Air rescue or a tax holiday? State aid and FlyBe Government Support

Introduction

News emerged on 12 January that the regional airline FlyBe was close to entering insolvency proceedings.   By 13 January, FlyBe's two owners, Connect Air and Virgin had agreed a rescue package with HM Government understood to include the short-term deferral of an outstanding air passenger duty (“APD”) tax bill of £106m, a possible loan, and the promise to review APD levels before the March budget.  Whilst this move has staved off the collapse of FlyBe (at least for now), it has proved controversial legally, triggering two legal challenges from two of FlyBe’s competitors, Ryanair and IAG (the parent company of Iberia and British Airways).  

The complainants have alleged the Government’s support amounts to illegal state aid, contrary to Article 107 of the Treaty on the Functioning of the European Union (“TFEU”).  This provision of the Treaty is enforced by the EU Commission but may also be invoked by competitors before the national courts of the EU.  The IAG has filed a complaint with the Commission in this case, whereas Ryanair is threatening to launch a judicial review before the UK courts. 

Why is the package controversial?

Article 107(1) prohibits the grant of publicly backed aid to businesses where the aid favours the recipient over its rivals and is capable of affecting competition and inter-state trade.  The scope of Article 107 covers direct subsidies as well as other forms of advantages such as preferential loans or capital subscriptions, a guarantee by a public body of debts, the sale of a public asset at an undervalue or the purchase of an asset by the public body at an overvalue.    

In this case, Ryanair has complained that the deferral of the collection of tax amounts to a "tax holiday", which grants FlyBe a selective advantage over its rivals.  Ryanair may point to previous cases which have illustrated that tax advantages can amount to state aid where these amount to selective advantages to a limited number of undertakings.  

Ireland, for example, was subject to an investigation by the EU Commission in relation to tax treatment of Apple Inc by certain decisions of the Irish Revenue Commission.  The Commission found these rulings were inconsistent with others relating to other businesses which competed with Apple.  This culminated in a decision ordering Ireland to recover €13 million in unpaid taxes from 2004-2014 from Apple.  That decision is currently under appeal by both Ireland and Apple itself.  It highlights the general principle that taxation measures must be set generally and must not favour one or a limited number of undertakings.  For that reason, if the Government does review ADP levels before the budget there will be nothing to prevent a reduction or exemptions, as long as those measures benefit all competitors equally. 

Deferring the collection of a debt owed to a public body can also be legally problematic. The state is expected to act in the same way as a reasonable private sector creditor would.  There can be State aid if a private company is given extra time to pay amounts owing if a private creditor would have demanded the repayment of debt instead.  

Are there special rules on rescue packages and State aid?

Yes. The EU’s rules on rescue and restructuring are set out guidelines issued by the Commission in 2014. These allow various forms of support to be issued to firms in jeopardy, although subject to conditions.  The guidelines cover aid in the form of loans or loan guarantees.  Loans must not be unduly favourable, for example, with reference to the rate of interest set or collateral taken to secure the loan.  The Guidelines lay down criteria for determining this.

The Government in this case appears not to have relied on the Guidelines, at least in relation to the deferral of APD payments.  That may be because the Guidelines require the Commission’s prior approval as well as a comprehensive plan to restructure the beneficiary (which must also be approved).  It was perhaps felt that Flybe’s situation had reached a point where there was inadequate time to satisfy these requirements.   

This area of State aid law has been controversial in the UK before.  In 2016, British Steel entered insolvency, placing 5000 jobs at risk.  It was refused an emergency loan by the UK Government, which considered that a loan could not be granted due to the terms of the loan not being commercial, which would fall foul of the rescue guidelines. 

Are there defences to the complaints?

There is nearly always a defence where a public sector body can show that its actions as a creditor are in line with those of how a hypothetical private sector creditor would behave in the same situation.   This is termed “the market economy creditor principal”.  The Commission and EU Courts have recognised that a creditor will not always push for payment straight away, especially where this would trigger insolvency of the debtor and lead to the public sector receiving less money in the long run. 

The Commission, however, will review critically whether indeed a creditor would have been lenient in the same situation, taking into account factors such as whether the debt is secured against collateral and the length and complexity of insolvency proceedings, as well as whether forced sale of assets would have generated more revenue.  In a recent case, the Government of Slovakia failed to rely on this defence successfully in relation to the scaling down of a tax bill to assist a debtor near insolvency.  The Commission calculated the Government would have recouped more from the insolvency process.   

