EU Proposes to Regulate Companies That Receive Foreign Governments Support – How Will This Affect Foreign and Israeli Companies?

Barnea Jaffa Lande & Co.
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On July 13, 2022, the European Parliament and the European Council agreed on a new regulation concerning “foreign subsidiaries that distort the European market.” Their agreement is the final stage prior to voting on the regulation’s approval. Voting is likely to take place later in 2022.

The proposed regulation grants the European Commission the power to take measures against companies operating in the European market that receive significant government support from countries that are not European Union members. Companies with a significant volume of activities in the European market and that received considerable government support from a foreign government must now report this. Companies that want to participate in major government tenders in Europe must report the volume of government support they received.

Upon approval of the regulation, many foreign companies, among them Israeli companies, will need to ascertain whether the European Commission’s reporting obligation applies to them. Foreign companies controlled by major European companies or companies participating in government tenders in the European Union must report the government support they receive. All foreign companies operating in the European market will be subject to a regime that authorizes the European Commission to conduct investigations about the support these companies received from the government.

Government Subsidies and Support

The issue of subsidies or government support repeatedly arises during discussions about international trade. The accepted economic theory encourages international free trade, which creates free competition between local manufacturers and foreign manufacturers. However, in order to be effective, competition must be fair. In other words, the price manufacturers charge should reflect their manufacturing costs. Governments’ support of manufacturers distorts the competition and makes it ineffective.

A manufacturer that receives support from its home country’s government can set a consumer price that does not accurately reflect its manufacturing costs, since the government partially covers such costs. As a result, manufacturers that do not receive support (both local manufacturers and those that import from countries where there is no government support) face an adverse impact. In the European market, there is close supervision of support that EU member states grant to manufacturers within their jurisdictions. However, until now, there was no comprehensive European legislation that addressed the question of support provided by countries outside of Europe for products sold inside Europe. As a result, such entities enjoyed a competitive advantage, such as a lower price or a preferred technology.

Principles of the Proposed New Regulation

The proposed new regulation focuses on three topics:

  1. Defining government support (subsidies) that distorts the competition the regulation addresses.
  2. Defining the European Commission’s authority to investigate the impact of subsidies on the market and to impose “redressive” obligations on companies that received support from foreign governments.
  3. Imposing reporting obligations on companies.

Government Support

The proposed regulation defines government support as support that fulfills the following four cumulative criteria:

  1. Any financial or nonfinancial support, whether the company received it in relation to activities in the European market or for any other activity.
  2. Support a company received from a foreign government (i.e., from a country that is not an EU member state) or from an entity or company operating on behalf of the government granting the support.
  3. Support that grants a company a “benefit that it could not have obtained under normal market conditions.”
  4. A particular company or industry received the support, and not the market as a whole.

This broad definition can include, for example, any benefit a country grants to startup companies. This includes in the form of encouraging investments or research grants, the granting of export guarantees, support to enterprises encountering difficulties, etc.

The definition does not include benefits provided to the entire economy (for example, tax reliefs) or the winning of a competitive government tender.

The proposed regulation grants the European Commission the authority to intervene in any instance whereby government support distorts competition in the market. In other words, it can intervene in instances when government support enables a company to improve its competitive positioning and thus adversely affects the competitive positioning of other companies in the market. Examples of such instances are when a company is able to charge a lower price for its products (since the foreign government paid for a portion of its expenses) or when the technology in its products is preferable due to foreign government assistance.

The regulation proposes several indicators for instances when it is possible to view support as distorting the market. Examples include unlimited support, support specifically for exports, etc. On the other hand, the regulation also proposes several indicators for instances when it is reasonable to assume support does not constitute distortion of the market:

  • Support of research.
  • Support of environmental protection.
  • Support of corporate social responsibility.
  • The regulation also states that foreign government support that totals less than EUR 4 million over the last three years does not distort competition.

The European Commission’s Authority

For the purpose of enforcing the proposed regulation, the European Commission will have extensive investigative powers over companies operating in the European market. The commission may demand documents and reports, conduct inspections at the company’s offices, and seize documents. The commission will even have the authority to operate outside the European Union, if the foreign country does not object.

If the commission determines a company is receiving government support that distorts the competition, the commission may impose redressive measures on that company. These measures are diverse and can include:

  • Obligating the company to refrain from operating in particular markets.
  • Granting competitors access to infrastructure, or to assets developed with the help of the foreign subsidy.
  • Repaying the subsidy to the foreign government.
  • Ordering the dissolvement of a concern of companies.

The Reporting Obligations

In addition to the commission’s independent investigative authority, the proposed regulation imposes reporting obligations on two types of transactions:

  1. The first type of transaction under the reporting obligation is a transaction for the acquisition, merger, or founding of a joint venture, when at least one of the companies involved in the transaction (regardless of whether it is the acquirer or the acquiree) is a European company with an annual turnover of EUR 500 million, and when all of the companies involved in the transaction received foreign government support aggregately totalling more than EUR 50 million over the last three years. We note for the purpose of this reporting obligation, the annual turnover and the foreign government support also include all companies controlled by the merging companies. For example, when a major European company, which controls a foreign company, acquires another European company, the acquirer company must report the support received by the foreign company that it controls, even if the foreign company is not involved in the acquisition itself.
  2. The second type of transaction under the reporting obligation is participation in government tenders in the European Union whose volume exceeds EUR 250 million, provided the total government support from a single foreign government of a company participating in the tender, of its subcontractors and of its principal suppliers, exceeds EUR 4 million over the last three years. The government support does not have to relate to the tender itself.

Also in this instance, a foreign company may be under a reporting obligation even if it is not the main contender in the tender. If a company fails to comply with the reporting obligation, the European Commission may prevent the merger, put a freeze on the tender, or even impose fines on companies that fail to report as required.

Implications for foreign and Israeli Companies

In the modern global economy, nearly every major European company controls companies in countries outside of the European Union. Furthermore, nearly every major government tender in Europe also includes foreign bidders, at the least as subcontractors or as suppliers.

Therefore, we can assume in any case that companies, at the very least, will need to ascertain if a reporting obligation applies to them for nearly every major merger transaction or major government tender. Additionally, according to the regulation, the European Commission will have the power to investigate the matter of government support even when no reporting obligation applies.

Consequently, foreign companies controlled by European companies, foreign companies participating as subcontractors or suppliers in major government tenders in Europe, or even companies with a significant volume of activity in Europe, must be aware of the reporting obligations and the proposed regulation’s potential implications. The extremely broad definition of “government support,” as explained above, means a large volume of government assistance to companies, whether direct or indirect, will fall under this definition.

The proposed regulation is subject to agreements between the European Union and other countries, agreements that could limit the extent of the regulation’s application. The association agreement between Israel and the European Union refers to the subject of government support. This 2000 agreement prescribed the need to set rules with regard to government support, but the parties have so far not done so. If the relevant government ministries in Israel insist on adoption of rules for enforcement of the agreement, this could reduce Israeli companies’ exposure, whether by narrowing the definition of “government support” or by providing leniency in relation to the reporting obligation. However, as long as the ministries take no action, Israeli companies operating in the European Union will be subject to the broad application of the regulation, upon its adoption.

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DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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