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State aid law: the undertaking in difficulty test is relaxed

30 June 2020
On the 29 June 2020, there was welcome news for many organisations which have previously been rejected from obtaining public funding due to the  inclusion of the "undertaking in difficulty" test in the State aid Temporary Framework, which has meant that those not satisfying this test as at the end of December 2019 were excluded from support. 

Following many suggestions, the European Commission has amended the Temporary Framework so that micro and small enterprises are now subject to a light touch test, which only focusses on whether the aid recipient was subject to insolvency action on 31 December 2019 and had outstanding obligations under the Rescue and Restructuring Guidelines. We anticipate this news will lead to many organisations that were previously excluded reapplying for public funding. It will also be a welcome relief to many fund managers for whom applying the test was a significant administrative burden.

Although generally the Temporary Framework has been welcomed by Public Sector bodies administering State aid and businesses looking for financial support, the undertaking in difficulty test has been a sticking point, leading to viable businesses being rejected from support programmes during the Covid-19 pandemic. 

As a result, a number of organisations have lobbied for the rule to be changed, including DWF's Alexander Rose who had an article, written with Allie Renison of the Institute for Directors in the Telegraph. Particular problems have arisen for small technology businesses and in respect of applications for the Coronavirus Business Interuption Loan Scheme. 

Speaking to the European Parliament's economic affairs committee in late May, the EU Commissioner for Competition, Margrethe Vestager acknowledged that the business models of some startups meant that, "from a first-hand glance," they might appear ineligible for aid under the Temporary Framework and that resolving this was "a priority issue".

On 29 June 2020, following a consultation, the Commission announced the third amendment to the Covid-19 Temporary Framework made with the aim of resolving the "undertaking in difficulty issue" in respect of micro and small enterprises (i.e. undertakings with less than 50 employees and less than €10 million of annual turnover and/or annual balance sheet total). It also amends existing rules to provide for incentives for private investors to participate in Covid-19 related recapitalisation measures. 

Background and previous amendments

The original Temporary Framework was adopted by the Commission on 19 March 2020 and created a basis for governments to create State schemes allowing five different types of State support, including the €800,000 limited amounts of aid option. 

The Temporary Framework was first extended on 3 April 2020 adding additional flexibility to support Covid-19 related R&D&I, testing centres and factories to manufacture Coronavirus related devices, equipment and treatments. The UK's State aid umbrella scheme was approved on 6 April 2020, allowing the UK's Public Sector bodies to make use of six of the State aid options within the Temporary Framework.  The Temporary Framework was extended for a second time on 8 May 2020 to allow for recapitalisation aid and subordinated debt instruments.

Third amendment

The third amendment extends the scope of the Temporary Framework to:

  1. support certain micro and small enterprises, including start-ups that were already in difficulty before 31 December 2019, and
  2. provide incentives for private investors to participate in coronavirus-related recapitalisation measures.

Micro and small enterprises

Until now, all undertakings that were already in difficulty as at 31 December 2019 would not be eligible for support under the Temporary Framework. The rationale behind this was that the Covid-19 emergency should not be used as a cover to prop up businesses that were failing anyway, only those that are fundamentally sound but for the current crisis (as to do otherwise would distort the market and result in creditors receiving the benefit of the public funding). 

To ensure only viable undertakings received aid, the Commission's Temporary Framework referred to the  the 'undertaking in difficulty' test at Article 2(18) of the General Block Exemption Regulation. The problem was that this test does not align with the way many viable small businesses are structured. The test was felt to be unnecessarily inflexible therefore. 

Although this won't benefit medium and large businesses, it is likely to be welcomed because small and micro businesses make up 99.3% of the total business population in the UK, according to data captured at the start of 2019. The Commission's rationale in making the change is that given their limited size and involvement in cross-border transactions, temporary State aid to micro and small companies is "less likely to distort competition in the Internal Market than State aid to larger companies".

Private investor contributions

The third amendment also adapts the conditions for recapitalisation measures under the Temporary Framework for those cases when private investors contribute to the capital increase of companies together with the State. The changes:

  1. allow enterprises with an existing State shareholding to raise capital similar to private enterprises, whilst maintaining the same safeguards to preserve effective competition in the Single Market; and
  2. encourage capital injections with significant private participation also in private companies, limiting the need for State aid and the risk of competition distortions. In particular:

a. if the State decides to grant recapitalisation aid, but private investors contribute to the capital increase in a significant manner (ie. at least 30% of the new equity injected) at the same conditions as the State, the acquisition ban and the cap on the remuneration of the management are limited to 3 years; and
b. the dividend ban is lifted for the holders of the new shares as well as for existing shares, provided that the holders of those existing shares are altogether diluted to below 10% in the company.

Conclusion

Many small and micro enterprises will welcome the relaxation of the 'undertaking in difficulty' test. It will enable them to reapply for public funds. Public Sector bodies administering funds are also likely to welcome the changes, as they will not be required to undertake as detailed checks in order to award aid in a compliant way. This change is likely to act as a life line for a number of small businesses that might otherwise be forced out of business.

DWF has the largest State aid law team in UK private practice and is able to draw upon market leading experts in our UK and other international offices. Our experience in this area includes working within the European Commission, Central Government, Local Government and with private sector bodies receiving funds. We are on hand if it would be useful to discuss the issues raised in this Article or any other element of State aid law. 

Further Reading

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