Introduction
It has recently been confirmed in the case law that Member States are not obliged to implement a procurement procedure when they grant State aid. This means, of course, that the public funds they provide do confer an advantage on their recipient undertakings. Compliance with public procurement procedures affects the compatibility of the aid with the internal market. Indeed, certain State aid rules such as those in the 2012 SGEI Framework explicitly require compliance with public procurement law.
However, in its decision SA.103361 on Croatian aid to the operator of the Istrian “Y” motorway, the Commission approved the aid despite the fact that it was granted directly to the operator. This was because it benefitted from the exception in Article 43 of Directive 2014/23 on concessions.1 The operator had been awarded the concession for the motorway in 1995. The aid was embedded in a three-year extension of the concession from 2038 to 2041.
What makes this case even more interesting is that the aid was classified as compensation for a public service obligation that was imposed on the operator with respect to the new parts of the motorway.
Background
In November 2022 Croatia notified to the Commission a State aid measure concerning the seventh amendment to a concession agreement concluded in September 1995 with company Bina-Istra for the financing, construction, operation and maintenance of the Istrian “Y” motorway. The purpose of the amendment was to extend the concession by three years.
The Commission decision explained that “(20) the existing concession agreement includes the payment to Bina-Istra by the Government of a financial contribution in a certain year only to the extent that Bina-Istra’s projected revenues from the tolls and secondary developments are less than Bina-Istra’s projected costs for the year in question, taking into account a gain/pain share mechanism reflecting the traffic risk borne by Bina-Istra (in the form of a contribution paid or a Surplus Bonus Amount received by the concessionaire).”
The public service compensation was calculated according to a complex formula that took into account unforeseen developments and revenues from toll and costs and then apportioned any gains or losses between the government and the operator.
The extension of the concession concerned the construction of new lanes, connections, bridges, tunnels, overpasses and underpasses. For some of the new parts of the motorway [e.g. tunnel] tolls would also be charged. The cost of the extra works was estimated at EUR 199 million in real terms (2022 prices) and EUR 203.6 million in nominal terms.
Why was extension of the existing concession necessary?
The Commission decision explained the logic of the extension of the concession.
Croatia submitted that “(37) the reasons for the proposed ‘three-year’ extension of the concession are twofold:
(i) allow longer debt amortisation and sufficient financing of the construction works from tolls, thereby avoiding excessive financial contribution from the Government in the context of unprecedented pressure on the State’s resources, and
(ii) align the length of the concession with the maturity of the long-term debt that finances the construction works, along with an effectively conditional, up to 12 months tail period.”
Avoiding excessive financial contribution from the government
“(38) On the basis of a Net Present Value (“NPV”) analysis, […] the NPV of the projected financial contribution from the State can be reduced through the extension of the concession until 15 March 2041. The annual breakdown of the projected financial contribution is rendered more manageable as a result of the extension, compared to […] without the benefit of the extension. In particular, the annual amount of the financial contribution can be reduced to about EUR 30 million (from EUR 43 million without extension)”.
“(39) The proposed extension of the concession also allows re-financing/restructuring all of the existing debt alongside raising new long-term debt […] in order to benefit from the improved Croatia’s credit rating, and consequently, to minimise the financial contribution so far as possible.”
It is not clear in the decision why the improvement in Croatia’s credit rating affected the debt of the operator. I suppose that the risk margin demanded by creditors took into account country risk.
Then the Commission explained that Croatia needed to reduce its national debt which had increased as a result of covid-19 and the extra public spending that was necessitated by the war in Ukraine.
“(42) Without the benefit of the extension, the annual amount of the required financial contribution would increase to nearly EUR 50 million, reinforcing therefore, in the view of the Croatian authorities, the need for the extension in order to keep the financial contribution at levels that do not over-burden the State’s financial capacity. With the extension, the annual financial contribution can be reduced to around EUR 39 million.”
