In a decision of particular relevance to parties involved in projects which receive public funding, the Court of Appeal has considered for the first time the application of the private investor principle in a State aid challenge.   State aid is a risk area for projects which receive public funding because the consequences of unlawful State aid are drastic: the amount paid plus any interest has to be recovered by the state from the recipient.  In R (Sky Blue Sports and Leisure Ltd) v Coventry City Council [2016] EWCA Civ 453 the Court of Appeal ruled that public bodies are allowed the same wide range of discretion when taking entrepreneurial decisions as would be available to a private investor.  The relevant test is whether a prudent investor could have been prompted to enter into the transaction, as it is only where that is "inconceivable" that the only plausible explanation for the provision of the public funds is State aid. 

On 15 January 2013, Coventry City Council (CCC) resolved to make a loan of GBP 14.4 million to Arena Coventry Limited (ACL), the operating company of the Ricoh Arena. At the time of making the loan, CCC indirectly owned a 50% stake in ACL. ACL was experiencing financial difficulties because Coventry City Football Club (CCFC) which had a licence to use the ground and a sub-lease of the offices at the stadium had defaulted on its rental obligations to ACL. This meant that ACL was not able to service a loan of GBP 22 million from Yorkshire Bank (the Bank).

ACL was accordingly vulnerable. The Bank had extensive security and step-in rights pursuant to which the operating sub-lease of the Arena was at risk. The owners of CCFC (companies in the SISU group) also sought to gain control of ACL by purchasing the Bank's debt. In these circumstances CCC loaned ACL the sum required to pay off its loan from the Bank. SISU alleged that this amounted to state aid.

At a judicial review Hickinbottom J concluded that the making of the loan by CCC fell within the wide ambit extended to public authorities in that area and did not constitute State aid under article 107 of the TFEU. The relevant test was whether, in similar circumstances, a hypothetical investor, with the same characteristics as that particular public body, might have made that decision. 

For a more in-depth analysis of the first instance decision please see our earlier Litigation Review article.¹

Private investor or state aid

The Court of Appeal considered whether Hickinbottom J's assessment that the private investor principle had been satisfied was vitiated by demonstrably wrong findings of primary fact or whether his assessment fell outside the generous ambit of reasonable decision making afforded to a judge. 

The court restated the principle that a public authority has a "wide margin of judgment" when considering whether or not to make an investment. Public undertakings, like private undertakings, exercise entrepreneurial skills when analysing the risk of an investment. This means there will often be a wide spectrum of reasonable responses to a specific commercial situation.

Lord Justice Tomlinson approved Hickinbottom J's summary of the relevant legal principles which govern the private investor test. The court stated that the test was not whether a prudent investor would ordinarily be expected to have entered into the transaction, but rather whether he could have been prompted to do so, because it was only when such conduct could be entirely ruled out as inconceivable that the only remaining plausible explanation for the provision of public funds was that it had to be regarded as State aid. 

The comparator private investor should be given the same characteristics as the public body. In this case, that means it: (a) is the freeholder of the Arena; (b) has invested in the development of that Arena; and (c) has a 50% shareholding in ACL which was not without reasonable prospect of acquiring value and delivering a return in the future. The court recognised that a shareholder in the relevant undertaking may be more likely to have long-term objectives and to be less focused on making a short-term profit. A hypothetical private investor is permitted a degree of optimism as to future profits and an existing shareholder may be more likely to invest in a business which is experiencing financial difficulty if it believes there is a reasonable likelihood that the business will become profitable again.

Investment decision should be based on economic valuation

The court refined the formulation of Hickinbottom J and concluded that a public body should (like a private investor) base its investment decision on an economic valuation, although this does not need to be prepared by an independent expert. In the present case the Council's own officers could (and did) provide this economic analysis to the elected members of the Council. Where an independent expert is appointed, this may corroborate the credibility of the assessment. However, the court should not conduct an examination of the public body's judgment in choosing the source from which it took advice.

When conducting its economic valuation the public body is entitled to have regard to a contemporaneous offer of funding by a bank or other lender. Even an exposed bank is unlikely to put forward restructuring terms which it believes its customer will be unable to comply with. 

A public body is entitled to have regard to its policy objectives when taking a decision. That is the case even where the decision is a commercial one. It is only when considering whether a transaction is state aid that the public body must ignore matters of policy. A hypothetical investor must not therefore take any public policy considerations into account as it is motivated by profit rather than policy.

Comment

This decision is of particular relevance to parties involved in projects which receive public funding. State aid is a risk area for these projects because the consequences of unlawful state aid are drastic: the amount paid plus any interest has to be recovered by the state from the recipient. There is also a risk that damages actions may be brought by competitors. This is a significant public law decision as it is the first time the Court of Appeal has considered the application of the private investor principle in a state aid challenge. 

The Court of Appeal has confirmed that a public body has a wide margin of discretion when applying the private investor principle. This means that there is a high hurdle for claimants to overcome when seeking to establish there has been unlawful state aid. It is only necessary for a public body to establish that a hypothetical investor, with the same characteristics as that particular public body, could have been prompted to make that decision. The hypothetical private market investor is not unduly prudent and is entitled to take calculated risks unless the risk is one that no rational investor could conceivably countenance.

The Court upheld the principle that not all private market operators invest for the same reasons. Indeed some investors are willing to retain and restructure investments because they consider there is a realistic prospect of longer-term profits. An existing shareholder might be more likely to invest in a business which is experiencing financial difficulty because of the potential for future returns. The different economic considerations and motivations of different public bodies should be reflected in the status of the hypothetical investor.

Footnote

[1] http://www.allenovery.com/publications/en-gb/european-finance-litigation-review/northern-europe/Pages/Application-of-the-private-investor-principle-in-state-aid.aspx.