Compensation for the Net Cost of Public Service Obligations (Part I)

Public service obligations must be imposed through an act of entrustment that defines clearly the terms of the service and the duration of the obligation.

The “reasonable profit” in the public service compensation should reflect the risk borne by the provider.

Introduction

In 2009, the Commission received several complaints concerning State aid that Italy had granted to the various shipping companies in the former state-owned Tirrenia group. The aid was in the form of compensation for public service obligations. Those complaints triggered several Commission investigations that led to a number of different decisions most of which found that the aid was compatible with the internal market, although in some cases the aid was incompatible with the internal market and had to be recovered.

Interestingly and rather exceptionally, the Commission also found that some of the aid measures were free of State aid because they conformed with the four Altmark conditions [see Decision 2020/1412 on Tirrenia; Decision 2021/4268 on Siremar and Toremar].

In addition, in previous decisions the Commission investigated the possible existence of State aid in favour of undertakings that in the meantime had acquired some of the aided shipping companies.

In the present case, the Commission also had to examine conformity with the Altmark conditions and the presence of State aid in the sale of Laziomar to CLN, shipping operator. This was because when CLN acquired the assets of the Laziomar, at the same time it was also encumbered with the obligation to provide public services in return for adequate compensation.

Another issue that had to be taken into account by the Commission was a berthing priority enjoyed by Laziomar, that was not available to other private ferry companies.

The Commission investigation in the measures in favour of Laziomar resulted in Decision 2022/1328 which is reviewed in this article.[1]

Italy argued that the public measures that were investigated by the Commission did not contain State aid because the public service compensation conformed with the Altmark conditions. Even if it did not conform with those conditions, any aid was compliant with the requirements of the 2012 SGEI Decision [Commission Decision 2012/21]. The number of passengers carried by Laziomar did not exceed the annual threshold of 300,000 per year laid down by Article 2(1)(d) of the 2012 Decision. With respect to the berthing priority, Italy stated that all ferry companies paid berthing fees. As for the sale to CLN, Italy insisted that a market price was paid, as CLN was chosen following a competitive selection procedure.

This article is divided into two parts. Part I reviews the assessment for the existence of State aid. Part II reviews the assessment of the compatibility of the aid with the internal market.

Part I

The Commission divided the measures it examined into two categories: The successive prolongations of an old contract and the award of a new contract.

Existence of State aid in successive prolongations of public service contracts

The critical issue here was whether Laziomar obtained an advantage in the meaning of Article 107(1) TFEU. Italy claimed that the compensation conformed with the Altmark conditions. Since the four Altmark conditions are cumulative, the Commission chose to examine the fourth condition, according to which the recipient of the public service compensation is chosen on the basis of a competitive selection procedure or the compensation is calculated by reference to the costs of an efficient undertaking in the same sector.

The Commission concluded that the fourth condition was not satisfied because no tender procedure had been organised before the contracts were awarded to Laziomar and because no information had been submitted by Italy to prove that the compensation had been determined on the basis of an analysis of the costs of a “typical undertaking, well run and adequately provided”. [paragraphs 158 & 159 of the Commission Decision]

Since the Commission found that all of the criteria of Article 107(1) applied, the successive prolongations of public service contracts constituted State aid.

The Commission also found that the berthing priority constituted State aid because it conferred an advantage that was financed through loss of state resources. The priority had economic value for which Laziomar did not pay any fee extra to the standard fee paid by all ferry operators. [para 162]

Existence of State aid in the award of a new public service contract bundled with Laziomar’s business

For this measure too, the Commission had to examine whether it conformed with the four Altmark conditions.

Condition 1: Genuine service of general economic interest [SGEI]

Since there is no EU definition of SGEI, the Commission first noted that “(171) national authorities are therefore entitled to take the view that certain services are in the general interest and must be operated by means of public service obligations to ensure that the public interest is protected when market forces do not suffice to guarantee that they are provided at the level or conditions required.”

Given that in the case of maritime services there are specific EU rules, the Commission based its assessment on the following criteria:

“(177): […]

(1) Whether there was user demand;

(2) Whether that demand was not capable of being satisfied by the market operators in the absence of an obligation imposed by the public authorities (existence of a market failure)

(3) Whether simply having recourse to public service obligations was insufficient to remedy that shortage (least harmful approach).”

User demand: There was indeed user demand that was evident by the number of passengers per year on each of the routes operated by Laziomar.

Existence of market failure: The SGEI Communication, paragraph 48, makes it clear that a public service obligation may not be imposed when the market provides the service adequately in terms of price, quality, frequency, geographic coverage, etc. In this case, the Commission noted that “(187) other operators offered ferry services on some of the routes subject to the new public service contract albeit not necessarily throughout the entire year, with the same frequency and same type of service.” The Commission also detected “(190) major differences concerning the type, the regularity, the capacity and the price of the services offered” by other ferry operators.

