Serbian state aid authority clears government support to Air Serbia

On 1 August 2013, the Serbian government, the country’s national air carrier Jat Airways (at that time wholly owned by Serbia), and the air carrier from the United Arab Emirates Etihad Airways entered into a series of agreements related to Jat. Five agreements were concluded in total – Transaction Framework Agreement, Support Services Agreement, Investment Agreement, Consulting Services Agreement, and Shareholders’ Agreement. By way of this transaction, Etihad acquired a 49% stake in Jat (which has been renamed to Air Serbia), the remaining 51% being held by the Serbian state.

The agreements, which have not been disclosed to the public, envisage wide-ranging cooperation between Serbia and Etihad related to the operation of Air Serbia. Most importantly, the transaction includes significant financial support to Air Serbia by the Serbian government. This aspect of the transaction has been examined by the Serbian state aid authority – the Commission for Control of State Aid – which established, in a decision of 21 February 2014, that state aid granted to Air Serbia is in accordance with the law.

Procedural background

Based on the Serbian Law on Control of State Aid (Zakon o kontroli državne pomoći), before granting any form of state aid, the grantor must notify the aid to the Commission for Control of State Aid (ex ante control). The Commission then examines whether the planned aid complies with the requirements laid down in the law and the Decree on the rules for grant of state aid (Uredba o pravilima za dodelu državne pomoći). If state aid is granted without the Commission’s prior approval, the Commission may perform ex post control of the granted aid.

Even though it envisages several forms of government support to Air Serbia, the Jat-Etihad transaction was not initially notified to the Commission. In October 2013, however, the Ministry of the Economy notified the Commission of the planned issuance of a state guarantee for the benefit of Etihad and upon request of Air Serbia. From this notification, the Commission learned that this guarantee represented only one in a series of measures of state support to Air Serbia provided for in the agreements signed on 1 August 2013. Since none of these other measures were notified to the Commission, the state aid authority initiated on 9 December 2013 the procedure of ex post control. In February 2014, the Commission issued a decision clearing the government support to Air Serbia, finding that the aid satisfied the conditions for the grant of restructuring aid to a firm in difficulty.

Conditions for the grant of aid to a firm in difficulty

The conditions under which state aid can be granted to a firm in difficulty are laid down in the Decree on the Rules for Grant of State Aid. The Serbian State Aid Decree draws heavily on the EU guidelines on State aid for rescuing and restructuring firms in difficulty.

It provides that a firm is in difficulty if it is unable, whether through its own resources, with the funds from shareholders or creditors, or from other resources available on the market, to stem losses which, without outside intervention by the public authorities, will almost certainly condemn the firm to go out of business in the short or medium term. A firm will be certainly considered to be in difficulty if it fulfils the criteria for initiation of insolvency proceedings. If not, it will qualify as firm in difficulty if there are obvious indicators of such condition, such as increasing losses, diminishing turnover, growing stock inventories, excess capacity, declining cash flow, mounting debt, rising interest charges and falling or nil net asset value.

If a firm qualifies as a firm in difficulty, it may receive aid for restructuring provided that it prepares a restructuring plan and undertakes compensatory measures in order to avoid significant market distortions (divestment of assets, reductions in capacity or market presence), and further provided that the amount of aid is limited to the minimum required for the implementation of measures from the restructuring plan. The restructuring plan must (i) be able to restore the long-term viability of the firm within a reasonable timescale, (ii) provide for liquidation of organizational units which create losses, (iii) describe the circumstances that led to the firm’s difficulties, (iv) provide for a form of organization that will enable the firm, after the restructuring is completed, to cover all costs including depreciation and financial charges, (v) specify the start and end dates of the restructuring.

The restructuring aid beneficiary must finance a part of the restructuring costs from its own resources or from external financing at market conditions. The minimum required percentage of the firm’s own contribution depends on its size, and ranges from 25% for small enterprises to 50% for large firms (Air Serbia is considered to be a large firm).

Air Serbia’s restructuring plan

As part of the state aid notification, the government submitted to the Commission the plan of restructuring of Air Serbia. While this document is not publicly available, it is summarized in the Commission’s decision.

The plan states that Air Serbia is technically insolvent, has lost more than one quarter of its share capital in the previous period, and is not able to meet its short-term obligations due to limited funds. The plan identifies four main reasons for this situation: obsolete fleet (the average age of the aircraft of 26 years), accumulated financial liabilities, inadequate corporate management, and unfavorable business conditions (low GDP growth in Serbia, devaluation of the Serbian dinar, entry of low-cost carriers into the market).

