Newsletter Cross Section Science

EU State Aid Law: “Union Framework for State Aid to Research, Development and Innovation” – Innovations

On July 1, 2014, the Union Framework for State Aid for Research, Development and Innovation of (Union Framework) entered into force, replacing the previous Community Framework for State Aid for Research, Development and Innovation. The Union Framework contains several innovations that should be of great interest to universities and research institutions as well as to research-based companies.

Like the previous EU framework, the new Union framework basically considers two levels:

1. The first level is about the relationship of the state to universities/research institutions. According to the Union framework, the decisive factor is the distinction between economic and non-economic activities. This is because measures taken by a university/research institution only fall within the scope of EU state aid law if they constitute an economic activity.
2. The second level regulated in the Union Framework is primarily concerned with the relationship between research institutions and higher education institutions and companies. In terms of EU state aid law, the decisive factor at this level is whether a company is favored by measures taken by the research institutions/universities and whether this leads or could lead to a distortion of competition.

The division of the EU framework into two levels makes sense for the following reason: Universities and research institutions can, in principle, qualify as enterprises in the sense of EU state aid law themselves and are thus also subject to the provisions of EU state aid law as potential recipients of EU state aid. However, universities and research institutions can also be potential providers of EU state aid in that their activities give rise to an “advantage to an enterprise” within the meaning of EU state aid law that is relevant under EU state aid law.

What legal norms exist in addition to the Union framework?

According to the general prohibition of granting state aid, Art. 107 para. 1 of the Treaty on the Functioning of the European Union (TFEU), “any aid granted by a Member State or through State resources in any form whatsoever which distorts or threatens to distort competition by favouring certain undertakings or the production of certain goods shall, in so far as it affects trade between Member States, be incompatible with the internal market.”

Accordingly, an impermissible state aid pursuant to Art. 107 para. 1 TFEU can always be assumed if the following conditions are cumulatively fulfilled:

• Governmental action or action financed by governmental funds (of any kind),
• thereby the occurrence of an advantage of a certain enterprise or branch of production
• and existence of (at least potential) distortion of competition and effect on intra-Community trade.

At this point, we will take a closer look at the second point, namely the potential entrepreneurship of a university or a research institution.

The concept of an enterprise within the meaning of Art. 107 TFEU covers all legally independent entities that are engaged in economic activity. It therefore depends on whether a university/research institution is engaged in economic or non-economic activities. If a measure can be classified as non-economic, it is considered “aid-free” from the outset and falls outside the scope of EU state aid control.

And this is precisely where the privileged treatment of the EU Framework comes in, because it presumes for the benefit of research institutions and universities that certain economic activities are classified as non-economic and thus not relevant under EU state aid law.

However, the EU Commission has classified certain activities as economic on a blanket basis and some as non-economic on a blanket basis. This includes, for example

• the leasing of equipment or laboratories to companies,
• the provision of services to companies or
• contract research.

After that, e.g. the provision of infrastructure and related services – also in the context of start-up support – are classified as economic activities. This is because an infrastructure provision regularly includes, in particular, the above-mentioned activities of “rental of equipment or laboratories” and “provision of services”.

The market relevance of this specific activity of a university/research institution, which is required for economic efficiency, is based on the fact that the rental of premises and infrastructure is basically a service that can also be provided by other market participants – without any connection to universities or research – and is actually provided.

Under EU state aid law, it does not matter whether the leasing or provision of infrastructure or services by the university/research institution is to university-owned or university-related institutions or to third parties.

It can be argued in principle that the provision of infrastructure to own institutions as a purely internal matter of the university administration/research institution has no external effect and is thus not market-related in the sense of EU state aid law. However, from an EU state aid perspective, the internal character of a service relationship is not (or no longer) relevant if it is not a matter of genuine university affairs/research institution affairs, such as research or teaching, and the entity benefiting from the university/research institution can be considered an enterprise within the meaning of EU state aid law.

Non-economic activities according to the Union framework

As if the application of EU state aid law and the EU Framework were not complicated enough, the EU Framework differentiates once again in the area of non-economic – and thus EU state aid-free – activities: there one finds, firstly, the primary non-economic activities, and secondly, the economic activities that are treated as equivalent to non-economic activities. Third, the so-called privileged economic activities, which are also classified as non-economic activities. All of these activities are ultimately classified as non-economic, but the assimilated and privileged activities are subject to further conditions.

Primary non-economic activities according to the Union framework

First of all, the primary non-economic activities: The following are recognized as such in accordance with margin note (marg. no.) 19a of the new Union framework

• the training of more or better qualified human resources,
• independent research and development to increase knowledge and understanding, and
• the wide dissemination of the research results.

