European Commission authorises Member States' Covid-19 related equity stakes and subordinated debt
Following detailed consultations with Member States, the Commission has now updated and amended the Temporary State Aid Framework (first adopted on 19 March) (the Temporary Framework) and has set out the conditions pursuant to which Member States are permitted to inject equity and/or hold subordinated debt in entities which have been hit by the Covid-19 pandemic. In each case, Member States will have to notify an aid scheme or individual aid to the Commission for approval before the measures can be implemented. The inclusion of these measures within the Temporary Framework will, however, enable Member States to take advantage of the fast track clearance process that the Commission has put in place for Covid-19 related State aid.
The Commission is mindful of the fact that State aid granted in the form of large equity injections (or other hybrid capital instruments) can have a highly distortive effect on competition. It will therefore only allow such public interventions as a last resort, where no other appropriate solution can be found. The level of public funding must also be limited to the minimum necessary to ensure the viability of the undertaking (i.e. the relevant corporate group) and must not go beyond restoring its capital structure to its pre-Covid-19 position. Moreover, Member States will need to demonstrate in each case that it is in the common interest to intervene. This is likely to include situations where the failure of a company may result in significant unemployment, the company is perceived to be innovative or of systemic importance, and/or its exit may otherwise disrupt the provision of an important service.
The aid granted by the Member State can exceed the cap of €800,000 which applies to other State aid measures under the Temporary Framework (subject to an obligation to notify any individual recapitalisation which exceeds €250m). However, as with other State aid measures which the Commission is prepared to approve under its Temporary Framework, the beneficiaries cannot include “financial” undertakings (i.e. banks or other financial institutions which are subject to different rules) or “undertakings in difficulty” as at 31 December 2019. This latter definition (which has been borrowed from the General Block Exemption Regulation) is drawn widely and is capable of catching many highly geared businesses which would otherwise be regarded as perfectly viable.
Recapitalisation measures approved under the Temporary Framework must be granted by 30 June 2021. Such measures can take the form of any equity (including newly issued shares or preference shares) and/or other hybrid capital instruments (including, for example, profit participation rights, silent participations and convertible secured or unsecured bonds). In certain circumstances Member States may also underwrite these instruments in the context of a market offering.
The Temporary Framework also contains detailed provisions setting out how any equity or hybrid capital investment should be valued and remunerated. These investments must be also include “step-up mechanisms” (which increase over time the remuneration which is owed to a Member State in return for its capital injection) in order to incentivise the beneficiary of the aid to buy back and reduce the shares held by the Member State.
Similar to the position it adopted when dealing with bank bailouts during the 2008 financial crisis, the Commission requires a number of strict governance conditions to be met before authorising any aid. These conditions should be considered carefully by any undertaking seeking financial support and include requirements that:
- as long as the Covid-19 recapitalisation measures have not been fully redeemed, the beneficiary of the aid cannot make dividend payments, nor non-mandatory coupon payments, nor buy back shares (other than in relation to shares held by the State);
- as long as at least 75% of the Covid-19 recapitalisation measures have not been redeemed, the remuneration of each member of management must not go beyond the fixed part of his/her remuneration on 31 December 2019. For persons becoming members of the management on or after the recapitalisation, the applicable limit is the lowest fixed remuneration of any of the members of the management on 31 December 2019. Bonuses, other variable or comparable remuneration elements are prohibited;
- as long as at least 75% of the Covid-19 recapitalisation measures have not been redeemed, the beneficiary of the aid (other than SMEs) cannot acquire a stake greater than 10% in any competing business or in any other business operating in upstream or downstream related market (subject to very limited exceptions). Additional behavioural commitments are also likely to be required in the event that the beneficiary of the aid is deemed to hold “significant market power”;
- until the Covid-19 measures are fully redeemed, large undertakings must also publicly report on how the aid received supports their activities in line with EU objectives and national obligations linked to the green and digital transformation, including the EU objective of climate neutrality by 2050 on an annual basis; and
- the aid received from the State shall not be used to cross-subsidise economic activities of integrated companies that were in economic difficulties already on 31 December 2019.
Many of these requirements are designed to avoid undue distortions of competition and incentivise an undertaking which has benefited from a capital injection to buy back the shares acquired by the State. The Commission seeks to ensure that public intervention remains temporary. Therefore where a Member State takes a shareholding of 25% or more, the Commission also requires the Member State to ensure that the beneficiary presents, within 12 months of the aid being granted, a clear exit plan to reduce that shareholding (unless the holding will be reduced to below 25% within one year). If the State’s holding has not reduced below 15% within either 6 or 7 years, depending upon the nature of the beneficiary (e.g. publicly listed company, SME etc.) a restructuring plan must be put in place and notified to the Commission. From a UK perspective, it remains to be seen how these requirements will be enforced over time and how any future enforcement may be affected by the ongoing Brexit negotiations with the EU.
