1

Ukraine must take careful account of EU State aid rules on rescue

and restructuring for firms in difficulty in the coming years

Dr. Eugene Stuart, Sigitas Cemnolonskis and Iana Roginska1

Annotation: In this article, we examine the key elements of the new (2014) EU rules on State

aid for rescue and restructuring of firms in difficulty. It will be important that policymakers in

Ukraine take note of these while there is still time to review the Ukrainian situation and, if

needed, to design new initiatives for business recovery that do not face the constraints of the EU

rules. As noted earlier, the available time is between three and six years.

I. Introduction: Tough medicine for Ukraine – but time is available

On 1 July 2014 the Law “On State Aid to Undertakings” was adopted in

Ukraine. State aid is essentially about the impact on competition and trade of

subsidies, tax breaks and other forms of government advantages which benefit

some firms and, therefore, can impact negatively on other firms. In the modern era

of free trade, these types of state economic intervention are now regarded as

problematic when they have a significant impact on trade and competition. With

the opening up of trade and the international position of a country (including EU

integration, WTO and Energy Community Treaty membership) a key consequence

is that international rules concerning state support to economic activity (and the

interests of new trading partners in the impact of state aids and subsidies on trade

1 Dr. Eugene Stuart has worked as an advisor on state aid and subsidy matters to the governments of

some 30 different countries. He is currently Team Leader with the EU funded Project: “Harmonisation of

Public Procurement System in Ukraine with EU Standards” - which is assisting the reform of public

procurement in Ukraine together with the inception of the country’s state aid regulatory system. Sigitas

Cemnolonskis, is a former Member of the Lithuanian Competition Council, is a Senior State Aid Expert at

the EU funded Project: Harmonisation of Public Procurement System in Ukraine with EU Standards.

Iana Roginska is also a State Aid Expert at the Project. The views expressed here are those of the authors

and are not to be understood as a specific viewpoint of the Project or as, in any way, reflecting an official

opinion of the European Union or any of its constituent or connected organisations.

2

and competition) need to be taken fully into account and must be applied in

Ukraine.

The Law on State Aid to Undertakings is essentially a framework law which will

require a substantial amount of secondary legislation laying down notification and

approval procedures with and for the national regulator (the Anti-Monopoly

Committee of Ukraine) and detailed rules for State aids of particular categories,

related to particular sectors and for particular purposes. Under the EU-Ukraine

Association Agreement, all of these State aid rules must be in line with (fairly

complex) EU rules, including related judgments by the Court of Justice of the

European Union.

These rules are tougher, more extensive and more demanding than the WTO

subsidies rules and there are important challenges for Ukraine as this process

unfolds.

It should be noted first that there is time to apply the new EU rules to State aids in

Ukraine. This is reflected in the new Law which provides a three year period (up to

August 2017) before the full State aid control system begins to operate. Moreover,

existing State aid schemes in Ukraine have a further period of up to three years to

be notified, examined and brought into line with the EU rules (if they are found not

to be in compliant after the Law comes into effect). In addition, the new State aid

control system in Ukraine will offer important benefits in the medium term

because it will:

1) help to achieve higher standards in public finance management, including

the avoidance of duplicating or wasteful public expenditure.

2) contribute to the anti-corruption efforts of Ukraine by ending secret

subsidies or subsidies to specific firms that have no justification.

3

3) increase the level of competition in the economy by reducing the cases

where an artificial competitive advantage is unnecessarily given to some

firms.

4) help to ensure that support measures to the business sector (in whatever

form) are well justified and likely to succeed in achieving tangible economic

results.

5) contribute to the functioning market economy in Ukraine by rationalising

future industrial modernisation, economic development and foreign direct

investment policies in line with best international practice.

6) help to meet the international commitments undertaken by Ukraine in

regard to state support to business and industrial sectors2.

On the other hand – even allowing for the time available - some of the EU State aid

rules to be applied in a Ukrainian context represent very tough medicine in regard

to solving some long-standing problems in the Ukrainian economy. In particular,

the freedom to act via public support measures in regard to firms in financial

difficulty (whether state enterprises or private firms) will be seriously curtailed

when the current EU rules concerning State aid for firms in difficulty3 are

introduced as secondary legislation under the Law and applied in specific cases in

Ukraine.

