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The scope of public service obligations must be proportional to the identified market failure.

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Introduction

On 1 March 2017, the General Court dismissed the application of Societe Nationale Maritime Corse Mediterranee [SNCM] against the Commission [case T-454/13, SNCM v Commission].[1] The Commission had found in decision 2013/435 that SNCM received incompatible State aid that had to be recovered.

SNCM carried out transport services between Marseille and Corsica. For those services it received compensation for the extra costs it incurred. The Commission considered this public service compensation [PSC] to be compatible State aid. SNCM also received compensation for additional services during the summer peak months. The Commission found the PSC for the additional services to be incompatible State aid because it considered that France had committed a “manifest error” in classifying the additional services as services of general economic interest [SGEI].

Therefore, the dispute between SNCM and the Commission centred on the proper definition of a service of general economic interest. The judgment represents a major legal victory for the Commission because it confirms the Commission’s approach since the adoption of the 2012 SGEI package. Government intervention to define an SGEI and impose a public service obligation [PSO] is justified only when there is a gap in the market. Moreover, the scope of the service and the corresponding obligation must be proportional to that gap.

The Commission’s decision-making practice

The first issue examined by the General Court was whether the Commission applied consistently the Altmark criteria. If the PSC complied with those criteria, it would not be State aid and therefore it would fall outside the jurisdiction of the Commission. The Court recalled that a public service obligation [PSO] is the same as SGEI [paragraph 87]. Then it rejected SNCM’s argument that in past cases the Commission accepted that additional services were genuine SGEI [paragraph 98]. The Court repeated the standard reply of EU courts that the concept of State aid is objective and corresponds to the facts of each case. The past practice of the Commission is irrelevant. Moreover, whether a service is or is not SGEI depends on the evolution of the market over time [paragraph 99].

 

 

The extent of Member States’ discretion

The Court reiterated that Member States have wide discretion in defining services they consider as SGEI. The Commission has powers only to check for manifest error. However, Member States cannot use their discretion to evade EU competition rules, especially where secondary legislation defines the content of PSOs [paragraphs 111-114].

The Court confirmed that the Commission applied correctly the provisions of secondary legislation and the interpretation of the case law concerning PSOs. In particular, the Court noted that secondary legislation on maritime transport referred to “insufficient services” as proof of need for public services [paragraph 118].

At this point the Court also referred to Article 56 TFEU which guarantees the freedom of provision of services and observed that PSC can obstruct free trade in services because it makes their provision less attractive to those undertakings that do not receive any compensation [paragraph 120].

1st Altmark criterion

The Court agreed with the Commission that the scope of the PSO must correspond to a public need which can be shown by the inadequacy of the services offered on the market. In other words, the need for public services is proven by the absence of private initiative [or supply] [paragraphs 124-125]. The scope of the PSO must also be proportional to the public need. [paragraph 133].

The Court stressed, rather significantly, that a Member State cannot just claim the existence of a general public interest. Inability to prove the need and proportionality of the PSO can constitute “manifest error” that the Commission is obliged to take into account [paragraph 133].

The Court also supported the approach taken by the Commission and rejected the argument of SNCM that the Commission’s assessment deviated from the requirements of the 1st Altmark. More specifically, the Court considered the Commission’s three-step approach as equivalent to the 1st Altmark criterion in that it showed, first, that there was no demand for additional services. Second, if there was demand, it could be satisfied by services supplied by market operators. Third, in case of extra demand, France should have chosen the least distortionary method of intervention which was to impose the same obligation on all market operators before granting compensation just to a single operator [paragraph 134]. Although the General Court endorsed the third step, it does not seem to be mentioned in the case law of the Court of Justice. At any rate, the third step makes economic sense.

One further comment is in order. The General Court referred, at several points, to the “proportionality” of the PSO. That the amount of State aid must be proportional as a well understood feature of the compatibility of aid. But here, the General Court seems to be going beyond the amount of the aid.  It seems to be stipulating that the scope of the PSO, rather than the amount of the aid, must be proportional. But proportional to what? It is reasonable to infer that proportionality in this context is determined according to the extent of market failure or the inability of the market to deliver the desired service. Naturally, there is a correspondence between the scope of the PSO and the amount of the necessary compensation (State aid). But this correspondence is not exact. The precise amount of PSC depends on the efficiency of the provider, the level of fees charged to consumers, the strength of demand, etc. Given that the amount of necessary compensation is only incidentally related to the scope of PSO, it appears that the General Court has now laid down a new requirement that constrains further the discretion of Member States. PSO must be proportional to the extent of market failure.

