Law Society of Scotland issues state aid warning to government over ferries fiasco

State aid regulated by the EU is financial assistance given by the government to companies or other organisations that has the potential to distort market competition.

EU state aid rules aim to ensure any government intervention produces a sustainable independent industry.

As revealed in The Herald on Sunday last week, the Competition and Markets Authority has already expressed its own concern about the "potential risks" of state control over the way ferries are operated, run and paid for in Scotland.

It warned of the dangers of now government-owned Ferguson Marine being awarded work without a competitive tender process, saying "it is unlikely to make it a commercially sustainable business" and "it may also have a negative impact on the wider industry".

READ MORE: SNP ferry 'fiasco' as ministers sued by their own company 

The Scottish Government took control of the last civilian shipyard on the Clyde in August after it collapsed because of the soaring costs of a contract with Caledonian Maritime Assets Ltd (CMAL), the taxpayer-funded company which owns ferries and other infrastructure used by publicly owned operator CalMac.

But there are concerns that public ownership is likely to make it harder to bid for some contracts under state-aid rules.

It comes amid a continuing wrangle over how the £97 million project for two ferries is now costing nearly £230m with no sign of either being available to passengers in the near future.

The previous Ferguson Marine owner, tycoon Jim McColl, who rescued the yard when it went bust in 2014, blamed repeated design changes by CMAL. He has said the prototype dual-fuel design, using both marine diesel and liquefied natural gas, required lengthy certification procedures.

One of the ferries, MV Glen Sannox – which is destined for the Arran-Ardrossan route – was due to enter service in the summer of 2018, but construction delays meant that was put back.

The second vessel, known only as Hull 802, was supposed to be delivered to CalMac in the autumn of 2018 for use on the Uig-Lochmaddy-Tarbert triangle, but that has also been held up.

READ MORE: Competition watchdog issues stark warning over ferries fiasco

The two new dual-fuel boats, the first UK-built hybrid ships of their type, are being built by the now publicly owned FMEL.

When considering the likely implications of the decision to take FMEL into public ownership, the Law Society said that as a company under Scottish Ministers' ownership it will be "under scrutiny to see that it is not a recipient [and/or donor] of unlawful state aid”.

It said if a vessel was to be procured this would mean that FMEL would need to obtain any future contract by winning it in a "procurement competition".

"Stakeholders should be mindful of the tensions inherent in a situation where one government-owned entity is procuring shipbuilding works, and there exists another government-owned entity, a public undertaking, which has specifically been acquired to maintain the tradition of Scottish shipbuilding," it said.

"Robust governance and clear separation of roles would be required to ensure compliance with procurement law by all concerned.

"The feasibility and risks of any scheme could only be assessed after appropriate legal advice and consultation, as well as consideration of taxation and other matters."

The intent of state aid rules is to avoid favouring a certain company or commercial group.

While state aid is not banned, it is tightly controlled and the final say on whether state aid is allowed is down to the European Commission. An EU member state should not provide support by financial aid, lesser taxation rates or other ways to a party that does normal commercial business.

A government can own a company under state aid rules but it is not allowed to keep it going if it would otherwise fail.

If a government can convince the European Commission that buying a business is a sensible move that any investor would make for a profit then it is not classified as state aid.

Under EU rules, member-state governments are allowed to provide state aid only with approval from the European Commission.

The UK is in a tranisition period to completely leave the EU by the end of the year, and in the meantime is still bound by its rules while the future trade arrangment is negotiated.

The Law Society said that it was likely in trade negotiations the EU would seek the continuation "of substantially similar" rules on state aid and competitive tendering.   And it talked of possible consequences to the UK if there ended up being any future dramatic divergence from the rules.

The Law Society also warned that because CMAL is government-owned any funds or benefit that it might make available to another party are 'through state resources' and are "capable in principle of amounting to state aid to the recipient".

Before the yard fell into administration and then public ownership, the Scottish Government provided two commercial loans totalling £45m, on which interest applied.

The Scottish Government in a response to a Freedom of Information question in 2018 seen by the Herald denied there was any state aid issue to address.

It came as the Scottish Government were asked to provide proof that it had applied for EU exemption for the transactions or had confirmation that they were not subject to state aid regulations.

The official response was: "Scottish Ministers have provided two commercial loan facilities to Ferguson Marine Engineering Limited. Both loan facilities were negotiated on fully commercial terms following detailed due diligence and with the benefit of independent third-party verification.

"On this basis we concluded there was no state aid present in the loan facilities provided to Ferguson Marine."

No proof of any approval from the European Commission appeared to be provided.

The Law Society also said that if CMAL and FMEL had been fully arms-length commercial entities, the pre-contract-award negotiations and the arising disputes "may have been handled differently".

READ MORE: How the tangled web of ferry operators and owners works ... in theory at least

For example, it said, it is likely that there would have been a full refund guarantee in place from a third-party lender to protect CMAL’s financial position and this "could have been relied upon to ensure (or compel) prompt performance of the yard’s obligations".

It said that "apart from procurement and state aid issues" the key ways to overcome challenges for procuring new vessels include having a " clear outline design brief" and a "contract and process for customer and designer to collaborate on the development of detailed integrated designs for the entire project".

There should also be a contract and process that ensures the building of a vessel to the specification.

It also says there should a system for continuous monitoring of progress and a clear basis for "identifying and authorising 'changes' and any consequent additional payments.

It said: "A contract needs to make it possible for a customer to say: ‘this is what you promised, and these are the consequences of failure to deliver in full and on time.’

In September, Derek Mackay, former finance secretary, was asked what assessment he had made over Ferguson Marine losing potential and existing contracts with the UK Government and other parties as a result of European Union state aid rules.

He replied: "I do not believe that the Government’s actions will deter work from coming to the yard, because I am making our objectives clear and the structure will ensure that we can maximise opportunities."

A Scottish Government spokesman said yesterday: “Procurement processes in relation to the yard will, of course, adhere to procurement law and compliance with rules on state aid matters.

“We have secured the immediate future of this important yard, protecting employment at a key business in Inverclyde, and we are fully committed to delivering a sustainable future for the workforce and maintaining shipbuilding on the Clyde.

“A strategy for future work will be crucial to the long-term viability of the yard and we are considering the best approach.

“While there is a lot of hard work to be done, the unpalatable alternative would have been for the Scottish Government to walk away, which would have resulted in hundreds of job losses, and the yard’s closure.”