State aid law is a concept that is unique to the European Union. State aid took center stage during the recent financial crisis, since EU Member States effectively needed approval from the EU before granting rescue packages or other loans designed to assist ailing banks and companies.

In a nutshell, EU State aid rules prohibit governments and other public bodies from granting subsidies – or any other advantages – to companies without prior approval from the European Commission. (This concept is similar to the more familiar standstill obligation and approval requirements of merger control). If a government grants a subsidy or other advantage to a company without prior approval, the European Commission will order the Member State to recover the so-called “illegal aid” from the company that benefited from it.

Once the European Commission orders the repayment of State aid that was improperly given to a company, the beneficiary has limited defenses available to it to avoid repayment. For example, a company usually may not claim that it legitimately believed that the aid was legally granted because every company is presumed to be aware of the State aid rules and is expected to verify the prior approval by the Commission. The only defense available is “total impossibility” – but even this defense is of limited assistance because courts only acknowledge total impossibility in insolvency cases.

This has important implications for companies seeking to acquire shares or assets of a company located in Europe – especially in the wake of the financial crisis during which many aid packages were given by national governments. First, there is a risk that the conditions for the granting of aid are no longer fulfilled if the beneficiary is acquired by another company (e.g., where the amount of aid depends on the size of the group. Second, the main risk is that an acquiring company finds itself liable for the repayment of aid if the target has benefited from illegal aid, which the European Commission later orders to be repaid. Therefore, companies seeking to acquire a target in Europe must very carefully assess whether the target has received illegal aid in the past. This is not easy because the concept of “State aid” in the European Union covers far more than subsidies. In general, any economic advantage granted by a public authority in the European Union to an undertaking and any exemption granted by a public authority from costs, taxes and other charges that an undertaking would usually have to bear, can constitute State aid. This means that loans and guarantees from a government (or other public body) can constitute State aid, if the beneficiary does not pay a market premium or does not provide a market collateral. Tax advantages such as lower tax rates, tax deferrals or tax exemptions for companies, industry sectors or regions may likewise be considered State aid. Above-market compensation for services provided for the State, or below-market prices paid for the acquisition of public companies, can also contain State aid.

This raises the question: How does an acquiring company assess the risk that it could later become liable for State aid improperly conferred on a target? The answer lies in the due diligence process. Companies need to look for warning signs of State aid, such as direct subsidies, loans from public bodies, State guarantees, tax measures and generally deals with public bodies. Companies, and their advisers, that identify such red flags need to verify whether these measures were properly notified to the European Commission, whether they have been approved by the European Commission and whether the aid was conferred in compliance with the approval decision. The European Commission’s website has a useful search tool for cases that companies may consult. However, acquiring companies will have to engage in a deeper analysis in more complex cases where it is not obvious that an apparent “advantage” actually constitutes State aid (e.g., if the target previously acquired a public company, or has provided services to the State). Where it is not clear whether a measure constitutes State aid, the acquiring firm may either resort to an expert opinion or adjust the purchase price according to the risk assessment.

The risk assessment will depend on whether the acquiring firm wants to acquire shares or assets. In share deals, independently of the price paid by the acquirer for the shares, the aid will be deemed to remain with the target that received the aid in the first place. The acquirer should therefore be aware of the risk of State aid recovery and adjust the price according to the risk assessment. For asset deals, as a general principle, as long as the acquirer pays a market price, he may not be held liable for the repayment of aid received by the target as the aid is deemed to remain with the seller. The devil is in the detail of proving that a market price has been paid. Moreover, if an asset deal only leaves an "empty shell" and the deal can be seen as circumventing the recovery order, the acquirer may still be held liable for the repayment of the aid. Whether the transaction can be seen as a circumvention of State aid rules is usually very difficult to determine.

Thus, while it is possible to mitigate the risks of State aid in acquisitions, it is extremely important that companies and their lawyers identify any red flags in the legal due diligence, correctly assess the risk and adjust the price tag accordingly so that subsidies do not turn into liabilities.