
However, for the vast majority of aid measures that are implemented without prior notification – i.e. those that are based on a block exemption regulation – Member States have to verify the incentive effect of the aid by confirming, among other things, that the aid application is submitted before the start of any work on the project for which they seek aid.
On 15 December 2022, the Court of Justice surprised us with a judgment that held that State aid may have an incentive effect even if the project has already started or even completed. That was the judgment in case C-470/20, Veejaam & Espo v Elering, which was a request for a preliminary ruling by the Estonian supreme court.
I will argue, however, that the judgment may lead to some perverse results.
Veejaam and Espo, two undertakings producing hydroelectricity, disputed the decisions of Elering, the Estonian authority responsible for granting renewable energy subsidies.
In October 2014, the Commission found an Estonian scheme for electricity produced from renewable sources [RES] to be compatible with the internal market in compliance with the 2014 guidelines on State aid for environmental protection and energy [EEAG].
In December 2017, the Commission found certain amendments to that scheme also to be compatible with the internal market. Neither the initial scheme, nor the subsequent amendment had been notified to the Commission.
In 2015, Veejaam replaced two generating units with a new turbine generator, installed on the power plant’s old dam, with the result that only a single measuring point remained of the previous units. In January 2016, Veejaam applied to Elering for a renewable energy subsidy. The application was rejected on the grounds that, among other things, the aid in question could be paid only in respect of electricity produced by a completely new generating unit.
In 2016, Espo also submitted an application for a renewable energy subsidy relating to energy produced at its existing plant with a new turbine. Its application was rejected for the same reasons as that of Veejaam.
Veejaam and Espo launched legal action against Elering’s decisions culminating to an appeal before the Estonian supreme court. That court stayed proceedings and submitted a request to the Court of Justice for a preliminary ruling on the interpretation of the EEAG.
The binding nature of Commission decisions
Before the Court of Justice answered the questions put to it by the referring court, it noted that although only national courts may interpret national law, they are bound by Commission decisions – i.e. in this case the 2014 decision and the 2017 decision – and the EU case law. So in adjudicating the dispute before it, the Estonian supreme court could not deviate from EU law, including the relevant Commission decisions. [paragraph 26 of the judgment]
The incentive effect of aid and submission of the application for aid after the start of work
The referring court asked whether the EEAG permitted an undertaking to obtain State aid even if the application was submitted after work had started on the project concerned.
The Court of Justice observed that according to “(28) paragraph 49 of the 2014 Guidelines, aid for renewable energy can only be found compatible with the internal market if it has an incentive effect. An incentive effect occurs when the aid induces the beneficiary to change its behaviour and that change in behaviour would not be undertaken without the aid. Thus, according to paragraph 50 of those guidelines, the Commission considers that aid does not present an incentive effect for the beneficiary in all cases where work on the project concerned had already started prior to the submission of the aid application by the beneficiary to the national authorities.”
“(30) In adopting such guidelines and announcing by publishing them that they will apply to the cases to which they relate, the Commission imposes a limit on the exercise of that discretion and cannot, as a general rule, depart from those guidelines, at the risk of being found to be in breach of general principles of law, such as equal treatment or the protection of legitimate expectations. That said, the Commission cannot waive, by the adoption of guidelines, the exercise of the discretion that Article 107(3)(b) TFEU confers on it. The adoption of a document such as the 2014 Guidelines does not, therefore, relieve the Commission of its obligation to examine the specific exceptional circumstances relied on by a Member State, in a particular case, for the purpose of requesting the direct application of Article 107(3)(b) TFEU, and to provide reasons for its refusal to grant such an application for aid”. [Here the Court cited case Kotnik, C-526/14, which concerned the application of Article 107(3)(b) to Slovenian banks.]
“(31) It follows from the foregoing, on the one hand, that the effect of the adoption of the guidelines contained in the 2014 Guidelines is equivalent to the effect of a limitation imposed by the Commission on itself in the exercise of its discretion, so that, if a Member State notifies the Commission of proposed State aid which complies with those guidelines, the Commission must, as a general rule, authorise that proposed aid. On the other hand, the Member States retain the right to notify the Commission of proposed State aid which does not meet the criteria laid down by those guidelines and the Commission may authorise such proposed aid in exceptional circumstances”.
“(32) It follows that the 2014 Guidelines are not capable of imposing independent obligations on the Member States, but do no more than establish conditions, designed to ensure that aid for renewable energy is compatible with the internal market, which the Commission must take into account, in accordance with the case-law […], in the exercise of the discretion that it enjoys under Article 107(3)(b)TFEU. Accordingly, […], the Commission acts within the framework of that discretion by declaring compatible with the internal market an aid scheme in respect of which the requirement of an incentive effect is met otherwise than by submission of the aid application before the start of the work.”
The Court of Justice concluded that “(33) paragraphs 49 and 50 of the 2014 Guidelines must be interpreted as not precluding national legislation establishing a renewable energy support scheme allowing an applicant for aid to obtain payment of that aid even if the application was submitted after work had started on the project concerned.”