2 The WTO Subsidies and Countervailing Measures Agreement, the WTO Trade Related Investment Measures

Agreement, the WTO General Agreement on Trade in Services, Article 18 of the Energy Community Treaty, Articles 49, 51, 53(2) and 94 of the (current) EU-Ukraine Partnership and Cooperation Agreement and Articles 262 to 267 of the (forthcoming) EU-Ukraine Association Agreement including a Deep and Comprehensive Free Trade Area. 3 European Commission: Guidelines on State aid for rescuing and restructuring non-financial undertakings in

difficulty, OJ C 249 of 31 July 2014.

4

In this article, we examine the key elements of the new (2014) EU rules on State

aid for rescue and restructuring of firms in difficulty. It will be important that

policymakers in Ukraine take note of these while there is still time to review the

Ukrainian situation and, if needed, to design new initiatives for business recovery

that do not face the constraints of the EU rules. As noted earlier, the available time

is between three and six years.

II. “Firms in difficulty” and the evolution of the EU State aid rules

Under the EU rules, a firm in difficulty refers to a situation when, without

intervention by the State, the firm will almost certainly go out of business in the

short or medium term4. Moreover, various indicators are used to establish this i.e.

if at least one of the following circumstances occurs:

Where more than 50% of the share capital of a company has been lost due to

accumulated losses;

Where a firm is subject to collective insolvency proceedings or fulfills the

criteria under its national law for being placed in collective insolvency at the

request of its creditors;

Where a large firm for at least two years has a debt to equity ratio of more

than 7.5 and its interest cover ratio is below 1.0.

Since the 1990s, in particular, the EU has tightened and considerably strengthened

its State aid rules in the interests of competition and freer trade; unencumbered by

ad hoc State aid decisions by Member State Governments. This has applied

4 2014 Rescue and Restructuring State aid Guidelines, Section 2.

5

especially to State aid to rescue or restructure firms in difficulty that, in principle,

should exit the market allowing remaining firms to compete efficiently. At the

same time, commercial bankruptcies have a social cost (e.g. lost employment,

regional decay, and, in some cases, leaving certain markets to be monopolised by

remaining firms). Thus, even in strict market economy and competition terms,

there may still be scope for some State intervention in regard to ailing firms.

However, and unlike in the past when most major state enterprises in most EU

Member States were bailed out at least once (e.g. airlines, coalmines, steel mills

etc.), the rules to be applied now focus on very limited State intervention (last

resort only and one time only), guarantees about the return of assisted firms to

economic health and very detailed supervision of rescues and restructuring

operations by the regulator (the European Commission in the European Union

context).

At the same time, the general rules – which are the focus here – do not apply to the

financial sector (where the EU continues to apply “temporary measures” since

2008 to rescuing and restructuring ailing EU banks) or to certain sectors (e.g.

railway transport) which are subject to sector specific rules in the event of rescue

and restructuring operations. Moreover, a firm which is in operation for less than

three years may not benefit from rescue or restructuring State aid.

III. The EU State aid rules on Rescue and Restructuring and their

application.

To constitute State aid, a measure in support of a firm in difficulty must involve

State resources, must confer a selective advantage and benefit on the firm receiving

the support and must have an actual or potential effect on competition and trade5.

5 TFEU Article 107(1).

6

Normally, when the State intervenes to assist a firm in difficulty all of these

conditions are met and there is little doubt that State aid is involved and, as a

result, the EU rules on State aid for rescue and restructuring apply. However, if the

State invests on normal market basis it can satisfy the so-called private investor

test and no State aid arises. This point is often argued in notified measures of

rescue and restructuring but this is rarely convincing to the European

Commission6. Similarly, if the terms of a debt write-off operate on normal market

terms, the so-called private creditor test is satisfied and again no State aid arises.

The EU rules on State aid for rescue and restructuring cover three situations (where

the measure at issue is State aid):

(1) State aid for the Rescue of a firm: Rescue aid refers to the situation where State

support to a firm in difficulty is needed to ensure its survival and its ability to meet

its short term obligations. Thus, rescue aid is intended to provide a brief respite

from a firm’s financial problems, for up to 6 months. The objective of rescue aid is

to keep the firm in business while working out a restructuring or liquidation plan. It

is a temporary support to undertaking. Although the purpose of such aid is only to

improve its financial situation for the period of next few months in some cases

rescue aid may also include some urgent structural measures. Rescue aid should

allow time to analyse the circumstances which gave rise to the difficulties and to

develop an appropriate plan (restructuring or liquidation) to remedy those

difficulties.

