Corona Reconstruction Fund stopped for the time being

On March 26, 2021, the German Federal Constitutional Court (GCC) held that the Own Resources Resolution Ratification Act (ERatG) must not be executed by the Federal President for the time being. In doing so, it temporarily averts the danger of taking a path to a fiscal union that as will be argued in this post, is contrary to EU law. What is behind this, and what is to be thought of the questions of EU law raised in this procedure?  The article addresses whether the European Own Resources System and the Corona Reconstruction Fund conform with EU law. As will be shown in this post, the EU may have acted ultra vires (i.e., outside its authority). In particular, the possibly insufficient earmarking of the Own Resources System and the Corona Reconstruction Fund, as well as the high-liability risk for the member states, are problematic. If such an ultra vires act were to exist, the GCC would, under its established case law and the German constitution, deny this EU program its effect in Germany and thus, in effect, finally stop the entire Corona Reconstruction Fund.

More on the domestic constitutional problems of the case can be found in the article from Verfassungsblog, which deals in particular with the violation of Germany’s constitutional identity.

The subject of the summary proceedings is the Own Resources Decision Ratification Act. This is the German law approving the financing of the European Union until 2027. It is the legal basis for the entry into force of the current Own Resources Decision of the European Union of December 14, 2020. The Own Resources Decisions of the European Union are based on Article 311 (3) TFEU and, in addition to other revenue, serve to finance the EU budget. The current Own Resources Decision enables the European Commission in Article 5 (1a) to take out loans of up to 750 billion euros with a term of up to 38 years. With these funds, the European Union intends to temporarily use 750 billion euros within the framework of its NextGenerationEU economic stimulus package to repair the immediate economic and social damage caused by the Corona pandemic. The most important instrument in this stimulus package is the Recovery and Resilience Facility, which will provide 627.5 billion euros in loans and grants to support reforms and investments in the countries of the European Union. Implementation of the economic stimulus packages by the European Union is only possible once all Member States have ratified the Own Resources Decision (Article 311 (3) sentence 3 TFEU).

The German Bundestag approved the Own Resources Ratification Act on March 25, 2021. The vote was preceded by a heated debate, during which the Minister of State at the Federal Foreign Office described the Own Resources System “as a necessary and overdue step towards a fiscal union”.

Constitutional complaint and urgent legal protection

The applicants of the constitutional complaint and the urgent application of 22.03.2021 criticised two points as alleged violations of EU law. Both of the listed allegations are based on the accusation of an ultra vires act.

1) The authorisation of the European Union to incur debt violates existing treaties and is an ultra vires act; according to its very wording, the raising of external funds is not a decision on the EU‘s own resources but on external resources.

2) The Own Resources Decision violates the EU legal principle that Member States must not be mutually liable for their respective liabilities and can act autonomously in their financial policy. The Commission alone could freely determine which Member States would have to repay the debt in the event of liability. Moreover, the liability limit is set so high that in a worst-case scenario, Germany would be liable for the entire 750 billion euros.

Existence of an ultra vires act?

The central question under EU law is whether the Own Resources Decision and the authorisation to incur debt violate the Treaties. If this is the case, this could constitute anultra vires act of the European Union.

First, the question arises as to why a Member State‘s constitutional court can decide on this question of EU law at all. The starting point is the primacy of application of Union law over any national law – including constitutional law – which is recognised today by both the GCC and the ECJ. However, since its Costa/E.N.E.L. ruling, the ECJ has assumed an unconditional primacy of application, which follows from the special nature of Union law as a new, independent legal order. In contrast, the GCC, like all other European constitutional and supreme courts, does not derive the primacy of application from Union law itself but assumes primacy by virtue of the constitutional authorisation of the Member States.

Ultra vires review(i.e., review of authority by a constitutional court of a Member State), refers to whether the EU institutions have exceeded their authority in a sufficiently qualified and structurally significant manner. Several European constitutional and supreme courts have already declared Union acts to be ultra vires (e.g. Cohn-Bendit ruling in France, Holubec ruling in the Czech Republic, Ajos ruling in Denmark, PSPP ruling in Germany). In the specific case, the question is whether the Own Resources Decision is manifestly in violation of the Treaties. As far as the question of the legal basis is concerned, it can be assumed that the constitutional complaint will not be successful. The situation is different, however, concerning the questions of earmarking and liability risk.

Sufficient legal basis and earmarking?

It is undisputed that Article 311 (3) TFEU is the legal basis under Union law for the European Own Resources Decision of 14.12.2020. According to this, the Council, acting unanimously in accordance with the special legislative procedure and after consulting the European Parliament, adopted a decision setting forth provisions governing the Union’s own resources. However, according to Article 311 (3) sentence 2 TFEU, only the Union’s own resources can be introduced. The applicants argue that borrowed funds are not the Union‘s own resources. However, according to the wording of the contracts, only the Union’s own funds (own resources) and no external funds (external resources) could be raised. This is a very restrictive literal argument based on the differentiation between debt and equity capital in business economics. The ECJ, with its strongly teleologically oriented case law guided by the idea of effet utile, will most likely not follow this line of argument. Instead, it will probably endorse a broad understanding of “own resources“. Should the GCC follow the applicant’s argumentation, a referral to the ECJ would be necessary in any case. There is no acte clair that would make a referral unnecessary.

