In May 2021, the EU Commission presented its “Proposal for a Regulation of the European Parliament and of the Council on foreign subsidies distorting the internal market”. The proposal is supposed to close a “regulatory gap” resulting from the fact that the EU State Aid rules strictly limit the ability of EU Member States to subsidize companies active in the EU without the Commission’s approval, whereas no similar limitation and control mechanism exists for subsidies granted by third countries.
The proposed regulation is currently being discussed in the European Parliament. Its enactment is among the EU institutions’ top legislative priorities for 2022. If the regulation is adopted without significant changes to the current proposal, it will have a major impact on M&A transactions and significantly increase the costs and the administrative burden for many domestic and foreign companies doing business in the EU internal market.
New ex officio investigative tool
The proposal will allow the Commission to investigate potential distortions of competition arising from “foreign subsidies” of non-EU-countries for undertakings active in the internal market, and to adopt “redressive measures” in order to remedy such distortions of competition. To this end, the Commission will be entitled to investigate on its own initiative the existence of foreign subsidies, including any foreign subsidies granted in the last 10 years prior to the start of the application of the proposed regulation to the extent they continue to have distortive effects after the start of the application of the proposed regulation.
New notification obligations
The proposal also introduces new notification obligations based on certain turnover and value thresholds, namely:
- An obligation to notify certain M&A-transactions (“concentrations”), i.e. acquisitions of control of EU-based targets or mergers and joint ventures involving an undertaking based in the EU, where (a) the EU-based undertaking has an aggregate EU-turnover of at least EUR 500 million, and (b) all undertakings involved received aggregate “financial contributions” from third countries exceeding EUR 50 million in the last three years prior to the notification;
- An obligation of undertakings participating in public procurement procedures (“PPP”) with an estimated value of at least EUR 250 million to notify all (!) “foreign financial contributions” received in the last three years prior to notification or declare that no such financial contribution was received during this period of time.
In addition, the Commission is entitled to request the ad hoc-notification of concentrations or PPP participations even if they do not meet these thresholds.
The notification obligations are accompanied by standstill obligations: notifiable M&A-transactions cannot be closed, and public tenders cannot be awarded to bidders that had to notify foreign financial contributions, before the Commission has concluded its foreign subsidies review. A failure to notify or to respect the standstill obligations can be sanctioned with substantial fines (i.e. up to 10% of aggregate global turnover of the undertakings concerned).
The “financial contributions provided by third countries” that determine the notification obligations are defined extremely broadly and include many types of transactions and measures that ultimately may not be “subsidies” at all:
- Relevant financial contributions include the transfer of funds or liabilities, such as capital injections, grants, loans, loan guarantees, fiscal incentives, setting off of operating losses, compensation for financial burdens imposed by public authorities, debt forgiveness, debt to equity swaps or rescheduling, but also any foregoing of revenue that is otherwise due and even the mere provision or purchase of goods or services, regardless of whether these transactions are conducted at market terms or not.
- Relevant “third country” originators of “foreign financial contributions” are not only foreign government authorities, but also all public and even private entities whose actions can be attributed to the third country.
Importantly, all such “financial contributions” from all third countries granted in the last three years prior to notification have to be taken into account, regardless of whether they are directly or even indirectly linked to the transaction/PPP participation at issue. The relevant “financial contributions” are not confined to contributions received by the legal entities directly participating in an M&A-project or PPP. Rather, all financial contributions received by any member of the corporate group of the participating entity have to be added together for the purpose of assessing whether the notification thresholds are met. Given the broad scope of the notion of “financial contribution”, the identification of all such relevant contributions alone will be very difficult and burdensome for the undertakings concerned.
Should the notification requirements and the definition of the relevant “financial contributions” remain unchanged during the legislative process, it is likely that a very large number of transactions of internationally active companies will have to be notified and reviewed under the new regulation. It remains to be seen whether and how the Commission will be able to cope with this additional workload.
The notification and review procedures are independent from potential other reviews, e.g. under the EU Merger Regulation (EUMR), with the result that companies may have to prepare and file parallel notifications and cope with parallel proceedings under different legal instruments with different timelines and standstill obligations.
- The review of notifiable concentrations is closely modelled after merger control procedure under the EUMR: a preliminary investigation (“phase I”) lasting 25 working days, potentially followed by an in-depth investigation (“phase II”) of additional 90 working days (with possible extensions upon request and in case of a submission of commitment proposals).
- The review of notifiable PPP participations is subject to different timelines: the preliminary investigation can last up to 60 days, and the in-depth investigation can last up to 200 days from the receipt of the notification.
