This article is an excerpt from The Art of Tendering: A Global Due Diligence Guide, which is available for purchase.
In its April 2019 decision in Pentland Ferries v. Scottish Ministers, the Scottish Court of Session dismissed a case where a ferry service company challenged government subsidies provided to a competing ferry service. The case dealt with subsidized passenger and vehicle ferry services to the Orkney and Shetland islands. The complainant challenged the government’s decision to subsidize those services, arguing that as a competing ferry service, the subsidy provided an unfair advantage to its competitor and put it at risk of going out of business.
As the Court detailed, viable ferry services were critical to maintaining the population base on the islands in question:
The pre-appraisal report emphasised that passenger and ferry services between the northern isles and the Scottish mainland are essential for the economies and sustainability of Orkney and Shetland Islands. Orkney has an increasing population with recent rates of growth exceeding the Scottish average. However the population is aging and the retention of younger people remains the challenge for the years ahead. The economy is relatively stable though some individual sectors have had significant changes. In particular the proportion of the GVA represented by transport and storage rose from 7.5% to 11.4% between 2000 and 2014. This has implications for demand for ferry services. The report concluded that frequent reliable and affordable transport to the Scottish mainland was a critical issue for Orkney in keeping younger “cohorts” on the islands. The report noted that Orkney and Shetland are unusual in that they are significant exporters of physical products. The success of agriculture, the principal industry on Orkney, was highly dependent on the provision of frequent and reliable ferry services with sufficient capacity and a timetable specifically attuned to the needs of exporting industries.
The government relied on these facts to support its decision to subsidize the ferry routes in question. However, the complainant challenged the government’s subsidy, alleging that it was a breach of applicable open competition rules since the subsidy put the viability of its own previously profitable services in peril:
Mr Lindsay QC for the petitioner explained that the petitioner’s route was a profitable one. They provided the ferry and also the terminals. Over the years they have upgraded the ferries and a new ferry, the MV Alfred, is to be in service for the summer. The business was growing. The competing Scrabster route was heavily subsidised. The extent of the subsidy exceeded the petitioner’s operating costs by some margin. The respondent provided the ferry the MV Hamnavoe through a leasing arrangement and they had to pay wharfage charges for the terminal. Despite the high level of subsidy the Stromness route was losing market share to the petitioner. The potential new subsidised contract had an estimated subsidy of £370 million for the whole bundle of routes. The proportion attributable to the Scrabster route had more than doubled from that available under the present contract. It was for this reason that the petitioner was concerned that the existence of the subsidy provided a threat to their profitability and continued trading.
As the Court noted, the challenged subsidies were regulated by Scotland’s Marine Cabotage Regulations and related case law, which recognized that any subsidy had to be non-discriminatory, necessary, and proportionate. As the Court explained, the starting point of the subsidy analysis was determining whether the payment of a subsidy was an unlawful state aid that distorted the market. A subsidy was only lawful if the state had first identified a market failure. The onus was on the government to demonstrate that such a failure existed and to show that it would have to establish that regular transport services would be inadequate if left to market forces alone. Furthermore, the subsidy had to be proportionate, had to be available on a non-discriminatory basis and could not lead to undue market distortions.
The Court also noted that the government’s subsidy decisions were subject to Wednesbury unreasonableness principles. While the government was afforded a wide margin of discretion in making its subsidy decisions, those decisions had to be made in accordance with applicable open competition rules:
As I have indicated above parties are agreed that the test for this court is whether there has been manifest error on the part of the respondents. Such a test broadly equates to Wednesbury unreasonableness. It is also, I think, accepted that the respondents have a wide margin of discretion in the decision making process. That discretion however has to be exercised in accordance with the Marine Cabotage Regulations and the case law of the CJEU. In particular they must follow the principles enunciated in the Altmark case.
In applying those standards, the Court ultimately upheld the reasonableness of the government’s decision, concluding that there was a “wealth of evidence” to support the subsidy. In support of its ruling, the Court noted that the subsidized route, together with the complainant’s route, were both necessary to provide the overall required service capacity. The Court found that the subsidy was necessary to help promote future growth by supporting both the importing and exporting aspects of the island economies. The Court also found that the government was able to prove that the subsidized route was not viable without the subsidy due to higher fuel costs for the longer crossing and that the complainant was unable to show that those subsidies were disproportionate. Furthermore, the Court concluded that maintaining two routes was not irrational since each route presented different benefits to the market.
While the Court ultimately rejected the challenge, this decision shows how government subsidy decisions favouring one service provider over another could be subject to legal challenge based on specific industry regulations and on the general reasonableness standards that apply to government decision-making and open competition. Public institutions therefore need to be ready to defend their decisions with proof of a rational, evidence-based decision-making process.