The Court did not elaborate on how the aid could have had an incentive effect when the application was submitted after the start of work. However, it provided a more explicit guidance in its next reply to the referring court.
Incentive effect and the need for aid in order for the investment to be undertaken
The next question submitted by the referring court was whether the aid had an incentive effect if, without the aid, the investment could not have been undertaken.
The Court, first, recalled that “(35) according to paragraphs 51 and 52 of the 2014 Guidelines, at the time of the aid application, applicants must describe, in the form adopted by the competent authorities, their situation without the aid, that situation constituting the counterfactual scenario. In addition, when the competent authority receives the application, it must assess the credibility of that scenario and confirm that the aid has the required incentive effect. A counterfactual scenario is credible if it is genuine and relates to the decision-making factors prevalent at the time of the decision by the beneficiary regarding the investment.”
“(36) Thus, it is not apparent from the wording of those paragraphs that the aid applied for, with a view to making an investment necessary to enable an economic operator to meet the stricter terms laid down for obtaining an environmental approval, does not present an incentive effect in all cases. In those circumstances, it must be found that the change to the terms of environmental approval, in the event that the aid were not to be paid, is one of the factors which the national authorities must take into consideration when assessing the credibility of the counterfactual scenario.”
The statement of the Court in paragraph 36 is puzzling and difficult to understand for the following two reasons. First, paragraph 50 of the EEAG states unambiguously that in “all” cases the application must be submitted before the start of work. Therefore, logically the two subsequent paragraphs describe how the incentive effect is assessed after the application is submitted but before work has started. This is ignored by the Court. Second, aid that enables an economic operator to meet stricter environmental terms normally lacks incentive effect because the operator would incur the extra costs anyway.
However, the Court of Justice went on to take into account the ability of the operator to undertake the extra investment.
“(37) In the present case, it is apparent from the order for reference that Veejaam, which is the only applicant in the main proceedings concerned by the second question referred for a preliminary ruling, first, made an investment consisting in the replacement of the existing generating unit by a new generating unit in order to fulfil the new terms imposed by the Estonian legislation for obtaining the environmental approval necessary for electricity production and, secondly, claims that that investment was made possible only by the prospect of being granted the aid for renewable energy.”
“(38) In those circumstances, […], it will be for the referring court to determine the credibility of the counterfactual scenario submitted by Veejaam and, in particular, to verify the likelihood that that company would have ceased its activity had it not obtained the aid at issue. In the context of that assessment, the referring court is required, […], to comply with the conditions laid down in the 2014 Decision and the 2017 Decision. It is for that court, when examining the credibility of that scenario, to analyse a range of relevant factors and data such as Veejaam’s income and expenditure, in the absence of aid, in order to produce electricity in accordance with the new terms for obtaining the environmental approval at issue.”
“(39) In the light of those considerations, […] State aid may have an incentive effect where the investment made by an economic operator in order to comply with a change to the terms of environmental approval, that approval being necessary for the operator’s activity, would probably not have been made without payment of the aid concerned.”
In other words, the Court concluded that if an operator cannot bear the extra cost of stricter terms, then State aid may have an incentive effect because without the aid that operator would cease production of electricity.
The Court seems unaware that this conclusion leads to a perverse result. An efficient producer who is able to bear the extra costs of the stricter terms would not qualify for the aid or would qualify for less aid. An inefficient producer that is unable to bear the extra costs would, by contrast, qualify for the aid or for a larger amount of aid.
In addition, the conclusions of the Court of Justice are pertinent only in situations where the environmental improvement is unobtainable without the aid also in the counterfactual situation and the operator would exit the market without the aid, as a result of stricter terms. However, if there is no environmental harm in the counterfactual scenario of no aid and the operator exits the market, then State aid serves no public policy purpose.
New or existing aid
The referring court also wanted to know whether the extension of the scheme in question resulted in new aid. This is a perennial question, yet it is rather clear both in the procedural regulation [Regulation 2015/1589] and in the case law that any alteration of an existing aid measure results in new aid. An existing aid scheme is altered when its terms are modified in a way that it affects its compatibility with the internal market [i.e. the conditions authorised by the Commission are modified] or its budget is increased by more than 20%. As may be recalled in this case, although the scheme and its subsequent extension were implemented in violation of Article 108(3) TFEU, the Commission still found them to be compatible with the internal market. Therefore, the aid was illegal until its compatibility was confirmed by the Commission.
The Court of Justice pointed out that “(43) the period of validity of existing aid is a factor likely to influence the evaluation, by the Commission, of the compatibility of that aid with the internal market”. “(44) Thus, extension of the duration of existing aid must be considered to be an alteration of existing aid and therefore, in accordance with Article 1(c) of Regulation No 2015/1589, constitutes new aid”.
“(45) In the present case, […], first, […] that scheme was to be implemented only until 31 December 2014, secondly, […] it was by taking that date into account that the Commission carried out its assessment in the 2014 Decision and, thirdly, […] the Republic of Estonia maintained that scheme in force during 2015 and 2016, that is, after 31 December 2014.”
