State aid | Part IV– European Commission amends Temporary Framework for a second time to include aid recapitalisation and subordinated debt measures

The European Commission has amended the Temporary framework for State aid for a second time, with the changes as of 8 May 2020 aimed at further supporting Member State economies during the Covid-19 outbreak.

There are a number of exceptions that allow governments to support businesses affected by the coronavirus crisis – as explained in our previous Insight in this series – and the European Commission has provided guidance on the application of some of these exceptions in its Temporary Framework. In the meantime, the Commission has already approved an estimated €1.9 trillion in State aid schemes from a variety of Member States providing for different types of measures.

In its first amendment, the Commission extended the scope of the Temporary Framework to various aid measures to support research and development efforts related to Covid-19 relevant products as well as testing and upscaling infrastructure for such products and their production. The Commission's second amendment to the Temporary Framework extends the scope of this aid to recapitalisation measures and in the form of subordinated debt.

Eligibility and entry

Recapitalisation can be achieved in the form of equity and hybrid capital instruments. However, this type of aid should only be considered if no other appropriate solution can be found. The second amendment to the Temporary Framework, therefore, sets out various eligibility and entry conditions for this type of aid, in particular that the company would go out of business or face serious difficulties to maintain its operations without the aid and that the company is not able to find financing on the market at affordable terms. Moreover, only companies that were not in difficulty before 31 December 2019 should be recapitalised.

In order to ensure that the State intervention is proportionate, the recapitalisation must not exceed the minimum needed to ensure the viability of the company in need and should serve the purpose of restoring the capital structure of the company to pre-Covid-19 levels.

The Temporary Framework foresees the obligation for large companies to report on how the aid supports their activities and is in line with EU and national obligations linked to the green and digital transformation. This reflects the widely held view that the recovery from the current crisis should further the green and digital transformation agenda. Member States shall also publish the details of the companies benefitting from the aid.

Remuneration and exit

Clear and stringent conditions must be set regarding the State's remuneration and exit from the equity of the aid beneficiary, following the principles outlined in the Temporary Framework. The State shall receive appropriate remuneration for its investment.

In relation to the remuneration of equity instruments:

• For publicly listed companies, the investment shall be made at a price that does not exceed the average share price of the beneficiary over the 15 days preceding the request for the recapitalisation. For other companies, the investment shall reflect the market value of the equity, to be established by an independent expert.
• In order to incentivise the company to buy back the State’s investment, the measure shall include a step-up mechanism (or other mechanism having an equivalent effect), which can take the form, for example, of additional shares granted to the State. The mechanism will be activated if four years after the investment the State has not sold at least 40% of its participation and/or if six years after the investment the State has not sold its entire participation (for non-listed companies, five and seven years after the investment, respectively).
• The aid recipient should at any time have the possibility to buy back the equity stake that the State has acquired. To ensure that the State receives appropriate remuneration for its investment, the buy-back price should be the higher of the nominal investment by the State (increased by a fixed annual interest rate); or the market price at the moment of the buy-back.

For the remuneration of hybrid capital instruments:

• The overall remuneration shall factor in the characteristics of the instrument chosen (including its level of subordination, risk and all modalities of payment), incentives for exit (such as step-up and redemption clauses) and an appropriate benchmark interest rate.
• The minimum remuneration shall be at least equal to the base rate (one-year interbank offered rates (IBOR) or equivalent as published by the Commission), plus a fixed premium.
• The conversion of hybrid capital instruments into equity shall be conducted at 5% or more below Theoretical Ex-Rights Price (as defined in the Temporary Framework) at the time of the conversion.
• After the conversion into equity, a step-up mechanism shall be included to increase the remuneration of the State (in line with certain specific conditions and parameters set out in the Temporary Framework).

Secondly, conditions shall be set concerning the State's exit from the aid beneficiary:

• The recapitalisation shall be redeemed once the economy stabilises. Member States shall put in place a mechanism to gradually incentivise redemption.
• The remuneration shall be increased to converge with market prices, in order to incentivise the aid beneficiary to redeem the recapitalisation and to minimise distortions of competition.
• The recapitalisation measures shall contain appropriate incentives in order for companies to redeem the equity or hybrid instruments and to look for alternative capital, when possible.

Governance and undue distortion

In order to prevent undue distortions of competition, aid recipients shall not take excessive commercial risks; engage in aggressive commercial expansion financed by the aid; nor advertise the fact that they are beneficiaries of aid for commercial purposes.

Furthermore, until the State has fully exited from the aid beneficiary, there is a ban on dividends and share buybacks. There is also a strict limitation on the remuneration of management (including a ban on bonuses) and in acquisitions of stakes of more than 10% of competitors (including upstream and downstream operations) until at least 75% of the recapitalisation is redeemed.

Exit strategy

Aid beneficiaries (other than small and medium-sized enterprises) that have received a recapitalisation representing more than 25% of equity shall develop a credible exit strategy. The exit strategy shall be submitted to the Member State within 12 months after the aid is granted and must be endorsed by the Member State.

In addition, aid beneficiaries shall periodically report to the Member State the progress in implementing the repayment schedule, as well as the compliance with governance requirements and remedies against undue distortion of competition.

If, however, six years after the recapitalisation of a publicly listed company (and seven years for other companies) the State's exit is uncertain, the company's restructuring plan will have to be notified to the Commission. The Commission will then assess whether the plan is credible enough to ensure the company’s viability, also taking into account EU objectives and national obligations linked to the green and digital transformation.

Subordinated debt

EU Member States have the possibility to provide at favourable terms subordinated debt, which is subordinated to ordinary senior creditors in the case of insolvency proceedings. This type of aid will have to fulfil the existing conditions set by the Temporary Framework in respect of debt instruments, with additional requirements for credit risk mark-ups and the permitted amounts compared to senior debt.