Aligning the concession length with the financing
“(43) The formal duration of the concession matches the tenor of the long-term debt as mentioned in recital (37). In addition, the Croatian authorities explained that such matching of the duration of the concession and the tenor of the long-term debt is a standard requirement of lenders in relevant infrastructure projects such as the Istrian Y motorway.”
Risk & rate of return comparison
Next the Commission examined the rate of return of the operator and how the risk was shared between the government and the operator. The Commission recalled that “(44) the terms of the concession were modified in the fifth amendment to the 1995 concession agreement, approved by the 2018 Commission Decision, in order to significantly rebalance the risk in favour of the Croatian government, putting an end to a guaranteed return for the concessionaire.”
“(45) Although the traffic on the Istrian Y motorway and therefore the toll revenues are forecasted to increase, that projected increase is more to the advantage of the Government than to the advantage of Bina-Istra for the following reasons:
a) under the financial contribution mechanism, the increased toll revenues will allow for the greater self-financing of debt, reducing the financial contribution required.
b) under the gain/pain share mechanism, the possibility to retain 30% of Available Cash where no financial contribution is required during year “n+1” is capped at EUR [[…]] per year, meaning that increased toll revenues will not materially benefit Bina-Istra, but will benefit the Government, which will retain the remainder of the Available Cash as the concession fee.
c) Bina-Istra continues to bear a degree of traffic risk under the gain/pain share mechanism through the concessionaire contribution.”
“(47) Moreover, […] the project’s rate of return is reduced compared to the existing concession agreement. According to the estimates of the Internal Rate of Return (“IRR”) analysis […], the project IRR for the Proposed Amendment is estimated between [3-6]% and [3.1-6.1]%, with a central case at [3.05-6.05]%, while the project IRR for the existing concession agreement is estimated between [4-7]% and [4.1-7.1]% with a central case at [4.05 -7.05]%. The equity IRR under the existing concession agreement and under the Proposed Amendment, in a central case scenario, is estimated at [10-13]% in both situations.”
Consistency with EU public procurement rules
Croatia argued that “(49) the Proposed Amendment does not give rise to a requirement to hold a new concession award procedure pursuant to the Directive 2014/23/EU of 26 February 2014 on the award of concession contracts (“the Concessions Directive”), as the derogation provided for by Article 43(1)(b) is applicable to […] the proposed extension, which is inextricably and exclusively linked to these additional works.”
“(50) Article 43(1)(b) of the Concessions Directive sets out the following requirements for a derogation to apply in the case of necessary additional works or services:
i. The additional works or services by the original concessionaire have become necessary, and were not included in the initial concession (Article 43(1)(b));
ii. a change of concessionaire cannot be made for economic or technical reasons (Article 43(1)(b)(i));
iii. a change of concessionaire would cause significant inconvenience or substantial duplication of costs for the contracting authority (Article 43(1)(b)(ii)), and
iv. any increase in value does not exceed 50% of the value of the original concession (Article 43(1)(b), last subparagraph).”
Croatia considered that “(51) all requirements referred to above are fulfilled for the following reasons:
i. Additional works or services by the original concessionaire that have become necessary, and that were not included in the initial concession: […]
ii. A change of concessionaire cannot be made for economic or technical reasons: a “change of concessionaire” could potentially encompass two different scenarios: (i) terminating the existing concession agreement and re-procuring a new concession covering the extended concession that is the subject of the amended concession agreement; or (ii) appointing a second concessionaire to undertake the concession with respect to the subject matter of sub-phases 2B2-2 and 2B2-3 only and operate concurrently with Bina-Istra. Neither scenario can be seriously contemplated by the Government due to economic or technical considerations. […]
iii. A change of concessionaire would cause significant inconvenience or substantial duplication of costs for the contracting authority: scenario (i) above would lead to substantial inconvenience and costs, taking into account the possibility of a protracted legal dispute with Bina-Istra and the technical issues associated with scenario (ii) above would lead to the same.
iv. Any increase in value does not exceed 50% of the value of the original concession”.
