COVID-19: The European Commission expands the Temporary Framework to allow authorization of state aid in the form of recapitalization and subordinated debt measures

On the one hand, this amendment to the Temporary Framework will allow member states to provide recapitalizations out of public funds to non-financial companies in need through equity instruments (in particular by issuing new shares) or hybrid capital instruments (in particular profit participation rights or convertible bonds). Moreover, member states are free to design national measures in line with additional policy objectives, enabling green and digital transitions, or preventing fraud, tax evasion or aggressive tax avoidance.

Member states can notify recapitalization schemes or individual aid measures. The aid schemes are general frameworks that member states can design to grant individual aid based on them. When approving a scheme, however, the Commission will request the separate notification of aid to a company above the threshold of €250 million for individual assessment. The restriction has also been kept in place on granting aid under the Temporary Framework to companies that were already in difficulty on December 31, 2019.

Besides these limits, the Commission sets a number of safeguards to avoid undue distortions of competition in the single market, in relation to:

1. The necessity, appropriateness and size of intervention: recapitalization aid should only be granted if no other appropriate solution is available, and it must also be in the common interest to intervene (for example, to avoid social hardship and market failure due to significant loss of employment, the disappearance of an innovative or a systemically important business or the risk of disruption of an important service). Additionally, the aid must also be limited to enabling the viability of the company and should not go beyond restoring the beneficiary's capital structure before the COVID-19 outbreak.
2. The state’s entry in the capital of companies and remuneration: the state must receive sufficient remuneration for the risks it assumes and the remuneration mechanism needs to incentivize beneficiaries or their owners to buy out the shares acquired by the state to ensure that the state's intervention is temporary.
3. The state’s exit from the companies’ capital: an exit strategy must be drawn up for member states, especially as regards large companies that have received significant recapitalization aid. If six years after recapitalization aid to publicly listed companies, or up to seven years for other companies, the exit of the state is in doubt, a restructuring plan for the beneficiary will have to be notified to the Commission.
4. Governance: beneficiaries are subject to bans on dividends and share buybacks until the state has exited completely. Moreover, until at least 75% of the recapitalization is redeemed a strict limit must be placed on the remuneration of their management.
5. Cross-subsidization and acquisitions: beneficiaries cannot use the aid to support economic activities of integrated companies that were in difficulties before December 31, 2019. And until at least 75% of the recapitalization is redeemed, beneficiaries, other than small and medium-sized companies, are prevented from acquiring a stake of more than 10% in competitors or other operators in the same line of business.
6. Transparency and reporting: if recapitalization aid is granted as part of schemes, member states have to publish details on the identities of the companies that have received aid and the amount within three months of the recapitalization. Furthermore, beneficiaries other than SMEs have to publish information on the use of the aid received.

This new Temporary Framework also provides the option for member states to support businesses facing financial difficulties due to the COVID-19 pandemic by providing  subordinated debt to them with favorable terms. These instruments are subordinated to ordinary senior creditors in insolvency proceedings and add to the toolbox available to member states under the existing Temporary Framework to provide financial support to businesses.

Subordinated debt cannot be converted into equity while the company is a going concern and the state assumes less risk. Since this type of debt increases the ability of companies to take on senior debt in a manner similar to capital support, aid in the form of subordinated debt includes higher remuneration and a further limitation as to the amount compared with senior debt under the Temporary Framework. If member states want to provide subordinated debts in amounts exceeding the thresholds, the same conditions for recapitalization measures will apply.

Despite this new amendment, the Temporary Framework will be kept in place until December 2020. Since solvency issues may materialize only at a later stage as this crisis evolves, however, the rules applicable to the  recapitalization will be extended until June 2021. In any event, the Commission will assess before December 2020 whether they need to be extended. Based on its recent practice, if the need arises the Commission could review and amend the Temporary Framework without waiting for that time limit to expire.

It needs to be underlined that the Temporary Framework is not directly effective legislation, instead a communication in which the European Union announces the criteria that it is going to use to decide on the compatibility of the various types of State aid with EU law. The Temporary Framework does not release member states from the obligation to give prior notification to the Commission of the aid they intend to put in place and to wait until it has been authorized in a formal decision to be able to grant the aid.

Click here for the Temporary Framework approved by the Commission.