Application of the "private investor principle" in state aid
R (Sky Blue Sports and Leisure Ltd) & ors v Coventry City Council & ors [2014] EWHC 2089 (Admin), 30 June 2014
In a dispute over whether a public authority's loan to a football stadium joint venture constituted illegal "state aid" under EU rules, the English High Court considered the application of the "private investor test". In dismissing this challenge, the court emphasised that there is a wide spectrum of reasonable responses available to a hypothetical private investor and accordingly a public authority should likewise be afforded a wide margin of discretion when taking investment decisions. Falling foul of EU state aid rules is a risk area in any project involving public funding.
Background
The claimants were members of the SISU group, which owned Coventry City Football Club (the Club) which, between 2005 and 2013, played its home games at the Ricoh Arena in Coventry. The Ricoh Arena is owned by Coventry City Council and leased to Arena Coventry Limited (ACL), a joint venture in which the Council had a 50% interest. The Arena was financed by a GBP 22 million bank loan from Yorkshire Bank (the Bank).
Following relegation, the Club fell into financial difficulties and was unable to pay its rent to ACL. This culminated in a "rent strike" designed to put pressure on ACL and force through SISU's restructuring proposal, namely that it would purchase 50% of ACL and buy the bank debt in whole or in part. However, SISU was ultimately unable to agree terms, leaving the Council with two possible options: lend ACL the money it needed to service the bank loan, or wind ACL up.
The Council decided to loan ACL GBP 14.4 million, for 41 years (the remaining term on the lease) at an interest rate of 5% per annum for the first five years of the facility, and thereafter at the discretion of the Council but no less than 5% nor more than 2% above the Public Works Loan Board rate, the rate at which the Council could borrow money.
The claimants sought to challenge the legality of that decision to make a loan, on the grounds that the transaction constituted state aid within the meaning of Article 107(1) of the Treaty on the Functioning of the EU (TFEU) and was not notified to the European Commission in advance as required by Article 108(3). They argued it was thus unlawful under EU law. Conventional domestic judicial review arguments were also pursued namely that the Council failed to take into account several material considerations and the decision to make the loan was irrational.
State aid and the "private investor test"
Article 107(1) TFEU provides that:
"… [A]ny aid granted by a Member State or through State resources in any form whatsoever which distorts or threatens to distort competition by favouring certain undertakings…shall, in so far as it affects trade between Member States, be incompatible with the internal market".
The role of a national court is to determine whether aid is state aid within the meaning of Article 107(1), not to determine whether the State aid is justified as this is a matter for the Commission under Article 108(3) TFEU. To determine whether or not aid distorts or threatens to distort competition the "private investor test" must be applied. This is an objective test of whether a rational private investor would have entered into the transaction in question on the same terms, having regard to the foreseeability of obtaining a return and leaving aside all social and policy considerations.
Private investor test satisfied
SISU argued that no rational private market investor would have entered into the transaction on the terms entered into by the Council because:
- the value of ACL was less than half of the sum advanced and accordingly the security for the loan was inadequate;
- the term of the loan (41 years) was substantially longer than any term which a private investor would have countenanced;
- the interest rate and rate of return on the loan inadequately reflected the commercial risk; and
- there was no commercial justification for the loan. The Council took into account policy objectives rather than commercial objectives as evidenced by the fact that it did not pursue an alternative to the granting of the loan.
In dismissing the claim, the court held that the hypothetical private investor must be given the same characteristics as the Council, namely that it was a 50% shareholder in ACL and not a new investor. The hypothetical investor would be unlikely to focus exclusively on the loan to value ratio. The 41-year term of the loan was not substantially longer than any term which a private investor would have countenanced. On the basis of restructuring the business it would reasonably be open to a private investor to make a loan over the term of the lease.
The court applied the EU Commission's methodology to assess whether an interest rate is at market rate for the purpose of applying state aid rules and determined that the minimum loan rate of 5% was approximately equal to the reference rate generated by the methodology. Subsequently it was not one which no rational private market operator would have countenanced. Obtaining a commercial interest rate of return was only one of the commercial objectives of the Council.
There was commercial justification for the loan. The failure of the Club to pay rent had put the Council in an untenable position and the only viable alternative was to wind up ACL. Furthermore the Bank believed ACL could service a loan greater than that provided by the Council. The court emphasised that the Council was perfectly entitled to consider what transaction it wished to enter into as a political matter, in accordance with the duties it owes to the public, and then to consider whether it would be compelled by EU law on State aid grounds not to proceed.
Comment
The risk of falling foul of rules on state aid is a risk area in any project which receives public funding. The consequences of unlawful state aid are drastic: the amount paid plus any interest has to be recovered by the state from the recipient. Given the lack of reported decisions by the English courts in this area, which is highly fact dependent, this case provides a useful reference point on the approach the court takes when assessing whether or not there is state aid.
The case demonstrates how difficult it can be for a claimant to establish that there has been state aid. The court emphasised the wide spectrum of reasonable reaction's to commercial circumstances in the private market. This effectively gives a public body a wide margin of judgment when applying the private investor test. It is only necessary to establish that a hypothetical investor, with the same characteristics as that particular public body, would have made that decision. It does not need to be a decision that every private market economy investor would have made.
The court also endorsed the principle that not all private market operators invest for speculative or short-term gain, recognising that some investors are willing to retain and restructure investments because they consider that there is a realistic prospect of longer-term profits. This means that an existing shareholder is likely to have different considerations and motivations to a new investor, which should be reflected in the status of the hypothetical investor.