The definition of the additional service as SGEI

The General Court then turned its attention to the question whether the additional service during the peak months could also be classified as SGEI. It noted the following. First, the two services were described differently in the act imposing the PSO [paragraph 147]. Second, the obligations imposed on SNCM for the additional service were limited and less precise [paragraph 151]. Third, the basic service had to be provided with ships that could carry both passengers and cargo while the additional service could be provided with ships carrying only passengers [paragraph 152]. [I do not understand why either the Commission or the Court thought that this difference was essential. The need in peak periods was the transportation of additional tourists.] Fourth, SNCM could not credibly argue that it needed the additional service reserved for itself in order to use any surplus revenue to cross-subsidise the loss-making basic service. The Court did not consider the argument as credible because both services were loss making [paragraph 155]. [The case law on Article 106(2) recognises that Member States may create monopolies by granting exclusive right to SGEI providers in order to be able to cross-subsidise services.]

The lesson that should be drawn from paragraphs 147-155 of the judgment is that if different services are to be considered as falling within the scope of the same PSO they must be defined in similar detail and impose similar obligations.

The General Court also noted that the compensation for the additional service contravened the principles of necessity and proportionality because there was no evidence that the two services were technically complementary or reinforced each other’s economic efficiency [paragraph 167].

Territorial cohesion

SNCM argued that both services were essential for guaranteeing the territorial cohesion of France. The General Court concurred with the Commission that territorial cohesion could be achieved by services supplied by the market, as well as by public services. In order for Member States to define an SGEI, it is not sufficient that they resort to territorial cohesion. They must show that territorial cohesion cannot be achieved by the market. Then the SGEI must correspond to the market deficit or gap [paragraph 172].

These are powerful statements. EU rules limit significantly the discretion of Member States. On the other hand, it can be inferred that if Member States can show that certain distinct services are inter-related either technically or economically, they can extend the SGEI definition to include services that are provided by the market. In this particular case, the General Court rejected the argument of the SNCM that the additional service also had to come under the same PSO on the grounds that it was defined more loosely and that it was loss-making. In principle, however, a profit-making service [which can be provided by the market] can be bundled together with an unprofitable service for technical or economic reasons. The Court returns to the issues of technical complementarity or economic efficiency in paragraphs 174, 179, 182 & 184.

Market gap and substitutability of services

The Commission had considered that there was no market need for the additional service in peak periods because the trip from Marseille to Corsica could be substituted by a trip from Toulon to Corsica. Although travellers originating from Marseille would have to travel extra over land to Toulon, the sea leg of the journey from Toulon to Corsica was shorter. Therefore, in terms of total travel time, the two journeys were very similar.

In order to determine whether the services from Toulon provided by market operators without receiving compensation could substitute for the services from Marseille, the Court took into account the similarity of the travel time, the fact that the services were of similar quality and the apparent absence of consumer demand for extra services from Marseille.

SNCM also argued that the Commission failed to establish that the French authorities had not acted like a private investor. The Court wholly rejected this argument and observed that a public authority that provides compensation cannot claim that it behaves as a private investor because, by definition, it acts as a public authority [paragraph 233].

 

4th Altmark criterion

SNCM had been selected after tender. It claimed that the selection process satisfied the 4th Altmark criterion. The General Court, on a number of grounds, agreed with the Commission that that process did not identify the SGEI provider that could offer the service in question at the least cost to the community.

First, the tender was based on a negotiated procedure. This procedure allowed the awarding authority too much discretion, which could have discouraged the participation of more companies [paragraph 241]. Second, only two companies submitted bids, even though more companies were providing similar transport services to and from Corsica [paragraph 242]. Third, the period for submission of bids from the date of the announcement of the tender was too short. And so was the starting date of the contract [paragraph 245]. Fourth, restrictive technical specifications prevent more companies from participating [paragraph 247]. Fifth, the single competitor’s offer was rejected because it could not specify the precise date for the start of the service [paragraph 249]. Although there is little doubt that the first, third and fourth reasons had exclusionary effects, it is puzzling why the Court considered the second reason to be of relevance, given that no corroborating proof was mentioned, and why the fifth reason was not a legitimate condition that could be demanded by the awarding authority.

