The Concept of “Undertaking in Difficulty” and Evidential Requirements

The “subscribed share capital” of a company includes the capital that is already paid and any future amount that shareholders have irrevocably committed to pay.

Introduction

Undertakings in difficulty may not receive any kind of aid except aid to compensate for damage caused by a natural disaster or exceptional occurrence and, under strict conditions, rescue and/or restructuring aid.

In most cases, an undertaking is in difficulty when it has lost more than half of its capital. This raises the question what is capital. This is not a trivial question because different Member States have different definitions of what constitutes capital and when shareholders’ money can be counted as capital that belongs to a company. The Court of Justice provided an answer to that question on 27 January 2022, in case C347/20, SIA Zinātnes parks. The answer of the Court is important because it “harmonises” to a certain extent the concept of capital across the EU.

The case arose form a request for preliminary ruling from a Latvian court. It concerned the application of Article 125(3)(a)(ii) of Regulation 1303/2013 on structural and cohesion funds [the Common Provisions Regulation [CPR] of the previous financial period]. Article 125 excluded from EU funding undertakings in difficulty. The referring Latvian court asked the Court of Justice to interpret the concept of “undertaking in difficulty”.

Background

Zinātnes parks, a Latvian limited liability company, had appealed against a decision of the Ministry of Finance of Latvia that rejected the application of Zinātnes parks for funding from a programme that was co-financed by the European Regional Development Fund [ERDF].


The full text of the judgment can be accessed at:

CURIA – Documents (europa.eu)


Zinātnes parks submitted its application on 30 April 2019. At the same time it informed the Ministry that its shareholders agreed to increase its capital. The Ministry rejected the application because it considered Zinātnes parks to be an “undertaking in difficulty” within the meaning of Article 2(18)(a) of Regulation 651/2014, the General Block Exemption Regulation [GBER].

The referring Latvian court explained that the parties agreed that if the information contained in Zinātnes parks’ most recent financial report, corresponding to 2018, were to be taken into account, Zinātnes parks would be classed as an “undertaking in difficulty”. However, after the increase of its share capital, Zinātnes parks no longer fulfilled any of the criteria of an “undertaking in difficulty”.

The two parties disagreed on whether the entry of the increase in share capital in the Commercial Register of Latvia and the evidence offered by Zinātnes parks during the procedure for examining project applications should have been taken into account by the Ministry. Also there was disagreement on the interpretation of the concept of “subscribed share capital” in Article 2(18)(a) of the GBER.

What is subscribed share capital?

The Court of Justice, first, confirmed that indeed Article 3 of the CPR [Regulation 1301/2013] excludes undertakings in difficulty.

Then it noted that the definition of an “undertaking in difficulty” in Article 2 of the GBER sets out a number of alternative criteria, including accumulated losses of more than half of the subscribed share capital. However, the concept of subscribed share capital is not defined in the GBER.

The Court explained that “(42) both the uniform application of EU law and the principle of equality require that the terms of a provision of EU law which makes no express reference to the law of the Member States for the purpose of determining its meaning and scope must normally be given an autonomous and uniform interpretation throughout the European Union. In addition, the meaning and scope of terms for which EU law provides no definition must be determined by reference to their usual meaning, while also taking into account the context in which they occur and the purposes of the rules of which they are part”.

“(43) In that regard, it must be stated that, in the context of limited liability companies, the expression ‘share capital’ refers, in its usual sense, to the value of the contributions which the members or shareholders of a company have made available or have undertaken to make available to that company, in return for being issued with shares. As for the term ‘subscribed’, it is generally used to designate the sum which current or future members or shareholders have irrevocably committed to contributing to the company, regardless of whether or not the corresponding contributions have already been paid up. It is only when that word is in turn followed by the adjective ‘paid up’ that, by way of exception, the expression ‘subscribed share capital’ is used to refer only to the share capital actually paid by those members or shareholders.”