(2) State aid for the restructuring of a firm: The purpose of restructuring aid is to

restore the long-term viability of the beneficiary on the basis of a feasible, coherent

and far-reaching restructuring plan (verified by the European Commission).

6 Case T-301/01: Alitalia v. Commission [2008] ECR II-1753, Decision 2009/155/EC Alitalia [2009], OJ L 52/3 and

Commission Decision in Case SA 30584 Malev Hungarian Airlines, 9 January 2012.

7

Restructuring aid is designed to allow the reorganisation and rationalisation of the

firm and its activities on a more efficient basis. Restructuring aid typically involves

not only financial restructuring in the form of capital injections by new or existing

shareholders and debt reduction by existing creditors but also physical

restructuring. In cases when restructuring aid is to be provided, the recipient of

such aid is required to provide a feasible and detailed restructuring plan.

(3) Temporary State aid for restructuring a firm: The EU rules also envisage a

temporary restructuring measure available only to Small and medium-sized

enterprises (SMEs), designed to “simplify the granting of state aid for

restructuring SMEs”. This support may be provided for a shorter period than for

the standard restructuring support and it may only be granted in the form of loans

or loan guarantees. The recipient of temporary restructuring support is also

required to provide a restructuring plan, but this is a simplified version of the

normally required restructuring plan. The introduction of this new sub-category of

restructuring aid under the July 2014 EU rules is intended to bridge the gap

between rescue aid (which has a maximum duration of six months) and more

complex restructuring aid in cases where the recipient is an SME.

Against this conceptual background, the rules are applied as follows.

First, all State aid measures involving rescue and restructuring must be notified

individually to the European Commission7. As regulator, the Commission will

decide whether or not the notified measures can be approved – i.e. exempted from

the general principle of prohibition of State aid in the Treaty on the Functioning of

the European Union (TFEU)8 with reference to the degree to which the rescue

7 By analogy, the Ukrainian secondary legislation will need to require advance notification to and approval by the

Anti-Monopoly Committee of Ukraine. 8 TFEU, Article 107(1).

8

and/or restructuring measure proposed would facilitate the development of certain

economic activities or of certain economic areas, with unduly affecting trading

conditions to an extent contrary to the EU common interest9.

In its assessment, the new rules require the following questions to be answered in

the affirmative for the Commission to consider the exemption of a rescue and

restructuring State aid measure:

(a) Does it contribute to a well-defined objective of common interest? A

State aid measure must aim at an objective of common interest. Simply

preventing an undertaking from exiting the market is not an objective of

common interest. The State aid measure must aim to “prevent social

hardship or address market failures by restoring the long-term viability of

the undertaking.” This needs to be established by showing the impact of

allowing the intended beneficiary firm to fail e.g. raising unemployment in a

high unemployment region (including knock-on effects on other firms

employment), disruption or abolition of an important (possibly a public)

service, the possible permanent loss of important technical knowledge or

expertise. Aid will also only be in the common interest if it can make a

difference to the situation that would prevail without aid.

(b) Is there a clear need for State intervention? In general, this means that a

State aid measure must bring about an improvement that the market could

not deliver itself.

(c) Is the State aid measure appropriate and proportionate? The EU

Member States proposing a rescue and/or restructuring measure must

demonstrate that the support to be provided is in a form that allows the

9 This reflects the wording of Article 107(3)(c) of the TFEU.

9

purpose of the measure to be achieved in the least distortive way and that

does not involve over-compensation. In part, this means that rescue State aid

must be restricted to the amount needed to keep the beneficiary firm in

business for six months and the amount and intensity of restructuring State

aid must be limited to the strict minimum necessary to enable the

restructuring to be undertaken, in the light of the firm’s existing financial

resources, its shareholders or the business group to which it belongs.

Moreover, a sufficient own contribution to the costs of the restructuring by

the beneficiary firm must be ensured.

(d) Does the State aid measure have an incentive effect? On this, it must be

shown that, in the absence of the State aid proposed, the beneficiary firm

would not have been restructured, sold or wound up in a way that could

achieve the objective of common interest.

(e) Is the design of the measure sufficient to avoid undue negative effects on

competition and trade between EU Member States? The negative effects of

the State aid must be limited, so that the overall impact of the measure on

competition and trade is positive. Thus, for example, repeated interventions

in respect of the same firm are not permitted - this is referred to as the ‘one

time, last time’ principle10

. The idea here is that repeated rescue and/or

restructuring interventions would be contrary to the EU common interest as

they demonstrate that the firm’s difficulties are either of a recurrent nature or

were not dealt with adequately when the earlier State aid was granted.