Substantive test
In substantive terms, the proposal entitles the Commission to examine whether foreign financial contributions constitute “foreign subsidies” that “distort the internal market”, and to ensure that such distortions are remedied by commitments of the undertakings concerned, or by “redressive measures” imposed by the Commission. The Commission may also prohibit notifiable transactions or tender awards to subsidized undertakings if no appropriate commitments are offered by the undertakings concerned.
Foreign subsidies shall be deemed to exist where a financial contribution of a third country (i) confers a “benefit” to an undertaking engaging in an economic activity in the internal market; and (ii) is “selective”, i.e. limited to one or more specific undertakings or industries. These notions are very similar to the well-established concepts of “advantage” and “selectivity” under EU State Aid law and will likely be interpreted in line with the case law and Commission practice on the corresponding EU State Aid law concepts. Broadly speaking, this means that a “foreign subsidy” will be deemed to exist if an undertaking/industry obtains a financial contribution from foreign state resources (or resources/entities attributable to the foreign state) at terms that the undertaking could not have obtained from private actors on the market, and if that financial contribution is not made available to all other undertakings/industries in a similar situation.
If a foreign contribution constitutes a foreign subsidy, the Commission will further assess whether this subsidy “distorts the internal market”, i.e. whether it is liable to improve the competitive position of the undertaking concerned in the internal market and thus actually or potentially negatively affects competition on the internal market. The proposal contains a non-exhaustive list of indicators factoring into this assessment, such as the amount and nature of the subsidy, the economic and competitive situation of the undertaking and the markets concerned, the purpose and conditions attached to the foreign subsidy, as well as its use on the internal market.
The proposal also specifies certain categories of foreign subsidies that will “most likely” be deemed to distort the internal market, i.e.
- Foreign subsidies granted to an ailing undertaking in absence of a viable restructuring plan;
- Unlimited guarantees for debts/liabilities of beneficiary undertakings;
- Subsidies directly facilitating a concentration or the submission of an “unduly advantageous tender” that would enable the undertaking concerned to win a public contract.
On the other hand, the proposal states that “de minimis”-subsidies with a total amount of less than EUR 5 million over a period of three years are deemed “unlikely” to distort the internal market.
If the Commission finds that a foreign subsidy distorts the internal market, the Commission will further assess whether the distortive effects may be counterbalanced or possibly even outweighed by positive effects “on the development of the relevant economic activity”. The outcome of this “balancing test” is supposed to determine the need for commitments or redressive measures and their respective scope and content.
Regrettably, the proposal does not contain any guidance as to how the “balancing test” shall actually be applied in practice. The Commission seems to be left with almost unlimited discretion in weighing the negative and positive effects of the foreign subsidy and in deciding on the redressive measures or commitments it deems appropriate. It is likely that the Commission will use the “balancing test” and its power to request commitments or impose redressive measures in order to shape foreign subsidies, their use in the internal market and/or the activities of the beneficiaries in a way that would ensure the equal treatment of recipients of foreign subsidies on the one hand, and recipients of State Aid granted by EU Member States on the other hand. However, this is not guaranteed, and there remains a significant risk that foreign subsidies and their recipients may be held to stricter standards than the ones applicable under EU State Aid law.
Red tape and legal uncertainty
There is no question that the new regulation will lead to significantly more red tape for any company doing business or willing to invest in the EU. The notification procedure for planned acquisitions and PPP participations will be costly and time-consuming. The new system is to run in parallel to the merger control systems at EU and national level, as well as the national rules of foreign trade law and investment control which will also continue to apply. The standstill obligations, as well as the potential risks and uncertainties resulting from the new foreign subsidies control proceedings will also have to be addressed and catered for in M&A deal documentations.
From the perspective of a foreign investor, all these parallel regimes with different requirements and objectives create a complicated maze for investment projects in the EU that will be increasingly difficult – if not impossible – to navigate without highly specialized legal advice of practitioners experienced not only in M&A-deals and merger control, but also in EU State Aid law and national FDI regimes.
The Commission has announced that it will be issuing detailed guidelines on the application of the new law once the proposed regulation has been adopted. Until such guidance will enter into force and will consequently bind the Commission when exercising its discretion, undertakings active in the EU and benefitting from foreign subsidies (or undertakings acquiring EU-based recipients of such subsidies) will be exposed to significant legal uncertainty when investing and/or competing in the EU.
On the other hand, the practical relevance of the new proposal will largely depend on the reaction of foreign countries. Art. 40 (7) of the proposal explicitly stipulates that international agreements concluded by the EU take precedent over the proposed new regulation. The very far-reaching and ambiguous content of the proposal may therefore be a bargaining chip and a strategic attempt of the EU to demonstrate to third countries that there is a need for bilateral or multilateral trade agreements with clear rules for a fair and predictable investment regime and for legal certainty for foreign investments. It remains to be seen whether this strategy will succeed.
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