“(44) It follows that, in so far as Article 2(18)(a) of Regulation No 651/2014 uses the words ‘subscribed share capital’ without further specification, those words must be understood as referring to all the contributions which current or future members or shareholders have already made or have irrevocably undertaken to make.”

“(45) That conclusion is confirmed by the objectives pursued by Regulation No 651/2014, read in context.”

“(46) In that regard, it should be recalled that the alternative criteria for defining the concept of ‘undertaking in difficulty’, set out in Article 2(18) of Regulation No 651/2014, seek to clarify the scope of Article 1(4) of that regulation, according to which that regulation does not apply to aid granted to undertakings in difficulty, with the exception of aid schemes to make good the damage caused by certain natural disasters.”

“(47) According to recital 14 of that regulation, the objective pursued in turn in Article 1(4) and, consequently, by the concept of an ‘undertaking in difficulty’ is to ensure that aid granted to the undertakings concerned is assessed in the light of the guidelines specifically concerning State aid for rescuing and restructuring undertakings in difficulty, in order to prevent circumvention of those guidelines.”

“(48) In that regard, the Communication from the Commission concerning the Guidelines on State aid for rescuing and restructuring non-financial undertakings in difficulty (OJ 2014 C 249, p. 1), to which recital 14 of Regulation No 651/2014 expressly refers, states, in paragraphs 20 and 23 thereof, that ‘an undertaking is considered to be in difficulty when, without intervention by the State, it will almost certainly be condemned to going out of business in the short or medium term. […] Given that its very existence is in danger, an undertaking in difficulty cannot be considered an appropriate vehicle for promoting other public policy objectives until such time as its viability is assured’.”

“(49) In the light of the information in that communication from the Commission, the objective set out in recital 14 of Regulation No 651/2014 and the related criterion laid down in Article 2(18)(a) of Regulation No 651/2014 must be interpreted as seeking to assess the ability of the company concerned to maintain its activity in the short or medium term.”

“(50) Examination of that criterion therefore requires account to be taken of all the contributions which the members or shareholders have irrevocably undertaken to make. Even where they have not yet been paid up, those contributions represent, in the same way as the contributions that have been paid up, relevant information concerning the ability of the company concerned to maintain its activity in the short or medium term.”

“(51) Consequently, the concept of ‘subscribed share capital’ within the meaning of Article 2(18)(a) of Regulation No 651/2014 must be interpreted as constituting an autonomous concept which refers to all contributions which current or future members or shareholders of the company have made or have irrevocably undertaken to make.”

The case of Zinātnes parks

The Court of Justice went on to apply the concept of subscribed capital, as interpreted above, to the case of Zinātnes parks.

“(52) In the present case, it is apparent from the documents submitted to the Court, […], that a general meeting of the members of Zinātnes parks, prior to the submission of its project application to the competent national agency for funding under an ERDF co-financing programme, consented to an increase in its share capital by means of the contribution, by a specified member, within a specified period, of new shares with a share premium. In the light of the autonomous and uniform interpretation of the concept of ‘subscribed share capital’ set out in the preceding paragraph of this judgment, it is for the referring court to assess whether those facts, established at the time that project was submitted, demonstrate the existence of an irrevocable commitment on the part of those members to carry out that increase in capital on the basis of the criteria laid down for that purpose by the national law under which the company concerned was incorporated.”

In other words, although the Court of Justice, as is its normal practice, left it to the referring national court to verify the relevant facts, it also made it clear that if the increase in capital was binding, then Zinātnes parks might not have been an undertaking in difficulty. What we do not yet know is whether the capital increase was sufficient to repair the previous loss of capital and could also reduce the possible high indebtedness or low liquidity of Zinātnes parks. These are important issues because there are several non-cumulative indicators of financial difficulty.

What is the relevant evidence that the granting authority must consider?