10

Where less than 10 years (with some exceptions) have elapsed since an earlier rescue aid or temporary restructuring support was granted to the same firm (or the restructuring period came to an end or implementation of the restructuring plan was halted), the European Commission will not allow further rescue aid, restructuring aid or temporary restructuring support. Thus, “one-time-last-time” has a 10 year life-cycle.

10

(f) Is the State aid measure transparent? EU Member States, the European

Commission, competitors and the public must have easy access to all

relevant acts and pertinent information about rescue and restructuring State

aid, after it is approved and awarded.

If any one of the above criteria is not met, the State aid will not be considered

compatible with the internal market and will therefore be prohibited.

IV. State aid for commercial restructuring

While rescue State aid is a very short term arrangement (aimed in large measure at

designing a viable restructuring plan), restructuring State aid raises particular

competition concerns.

In practical terms, restructuring State aid often involves long-term loans,

recapitalization schemes, tax or social security reliefs or exemptions, debt write-

offs or indeed some combination of these measures. The restructuring itself will

typically involve a financial reorganization of the firm’s capital and a business

reorganization of the firms activities. Under the new EU State aid rules, the general

principle is to allow restructuring State aid only in circumstances in which any

distortions of competition are offset by the benefits flowing from the firm's

survival. Thus, European Commission authorisation is generally granted only if

strict conditions are met:

11

a restructuring plan must be designed, approved and fully implemented11

that restores the firm's long-term viability within a reasonable timescale;

compensatory measures must be taken to prevent or to minimise the risks of

distortion of competition (divestment of assets, reductions in capacity or

market presence, etc.);

the aid must be limited to the strict minimum and the rules on the

beneficiary's contribution must be complied with;

further case specific conditions may be attached by the European

Commission to the authorisation of the aid;

regular reports on the implementation of restructuring plans must be

provided by the Member State concerned to the European Commission and

these are published.

The conditions for authorising restructuring aid are, however, less strict where the

aid is granted to small firms; since the impact on competition is generally less in

these cases than rescue or restructuring operations involving medium-sized and

large firms.

TWO ITALIAN CASE STUDIES

While there have been some important updates and innovations in the new EU

rules on State aid for rescuing and restructuring firms in difficulty, tough rules on

similar lines have existed and been strengthened over the last twenty to thirty

years. Thus, the general manner of application of the State aid rules in rescue and

restructuring cases can be illustrated by some cases that precede the new rules.

Here we offer two illustrative cases.

11

Where a restructuring plan is not followed or if it is changed without approval, the European Commission can re-classify the State aid as “mis-used”, in which case it order the aid to be recovered – even at the risk of precipitating bankruptcy.

12

I – Rescue aid to Sandretto Industrie srl – illegally continued too long12

In January 2007, the Commission approved rescue aid of €5 million in the form

of a guarantee on two credit lines to Sandretto Industrie srl. The Turin based

firm, originally established in 1947 as Fratelli, was engaged in the manufacture

of injection moulding machines for thermoplastics. In 2007, Sandretto had an

annual turnover of €30 million and employed 340 people. The Commission

approved the state guarantee on the grounds of serious social difficulties facing

the company. As rescue aid this was limited to maximum six months, in line with

the prevailing guidelines on rescue aid. As no restructuring plan was submitted

and the Italian authorities had not provided information on the termination of the

guarantee after six months, the Commission opened a full investigation of the

case in June 2008. It soon established that the guarantees had been called

resulting in a €5 million debt by Sandretto to the State.

Commenting on the case, then EU Competition Commissioner Neelie Kroes said:

“By definition, rescue aid can only serve to keep an ailing firm in business

for the time needed to work out a restructuring or a liquidation plan. When

a measure goes beyond the six months limit, we have a duty to investigate

to ensure that an ailing firm's competitors do not lose business or even go

bankrupt because of unfair and unjustified subsidies."

The Commission concluded that the €5 million in rescue aid to Sandretto, insofar

as it was prolonged beyond 24 January 2008 and benefited Sandretto until it

ceased all its activities on 29 June 2009, constituted a misuse of State aid which

could not be considered compatible with the common market and must be

recovered by Italy with interest from the beneficiary Sandretto Industrie srl.