Presence of State aid
The notified extension satisfied all of the criteria of Article 107(1) TFEU.
With respect to transfer of state resources, the Commission recalled that “(65) according to settled case-law, the granting without tendering of licences to occupy or use public domain, or of other special or exclusive rights having an economic value, may imply a waiver of State resources and create an advantage for the beneficiaries. Similarly, any amendment, like for instance a prolongation of a concession, can only be provided by the State and should therefore be considered as imputable to it.”
With respect to economic advantage, “(68) the measure gives the concessionaire the right to operate the Istrian Y motorway for a longer period than was agreed in the existing concession agreement, and thus to perceive the economic benefit deriving from operating the motorway for an additional number of years. This constitutes an advantage for the concessionaire.”
Then the Commission rejected the Croatian argument that the public service obligation imposed on the operator of the motorway satisfied the Altmark conditions and that, as a result, was free of State aid. According to the Commission, the concession did not comply with the fourth Altmark condition. “(71) The concessionaire upon which an obligation is imposed has not been chosen by way of a public tendering procedure for the purpose of providing the service described under the present measure which is the provision of motorway services according to the conditions set in the proposed seventh amendment to the existing concession agreement. Therefore, the Fourth Altmark Criterion is decisive for the assessment.” “(72) At the same time, nor during the pre-notification phase neither in the notification did Croatia provide a comprehensive cost analysis as the one required under the Fourth Altmark Criterion, notably on the costs of a typical, well-run undertaking.”
The measure was selective because it benefitted only one undertaking and it affected intra-EU trade and distorted competition.
Compatibility of the aid with the internal market
The Commission assessed the compatibility of the aid on the basis of the 2012 SGEI Framework and in particular, sections 2.2 to 2.10 of the Framework. It found the following:
The public mission entrusted to the operator was a genuine service of general economic interest because there was a social need that could not be satisfied by the market. “(86) Realizing investments on the Istrian Y motorway could not be done without public support”, “(88) the investment at stake is necessary in order to implement a series of important public interest objectives”, and “(90) Croatia has given proper consideration to the public service needs by holding various public consultations”.
The entrustment act specified the public service obligations and the methods of calculating compensation. “(92) The act or series of acts must specify at least:
(i) the content and duration of the public service obligations;
(ii) the undertaking and, where applicable, the territory concerned;
(iii) the nature of any exclusive or special rights assigned to the undertaking by the granting authority; (iii) the description of the compensation mechanism and the parameters for calculating, monitoring and reviewing the compensation; and
(iv) the arrangements for avoiding and recovering any overcompensation.”
With respect to compliance with EU public procurement rules, the Commission considered that the extension of the concession did conform with the relevant rules in Article 43(1)(b) of the Concessions Directive. “(115) The fulfilment of the requirements of Article 43(1)(b) (i) and (ii), namely that a change of concessionaire cannot be made for economic or technical reasons and that a change of concessionaire would cause significant inconvenience in terms of decreases in the quality of service, delays affecting the operation of the motorway or
substantial duplication of costs for the contracting authority is argued by the Croatian authorities in recital (51), by invoking two distinct scenarios (“scenario (i)” and “scenario (ii)”) which must be examined by the Commission.”
“(116) As regards scenario (i), termination and re-procurement of the concession, the Commission observes that such a change cannot be made for economic and technical reasons and would lead to both a significant inconvenience and a substantial duplication of costs. A termination of the concession would likely be contested by the current concessionaire. Only after a final judgement is reached, would the contracting authority have the necessary legal certainty and clarity needed to re-procure the concession.”
“(117) With regard to scenario (ii), which consists in the appointment of a second concessionaire to run a separate concession for the additional works concurrently with the existing one, the Commission accepts the arguments of the Croatian authorities indicating that such a second concession cannot be made for technical reasons and would both lead to a significant inconvenience and a substantial duplication of costs.”