Indeed, the troubles of Zinātnes parks were not necessarily over because the referring court also asked whether Article 3(3) of the CPR required managing authorities, when determining whether a project applicant was not in difficulty, to take account only evidence which conformed with the requirements for project selection as defined by the managing authority.

It is worth quoting at length what the Court of Justice had to say on the obligation of national authorities to base their decisions on reliable evidence. Although what the Court said concerned the management of structural funds, it is also applicable to State aid, given that many aid measures are co-financed by EU structural and investment funds.

First, the Court noted that “(56) Article 3(3) of Regulation No 1301/2013 merely states that the ERDF does not support undertakings in difficulty as defined by the EU rules on State aid. It must therefore be held that that provision does not contain any indication as to the nature of the evidence which may be taken into account in order to establish that an undertaking is not in difficulty.”

“(57) That said, it is apparent from the wording of Article 125(3) of Regulation No 1303/2013, which defines the role of the managing authorities responsible for the management of operational programmes, that those authorities are required to draw up and, once approved, to apply appropriate selection procedures and criteria, and are also required to satisfy themselves, inter alia, that the beneficiaries of the aid have the financial capacity to fulfil the conditions for support and therefore, in the case of ERDF support, that the beneficiaries are not ‘in difficulty’ within the meaning of Article 2(18) of Regulation No 651/2014.”

“(58) In order to comply with that obligation, the managing authorities must necessarily rely on information that is sufficiently reliable to rule out any reasonable doubt as to the financial situation of the companies concerned.”

“(59) As regards the determination of the precise nature of the evidence which may be taken into account, given that EU legislation contains no indication in that regard, it falls within the procedural autonomy of the Member States, since the competent national authorities have, in that regard, discretion in drawing up the project selection procedure.”

“(60) However, in accordance with the principles of equivalence and effectiveness, those evidential requirements must not be more demanding than those governing similar situations subject to domestic law, provided that such requirements, if applied, would make it possible to preserve the effectiveness of Article 3(3) of Regulation No1301/2013; nor should they make it excessively difficult or impossible in practice to exercise the rights conferred by EU law, in particular the right of every project holder to be able effectively to submit it in order to receive ERDF support”.

“(61) In so far as the procedure at issue in the main proceedings concerns the grant, in the context of ERDF programmes, of funding from the budget of the Union and that, as such, it constitutes a measure implementing EU law, it must also comply with the general principles of EU law, which include, in particular, the principles of equal treatment, transparency and proportionality which are of fundamental importance where a procedure involving economic operators is at issue”.

“(62) Compliance with the principles of equal treatment and transparency implies, in particular, that the same evidential requirements apply to all applicants for the same programme and that those requirements be made public […] As regards the principle of proportionality, under that principle, those requirements must not go beyond what is necessary to ensure that the substantive conditions laid down by EU law have been met”.

“(63) It is for the referring court to assess whether, in the present case, all of those conditions are satisfied. However, in order to guide it in that assessment, the Court may provide it with all the guidance as to the interpretation of EU law which may be useful to it”.

“(64) In that regard, it is apparent from the national legislation cited by the referring court that the classification as an ‘undertaking in difficulty’ must, in accordance with the requirements laid down in that legislation for the purposes of the selection procedure, be made solely in the light of the information contained in the most recent publicly available final annual report or, if an interim activity report approved by a sworn auditor is submitted by the project applicant, in the light of the information contained in that report. Where the project applicant refers to publicly available information concerning an increase in share capital undertaken after the most recent final annual report, that information will be taken into account where it is accompanied by an interim activity report approved by a sworn auditor.”

“(65) First of all, since a company may, in principle, have an interim report drawn up by a sworn auditor at any time without this representing a cost to the company which is so excessive that such a requirement would make it excessively difficult or impossible in practice for a company which was ‘in difficulty’, within the meaning of Article 2(18) of Regulation No 651/2014, when its most recent final annual report was drawn up to demonstrate that it is no longer in difficulty, such rules cannot, in principle, be regarded as contrary to the principle of effectiveness.”

