Lorand
Bartels

Counsel, London/Brussels

Martin
McElwee

Partner, London/Brussels

Merit
Olthoff

Partner, Brussels

 

Increasing legal challenges to subsidization under existing law

The most frequent – and most advertised – subsidies of the 2020s to date are green subsidies, including favorable tariffs for green energy and subsidies for other green industries such as wind farms and solar panels, with the aim of facilitating a Net Zero ambition. In recent years, the EU and its member states have spent around €75bn in subsidies for renewable energy, primarily in the form of feed-in tariffs and feed-in premiums. This amount is, however, dwarfed by the US Inflation Reduction Act (IRA), due to come into force in 2024, which offers $369bn in green subsidies, this time mainly in the form of tax credits. Fears of relocating production have led to calls for the EU to respond by increasing its own green subsidies.

There has so far been an unofficial understanding among governments that green subsidies should in principle be regarded as being compatible with good public policy goals and, as such, should not be challenged. However, there are limits. One is that the use of local content should not be a condition for receiving a subsidy. Such local content conditions are often seen as a means of attracting domestic political support for green subsidies, but they are highly distortive and prohibited under WTO law. In 2022, the EU complained successfully about local content requirements in the UK’s Contracts for Difference subsidy for low-carbon energy production, and the EU, Japan and Korea have publicly complained about local content conditions in the incoming IRA. Subsidies conditioned on increasing exports are similarly prohibited by WTO law and liable to challenge.

More sophisticated green subsidy schemes are also coming under scrutiny. Some governments have adopted emissions trading schemes that rely on cap-and-trade certificates. Over the past two years, the United States has made two determinations in unilateral anti-subsidy investigations that the granting of free certificates by both the EU and Korea amounted to a subsidy, leading it to impose countervailing duties on imports considered to have benefitted unfairly from such subsidies. A WTO challenge to these determinations cannot be ruled out.

Companies should assess the risks associated with green subsidies before obtaining them, as they are increasingly being challenged in major jurisdictions.

New subsidy control mechanisms

2023 will witness two new subsidy regimes bringing more regulatory complexity.

• The EU is introducing new rules to tackle “foreign” subsidies granted by non-EU governments to businesses operating in the EU. The idea is to plug a gap in existing WTO and EU state aid rules, as WTO rules only cover subsidies to businesses within the jurisdiction of the granting body and EU state aid rules only govern subsidies granted by EU member states.
• The UK is introducing its own subsidy control regime following Brexit, which will be the main framework to help deliver on the UK government’s 2050 Net Zero goal. The new regime in the UK envisages establishing a relatively flexible framework when compared with the EU state aid regime, but at the same time it remains bound by the principles set out in the UK-EU Trade and Cooperation Agreement, which have been transposed into domestic law.

EU foreign subsidies regime

The regime will come into effect in mid-2023 and will have a considerable impact on mergers and acquisitions and public procurement procedures in the EU.

For targets established in the EU, it will create a third level of mandatory and suspensory M&A review alongside merger control and FDI reviews, at least for major acquisitions. The review will focus on whether any foreign subsidies distort the internal market by distorting either the competitive bidding process or competition in markets where the target operates. Subsidized buyers may be requested to repay the subsidy or offer other remedies to obtain EU clearance.

As regards the EU public procurement procedures, bidders will be required to inform the contracting authorities of the non-EU public funding they obtained – and the contracting authorities are required to transfer that information to the EC for review. The EC’s review is suspensory (exceptions apply) and might result in the prohibition of the award of the contract to subsidized bidders.

All businesses with any non-EU public funding across all sectors and jurisdictions (and regardless of nationality) will be affected by the regime. This regime will likely become a key feature of the M&A due diligence process, affecting data gathering for regulatory filing requirements, deal certainty and timetables.

It is also worth noting one major uncertainty in the regime: the overlap between the new regime and the WTO rules on subsidies. A strict reading of the WTO rules would suggest that subsidies that are even remotely related to goods cannot be subject even to a notification under the new regime, which would significantly reduce its reach. However, this point is unlikely to be settled before the regime enters into force; therefore, businesses should start to prepare now assuming that all subsidies will be covered by the notification obligations.

UK subsidy control regime

The new UK subsidy control regime will come into effect from January 4, 2023 and is intended to be more flexible than the EU state aid regime in order to unlock funding for key strategic areas of the UK economy. All private stakeholders benefiting from funding will be affected by the new regime, and contractual counterparties to public authorities are also likely to be affected.

Under the new regime, public authorities will need to self-assess compliance against a set of principles that are broadly similar to the policy goals of the EU state aid regime but much less detailed than the EU rules. The key difference is that public authorities are not required to first obtain approval from a regulatory body before granting the aid, which may add flexibility and speed, but at the cost of certainty. That said, public authorities may, in certain cases, have the benefit of nonbinding advice from the newly created Subsidy Advice Unit, which sits within the CMA. In practice, the assessment against the subsidy control principles is expected to be less than straightforward given the lack of precedent and potentially subject to challenge on judicial review grounds. Such challenges are more likely to be with respect to subsidies with a greater impact on competition and investment in the UK and/or international trade. The risk of an adverse judicial review challenge will be disproportionately borne by the private stakeholder beneficiary, which could be subject to a recovery order if the subsidy award is successfully challenged.

To minimize the risk and potential impact of a successful challenge, it would be essential for private stakeholder beneficiaries to (i) work closely with public authorities and conduct their own rigorous self-assessments; (ii) ensure that contractual protections are in place to allocate risk, including taking the risk of challenge into consideration when setting the transaction timetable; and (iii) consider and develop worst-case-scenario defense strategies from the outset of the proposed arrangement.

With thanks to Bola Ajayi and Aytaç Çelebi for their contributions to this theme.

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