Recovery of incompatible aid

The Commission had ordered France to recover the full amount of the compensation for the additional service. SNCM argued that the Commission did not take into account the costs that it had incurred in providing the additional service.

The General Court rejected this argument. Since the compensation did not comply with Altmark, the whole amount was State aid. Given that the additional service was not SGEI, the aid could not be authorised on the basis of Article 106(2). Given then that it was operating aid, it could not be compatible with the internal market under Article 107(3). Therefore, the Commission had to order the recovery of the whole amount of the compensation.

The Court also rejected SNCM’s argument that the payment of the aid back to the French authorities would be its “death sentence” and would lead to its bankruptcy. If bankruptcy is the consequence of recovery, then it means that the aid enabled the recipient to remain artificially in the market. Therefore, exit from the market is the natural outcome of restoring competition to its state before the granting of the aid.

Legitimate expectations

SNCM’s final argument was to claim that past decisions of the Commission led it to entertain legitimate expectations that the compensation was either no aid or compatible aid. The General Court reiterated the three principles that are used to determine the existence of legitimate expectations. First, an EU institutions has given to the aid recipient specific and unconditional assurances. Second, these assurances can lead to the formation of expectations. Third, the assurances must be in conformity with EU law [paragraph 282]. Then the Court went on to explain that none of the three principles applied to SNCM’s case. The Court rejected once more the SNCIM’s claim that previous Commission decisions allowed SNCM to entertain legitimate expectations. The decisional practice of the Commission is not relevant because market conditions evolve over time [paragraph 286].

Conclusions: Can unprofitable services be bundled together with profitable ones?

In the end, the General Court dismissed in its entirety the appeal of SNCM. This is an important judgment for at least four reasons. First, it confirms that the definition of SGEI and the imposition of a PSO must reflect a market need that is manifest in the unwillingness or inability of the market to provide the service in question.

Second, despite the discretion they enjoy, Member States must limit the scope of the PSO to the identified gap in the market. This is because the PSO must be proportional to the extent of market failure.

Third, Member States, however, may extend the scope of the PSO [and, in effect, bundle together profitable and unprofitable services] when they can demonstrate that there are technical or economic efficiency reasons [e.g. different services are complementary or the bundled services generate economies of scale].

Fourth, when Member States are not sure about the correct definition of the SGEI or PSO, the provision of compensation is riskier than other types of State aid because compensation is operating aid that is not normally allowed.

Lastly, in an article that was published here on 7 February 2017, I wrote that unprofitable services can be bundled together with profitable ones [see http://stateaidhub.eu/blogs/stateaiduncovered/post/7909]. That article reviewed the judgment in case T-92/11 RENV, Jørgen Andersen, v European Commission, which concerned rail and bus transportation. DSB, the incumbent Danish rail operator was obliged to provide services on routes that were also served by other operators using busses. In light of the judgment in the SNCM case, it is now amply clear that Member States may not arbitrarily lump together profitable with unprofitable services. The aim of the Danish PSO was to ensure seamless mobility. Therefore, Denmark was justified to define a PSO with a wide scope that covered also some profitable routes. By contrast, France did not provide any credible justification for the bundling of different services.

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[1] The judgment does not yet exist in English. The text of the judgment in other languages can be accessed at:

http://curia.europa.eu/juris/fiche.jsf?id=T%3B454%3B13%3BRD%3B1%3BP%3B1%3BT2013%2F0454%2FJ&pro=&lgrec=en&nat=or&oqp=&dates=%2524type%253Dpro%2524mode%253DfromTo%2524from%253D2017.02.06%2524to%253D2017.04.06&lg=&language=en&jur=C%2CT&cit=none%252CC%252CCJ%252CR%252C2008E%252C%252C%252C%252C%252C%252C%252C%252C%252C%252Ctrue%252Cfalse%252Cfalse&td=%3BALL&pcs=Oor&avg=&mat=CONC.AIDE%252Cor&etat=clot&jge=&for=&cid=707309.

[Photo credit: timeyres from flickr.com]

 



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