“(118) The Commission further observes that since the new/additional concessionaire would need to be selected in a procurement procedure, and only thereafter commence negotiations with lending institutions, it is certain that the overall duration of the foreclosure of the market would be longer, and the total economic cost for the contracting authority therefore higher, with a re-procured concession as indicated in recital (116), or with a concurrent concession as indicated in recital (117), than with an extension however for exactly the same results as regards the accomplishment of additional works and the objectives of the concession.”
Amount of compensation
According to the SGEI Framework, the amount of compensation should primarily calculated on the basis of the net avoided cost [NAC] methodology. The NAC is the net cost [i.e. extra cost minus extra revenue] that is avoided without the public service obligation. However, other methodologies are allowed too, if proven to be more appropriate.
The Commission acknowledged that in this case “(132) the SGEI is the essence of the activity carried out by the beneficiary and the net avoided cost methodology does not apply. Therefore, the net costs incurred in discharging the public service obligation must be established on the basis of the cost allocation methodology as further laid down in points 28 to 32 of the SGEI Framework.”
“(133) The methodology followed by Croatia to set the amount of compensation relies on the financial balancing of the cost for discharging the public service obligation with the revenues that are accrued taking into account the relevant receipts and a reasonable profit.”
“(134) The costs considered relate to the expected operating costs of the concession and to the expected additional investment costs incurred for the realization of the [additional] works, including the relevant financial charges.”
“(135) The revenues considered are all the expected concession related revenues (tolls and side activity), including the additional revenues that are expected to be generated […] The financial model therefore includes both the additional revenues […] for the period before extension and the full revenues and costs of the entire concession (i.e. including previous phases) for the extended period.”
“(136) The envisaged extension of the concession, has been computed as the minimum amount of years that are necessary to cover the costs and the financial charges related to the [additional work], including a reasonable profit to the concessionaire. Further, the available cash and concession fee mechanism ensure a continuous update during the duration of the concession to adapt to the actual costs and revenues keeping nevertheless a cap on the reasonable profits of the concessionaire (see recitals (20), (21) and (45)).”
The Commission concluded that this methodology was compliant with the SGEI Framework.
Reasonable profit
The tolls that may be charged are determined by the Croatian government and ensure that they remain affordable for users. The expected profits of the concessionaire are capped.
“(140) The benchmarking analysis provided by Croatia indicates that the project IRR of the amended concession, which ranges between [3-6]% and [3.1-6.1]%, is within the range of other European highways IRR and has decreased with the proposed amendment compared to the existing concession agreement (the current estimate of the project IRR with the sixth amendment is between [4-7]% and [4.1-7.1]%). This is also the case when considering the new economic conditions simulation (between [4-7]% and [4.1-7.1]%).”
“(141) In view of the above, the Commission considers that the expected profits of the present measure can be considered as reasonable and in line with the SGEI Framework.”
Efficiency Incentives
Paragraph 39 of the SGEI Framework, requires Member States to introduce incentives for the efficient provision of SGEI.
“(143) Croatia explained that there is still an appropriate efficiency incentive under the Proposed Amendment in the form of the existing O&M [operation & maintenance] savings share mechanism (see footnote 24). In a nutshell, under this mechanism, Bina-Istra retains 60% of ordinary O&M savings and 50% of the extraordinary O&M savings, with the remainder included in the available cash, thereby reducing the amount of the financial contribution.”
Overcompensation
Paragraph 49 of the SGEI Framework prohibits overcompensation.
“(148) This [financial] mechanism is specifically designed to ensure that there is no overcompensation as it involves independent experts and it gives the Government the ability to review and exercise control on each step of the calculation.”
“(149) The Commission notes that, while there is no “claw-back” mechanism as such under the existing concession amended by the Proposed Amendment, the financial contribution mechanism provides for a correspondence between revenues and costs. The overall financial mechanism, including the pain/gain mechanism, and the Available Cash is ensuring that there is no overcompensation.”
In the end, the Commission concluded that all of the conditions of the SGEI Framework were satisfied and proceeded to authorise the measure.