Least harmful approach: The imposition of public service obligations and the provision of compensation were unavoidable as “(196) the operation of most routes, especially in the low season, is lossmaking, so that without public service compensation they would not be operated at all.”

The berthing priority was found to be necessary for maintaining the regularity and promptness of operations that was part of the definition of the public service.

Condition 2: Pre-determined parameters of compensation

“(201) The Commission notes that the parameters at the basis of the calculation of the compensation have been established in advance and observe the transparency requirements in line with the second Altmark criterion.”

“(202) More specifically, the parameters on the basis of which the compensation was calculated are explained in detail in the CIPE Directive and have been applied in the new public service contract (and annexes thereto) while the maximum compensation amounts are laid down in the 2009 Law. The method of calculation of the compensation, including for instance the cost elements taken into account, are detailed in the CIPE Directive. Since the berthing priority does not entail financial compensation for Laziomar, the Commission considers that this measure complies with the Altmark 2.”

Condition 3: No over-compensation

The compensation may cover the net extra costs of the public service obligation, plus reasonable profit. The Commission, first, observed that “(205) the Altmark ruling does not provide a precise definition of the reasonable profit. According to the SGEI Communication, reasonable profit should be taken to mean the rate of return on capital that would be required by a typical company considering whether or not to provide the service of general economic interest for the whole duration of the period of entrustment, taking into account the level of risk. The level of risk depends on the sector concerned, the type of service and the characteristics of the compensation mechanism.”

The Commission had initially expressed doubts as to the rate of return on capital because “(206) the 6.5 % fixed risk premium did not reflect an appropriate level of risk because prima facie Laziomar did not appear to assume the risks normally borne in the operation of such services. More specifically, the cost elements for the purpose of calculation of the compensation include all costs involved in the provision of the service and variations in e.g. fuel prices have been taken into account.”

“(207) The Commission notes that certain aspects of the compensation method as laid down in the new public service contract, indeed seem to reduce the commercial risk incurred by Laziomar. In particular, the maximum fares that Laziomar can charge are adjusted annually to take into account inflation and reflect variations in the consumer price index. Moreover, the new public service contract contains certain clauses […] that aim at maintaining the economic-financial equilibrium of the public service. In particular, in case the public service compensation would be insufficient to cover the cost of the services entrusted by the new public service contract, these clauses allow to revise (i) the tariff system; (ii) the level of the public services offered; (iii) the level of the annual price cap; and (iv) the capital grants for investments.”

“(208) According to Article 25 of the contract, when there is a discrepancy in its economic and financial balance, Laziomar may request a rebalancing by submitting a proposal to the Region of Lazio.”

“(209) Although these safeguards seem to reduce the commercial risk incurred by Laziomar, the Commission considers that the company remains exposed to the risk that the compensation may not be sufficient to cover the costs of running the service. The rebalancing proposal may not always be accepted … Until a decision is adopted, Laziomar must continue to operate the public service unaltered. Indeed, as submitted by Italy, this mechanism is difficult and very strict to apply, and therefore Laziomar has so far not used this possibility.”

“(210) In addition, the Commission notes that not all cost categories are subjected to a rebalancing contribution. Particularly, according to Article 25 of the public service contract, the costs related to managerial inefficiencies, the financial charges, any increases in staff unit costs to meet labour legal requirements and any costs related to the commercial policy applied by Laziomar should be borne by Laziomar itself. Therefore, Laziomar remains incentivised to perform efficiently and at the least cost to the community.”

Then the Commission found that the compensation that had been received by Laziomar implied that the remuneration of capital was zero (0) instead of 6.5%. [paras 211 & 212]

But the Commission still compared the rate of 6.5% “(214) with the median return on capital generated by a benchmark group in 2013 (the year before Laziomar’s entrustment). The benchmark group consists of selected ferry operators that offered maritime connections within Italy or between Italy and other Member States. The analysis shows that the return on capital applied to Laziomar is similar to the median return generated by the companies in the benchmark group. This comparison illustrates that in the year before Laziomar’s entrustment, a 6.5% return on capital was not unreasonable.”

Condition 4: Competitive selection or efficient operator

What made the assessment of compliance with the fourth Altmark condition particularly challenging was that the maximum annual amount of public service compensation had been set in advance at EUR 10 million per year. In addition, the call for expressions of interest indicated that the objective was to sell Laziomar at a fixed price of EUR 2.3 million. That price was based on valuation performed by an independent expert and was not negotiable. Therefore, the successful bidder would be the one who would request the smallest annual amount under the EUR 10 million ceiling.

