State aid and airlines: EU General Court annuls Lufthansa and SAS bailouts

In two judgments of May 10 (Cases T-34/21 and T-238/21), the General Court (“GC”) annulled the aid of €6 billion and €1 billion granted to Lufthansa and SAS by the German, Danish and Swedish governments, respectively, to alleviate their difficult situation caused by COVID-19. This recapitalization aid was notified between May and August 2020 to the European Commission, which declared it compatible with the internal market.

The GC annulled the Commission decisions approving the aid in response to an appeal brought by Ryanair (together with Condor in the Lufthansa case). This is just the latest round in the legal battle over state bailouts for rival carriers since the beginning of the pandemic (see our previous posts here and here). Below we summarize the most relevant aspects of both cases.

The Lufthansa case

In May 2020, the German government approved a €9 billion financial package aimed at stabilizing Lufthansa’s delicate economic position. The most important measure (now annulled) was the recapitalization of the company, valued at €6 billion. It consisted of three instruments: (i) an equity stake of about €300 million; (ii) a non-voting equity stake (“silent participation”) valued at €4.7 billion; and (iii) a silent participation with the features of a convertible debt instrument worth €1 billion.

The Commission authorized the scheme based on the “technical illiquidity” faced by the company—which allegedly required a capital increase to maintain its operations and to avoid insolvency. In addition, the Commission considered that the safeguards agreed with the German government prevented undue distortions to competition. Those safeguards included (i) the prohibition of using the aid for advertising or commercial purposes; (ii) the impossibility of acquiring a stake of more than 10% in any competitor; and (iii) the transfer of landing and take-off slots to “new entrants” without a base at Frankfurt and Munich airports.

However, the GC upheld the appeals brought by Ryanair and Condor. It found that the Commission had erred in declaring the compatibility of the aid scheme under the Temporary Framework for State aid measures to support the economy in the current COVID-19 outbreak (the “Temporary Framework”), a Commission communication which relaxed the state aid framework to mitigate the negative impact of the pandemic on the economy.

In their appeals, Ryanair and Condor claimed that the authorization decision should be annulled on the grounds that the aid was excessive and unnecessary and that the Commission had made errors in its assessment. In particular, they complained about the lack of incentive to repay the bailout and the wrong method used by the Commission in defining the relevant markets in which Lufthansa had significant market power. We analyze below the main arguments put forward by the parties and the GC’s reasoning: 

• On the necessity of the aid, the judgment confirms the Commission’s conclusions regarding the systemic importance of Lufthansa and the serious difficulties the company would have to maintain its operations without the aid. However, the GC found that Lufthansa could have obtained the necessary financing on the markets at affordable terms. Hence, the state aid failed to comply with one of the basic conditions for approval. The Commission should have examined whether and on what terms Lufthansa could have obtained sufficient financing to meet its financial difficulties. In addition, an expert report submitted by the appellants showed that the German airline had sufficient assets to guarantee, at least, between €1 and €3.7 billion in debt on the markets. In view of the above, the GC ruled that one of the requirements of the Temporary Framework had not been met.

• According to the GC, the Commission decision is also wrong in that the aid scheme did not provide sufficient incentives to force Lufthansa to repay the bailout as soon as possible (and for the consequent exit of the German state from the shareholding)—as required by the Temporary Framework. Although the Court acknowledges the existence of alternative measures aimed at ensuring repayment, it recalls that they are complementary to, and not a substitute for, the step-up adjustment mechanism—i.e., the default incentive mechanism under the Temporary Framework.  In this sense, the Commission should have demonstrated that such alternative generated incentive effects similar to those of the step-up mechanism. 

• Finally, the GC considers that the Commission erred in assessing both the airports where Lufthansa had significant market power and the sufficiency of the remedies to ensure effective competition on the markets where Lufthansa was dominant.