The UK Government may seek to defend its actions by pointing to equivalent actions taken by other actual private sector entities in the same situation.  This is known as the principle of concomitance.  It can apply for example to allow a public sector entity to invest in a business on the same terms as other private sector investors.  In this case, the Government is not acting alone to help the beleaguered airline. FlyBe's two shareholders - Virgin and Connect - are understood to have agreed to inject £30 million in extra capital.  There may, however, be difficulties with the concomitance defence here.  How do you show equivalence between a deferral of ADP and the provision of extra capital?  The Government is acting as a creditor whereas the shareholders are acting as investors, subscribing to new capital.  In any event, the Government is putting at risk £100 million in unpaid duty, considerably more than the amount put forward by the shareholders.

In granting the assistance, the Government may have been motivated by the need to avoid 4,000 job losses.  However laudable that intention may be, it will not form the basis of a defence where aid has not been notified in pursuance of the rescue and restructuring guidelines.  Previous cases have made clear that social factors cannot be taken into account when deciding how to structure or collect landing fees.  That was clearly in the UK Government’s mind when it rejected British Steel’s pleas for an emergency loan. Ryanair itself found this out in a series of Commission decisions involving the grant of preferential landing fees by municipalities such as Charleroi and Strasbourg.  In those cases, the Commission made clear that the grant of lower fees for the airline would not be justified by a desire to increase the number of visitors to those regional cities.  That was a social factor which a rational businessperson would not take into account. 

It has been suggested that the Government may also provide loans to FlyBe in due course.  There are ways of doing this lawfully without needing the Commission’s prior approval.  The Commission has issued a guidance note on loans, which sets out proxy minimum rates of interest and collateral terms to be followed.  Satisfying the note will avoid the need for a clearance of the loan.  

Isn't the UK leaving the European Union?  Why does it matter?

Whilst the UK is in the departure lounge, it has not left yet!  The Commission has made clear that until the exit is complete, the UK will be expected to honour its obligations under TFEU.  Going forward, Article 126 of the draft EU-UK Withdrawal Agreement (which is expected to be approved by Parliament this month) provides for a transition or implementation period, starting at the UK's point of departure and ending on 31 December 2020.  Under Article 93 of the Withdrawal Agreement, the Commission will continue to be competent in relation to all matters of State aid up to the end of the transition period.  For a period of four years thereafter, the Commission will continue to have competence to enforce the rules in relation to any aid granted by the UK during the transition phase.

Following the end of the transition phase, the UK Government hopes to have in place a Free Trade Agreement (“FTA”) with the EU in order for free access to the single market to continue seamlessly.  The basic principles of the FTA are set out in a “Political Declaration” accompanying the Withdrawal Agreement, which effectively serves as a heads of terms for the negotiations in the transition period.  Article 77 of the Political Declaration sets out that the FTA will ensure "robust commitments to ensure a level playing field…The Parties should in particular maintain a robust and comprehensive framework for competition and state aid control that prevents undue distortion of trade and competition" (emphasis added).  How this statement of intent translates into an actual legal text remains to be seen, as are the finer details of the enforcement mechanism.  There is clearly a desire on the part of the EU27, however, to avoid a situation where the UK is able simultaneously to subsidise goods and services sold freely on the internal market, thereby putting European businesses at a competitive disadvantage.  

Comment – hard choices ahead

The Johnson administration has made noises that it may no longer wish for the UK to be bound by the EU rules on State aid.  Clearly, that may be seen to bring short-term political advantages.  The Government would have a freer hand to support businesses in difficulty as well as provided grants and subsidies to businesses and regions in difficulty.  Such moves would be in keeping with its desire to reach out to areas of the North of England which in the 2019 General Election showed themselves willing to vote Conservative.  The Government wants to reward the faith of Northern voters and has an interest in doing more to help regional areas which feel they have been left behind by the policies of the EU and successive domestic governments.

The freedom of action should not be overstated.  Firstly, the UK has signed up to become a member of the World Trade Organisation in its own right.  WTO rules also control the provision of public subsidies, although with a weaker enforcement mechanism than that mandated by the EU.  Secondly, from a practical perspective, the Government must also decide whether it wants this incidence to become a precedent?  Can it afford to provide assistance to every airline in difficulty and how does that sit with its other political objectives?  

The decision of whether or not to seek a clean break from the State aid rules (or a similar regulatory regime) involves difficult choices.  Concluding the FTA before 31 December is going to be extremely challenging.  Success in that endeavour is critical, however, to avoiding the disruption of a "no deal Brexit".  Business confidence has been improved by the likely passage of the Withdrawal Agreement through Parliament and the prospect of a FTA to follow.  The Commission will be reticent to do agree any FTA which allows the UK to deviate from the disciplines of its State aid rules.  The Government must weigh up the potential cost of a loss of access to the single market against the potential gains of being able to provide more support to businesses such as FlyBe and British Steel.  After all, if Brexit goes badly, FlyBe will by no means be the last distressed company to be seeking Government support.