Market Economy Investor Principle

Prof P. Nicolaides
Theme: State acting as investor
Investor = faces risk [ assumes/minimises risk exposure]
Shareholder/private investor
[acquisition of assets]
Facilitator of private investment
[i.e. risk-capital formation]
Creditor
[protecting own assets]
Guarantor of 3rd party risk
Vendor/operator
[sale of public assets, privatisation]
Purpose of MEIP
To identify when investment decisions of public authorities
contain elements of state aid, because

the state cannot be prevented from investing
=> principle of neutrality with regard to system of property
ownership [Article 345]

private undertakings cannot be prevented from receiving
state capital
=> principle of equality between public and private
undertakings
Source of funding
State aid
State State resources
Public undertakings
or agencies of State
Funds controlled
by the State
Actions imputed
to State
C-482/99, France v Commission (Stardust Marine): imputability shown by directives,
supervision, etc; C-83/98, France v Commission (Ladbroke)]: public control of funds
EU funds
Undertakings
MEIP benchmark: Two principles
Private investor guided by prospect of long-term profitability
[as for a holding company] and takes into account all risks &
costs to itself + all benefits to third parties
Private investor ignores:
social, regional or sectoral policy considerations
fate of assets/workers after sale
any tax receipts or social costs
image of public body or region [although see T-565/08 , Corsica Ferries]
Cont.
PI carries out ex ante study on profitability of project

PI compares return on project with other similar projects

PI takes into account all possible options & effects does not
wilfully ignore options or relevant information

PI never gives away anything for nothing
Roles of state
There is difference between obligations of state as
shareholder and as public authority

Public authority acting as PI ignores even its own obligations
as public authority [see T-268/08, Bank Burgenland]

Shareholder normally liable for debt up to liquidation value
of assets
Public authority normally concerned about cost of
redundancies, payment of unemployment benefits, aid for
restructuring, impact on industrial activity and
infrastructure, etc. [C-278/92, Hytasa]

A classification
PIP applies in following situations:
participation in capital, granting of loans, offering of
guarantees, sale of goods or services, payment of insurance
premia, reimbursement of salary charges
PIP does not apply to following situations:
public subsidies, tax exemptions, reduction of social
insurance contributions, charges related to dismissal of
workers, unemployment benefits and other social benefits,
industrial restructuring, public loans under unusual terms,
preparation of industrial parks
[T- 156/04, EDF]
When & why does public holding cause problems?
When funds are contributed in circumstances that would be
unacceptable to a private investor operating under normal
market conditions
Because, then recipients obtain advantage they would not
otherwise enjoy under normal market conditions

Note, concept of aid is objective according to its effects, not
motives: Injection of capital to remedy effects of fraud or
mismanagement does not make Art 107 inapplicable [but see
SA.31296 on capital injection in public water & sewage company,
KWL, in Leipzig]
What is the investment horizon of a private investor?
Profitability in the medium to long term
Distinction between short-term and long-term-term
[parent company may tolerate temporary losses of subsidiary in
order to maintain synergies, protect corporate image or
redirect activities of subsidiary]
Not accepted that governments can forecast better
Commission may not use hindsight - considers prospects at
point of investment
Important to identify comparable situations between public and
private investments
The importance of right time framework
C-482/99, France v Commission
ECJ annulled Comm. Dec. 2000/513 on injection of K from Crdit
Lyonnais subsidiary into Stardust Marine, inter alia, because K
was invested in tranches during a period of several years while
Commission examined prospects at a particular point in time
It follows that investment motive must be related to each
amount at every instance of investing
And is assessed on prevailing conditions

But in certain cases separate measures may be considered a
single measure [C-399/10 P, Bouygues v Commission (France
Telecom)]
Cont.
T-11/95 BP v Commission: Mere fact that undertaking has
received state aid does not mean that other K injections do
not satisfy MEIP
=> Commission has to assess each separate measure

MEIP applies to all transactions between state & same firm
ING v Commission, T-33/10
NL injected capital in ING and then accepted change in the
terms of its remuneration [ING paid back earlier at lower rate]

Commission: Capital injection was state aid. Therefore,
change in terms of remuneration was also state aid.
Moreover, the change lowered remuneration. Therefore, state
lost revenue [from EUR 15/share to EUR 10/share]

GC: Each transaction has to be assessed individually on basis
of available information
Commission failed to consider whether a PI would have
accepted a lower, but an earlier & certain return instead of a
higher but later & uncertain return

Confirmed by C-224/12 P, Commission v The Netherlands
What is the risk tolerance of a PI?
Commission accepts wide margin of judgment; acts when
public investment is beyond reasonable doubt
Risk assessed against market rates for comparable assets and
situations

The higher the risk, the higher the expected return
The larger the sacrifice [e.g. no voting rights for large amounts
of investment], the larger the expected reward
Losses in early years are OK provided measures taken to
eliminate them & compensate in terms of higher profits later on
What are the expectations of a PI?
Planned restructuring & expected productivity improvements
must be reasonable; i.e. no claimed huge increases in profit

In case of doubt whether investment is reasonable,
Commission expects proof that funds could be raised in
capital markets - hunches must be proven

Return must be commensurate to benefits enjoyed by
recipient company
PI aims for long-term and takes into account ALL effects
T-565/08, Corsica Ferries V Commission
GC annuls Comm Dec 2009/611 which had found that 1) sale
of SNCM for a negative price of EUR 158 mn and 2) aid to
individuals (employees) were not state aid
Commission accepted French arguments that a PI would take
into account negative publicity and social upheaval from
liquidation
GC: PI may indeed take such issues into consideration [C-
305/89, Italy v Commission]
But Commission did not show objectively how a PI would act
No quantification of probability and amount of future benefits
for MS
Cont.
Commission was wrong to find that the aid to individuals was
not state aid on grounds that it was not linked to legal or
contractual obligations of SNCM [i.e. no relief for SNCM]
There could be state aid indirectly because it made it easier
for workers to leave SNCM