“(46) Thus, in the light of the definition of the concept of existing aid, […], it must be held that the old scheme could be classified, after the adoption of the 2014 Decision and until 31 December 2014, as existing aid, since it had been found by that decision to be compatible with the internal market.”
“(47) By contrast, during the period between 1 January 2015 and the date of adoption of the 2017 Decision, which found that that scheme was compatible with the internal market including after its period of validity had been extended, the scheme must be classified as new aid within the meaning of Article 1(c) of Regulation 2015/1589 and ought, therefore, to have been notified to the Commission in accordance with Article 108(3) TFEU.”
Therefore, pursuant to “(48) Article 1(b) and (c) of Regulation 2015/1589, […] an existing aid scheme, the compatibility of which with the internal market has been established by a Commission decision, must be classified as ‘new aid’, within the meaning of Article 1(c) of that regulation, where that scheme is applied beyond the date which the Member State concerned had indicated to the Commission, in the context of the procedure for the assessment of the aid closed by that decision, as the date on which the scheme would cease to be applied.”
In other words, the extension of the period of validity of the scheme beyond the date approved by the Commission resulted in illegal aid. Indeed, this is confirmed by the Court in its reply to the last question of the referring court.
Timing of the granting of the aid and the consequences of granting illegal aid
The last question of the referring court was interesting. It asked whether aid could be granted after the expiry of an authorised scheme to an investment that was made before the expiry of that scheme.
The Court of Justice, first, noted that “(54) the old scheme may be classified, between 1 January 2015 and the date of adoption of the 2017 Decision, as ‘new aid’ within the meaning of Article 1(c) of Regulation 2015/1589, and that since that aid was implemented in breach of the obligation to notify laid down in Article 108(3) TFEU, it may be considered unlawful during that period. It is only after that scheme was found compatible with the internal market by the 2017 Decision that the scheme may be classified as ‘existing aid’ within the meaning of Article 1(b) of that regulation.”
“(55) Next, the prohibition laid down by Article 108(3) TFEU is designed to ensure that a system of aid cannot become operational before the Commission has had a reasonable period in which to study the proposed measures in detail and, if necessary, to initiate the procedure provided for in Article 108(2) TFEU. Article 108(3) TFEU thus institutes prior control of plans to grant new aid“.
“(56) In a situation where the Commission has, in relation to aid implemented in breach of Article 108(3) TFEU, adopted a final decision finding that that aid is compatible with the internal market pursuant to Article 107 TFEU, the Court has held that the Commission’s final decision does not have the effect of regularising, retrospectively, implementing measures which were invalid because they had been taken in disregard of the prohibition on implementation laid down by the last sentence of Article 108(3) TFEU.”
“(57) In such a situation, EU law requires the national courts to order the measures that are appropriate effectively to remedy the consequences of the unlawfulness. ”
“(58) That said, a distinction is to be drawn, in terms of the effects of implementation of aid in disregard of Article 108(3) TFEU, between the recovery of unlawful aid and the payment of illegality interest in respect of that aid”.
“(59) First, as regards the recovery of unlawful aid, premature payment of unnotified aid does not contradict the aim of ensuring that incompatible aid is never implemented, upon which Article 108(3) TFEU is based, where the Commission adopts a final decision finding that aid to be compatible with the internal market. Therefore, the national courts are not bound to order recovery of that aid”.
“(60) Secondly, the national courts are bound, under EU law, to order the aid recipient to pay interest in respect of the period of unlawfulness of that aid. That obligation, which is incumbent on the national courts, stems from the fact that the implementation of aid in breach of Article 108(3) TFEU gives the aid recipient an undue advantage consisting, first, in the non-payment of the interest which it would have paid on the amount in question of the compatible aid, had it had to borrow that amount on the market pending the Commission’s final decision, and, secondly, in the improvement of its competitive position as against the other operators in the market while the aid concerned is unlawful.”
“(61) Since, […], it cannot be precluded that an economic operator may benefit from the premature payment of the aid implemented in breach of the obligation to notify laid down in Article 108(3) TFEU, where the Commission adopts a final decision finding that that aid is compatible with the internal market, that provision also does not preclude that operator from obtaining that aid in respect of the period prior to such a Commission decision, as from that point at which the operator applied for the aid.”
On the basis of the above reasoning, the Court of Justice concluded that “(66) Article 108(3) TFEU must be interpreted as not precluding the granting of an application made by an economic operator for payment of State aid, implemented in breach of the obligation to notify laid down in that provision, first, in relation to the period prior to the Commission decision establishing that that aid was compatible with the internal market and, secondly, when that operator applied for the aid at a time when that aid was unlawful, since the aid had not been notified to the Commission, whereas the investment to which the aid was linked was made at a time when that scheme was lawful, since it had been found to be compatible with the internal market by a Commission decision, provided that, in both situations, the beneficiary of the aid pays the interest on any sums received, in respect of the period in which the aid is considered unlawful.”
This is an important judgment because of its interpretation of the concept of incentive effect. However, this interpretation seems to be appropriate only in certain situations and may also lead to the perverse result of supporting inefficient operators.
 The full text of the judgment can be accessed at: