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State aid ruling will help inform future investment of public funds, say experts

Out-Law Analysis | 23 May 2016 | 2:49 pm | 6 min. read

FOCUS: A recent ruling by the Court of Appeal in London will help public bodies invest public funds into business ventures without breaching state aid rules.

The Court of Appeal ruled that a loan provided by Coventry City Council to help keep afloat a company running the city's Ricoh Arena sports stadium when rent payments from the local football team dried up did not constitute illegal state aid. The Court's ruling dismissed an appeal against an earlier High Court decision which had reached the same conclusions.

The ruling is a cornerstone judgment in state aid case law. It highlights that public bodies have a good degree of commercial discretion when considering investing public funds. It represents a welcome reaffirmation of the application of the Market Economy Investor Principle (MEIP) to investments made by public bodies using public funds.

In 2013 Coventry City Council granted a £14.4 million loan to Arena Coventry Limited (ACL), the company that operates the city's Ricoh Arena. The loan was to be repaid over a period of over 41 years.

The Council owned a 50% stake in ACL and held the freehold of the land where the Ricoh Arena is situated. Coventry City Football Club (CCFC) held a licence to occupy the Arena and was contracted to pay rent to ACL for use of the stadium.

However, when CCFC defaulted on its rent payments ACL fell into financial difficulties as it was unable to service its own debt with its lenders. To help the company, Coventry City Council entered into an agreement with ACL to provide funding allowing ACL to meet its bank payments.

The Council's loan to ACL was, though, met with a state aid challenge by Sky Blue Sports (SISU), the owners of CCFC. It was alleged that the loan was not one which would be made by any other prudent investor on similar commercial terms. On this basis SISU claimed the loan failed the MEIP test because it provided ACL with a selective advantage and constituted state aid.

EU state aid rules are intended to prevent the distortion of competition caused by national governments granting advantages or incentives to particular companies. Companies found to have breached state aid rules can be ordered to pay back illegal reliefs granted over a period usually up to 10 years.

SISU's claims were initially dismissed by the High Court but the company appealed to the Court of Appeal, claiming flaws in the High Court's decision-making.

The Market Economy Investor Principle test

To assess whether the Council's loan provided ACL with a selective advantage, and therefore whether unlawful state aid had been provided, the Court of Appeal had to apply the MEIP test to the loan arrangement.

The test involves a hypothetical assessment of whether a private investor in comparable circumstances to the Council would have provided the same level of support if it were operating under normal market economy conditions. The test presumes that the hypothetical private investor would not provide an advantage to another without demanding compensation for the value that its actions generated for the beneficiary. 

According to the MEIP test a private investor in normal market conditions is motivated solely by the possibility of making profits or a return on investment. All other objectives, no matter how worthy, such as lowering unemployment or increasing regional investment, are ignored by that private investor.  As such, the MEIP test requires a public body investor to behave in the same way. However, the test recognises that the hypothetical private investor does not need to pursue the most profitable investment.  It is sufficient for the investment to give average returns. The private investor will not, according to the test, wilfully forego an obvious opportunity for profit. 

There are restrictions on the MEIP test and the concept of the hypothetical private investor.  The concept of the hypothetical private investor is narrower than the possible actual behaviour of some real investors, who may take excessive financial risks in the hope that the returns will be commensurately high. Public bodies investing public money are expected to act with due prudence and care. Gambling or acting on speculation would not therefore be acceptable. 

MEIP test assessments are not carried out retrospectively. An analysis is applied to the facts which were available at the time the relevant public body made the decision to invest. The financial measure or investment will not be assessed with the benefit of hindsight and it is irrelevant if the investment subsequently turns out to be profitable when at the outset there was no realistic benefit involved for the public body. If a project evolves, or if new investment decisions are taken later in the life of the project, the MEIP test must be considered on an on-going basis.  

The application of the MEIP test to any given circumstances entails a complex economic assessment, and will turn on its own facts, which are specific to the market in which the proposed transaction exists.

The Court of Appeal judgment

In assessing the case before it the Court of Appeal had to review a complex set of background facts that led to Coventry City Council providing its loan to ACL. It examined existing case law developed through the European courts and guidance issued on state aid that has been issued by the European Commission.

The Court confirmed the classic test of what constitutes state aid. State aid is aid granted by the state or through state resources that favours certain companies and distorts or threatens to distort competition and affects trade between EU countries. Where a state acts in a manner corresponding to normal market conditions, its transactions cannot be regarded as state aid, it said.

The Court also confirmed that the question as to whether a rational private market investor would have entered into a transaction is an objective question to be answered with regard to the basis of the information available at the time the investment was entered into.

For instance, courts will have regard to the evidence that was then available, and subsequent justification for aid being provided is irrelevant. Therefore, when a public body is contemplating an investment the information and evidence to hand at that time is of most importance if there is a subsequent requirement to analyse the measure for the presence of state aid.

Who constitutes a hypothetical rational private investor will vary in each state aid dispute, the Court confirmed. It said such an investor must be assumed to have the same characteristics as the public body concerned in each case.

In this case the Court determined that the rational private investor, whose hypothetical investment decisions were to provide the benchmark for measuring the legitimacy of Coventry City Council's loan to ACL, would have been a private investor with a similar shareholding in ACL to that held by the Council.

The Court recognised that there are some investors in for a short term punt, and others who take a longer term view of profitability, particularly if they have a sizeable shareholding. It also said that it is in line with the MEIP test to consider that some investors would continue to provide investment to a company in difficulties, particularly if they wished to preserve their shareholding by the company avoiding insolvency, when restructuring may reasonably return it to profitability.

The law recognises that there is "a wide spectrum of reasonable reaction to commercial circumstances in the private market" and that therefore "a public authority has a wide margin of judgement" when determining how to invest public funds in line with state aid rules, the Court confirmed.

When applying the MEIP test, the Court said that there was a requirement for public authorities to exercise entrepreneurial skills which imply a wide margin of judgement on the part of the investor. Importantly for all public authorities, it affirmed that a transaction will not fall within the ambit of state aid unless the recipient would manifestly have been unable to obtain comparable facilities from a private creditor in the circumstances of the case.

In reaching its conclusion that the Council's loan did not constitute state aid, the Court assessed a range of factors specific to the facts of the case. These included the fact that the loan was agreed at a commercial rate of interest, as agreed by all parties in the legal proceedings, and that a business plan drawn up by ACL at the time of the loan indicated that the company was reasonably likely to return to profitability within an acceptable period of time if the funding from the Council was received.

A good ruling for public bodies

The importance of this decision for public bodies seeking to invest in local enterprises or vehicles is that it provides a welcome confirmation that there is available a wide margin of appreciation available to do so.

While public body investments must still conform to the MEIP test, there is a recognition that public authorities can take a longer term view of their investments and require to be compared with hypothetical investors sharing similar characteristics.

Caroline Ramsay and Charlie Haggerty are experts in state aid and competition law at Pinsent Masons, the law firm behind Out-Law.com.