But Commission was right in finding that a concomitant
investment of EUR 8.75 mn by CGMF was not state aid
[principle of concomitance]
Which market benchmark?
Private investor must obtain return at least equal to average
of the market for same type of investment [e.g. in terms of
amount, rights, etc.] and risk

Average return is only analytical tool -- it is not automatic
criterion -- it must be adjusted in light of all available info and
factors
Benchmarks
Private investor
provides equity financing whenever NPV of expected future
cash flows [dividends] plus capital gains adjusted for risk
opportunity cost
Private vendor/operator
seeks highest possible price or best terms for sale or renting of
assets [price market price or NPV of future net income
generated by assets]
Private guarantor
covers risk with sufficient premium or security [premium
income or disposal value of security expected loss]
Private creditor
seeks to maximise recoverable assets & chooses least costly
option [C-271/13 P, Rousse Industry v Commission: choice
between bankruptcy & amicable arrangement]
A check list [Citynet Amsterdam, 2008/730]
Are all other investors market investors? Yes
Do investments by private investors have real economic
significance and are free from aid? Yes [each invests in
proportion to shareholding]
Are investments identical? Yes
Are all investments concomitant? Yes [yes, pre-investments by
municipality to be paid back and did not change risk of project
for the others]
Do public authority & other investors have relationships outside
the project? No
Is there a reasonable business plan? Yes [verified by
independent consultant]
Commission investigation of partnership in Trento
SA.33063: Public-private partnership to build broadband
network in province of Trento

State acts as PI when:
There is significant participation of PI
Or, there is sound business plan showing adequate return
on investment

In this case, Italy argues that low return is irrelevant because
investment is pari passu
However, private partner has exclusive supply agreement with
PPP
How is capital injection assessed?
[in healthy & troubled firms]
Recipient in financial trouble?
Yes No
Return comparable
to market rates?
No
No aid
Comparable private
investment?
Aid No aid
Compatible with IM if it complies
with relevant Guidelines
In case of R&R
Firm must attain
profitability
Could firm
obtain amounts
on K market?
No
Yes
Yes
Capital injection: no presumption of aid
[comparable investment actually made]
Capital contribution from public funds satisfies PI test if it is
made at same time as a significant capital contribution by a
private investor and in comparable circumstances
[T-296/97, Alitalia v Commission]

Comparable: similar size and conditions

But there may be aid where private investments occur only
after public investments [T-358/94, Air France; T-20/03,
Kahla]

Capital injection in case of restructuring
Two-stage assessment
I: Is investment the least costly option,
including non-intervention?
No
II: Is solution the least costly
recovery option?
Yes No
Compatible Incompatible
Excludes social costs of
liquidation from possible
non-intervention
but includes privately borne
redundancy costs
Yes
Separation of roles
of state as public
authority and as
share holder
State acts as
private investor
Private creditor: Debt write-off
Assets
Debt
secured unsecured
Creditor A
does not write-off
Creditor B
writes-off debt
Maximum
write-off
No PI grants unsecured loans to firm in difficulty
There is state aid if in court-supervised restructuring,
state is more generous than other creditors C-480/98 ES v Comm (Magefesa)
But
Closure
PI does take into account the cost of closure before deciding
whether to wind up a company

PI ignores costs borne by the State and all debts [e.g. unsecured
loans] that do not have to be repaid after closure or costs of
cleaning pollution for which it has no liability

Public authority may not include in cost of closure loans
previously granted as aid by itself
[C-334/99, Germany v Commission] [C-278/92, Spain v
Commission (Hytasa)]
Cont.
ECJ: Creditor weighs recovered amount v future amount after
restructuring & takes into account [see also T-152/99, HAMSA]:
Status [preferential or not]
Security
Chances of return of debtor to viability
Amounts
But if there is no agreed restructuring, creditor weighs proceeds
from insolvency v proceeds from procedure for recovery of debt
Where there are several methods for recovery, creditor must
consider all of those methods
Commission did not analyse all possible methods
MEIP v Altmark
Often there is confusion about MEIP and Altmark [because in
both there is no SA]

However, the logic is contradictory
Under MEIP, state seeks to obtain return
Under Altmark, state expends resources
Summary
Source
of funds:
Public?
Investment in
healthy firm
Investment in
troubled firm
Supply/sale of
products/assets
Recovery
of assets
Yes
No
Yes
No
Yes
No
Yes
No
N
O

A
I
D
Adequate
return?
At market
rates?
At best
rate/terms?
With private
investor?
AID
Exempted if:
there is restructuring plan
and/or fits in categories of exemption
Case study: Valencia film studios
Commission Decision 2013/126 [SA.22668]
Use of CAPM: Re = Rf + (Rm Rf)
Rf = 10-year govt bond (2004) = 4.1%
(Rm Rf) = 6.8% - 9.3% [academic study]; Comm takes 6.8%
= 1.59 [comparison with similar studios]
=> Re = 0.041 + 0.068*1.59 = 14.9%
[Commission rejects of 0.395 proposed by ES]

IRR [based on business plan of studios] = 5.74%
NPV of projected cash flows at discount rate of 14.9% =
= EUR 132 mn
Sensitivity analysis
- 132
5.74%