II- Capital Injections to Milan airport ground handling operators was illegal

rescue and restructuring State aid

In December 2012, the European Commission finalised a case against Italian

ground handling operator SEA Handling involving illegal State aid to firms in

difficulty and ordered that the aid of €360 million should be recovered.

In brief, the Commission concluded that some €360 million of state aid granted 12

Commission Decision C 19/08 of 30 September 2009 on a measure taken by Italy to rescue Sandretto Industrie srl of 13 April 2010.

13

in the form of capital injections between 2002 and 2010 by SEA, the state-

owned operator of the Milan Malpensa and Milan Linate airports, to its

subsidiary SEA Handling, ground handling operator at the airports, was

incompatible with EU state aid rules. The Commission's investigation found that

the assistance provided gave an undue economic advantage to SEA Handling

that its competitors, which had to operate without state subsidies, did not have.

The Commission's investigation also revealed that, given its consistently difficult

financial situation, SEA Handling would have been unable to secure such

financing from the market in 2002-2010 and no private investor, operating under

market conditions, would have accepted to grant this capital to the company.

Thus, the repeated capital injections provided SEA Handling with an undue

advantage that its competitors did not enjoy and therefore constituted state aid in

the meaning of the EU rules.

As regards the possible compatibility of the capital injections with the State aid

rules, the Decision notes that, as SEA Handling was in financial difficulties

throughout the period concerned, it could have lawfully received state aid under

the conditions set in the EU Rescue and Restructuring Guidelines13

. However,

the capital injections did not meet these criteria. Moreover, SEA Handling's

business plan failed to demonstrate, on the basis of sound and reliable

assumptions, that:

A) the company could become viable and operate without continued state

support.

B) SEA Handling would be contributing to the cost of restructuring.

C) compensatory measures to minimise the competition distortions brought

about by the significant state support received would be taken.

Accordingly, Italy was required to ensure that SEA Handling paid back the State

aid received with interest.

V. Implications for Ukraine

While the detailed State aid rules for rescue and restructuring cases under the Law

on State aid to Undertakings have yet to be written, they must reflect what has

13

The guidelines applicable to SEA Handling were the 2004 EU Rescue and Restructuring Guidelines that set out the conditions under which companies in financial difficulties could, at that time, receive state aid.

14

been described here in order to comply with the terms of the EU-Ukraine

Association Agreement. Thus, open-ended supports for otherwise bankrupt

business undertakings will no longer be possible, tough decisions about the future

of firms in difficulty will have to be made and the Anti-Monopoly Committee of

Ukraine, as the State aid regulator under the Law, will have to be satisfied that

future measures supporting ailing firms have a real chance of succeeding.

Most countries that have opened up to international free trade, especially with the

European Union, have had to face the reality that, even if they wanted to and could

afford to, free trade and market competition considerations meant that the freedom

to rescue firms in difficulty purely in a national context would not continue14

.

Ukraine must take careful account of EU State aid rules on rescue and restructuring

for firms in difficulty in the coming years. With time still available to examine the

detailed implications of the EU rescue and restructuring State aid rules more fully,

there is every possibility for new policy options to be explored, one-time-last-time

initiatives to be taken and measures to be put in place to purposefully resolve some

of the longest-standing inherited economic problems in the country.

Bibliography:

1. Treaty on the Functioning of the European Union,

OJ:C:2008:115:0047:0199:EN, retrieved from: http://eur-

lex.europa.eu/LexUriServ/LexUriServ.do?uri=OJ:C:2008:115:0047:0199:EN:PDF

2. Law of Ukraine “On State Aid to Undertakings”, 1.07.2014, № 1555-VII;

14

To take one example, prior to its EU accession in 1973, Ireland had a public agency “Foir Teoranta” specialised in the rescue and restructuring of Irish businesses. This ceased to operate from 1973.

15

3. Commission Decision C 19/08 of 30 September 2009 on a measure taken by

Italy to rescue Sandretto Industrie srl of 13 April 2010;

4. Case T-301/01: Alitalia v. Commission [2008] ECR II-1753, Decision

2009/155/EC Alitalia [2009], OJ L 52/3 and Commission Decision in Case SA

30584 Malev Hungarian Airlines, 9 January 2012;

5. European Commission: Guidelines on State aid for rescuing and restructuring

non-financial undertakings in difficulty, OJ C 249 of 31 July 2014.