The Commission assessed whether the tender procedure used by Italy was competitive, transparent, non-discriminatory and unconditional. “(223) To make this assessment, the Commission relies on the relevant guidance set out in its Notion of Aid Communication (in particular in its paragraphs 89 et seq.) and the SGEI Communication (in particular in its paragraphs 63 et seq.).”

Competitive and transparent procedure: A tender procedure has to be competitive to allow all interested and qualified bidders to participate in the process. Furthermore, the procedure has to be transparent to allow all interested tenderers to be equally and duly informed at each stage of the tender procedure [information has to be accessible, the tender has to be well-publicised, interested tenderers must be given sufficient time to prepare their offers, the selection and award criteria must be clear]. These conditions were satisfied in the present case. In addition, the Commission considered that a requirement for bidders to guarantee the continuity of the service was justified in the light of the objective of the measure. [para 227]

Non-discrimination: Bidders must be treated equally and selection and award criteria must be objective. In this case, all bidders [there were 7] were treated equally.

Services are provided at the least cost to the community: The first part of the fourth Altmark condition requires that the selected operator must be capable of providing the service at the least cost to the community. Italy chose the most economically advantageous offer. “(241) In relation to the use of the most economically advantageous offer, paragraph 67 of the SGEI Communication indicates that the ‘most economically advantageous offer’ is deemed also (in addition to the ‘lowest price’) sufficient to satisfy fourth Altmark criterion ‘[…] provided that the award criteria […], are closely related to the subject matter of the service provided and allow for the most economically advantageous offer to match the value of the market.”

In the case of Laziomar, Italy ranked offers on the basis of scoring of technical and financial aspects. The Commission concluded that “(243) the use of the most economically advantageous tender for the service concerned bundled with the sale of the Laziomar business enabled Italy to create effective competition and obtain a service with the highest possible value at the least cost to the community. In this regard, the Commission takes note of the fact that the annual remuneration that was awarded to CLN for the provision of the maritime service has been much lower than the maximum yearly compensation amount suggested by the Region of Lazio at the start of the tender.”

Strong safeguards in the design of the procedure where only one bid is submitted

The Commission still had to determine whether the procedure resulted in a market price because only one bidder – Laziomar – submitted an offer. Several other bidders expressed interest but only one eventually made a formal offer. Paragraph 68 of the SGEI Communication states that “in the case of procedures where only one bid is submitted, the tender cannot be deemed sufficient to ensure that the procedure leads to the least cost for the community”. The Commission itself acknowledged that it “(255) nuanced the position expressed in paragraph 68 of the SGEI Communication in its SGEI Guide by stating that ‘it does not mean that there cannot be cases where, due to particularly strong safeguards in the design of the procedure, also a procedure where one bid is submitted can be sufficient to ensure the provision of the service at ‘the least cost to the community’.”

“(256) The Commission considers that in the case under assessment, such safeguards were present. More specifically:

(1) The tender procedure was organised in such a way as to maximise interest from potential bidders. Furthermore, these potential bidders did not have to follow burdensome procedures and would not have had to incur significant costs to express their interest. […]

(2) Italy chose the restricted tender procedure to award the service contract, which is a two-stage process where only those operators that have been invited to the bidding stage may submit tenders. According to paragraph 66 of the SGEI Communication, ‘[…] a restricted procedure can also satisfy the fourth Altmark condition, unless interested operators are prevented to tender without valid reasons’. In fact, for this tender seven possible bidders (out of the eight that had initially expressed an interest) remained in the bidding phase, which shows that genuine competition was possible until the end of the tender procedure. […]

(3) The invitation to tender sent to the seven operators that had expressed an initial interest consisted of a fixed price for the sale of all the shares of Laziomar at EUR 2 272 000, which was not subject to review in the light of any offer of any kind . […] In addition, the invitation to tender consisted of a maximum annual remuneration for the public service, set by the Region of Lazio, at EUR 14 300 550 per year, net of the VAT payable for 10 years. All participants were invited to submit better offers as regards this annual remuneration for the public service on the basis of certain technical criteria. This is a particularly strong safeguard to ensure not only that the lowest possible bid in terms of annual remuneration for the public service (and hence the least cost for the community) is obtained but also that bidders were not discouraged from submitting a bid.”

“(257) The Commission considers that given the above safeguards the tender procedure was sufficient to ensure the provision of the service at the least cost to the community even if only one bid was eventually submitted.”

Given that all of the Altmark conditions were satisfied, the contract that was awarded to Laziomar was free of State aid.

[1] The full text of the Decision was published in OJ L 200, 29/7/2022 and can be accessed at:

https://eur-lex.europa.eu/eli/dec/2022/1328/oj

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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 is professor at the University of Maastricht and the University of Nicosia. 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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