Market economy operator tests

The Treaty on the Functioning of the European Union (TFEU) fundamentally prohibits granting aid.

According to this, a public action constitutes state aid if the following six conditions are met cumulatively:

1. A benefit is granted from state funds
2. A party is favoured
3. The action is granted to an undertaking or production of certain goods
4. Selection takes place, e.g. only a particular undertaking or production of certain goods is favoured
5. The favouring results in a distortion of competition or threatens to distort competition
6. The favouring affects trade between Member States. 

If one of these conditions is not met, the action is not counted as aid and the intended action may be granted without the restrictions of the law governing state aid.

Otherwise the action must be reported to the European Commission before it is granted, as part of a notification procedure. In exceptional cases, it is not necessary to report it (e.g. for de minimis aid, SGEI exemption notices, public service contracts under Regulation 1370/2007, General Block Exemption Regulation).

Classification as state aid can be triggered by any state support if it grants the undertaking a non-arm’s length advantage (favouring). In practice, the following actions are particularly relevant:

• Capital contributions (incl. debt to equity swaps)
• Loans (incl. from shareholders), promotional loans, sureties, guarantees
• Profit transfer agreements, subordination agreements, comfort letters
• Purchase or sale of real property and buildings
• Acquisition or disposal of shareholdings
• Rent, lease, concession and service agreements
• Availability of use of public infrastructure
• Absorption of operating expenditure or public services development costs
• Reduction or exemptions from taxes, fees and charges.

For an action to classify as aid it is not necessary for the state to make payments. It suffices if the state waives or defers contractual payments or grants leases at conditions below the market level.

In principle all undertakings and institutions are affected that are temporary or permanent recipients of state transfers. These are both undertakings in public ownership and private undertakings that receive state support either directly from the state or indirectly from undertakings in public ownership.

In principle, the actions of all industries can be classified as state aid, although the following industries which have a public connection are particularly included among the recipients of public transfers:

• Transport and infrastructure undertakings (e.g. airports and marine ports, transport companies)
• Social infrastructure enterprises (e.g. municipal real estate enterprises, trade fairs, congress centres, swimming baths)
• Health sector enterprises (e.g. hospitals)
• Energy supply companies (e.g. local authority-run power stations, electricity and gas network operators)
• Waste disposal companies
• Financial institutions (e.g. regional banks).

An aid audit by the European Commission might be initiated, for example, if competitors make a complaint or on its own initiative. 

If the Commission finds in its aid audit that the state action is substantively unlawful because it is not permissible, it will order the Member State concerned to withdraw the aid from the favoured undertaking. Furthermore, the favoured undertaking is usually charged interest for the period from when it was awarded the aid to the time it repays it.

Classification as favouring by state aid, that is, giving an undertaking an economic advantage, can be ruled out if the public body receives proper arm’s length compensation in return. In this case, the public entity acts like a private independent market economy operator.

The instrument of the market economy operator test (MEOT) gives the way to check and prove that the compensation received by the public body matches market conditions. Equity measures are tested in a private investor test, debt is tested in a private creditor test, and disposals are tested in a private vendor test. These instruments were developed as part of the EU Commission decision-making practice on state aid and the European courts. The MEOT serves as the key documentation and argumentation guidance if the EU Commission opens an audit.

If the test is positive, the action is not counted as reportable state aid. If the test is negative and none of the tightly defined exemptions for state aid apply, a permit will be necessary for the aid from the European Commission.

It should be noted that an MEOT does not count as passed from the outset if the company concerned is in difficulties, i.e. is not able to obtain the capital it needs on the capital market.

In the case of sales and purchases of shareholdings by a public body, a proof of the conformity of the aid is necessary, either through purchase prices that came about through competition or alternatively an expert opinion on the value of the business under IDW S1 may be obtained.

The design of a market economy operator test (MEOT) basically depends on the type of action planned by the public body and is usually adapted to match the specific case. An MEOT analyses whether the public body has made appropriate compensation in the form of a return at arm’s length.

The test is carried out ex ante, i.e. expected arm’s length returns at the time of the decision to carry out the transaction by the public body are examined. If the transaction was already carried out in the past, sometimes an ex post MEOT can serve as documentation, for which the date of the decision to carry out the transaction is taken as the yardstick.

In many cases, an MEOT in the form of a private investor test (PIT) is applied to equity transactions. In a PIT, profitability is calculated according to the internal rate of return or the discounted cash flow method. In practice, the values of the business concerned are compared in scenarios with and without the corporate action. The determinative comparative scenario is the most economically profitable alternative action without carrying out the corporate action. The PIT is considered passed if the business value in the scenario with the corporate action is more than the business value in the comparative scenario. The robustness of the results is proven in a sensitivity analysis, in which upside and downside scenarios are examined.

The steps in a private investor test

1. Plan
   Individual conceptualisation of the PIT for the planned public action
   
   
2. Planning scenarios
   Derive the base scenario including the corporate action and most profitable alternative action not including the corporate action (comparative scenario)
   
   
3. Cash flows
   Analyse and determine expected cash flows in the scenarios under consideration
   
   
4. Cost of capital
   Calculate risk-equivalent discounting interest rates based on capital market data and CAPM
   
   
5. Capital value comparison/IRR
   Discount the cash flows in the scenarios under consideration and carry out a capital value comparison or determine IRR
   
   
6. Sensitivity analysis
   Test the robustness of the results in sensitivity analyses (downside and upside scenarios)

An MEOT can also be applied to debt transactions conducted by a public body in the form of a private creditor test (PCT).

The arm’s length nature of the conditions agreed for the debt transaction is examined.

Debt transactions include such things as shareholder loans, sureties and guarantees. Interest rates, surety fees, terms and agreed covenants are to be examined for arm’s length to rule out any non-arm’s length advantage.

The conditions may be tested using capital market data by means of expert opinions or specific legally binding offers from credit institutions. Furthermore, the rules of the Commission’s reference rate communication and the state aid notice may be applied as simplified calculation methods.

To calculate arm’s length conditions, the creditworthiness of the recipient undertaking must first be determined using a rating as the basis to determine the proper interest rates and guarantee commissions. Creditworthiness is determined based on the undertaking’s financial statements, economic and financial budgeting and other financial data.

State-aid compliant exemptions or the aid framework scheme may also apply to debt. 

Take advantage of our many years of expertise and experience as recognised business experts for questions on state aid of all kinds. You will minimise your risk and profit from professional support with the process:

• Analysis of the requirements to ensure conformity with state aid in your specific case
• Well-founded documentation on the market conformity of a planned corporate action with a market economy operator test as an expert opinion (private investor test/private creditor test)
• Support with preparing and carrying out the reporting or prenotification process at the EU Commission, drawing on an extensive network of experts in public law