On the one hand, the Commission was entitled to define the markets at issue according to the “airport-by-airport” approach, under which each airport constitutes a distinct relevant market. Nevertheless, the Commission erred in identifying the airports where Lufthansa held a dominant position—which should thus be subject to additional measures to preserve effective competition. If the Commission had taken into account all relevant factors, it would have determined that Lufthansa had significant market power at Vienna and Düsseldorf airports, in addition to Munich and Frankfurt. Moreover, the Commission’s criteria were too flexible, and it should have considered other indicators such as the frequency of flights or the total number of seats available.

The GC finds no justification why competitors present at Munich and Frankfurt airports were denied access to the allocation of slots released by Lufthansa in compliance with the decision. In this regard, the Commission should have assessed the appropriateness of excluding competitors already present at each airport on the basis of their particular characteristics. Also, the Commission failed to state reasons why the transfer of slots should be made in exchange for remuneration and not free of charge. The fact that after three years no airline has acquired the slots released by Lufthansa—despite numerous reallocation procedures—only reinforces this argument.

The SAS judgment

In August 2020, the Commission authorized the Swedish and Danish governments’ project to contribute up to SEK 11 billion (approximately €1 billion) to SAS’s recapitalization. The measure comprised two instruments: (i) the subscription by Denmark and Sweden of state hybrid notes (the “hybrid capital instrument”); and (ii) the subscription by those two states of new common shares (the “equity instrument”).

Ryanair challenged this decision. In essence, it alleged the Commission’s failure (i) to demonstrate SAS’s eligibility for aid under article 107(3)(b) TFEU and the Temporary Framework; (ii) to assess other possible measures more appropriate and less distortive of competition; and (iii) to apply proper conditions regarding the remuneration and exit of the state.

The GC went on to directly assess the compatibility of the two instruments with the Temporary Framework and annulled the Commission decision:

• As regards the hybrid capital instrument, the GC dismissed Ryanair’s claims because remuneration increased over time, thus incentivizing the state’s exit in accordance with the Temporary Framework.

• As regards the equity instrument, the aid scheme did not provide for an increase in remuneration (i.e., an incentive for the state’s exit). The Commission decision considered that the alternative mechanisms under the scheme generated such an incentive effect, a possibility expressly provided for in the Temporary Framework. However, the GC accepted Ryanair’s arguments on insufficient reasoning. It also ruled that the Commission had failed to demonstrate that the “overall structure” of the measure and the combined effects of its components incentivized the state’s exit within the meaning of the Temporary Framework.

Although the GC found that Ryanair’s arguments regarding the hybrid capital instrument lacked substantiation, the equity instrument could not be separated from the rest of the contested decision. Therefore, the GC annulled the Commission decision in its entirety, as partial annulment would alter its essence.

Conclusions

The consequences of Ryanair’s victory are uncertain in the Lufthansa case, as the German airline had repaid the aid in full, with interest, before publication of the judgment.

In turn, the annulment of the aid granted to SAS may affect its restructuring process (not yet completed). In this regard, the Scandinavian airline has yet to repay the hybrid capital instruments that were part of its bailout package and may face additional interest. In fact, the publication of the ruling caused a drop in its stock price.

The judgments can be appealed before the CJEU within two months, so the final decision may take a long time. However, at least in the Lufthansa case, it seems unlikely that an appeal would reverse the outcome for the Commission: according to the judgment, any of the errors identified would in itself determine the nullity of the decision—and, therefore, the appellants would have to prove that the GC was wrong on all of them.

 In any case, Commission sources have suggested that EU competition regulators are unlikely to appeal the rulings.

On the other hand, and with respect to SAS, on July 4 the Commission opened a formal investigation to determine whether the aid granted to the Scandinavian company complied with state aid rules, de facto accepting the GC’s annulment of its previous authorization. However, the company could always appeal the forthcoming Commission decision (expected in a few months), which may lengthen the legal battle.

In short, and regardless of what happens in this specific case, the issue will be much talked about in the coming years. In fact, the GC has also recently annulled the Commission’s authorization of a €130 million aid granted by the Italian Government to several Italian licensed airlines in October 2020 (case T-268/21). Moreover, Ryanair’s appeal against French state aid to Air France—also authorized by the Commission—is still pending. We will continue to report on this blog.