“(66) Next, as regards compliance with the principles of equal treatment and transparency, it is not apparent from the documents before the Court that the referring court has doubts as to whether the requirements at issue in the main proceedings were duly disclosed or whether they are applicable without distinction.”

“(67) Lastly, as regards the principle of proportionality, having regard to the requirements surrounding the drawing up of annual reports, which contribute to the reliability of the information contained therein, and to the guarantees offered by a sworn auditor’s approval of interim activity reports, requiring a managing authority to base its decision exclusively on those types of documents does not appear to go beyond what is necessary to ensure that the condition laid down in Article 2(18) of Regulation No 651/2014 has been met.”

“(68) In those circumstances, EU law does not preclude, in principle, national legislation, such as that at issue in the main proceedings, from requiring a managing authority to assess the financial situation of an undertaking solely in the light of the information contained in the most recent publicly available final annual report of the company submitting the project application, and, where appropriate, in an interim activity report approved by a sworn auditor, provided that the interim activity report has been submitted to that authority, unless it is found that those requirements do not comply with the principle of equivalence, which is for the managing authority to determine.”

Requests for clarifications after submission of applications

The referring court asked whether Article 125(3) of the CPR precluded national legislation prohibiting requests or submission of clarifications after project applications were submitted.

The Court of Justice observed at the outset that “(71) the referring court does not specify whether, when it refers in the wording of its question to the submission of projects, it is referring to the deadline for submission of project applications laid down by national law or to the date on which the project application of a concerned project applicant was submitted. However, it is apparent from the documents before the Court that, in the case at issue in the main proceedings, Zinātnes parks submitted its file on the date of the deadline for submission of project applications laid down by national law. Accordingly, it does not appear necessary to examine the issue of whether EU law requires Member States to allow project applicants to provide clarifications after the submission of their project applications but before the deadline for submission of such applications. By contrast, that question arises in relation to clarifications that may be provided after that deadline.”

“(72) Next, it should be noted that Article 125(3)(d) of Regulation No 1303/2013 merely mentions that the competent managing authority must satisfy itself that each beneficiary of ERDF support has the administrative, financial and operational capacity to fulfil the conditions for support for each operation before approval of each operation, without specifying when that capacity must be assessed or when project applicants must provide that authority with the information necessary for the verification of that capacity.”

“(73) Given that EU law does not specify the deadline for providing the managing authorities with the necessary evidence, it is for the Member States to decide this within the limits laid down by the principles of effectiveness and equivalence, as well as by the obligation on every managing authority to ensure scrupulously compliance with general principles of law, which include the principles of equal treatment and transparency, referred to in Article 125(3) of Regulation No 1303/2013, as well as the principle of proportionality.”

“(74) As regards, in particular, the principles of transparency and equal treatment, it should be recalled that, where a Member State has set a deadline for project applicants to complete their file, those principles require the managing authorities to exclude from the selection procedure any application which has not been accompanied, by that date, by the necessary information”.

The case of Zinātnes parks

Finally, the Court of Justice applied the above principles to the case at hand.

“(75) The Member State concerned, while taking the view that the condition laid down in Article 3(3) of Regulation No 1301/2013 must be assessed at the date of approval of project applications, chose to prohibit those project applicants from completing their file after expiry of the deadline for submission of those project applications.”

“(76) That Member State cannot, however, be criticised for having set a deadline for project applicants to communicate all the information necessary to the competent managing authority which was earlier than the date of approval of project applications.”

Conclusions

The Court of Justice confirmed that EU law confers rights to applicants for aid from EU structural and investment funds. Managing authorities must apply procedures that ensure effective and proportional treatment of aid applications. However, managing authorities are also allowed, for the purpose of speedy and equitable treatment, to set deadlines and specify the evidence that must be submitted. Aid applicants must comply both with EU and national requirements intended to ensure effective implementation of EU funds.

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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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