New guidance published by the Ministry for Housing, Communities and Local Government on 29 November 2018 clarifies the "undertaking in difficulty" test applicable to ERDF projects and sets out steps which organisations delivering ERDF projects in England will need to meet in order to pass audit. In many cases, such as for ERDF grant recipients involved in delivering support programmes or with projects involving delivery partners, this will involve revising and updating existing procedures.
The ERDF Prohibition on undertakings in difficulty
The prohibition on undertakings in difficulty is set out at Article 3(3)(d) of Regulation 1301/2013 which reads "The ERDF shall not support:… (d) undertakings in difficulty, as defined under Union State aid rules". There are actually three slightly different definitions within European Union's State aid rules and we understand the European Commission has confirmed the relevant definition is the one set out at Article 2(18) of the General Block Exemption Regulation 651/2014 as amended (GBER).
It should be noted that whilst it is self-evident that if an award of ERDF funding to an undertaking is to be made via GBER then the undertaking in difficulty test would have to be met in any event, not all ERDF funding awards rely on GBER for State aid compliance, and other State aid block exemptions such as the De minimis Regulation (1407/2013) do not mandate the same test.
Article 2(18) of GBER sets out a five part test. There will be an 'undertaking in difficulty' when at least one of the following circumstances occurs:
"(a) In the case of a limited liability company (other than an SME that has been in existence for less than three years or, for the purposes of eligibility for risk finance aid, an SME within 7 years from its first commercial sale that qualifies for risk finance investments following due diligence by the selected financial intermediary), where more than half of its subscribed share capital has disappeared as a result of accumulated losses. This is the case when deduction of accumulated losses from
reserves (and all other elements generally considered as part of the own funds of the company) leads to a negative cumulative amount that exceeds half of the subscribed share capital. For the purposes of this provision, "limited liability company" refers in particular to the types of company mentioned in Annex I of Directive 2013/34/EU ( 4 ) and "share capital" includes, where relevant, any share premium.
(b) In the case of a company where at least some members have unlimited liability for the debt of the company (other than an SME that has been in existence for less than three years or, for the purposes of eligibility for risk finance aid, an SME within 7 years from its first commercial sale that qualifies for risk finance investments following due diligence by the selected financial intermediary), where more than half of its capital as shown in the company accounts has disappeared as a result of accumulated losses. For the purposes of this provision, "a company where at least some members have unlimited liability for the debt of the company" refers in particular to the types of company mentioned in Annex II of Directive 2013/34/EU.
(c) Where the undertaking is subject to collective insolvency proceedings or fulfils the criteria under its domestic law for being placed in collective insolvency proceedings at the request of its creditors.
(d) Where the undertaking has received rescue aid and has not yet reimbursed the loan or terminated the guarantee, or has received restructuring aid and is still subject to a restructuring plan.
(e) In the case of an undertaking that is not an SME, where, for the past two years:
(1) the undertaking's book debt to equity ratio has been greater than 7,5 and
(2) the undertaking's EBITDA interest coverage ratio has been below 1,0"
The revised ERDF Eligibility Guidance (version 9) explains the prohibition on undertakings and sets out the practical steps MHCLG, and therefore auditors of the programme, expect ERDF recipients to implement to demonstrate that project beneficiaries of ERDF are not "undertakings in difficulty".
The guidance covers three categories of potential undertaking in difficulty, these being:
- –ERDF grant recipients;
- –Beneficiaries of support under ERDF programmes; and
- –Delivery partners
Applicants for ERDF support to the Managing Authority
The test for organisations applying directly to MHCLG for an ERDF grant is not subject to any material change. All non-public sector applicants were already subject to a financial due diligence assessment to test their financial health, ongoing sustainability, ability to manage ERDF cash flow requirements and ability to repay ERDF funding.
Support provided by ERDF grant recipients to businesses
For programme bids, the ERDF grant recipient will need to quantify the value of the support (for support in any other form than a grant by applying the 'gross grant equivalent' test) and apply a different standard based on whether the award is £50,000 or more.
For awards below £50,000 the ERDF grant recipient must create and collect self-declarations signed by an authorised signatory of the beneficiary confirming that they have read the relevant definition and their organisation is not an undertaking in difficulty. The guidance suggests this may be incorporated into any declaration required under State aid rules. The declaration will need to be retained in line with ERDF record keeping requirements and may need to be produced at audit.
For awards of £50,000 or above the ERDF grant recipient must establish a system where information is submitted by the potential beneficiary and the ERDF grant recipient, or agent acting on their behalf, has carried out a verification as to whether the beneficiary is an undertaking in difficulty under any of the five tests. The information used in the assessment will need to be retained in line with ERDF record keeping requirements and may need to be produced at audit.
It should be noted that regardless of the value, the above test shall apply if the grant is included in calculating the eligible capital costs / expenditure of a project. This means the relevant steps must be put in place regardless of the value of the grant or the amount of ERDF contributed (for example it could be triggered by £1 of ERDF).
Undertakings that are delivery partners in ERDF projects
Organisations delivering ERDF projects are also responsible for ensuring that their delivery partners are not undertakings in difficulty. As above, ERDF grant recipients must make a formal financial assessment of their delivery partners in line with the definition of undertakings in difficulty.
ERDF grant recipients will need to review their procedures in light of this new guidance, particularly where they are involved in delivering a programme of support or have delivery partners involved in their projects. For many ERDF projects it will be necessary to develop new procedures and documentation to meet the requirements.
We have extensive experience of advising on ERDF projects, including making applications compliant and successfully defending projects from clawback. We have a detailed understanding of the organisations involved and the regulations (including those which have recently been amended, such as the, Revenue Generating Project rules at Article 61 of Regulation 1303/2013). Please get in touch if we can be of assistance.