This was no different in the previous EU aid framework. However, in the context of “training of more or better qualified human resources”, the new Union framework now explicitly classifies public education organized within the national education system and financed and supervised mainly or entirely by the state as a non-economic activity. Thus, the pure teaching activities of universities and other educational institutions are still considered non-economic activities.

However, it also follows that activities which are not predominantly or fully financed and supervised by the state, i.e. in particular the paid continuing education measures at universities such as the continuing education courses, certificate courses, company training courses etc. offered in many places, can now explicitly not (or no longer) be classified as non-economic activities. The same applies to training measures within the meaning of the State aid rules on training aid.

With regard to the non-economic nature of independent research and development activities aimed at increasing knowledge and understanding, the new Union Framework clarifies, compared to the old EU Framework, that such research and development activities, which may also be carried out in association with other research institutions, will now only be considered non-economic if they are based on “effective cooperation”.

Among them, according to para. 15h of the Union Framework

“to be understood as the cooperation based on division of labor between at least two independent partners with a view to an exchange of knowledge or technology or to a common goal, whereby the partners jointly define the object of the collaborative project, contribute to its implementation and share its risks and results. The total cost of the project may be borne by one or more partners, relieving other partners of the financial risks of the project.”

In this context, contract research and other unilateral provision of research services are explicitly not considered forms of collaboration and thus do not constitute – EU aid-free – independent research and development activities.

The last non-economic primary activity listed in the Union Framework is the wide dissemination of research results. Here, the new set of rules includes the clarifying addition that it must be dissemination “on a non-exclusive and non-discriminatory basis,” for example, through teaching, freely accessible databases, generally accessible publications, or open software. This is likely to include basic research in particular, since in cases of commercially exploitable research and development, the rights of use and exploitation and the associated publication rights are typically assigned to only one of the research partners and thus, in principle, there are no unrestricted dissemination opportunities.

Activities treated as non-economic

Knowledge transfer, still referred to as technology transfer in the old EU Framework, is not one of the primary non-economic activities listed above. The transfer of knowledge is, however, not covered by the procedure described in para. 19b of the Union framework, the “equality clause” is assigned to non-economic activities.

This is one of the main privileges granted to universities by the Union framework: An economic activity is considered non-economic in favor of universities. Under the Union Framework, the EU Commission classifies knowledge transfer activities as non-economic only if they are carried out either by the university or jointly with or on behalf of other research institutions or research infrastructures, and if the profits from these activities are reinvested in the university’s primary activities. This last new addition is significant insofar as it no longer depends on “revenues” as before, but now on “profits”.

Moreover, it is mandatory that these profits be reinvested in primary activities, i.e., training activities, independent research and development, or activities serving a wide dissemination of research results. This is a restriction that the previous EU framework did not provide for. Moreover, the previous EU Framework still spoke of reinvestment in the “core activities of research institutions.” Thereafter, it was not necessary that the revenue return be made to exactly the one university or research institution that was the initiator of the knowledge transfer.

Privileged economic activities /”sideline activities

New and certainly of considerable relevance in the future is the regulation of Rz. 20, which provides for privileged treatment under EU state aid law for such universities, research institutions or research infrastructures that engage in both non-economic and economic activities. The first provision here is that state funding in favor of universities is unobjectionable under state aid law only if it covers costs associated with the non-economic activities.

However, special features are then provided for those universities that are almost exclusively non-economic. The Rz. 20 of the new Union framework reads in part as follows:

“If the research facility or research infrastructure is used almost exclusively for a non-economic activity, its funding may fall outside the scope of State aid law altogether, provided that the economic use constitutes a purely ancillary activity directly related to and necessary for the operation of the research facility or research infrastructure or inseparably linked to the main non-economic activity and its scope is limited.”

On the legitimate question of when the above conditions are met, the Union framework provides further guidance:

“For purposes of this Union Framework, the Commission will presume that this is the case if the economic activities use the same inputs (such as materials, equipment, personnel, and fixed capital) as the non-economic activities and if the annual capacity allocated to the economic activity in question does not exceed 20% of the total annual capacity of the facility or infrastructure in question.”

Accordingly, there is nothing to prevent (state) funding of economic activities if the university is used almost exclusively for non-economic purposes. According to the wording of the EU framework, the criterion of “almost exclusive use” first requires that the economic use is a purely ancillary activity that is directly related to and necessary for the operation of the research institution or research infrastructure or that is inseparably linked to the main non-economic activity and that the scope of the economic use is limited.