In order to address these problems, the plan focuses on six areas: the planning of air routes in order to define an optimal flight schedule and size of the fleet; reduction of the number of employees; renewal of the fleet; new management structure; synergy effects (the restructuring plan states that, together with EtihadAir Serbia would have a better bargaining position with major suppliers); and a new commercial strategy and the strategy of rebranding, aimed at boosting sales.

The objective of the restructuring plan is to make the carrier self-sustainable within a period of three years and to start generating profits in the year 2017.

According to the plan, the financial burden of the restructuring will be borne jointly by the Serbian government and Etihad. In addition, Air Serbia will partly contribute to the restructuring costs with its own resources.

On its part, the Serbian government will assume all liabilities which relate to Air Serbia’s operation before the first quarter of 2014. These include loans taken out by the company, accrued liabilities to suppliers, deferred tax liabilities, unpaid salaries, and redundancy expenses. The government will also issue a guarantee for a short-term shareholder loan which Etihad is to provide to Air Serbia for the financing of the carrier’s ongoing operations. Further, together with Etihad, the government will co-finance several shareholder loans for the improvement of certain specific segments of Air Serbia’s operations (line and light maintenance, catering, and ground services). Finally, in order to cover the shortage of cash needed for the financing of Air Serbia’s operations, the Serbian government will provide funds to the air carrier either through direct subsidies or by way of a decrease in Air Serbia’s cash operating costs (including waiving revenue from airport charges at the Belgrade airport, which is owned by the state).

Etihad will provide assistance to Air Serbia in the form of shareholder loans for the financing of the air carrier’s ongoing operations and for the improvement of certain segments of the carrier’s operations. In addition, it will provide various services to Air Serbia related to marketing, yield management, establishment of a call center, rebranding of the internet presentation, and human resources. It is also claimed that Etihad will further enable savings in Air Serbia’s procurements, by using Etihad’s bargaining power towards suppliers (e.g., for the lease and purchase of aircraft). Finally, the plan promises that Etihad’s relationship with Airbus will enable Air Serbiato use the advance payment which Jat made to the aircraft manufacturer in 1998 (the payment was made for the delivery of aircraft, which never materialized) for the purchase of new aircraft.

Apart from receiving assistance from the government and from Etihad, the plan asserts that Air Serbia will partly contribute to the financing of the restructuring by its own resources. Specifically, the air carrier will generate funds by leasing out some of its aircraft and selling a part of its assets (old aircraft and real property).

The published version of the Commission’s decision does not reveal the total amount of aid that the Serbian government and Etihad will provide to Air Serbia based on the restructuring plan. However, the decision does disclose that the government measures will contribute to the total costs of restructuring by 46%, while the remaining 54% of the costs will be covered by Etihad and through Air Serbia’s own resources.

The plan claims the restructuring aid is justified since the winding up of Air Serbiawould have significant negative effects on the Serbian economy as a whole. It is stated that Air Serbia’s total contribution to the country’s GDP exceeds USD 700 million and that its operation is connected with approximately 21,000 jobs in Serbia. Further, it is said that the loss of the national air carrier would have adverse effects on exports and tourism, as well as on business sustainability of the country’s airports.

Apart from disposal of certain of Air Serbia’s assets (old aircraft and real property), the plan indicates that further compensatory measures would consists in the reduction of carrier’s seat capacity.

Finally, the plan states that the state support to Air Serbia is not expected to distort the market of air travel of passengers in the EU, due to the carrier’s low market share EU-wide. The summary of the plan, however, does not assess the effects of the aid on the Serbian market, nor does it comment on Air Serbia’s market share in Serbia.

Commission’s assessment

In assessing Air Serbia’s restructuring plan, the Commission found that it fully conforms to the Serbian state aid regulations. Specifically, the Commission established that Air Serbia qualifies as a firm in difficulty, has drafted an adequate restructuring plan, and plans to take appropriate compensatory measures. It further found that the amount of aid is limited to the minimum required for the implementation of the measures from the restructuring plan. The Commission, however, did not offer any in-depth analysis of the measures from the restructuring plan, but rather limited itself to the assertion that the proposed measures are in accordance with the requirements laid down in the State Aid Decree.

For instance, the Commission asserted that it had analyzed whether the proposed compensatory measures were proportional to the distortion of competition which will arise as a result of the state assistance to Air Serbia. However, no such analysis is to be found in the Commission’s decision, which merely states that the planned compensatory measures are “adequate” and proportional to the state aid’s negative effects on competition. Similarly, the Commission found that the distortion of competition arising out of the government aid to Air Serbia would harm competition less than the alternative option of Air Serbia’s departure from the market, but failed to provide any reasoning behind this conclusion.