Of course, not every equity stake held by Member States will necessarily constitute State aid. It has long been recognised that where a Member State acts as a normal commercial investor in a market economy (e.g. by purchasing shares at market price or investing pari passu with the private sector) such investments would not typically be regarded as State aid. The State aid rules do not apply in these circumstances and the Commission has publicly suggested that this can be of particular importance where Member States seek to avert the risk of hostile takeovers of strategic companies by foreign purchasers. However, in practice, it may well be difficult for a Member State to demonstrate that it is acting as a normal commercial investor by injecting capital into companies which are facing serious financial difficulties as result of the current crisis, particularly where future business plans are uncertain.
According to the Commission, competition is less likely to be distorted by subordinated debt (i.e. debt which is subordinated to ordinary senior creditors in the event of insolvency) than by equity injections. As a result, Members States are subject to fewer constraints when seeking to assist businesses through subordinated debt instruments, provided the subordinated element of the debt does not exceed:
- two thirds of the annual wage bill of the beneficiary of the aid (or the annual wage bill where the beneficiary is an SMEs); and
- 4% of the beneficiary’s total turnover in 2019 (or 12.5% where the beneficiary of the aid is an SMEs).
In addition, the subordinated debt should not exceed one third (for large enterprises) and/or half (for SMEs) of the amount of the senior debt. Subordinated debt in excess of any of those thresholds will be treated as akin to an equity investment and subject to all the constraints which apply to such investments.
In addition, any subordinated debt must also satisfy the conditions already in place for subsidised loans under the Temporary Framework. This includes, for example, requirements that the loan should not exceed 6 years; the amount of the loan should be linked to the beneficiary’s liquidity needs; the loans should not be available to those considered “undertakings in difficulty” as at 31 December 2019; and the total aid (typically the difference between the commercial and subsidised interest rates) should not exceed €800,000.
Other amendments to the Temporary Framework
The Commission has also amended the Temporary Framework to clarify that where aid is granted by way of a tax advantage, the tax liability in relation to which that advantage is granted must have arisen no later than 31 December 2020.
The position on combining State guarantees and subsidised interest rates has also been refined. The Commission now accepts that aid recipients can potentially benefit from both measures (subject to the overall cap on aid not exceeding €800,000) provided the measures relate to different loans. This is subject to any restrictions which may be imposed by pre-existing clearances and/or the Member States themselves.
Additional Covid-19 State aid developments in the UK and in the agricultural sectors
It is not yet known how the UK will take advantage of the greater scope for public intervention afforded by the Commission’s latest revision to the Temporary Framework. Currently the UK has received State aid clearance for four schemes: two clearances aimed at supporting SMEs (which we previously reported) and two further clearances:
- a clearance aimed at both SMEs and large corporates which allows the UK to provide aid to undertakings through direct grants, selective tax advantages, advance payments, State guarantees for loans and subsidised loans to undertakings with favourable interest rates, and support for R&D and testing facilities. Aid may be granted by any level of government and may be done so directly or, for guarantees on loans, through financial intermediaries. This clearance also makes provision for equity injections. Although any equity intervention under this clearance is not subject to all the various requirements outlined above, such intervention is in practice more limited as the total aid is capped at €800,00 per undertaking (although lower limits apply to the agriculture and fisheries sectors). In accordance with the criteria contained in the Temporary Framework, the aid is also not available to “undertakings in difficulty”.
- a clearance granted by the Commission on 11 May to support the self-employed and members of partnerships enabling them to claim similar support as that provided to furloughed employees.
Further information on the various UK financing support schemes (which are aimed at plugging gaps in liquidity rather than more extensive recapitalisations and restructurings) can be accessed here.
Finally, the Commission has also recognised that the agricultural sector across the EU may need additional State aid assistance due to the drop in demand following the Covid-19 crisis. It has therefore taken steps to authorise aid to support private storage of products in the dairy and meat sectors. For the dairy sector, products qualifying for private storage aid include butter, certain cheeses and skimmed milk powder, whereas qualifying meat products including bovine, sheep and goat meat. The measures specify permitted storage volumes and time periods, which in the case of cheeses are set differently for each Member State. Private storage aid is also available for the wine sector.
In the fruits and vegetables sector, spending limits on crisis prevention and management measures taken by producer organisations and associations of producer organisations have been lifted for the year 2020. This spending is ordinarily limited to one third of total spending on their operational programmes. Similar flexibility for sectoral support programmes has also been extended for farmers, olive oil producers and beekeepers, as well as for the EU’s school scheme which distributes fruit, vegetables and milk in educational institutions.
For further information on any of these issues please contact Fiona Beattie, Cameron Firth, or Christophe Humpe in the first instance.