In anticipation of the wave of requests from stricken companies due to the COVID-19 outbreak for more long-term State support, on 8 May, the Commission extended the scope of its State aid Temporary Framework to allow Member States to take stakes in non-financial companies affected by the outbreak by means of recapitalisation or subordinated debt instruments, in order to prevent their market exit.
The amendments are largely seen as loosening the State aid rules to allow Member States more flexibility in the range of options available to address the outbreak, although they come with strings attached. Recapitalisation measures will entail bans on dividends and bonuses for beneficiary companies, and a new obligation on Member States to ensure that the aid measures are consistent with the EU climate and digital objectives. They will also be subject to stringent conditions as regards the State’s remuneration and exit from the equity of the beneficiaries.
The amended Temporary Framework creates specific rules under which Member States are allowed to grant recapitalisation aid measures to non-financial companies affected by the COVID-19 outbreak. The need for these measures is expected to crystallise in the later stage of the outbreak’s evolution, as a result of which the amended rules allow these measures to be granted until the end of June 2021.
Under the general eligibility criteria, recapitalisation can only be granted to beneficiaries that were not in difficulty before the outbreak (31 December 2019) and would otherwise go out of business or face serious difficulty maintaining operations. Eligible companies must also not be able to find financing from the market on affordable terms. Equally, any other support measures that the Member State has introduced must be insufficient to allow the undertaking to remain viable. The recapitalisation should also be in the “common interest” — the Temporary Framework does not define this concept but makes reference to avoiding social hardship (e.g., from significant loss of employment), systemically important companies and services, or similar situations that the Member State will be expected to substantiate in their notification.
To ensure proportionality of the aid, the amount of the recapitalisation must not go beyond the minimum level needed to ensure the beneficiary’s viability. It cannot go beyond restoring the capital structure of the beneficiary that was in place before the outbreak (i.e., 31 December 2019). In assessing the proportionality of the aid, other State aid received or planned in the context of the COVID-19 outbreak shall also be taken into account.
Recapitalisation measures can be granted under approved State aid schemes, or as individual ad hoc State aid. However, aid to an individual beneficiary granted under schemes must be separately notified to the Commission if it exceeds €250 million.
The recapitalisation measures must be designed in a way that meets the EU’s policy objectives related to green and digital transformation of the EU economy, in order to allow more sustainable long-term growth and promote the transformation to the agreed EU objective of climate neutrality by 2050. Large companies that benefit from recapitalisation will have to report on how the aid received supports their activities in line with these EU objectives.
Types of recapitalisation measures
The new rules allow for two different kinds of recapitalisation measures: (i) pure equity instruments, such as the issuance of new common or preferred shares, and (ii) hybrid capital instruments, which have a debt and an equity component, such as profit participation rights and convertible secured or unsecured bonds. The State recapitalisation can take the form of any variation or combination of these.
State remuneration and exit
The core of the new rules is that the State will have to receive appropriate remuneration for its investment and design a mechanism to incentivise the redemption (buy-back) of the State’s stake in order to allow the beneficiaries to function independently once market conditions permit. For equity instruments, the price paid by the State cannot exceed the average share price of the beneficiary over the 15 days preceding its request for support. The State’s remuneration should represent an increase of at least 10% on the State’s investment, to be granted in additional shares, convertible bonds, or other mechanisms. The buy-back price should be the higher of the State’s original investment at a minimum interest rate or the market price at the moment of buy-back.
There will also be automatic step-up that is triggered after four years (if the State has not sold at least 40% of its participation) and/or after six years (if the State has not sold all of its shares). These deadlines can be set to five and seven years respectively for non-listed companies. The Commission will accept alternative proposals to ensure similar outcomes, however, provided the incentive effects on the exit of the State and the State’s remuneration are ensured. Furthermore, if after six years (or seven for non-listed companies) the State still holds more than 15% of the beneficiary’s equity, the Member State will have to notify a restructuring plan for that beneficiary company to the Commission for approval.
When designing hybrid instruments, Member States must “adequately factor in” elements like the level of subordination, risk, payment modalities, exit incentives and the benchmark interest rate, although there are no specific criteria for these features. The Temporary Framework acknowledges that the nature of hybrid instruments varies significantly, and so has taken a more general approach to the rules governing their grant. There are some clear requirements, however, including minimum remuneration rates until conversion, minimum conversion rates, and mandatory step-up mechanisms to incentivise beneficiaries to buy back the State capital injections.