However, the earmarking of the Own Resources Decision and the regulation establishing the Corona Reconstruction Fund is also important. According to Article 122 (1) and (2) TFEU, the European Union can take action with concrete measures using binding legal acts, for example, to grant a Member State financial assistance under certain conditions in the event of serious supply bottlenecks, natural disasters, or extraordinary events. The above-mentioned instruments of Union law within the framework of the NextGenerationEU economic stimulus packages and the Recovery and Resilience Facility are explicitly based on this provision. The critical point here is whether the economic stimulus packages are only aimed at overcoming the immediate consequences of Covid-19. Only if they remain limited to this exceptional case and comply with the narrow earmarking can they be based on the exceptional provision of Article 122 TFEU, which is to be interpreted narrowly in principle.

A system of “own resources“, which in this respect not only serves as a reconstruction programme but spills over into many other subject areas, would be difficult to reconcile with Article 122 TFEU. Germany, for example, plans to use 37% of the European Union’s allocations for climate protection and 20% for digitisation (BT-Drucksache 19/27838). While the use of funds for digitisation can be directly related to the Corona emergency due to the lockdown consequences and the limited possibilities of direct contacts between people, this is not the case for the use of funds for climate protection. It is not apparent why by far the largest share of Corona aid should be spent on climate protection, which has no connection to the Corona pandemic. On the contrary, if the pandemic has any “positive” effects, they have to do with the world climate. Of course, investments in climate protection can also create jobs. But it is doubtful whether this is still sufficiently directly related to combating the Corona consequences. For this reason alone, the GCC will also take a very close look at the earmarking of the European Union’s Own Resources Decision. Here, the constitutional complaint has a realistic chance of success.

Violation of the prohibition of mutual liability?

Moreover, a violation of Article 310 and Article 125 TFEU by the Own Resources Decision and the legal acts implementing the NextGenerationEU reconstruction fund is not unlikely. From these norms follows the Union principle that the Member States act autonomously in their fiscal policy and must not mutually assume responsibility for their respective liabilities. Article 125 (1) TFEU contains the so-called “no bailout clause” in this respect. According to this, financial equalisation between the Member States is prohibited in Union law. Neither is the Union liable for the liabilities of Member States nor are Member States liable for the liabilities of other Member States.

The possible liability volume and the liability period are very critical here. Due to the long duration of the loans, future federal parliaments will be bound to the Own Resources Decision until 2058. No one will seriously assume that regular and recurring waves of crises will not occur in Europe until the last repayment instalment in 2058. New aid packages will also be put together in the next crises, as has always happened in the recent past. In this respect, the Own Resources Decision could mark the European Union’s first step toward a fiscal union. The Corona emergency could be exploited to make a fiscal union inevitable through the normative power of the de facto. Instead of going down the path of amending the Treaties, the Member States and the EU seem to be attempting to form a fiscal union within the framework of budget planning.

The decisive question is whether Germany alone would be fully liable for 750 billion euros if necessary. If there are insufficient safeguards in the European Union’s own resources system, a violation of Article 125 TFEU is inevitable. Finally, the lack of economic transparency in the procurement of funds is also problematic. Where and how will the European Union raise 750 billion euros in debt? Which institutions will provide the loans? Does the European Commission have a free hand in this?

A closer look at the Own Resources Decision can provide some answers, at least for the time being.

Article 9 (4) and (5) of the Own Resources Decision initially appear reassuring. It follows that if there are insufficient EU budgetary resources to repay the debt, the European Commission will first make up this financing shortfall by active treasury management and, if necessary, by recourse to short-term financing on the money market. Only if these possibilities are not sufficient can the Commission, as a last resort, require the Member States to make the shortfall provisionally available in proportion to their respective contribution to the EU budget. This proportionate interim financing seems to exclude, at least formally, liability according to the motto “one is liable for all”.

The same pro rata provision of funds applies if a Member State cannot meet its share of the debt repayment. The defaulting Member State remains obliged to pay its financing share of the debt repayment. It can be concluded that this is not an assumption of liability in the true sense of the term, as funding from the remaining Member States is only temporary and not final. Legally, the defaulting Member State remains responsible and liable for its share of the financing and must pay it as soon as possible. It is a fact, however, that some Member States may not be able to make these payments.

However, Article 9 (6) of the Own Resources Decision reveals through several references (Article 6and Article 3 (1) and (2)) the enormous extent of the liability risk for each member state. Currently, according to Article 3(1) of the Own Resources Decision, the total amount of “own resources“ available to the Union for annual appropriations for payments must not exceed 1.40% of the sum of the gross national income of all Member States. In the future, from 2028, according to Article 6, the annual “own resources“ ceiling will be raised by a further 0.6 percentage points until 2058. This may sound like little, but in reality, it is much more. This is confirmed by the following example calculation for Germany. According to the Federal Statistical Office (Destatis), the gross national income in Germany in 2020 was 3,427 billion euros. This would result in a liability sum for Germany of 0.6% of the gross national income with 20.5 billion euros (exemplary for the year 2020) per year. According to Art. 5, the borrowing of 750 billion euros is at 2018 prices and is subject to a fixed deflator of 2% per year. Therefore, a total debt of the European Union of up to €820 billion must be expected by 2026. With a repayment term of 31 years (from 2028 to 2058), the liability sum for a member state like Germany could amount to up to 770 billion euros in the worst case. This would effectively lead to a fiscal union.

The GCC will thus still have to clarify important questions in the final decision. Due to the enormous extent of the liability risk, it is likely that other constitutional and supreme courts in Europe will also be called upon to decide on the future of the Corona Reconstruction Fund. Should the GCC and other European courts find that there is, in particular, a lack of earmarking of the Own Resources Decision or unacceptable liability risk, then they will likely stop this first step to a fiscal union that this post has argued is contrary to EU law.