However, this criterion of “almost exclusive use” could already be considered to be met if (all) economic activities use the same inputs (such as materials, equipment, personnel and fixed capital) as the non-economic activities and if the annual capacity allocated to the economic activity in question does not exceed 20% of the total annual capacity of the facility concerned. This “secondary employment regulation” is probably the most significant innovation and at the same time privilege for universities under the Union framework. This is because, according to this, all economic activities such as e.g. Contract research, leasing of infrastructure, and parts of education and training can be categorized as non-economic activities of the university, provided that no additional inputs are required and the 20% capacity limit is not exceeded. There are many arguments in favor of such a broad interpretation of the “secondary employment” provision. Primarily, it would provide solutions to the problem identified by the EU Commission of inadmissible cross-subsidization of the economic sector with public funds. In addition, it would take into account the fact that often at the second level, in the relationship between the company and the university, market prices are not obtained that are higher than the full costs to be applied by the university in the first level.

As things stand, however, this understanding of “ancillary activities” must at least be critically examined, because there is a certain residual risk that the EU Commission will not only require the use of the same inputs and compliance with the 20% threshold, but will also consider a direct link between the economic activities and the operation of the university to be necessary, or will require that these be inseparably linked to the main non-economic activity.

Requirements of the Union Framework for Price Determination in Contract Research and Research Collaborations

Previously, universities had to charge their contractors (companies) an appropriate fee for their research services and the rights to inventions to be transferred in the amount of the market price for traditional contract research projects. This is still provided for. A new feature is the determination of prices if there is no market price. Then the university can demand the price that corresponds to the total cost of the service.

If this cannot be realized, the price for contract research services together with rights can also be demanded, which results from negotiations conducted according to the so-called arm’s-length principle. What is required is that the university, in its capacity as a service provider, negotiates with the client to obtain the maximum economic benefit at the time of contracting, covering at least its “marginal costs.”

Also new in the Union framework is the price determination provided for the benefit of universities in the case of contract research services provided for the first time to a specific company. Provided that these contract research services are provided “for experimental purposes” and during “a limited period of time,” moreover, can be considered a “special research service,” the EU Commission generally considers the price charged to be the market price if the research service or contract research is unique and there is demonstrably no market for it.

Innovations for price determination in the field of research cooperation

When it comes to research collaborations and determining what prices should be charged by the university for research services and/or rights to inventions, much of the old familiar is found in the Union framework. As in the past, the EU Commission does not see any constellation relevant under state aid law if the companies involved in the research cooperation bear all the costs of the project or if the results, for which no intellectual property rights are established, can be widely disseminated and any intellectual property rights arising from the activities of the universities are assigned in full to the respective institutions.

The constellation in which intellectual property rights resulting from the project as well as related access rights are allocated to the various cooperation partners in a way that adequately reflects their work, their contributions and their respective interests is also unproblematic under EU state aid law. What has remained is that, instead of the aforementioned variants, universities can also demand a normal market fee for the intellectual property rights resulting from their activities that are transferred to the participating companies in order to comply with state aid law.

However, there have been changes in the determination of this “normal market remuneration”. This can either be set through an open, transparent and non-discriminatory competitive sales process or determined by an expert who confirms that the level of the fee is at least equal to the market price. It is also possible under the Union framework that the university, as the seller of the rights, can prove that it has actually negotiated the remuneration in accordance with the arm’s-length principle already outlined.

Another new feature is the variant of granting a “right of first refusal” to the rights to be transferred, as set out in the Union framework. In this case, the university can determine the specific pricing of the right at a later date and does not have to do so when the research cooperation agreement is concluded. Rather, during the course of the research project or after its completion, the University may seek to obtain more economically advantageous offers from third parties for the intellectual property rights. Depending on the outcome, the company involved in the cooperation would have to adjust its offer accordingly or waive its pre-emption option.

Other innovations in the Union framework

A major innovation in the Union framework concerns the on-lending of grants:

As a rule, universities and research institutions find themselves in a so-called sandwich position, namely between the state, which gives or finances the grants, and the company/third party that is ultimately to receive the grants. In this context, universities/research institutions assume the function of a “body forwarding the grants”. In order to provide relief under state aid law for universities and research institutions in such a situation, the EU Commission does not consider research institutions and universities to be recipients of state aid if they only act as intermediaries and pass on the total amount of public funding and any advantages (e.g. interest benefits) possibly obtained through such funding to the final recipients.

However, this privileging only occurs at the level between the state and higher education/research institutions.

Dr. Anke Empting, KPMG Rechtsanwaltsgesellschaft mbH, Düsseldorf

T 0211 4155597-161; aempting@kpmg-law.com

Aline Heurley, KPMG Rechtsanwaltsgesellschaft mbH, Düsseldorf

T 0211 4155597-160; aheurley@kpmg-law.com

Julia Paul, KPMG Rechtsanwaltsgesellschaft mbH, Düsseldorf

T 0211 4155597-163; juliapaul@kpmg-law.com