Governance and prevention of undue distortion of competition
The beneficiaries of recapitalisation measures will face: (i) ban on dividends and bonuses: until the State is fully bought out, beneficiaries cannot make dividend payments, non-mandatory coupon payments or buy back shares held by shareholders other than the State. Further, as long as at least 75% of the State’s recapitalisation measures goes unredeemed, the remuneration of the beneficiary’s management cannot exceed pre-outbreak levels. There is also a ban on bonuses being paid; (ii) acquisition ban: as long as at least 75% of the State’s recapitalisation measures have not been redeemed, beneficiaries (other than SMEs) must not acquire more than a 10% stake in competitors or other operators in the same line of business without Commission approval; (iii) advertising ban: beneficiaries receiving recapitalisation support cannot advertise it for commercial purposes; (iv) ban on cross-subsidisation: the recapitalisation cannot be used to cross-subsidise the economic activities of integrated undertakings that were in difficulty on 31 December 2019.
For companies requiring recapitalisation in excess of €250 million with significant market power on at least one relevant market, Member States must propose additional measures to preserve effective competition in those markets, e.g., structural or behavioural commitments. 
Subordinated debt instruments
The Commission considers subordinated debt less distortive than equity or hybrid capital, since it cannot be automatically converted into equity when the company is a going concern. As such, it has extended the existing rules for subsidised loans in the Temporary Framework to include subordinated debt. There are some extra requirements for debt instruments of this nature, however, including a limitation on the amount of subordinated debt that a company can be granted as compared to the senior debt it is already holding. These thresholds are one third for large companies and half for SMEs.
There are also overall limits on the size of the loan, taken from the pre-existing thresholds in the Temporary Framework. If these limits are exceeded then Member States will have to comply with the conditions applicable to recapitalisation measures (as outlined above).
Clarifications and amendments to the existing text of the Temporary Framework
The amendment also introduces some amendments to the text of the pre-existing temporary Framework. It makes clear that the Commission would like to encourage Member States to design temporary support measures under the Temporary Framework with EU green and digital objectives in mind, although it does not mandate this beyond recapitalisation measures. The amended rules reiterate that direct aid to financial institutions cannot be assessed under the Temporary Framework, although any indirect advantages from channelling guarantees or subsidised loans may fall within its auspices. Similarly, the general prohibition on aid to financial institutions will not preclude aid in the form of wage subsidies to employees of those institutions being granted and such schemes may still be assessed under the Temporary Framework.
Notwithstanding these clarifications, the application of the Temporary Framework has shown the need for further clarity on certain points as to the operation of the aid measures already covered. For instance, the Commission has been unequivocal in discussions with Member States that voucher-based solutions (instead of refunds) for the travel and tourism industry are not compatible with consumer rights. Instead of allowing companies to fob off customers with vouchers, it should be made clear that Member States can support operators through the Temporary Framework to ensure they can reimburse their customers. Comment
While these amendments are largely seen as loosening the State aid rules to allow Member States more flexibility in the range of options available to address the outbreak, given the strict conditions that must accompany any recapitalisation aid it remains to be seen how popular the measure will be. The requirement that recapitalisation aid can only be given if recipients are not able to find financing from the market on affordable terms may be superfluous. This is because, due to the restrictions relating to a recapitalisation, it can be expected that companies may seek to explore all other options (including other schemes approved under the Temporary Framework such as State guarantees for loans) before they are willing to accept the State as a shareholder. Both existing shareholders (who will not be able to take dividends or, in the case of large undertakings, engage in M&A above certain limits) and management (who will not be eligible for bonuses until the aid is repaid) can be expected to see the State recapitalisation option as a measure of last resort to save a company facing severe financial difficulties as a result of the outbreak.
Further, it is also not clear which behavioural or structural conditions for companies in receipt of recapitalisation support in excess of €250 million the Commission will consider sufficient. While the Commission will probably not be as strict as under the Rescue and Restructuring Aid Guidelines, the level of compensatory measures may vary from sector to sector, depending on the current competitive situation and the extent to which the sector is hit by the crisis. Those familiar with the Commission’s willingness to accept behavioural solutions in a merger control or antitrust context will already be aware that the Commission is often reticent to consider such measures capable of remediating perceived competitive distortions. If the Commission takes a similar approach with the recapitalisation measures, potential beneficiaries could see restructuring conditions attached to their support even where there is no reason to suspect that the granting State would have been able to exit without them. Without indications on the kinds of commitments the Commission will expect, this remains an unknown factor for Member States designing support.