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Council’s loan to Coventry Arena was not state aid

Edge of a stadium building Print publication

03/07/2014

The case of R (on the application of Sky Blue Sports & Leisure Ltd and others) v Coventry City Council [2014] EWHC 2089 (Admin) is an interesting one and it is worth reading the full judgment if you can for Judge Hickinbottom’s helpful analysis of the facts and why he concluded that Coventry City Council were acting as a rational private market investor would have done. This is a summary of the main points.

The law: State aid

The general rule is that aid which satisfies all these four limbs:

  • granted by the State or through State resources
  • favours certain undertakings
  • distorts or threatens to distort competition and
  • affects trade between Member States

is illegal State aid unless the EU Commission has approved it or it falls within a specified exemption.

Whether aid distorts or threatens to distort competition depends on the objective test of whether a rational private investor might 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 – the “private investor test” or “market economy operator test”. If they would have done, then the State has not given that undertaking an advantage over its competitors and there is no State aid.

The facts in this case

The claimants are all members of the SISU group of companies and between them they owned Coventry City Football Club (the Club), which up to 2013 played its home games at the Ricoh Arena. The Council owns the freehold of the Arena and also owns 50 per cent. of Arena Coventry Limited (ACL), which leased the Arena from the Council and sublet it to the Club.

The Club got into financial difficulties and could no longer pay its rent to ACL. In the end it went on rent strike, refusing to pay further rent unless a restructure took place. ACL needed the rent from the Club in order to service a bank loan and so discussed with SISU about SISU buying a stake in ACL, to prevent ACL becoming insolvent. These negotiations ultimately failed (because SISU wanted to drive down ACL’s value so that they could buy into it cheaply), leaving the Council with two options: loan ACL the money it needed to service the bank loan, or wind ACL up.

The Council eventually decided to loan ACL £14.4 million, for 41 years (the remaining term of the lease) at an interest rate of 5 per cent. per annum for the first 5 years, thereafter at the Council’s discretion but no less than 5 per cent. nor more than 2 per cent. above the Public Works Loan Board rate (which was effectively the rate at which the Council could borrow money). This was conditional on ACL preparing a business plan, which it did, and which showed that it could service the loan even in the worse-case scenario of there being no anchor tenant at the Arena and the Club not paying any further rent.

The challenge

SISU challenged the grant of the loan as being unlawful State aid because no private investor would have entered into the transaction on those terms. In particular:

  • the value of ACL was less than half the amount loaned and the security for the loan was hopelessly inadequate
  • the 41 year term of the loan was very substantially longer than any term which a private investor would have countenanced
  • the interest rate and rate of return inadequately reflected the commercial risk taken by the Council in respect of the loan
  • There was no commercial justification for the loan and the Council took policy objectives rather than commercial objectives into account when deciding to grant the loan.

Private investor principle

In this case the judge stressed that although the private investor test is an objective one, the law recognises that there is a wide spectrum of reasonable reaction to commercial circumstances in the private market and that consequently a public authority has a wide margin of judgment.  He stressed that the Council’s action in making the loan on the terms that it did must be compared with a hypothetical private market economy investor with the same characteristics as the Council – including that the Council was not a new investor but already held a 50 per cent. shareholding in ACL. Dealing with each argument in turn he concluded:

  • A private investor in the Council’s position would not focus exclusively on loan to value but would consider the longer term. It was also a condition precedent of the loan that ACL provided a business plan, which it did. That plan showed that it was able to service the loan and, with two seats on ACL’s board, a 50 per cent. shareholding and a major creditor, the Council was able to exercise considerable scrutiny over ACL’s commercial activities. The private investor in the Council’s shoes would have been properly entitled to take the view that ACL was capable of servicing a loan of £14.4m over 41 years, and the security was sufficient to make the risk of it failing to do so commercially worthwhile.
  • The 41-year term of the loan was not longer than that which a private investor would have countenanced, as a private investor that was also a shareholder could rationally have made a loan over the whole term of the lease, on the basis of a restructuring of the business.
  • Using the methodology that the EU Commission uses to assess whether an interest rate is at market rate for the purposes of applying the State aid rules, the interest rate the Council was charging was not dissimilar to the market rate.
  • The Council was perfectly entitled to consider what transaction it wished to enter into as a political matter, and then consider whether it would be constrained by State aid law not to proceed with that course. There was commercial justification for the loan because the alternative was ACL’s insolvency. A rational private investor in the Council’s position might well have considered that refinancing ACL on the terms agreed was commercially preferable to allowing ACL to become insolvent.

Comment

There seem to be two key themes to draw out of this case when assessing if a public authority acted as private investor would have done:

  • The comparison must be with a hypothetical private market economy operator in the same position as the public authority. In this case, it made a difference that the Council was a 50 per cent. shareholder with a long-term investment vision, not an outside investor.
  • The public authority has a wide margin of judgment as there is a wide spectrum of reasonable reaction to commercial circumstances in the private market. As long as they make a decision that a private market economy operator would have made, they need not show that it was a decision that all private market economy operators would have made.

This is good news for public authorities seeking to invest in private entities. As always, we would stress that each case turns on its facts and that a public authority seeks legal advice as early in the process as possible, so that the transaction can be structured in a way that does not breach State aid rules. For more information contact the authors.