You'd have to have been out of the country not to have heard about Northern Rock's problems. The news of the government's guarantee, its failed attempt to find a buyer, and now the recent announcement that it will be nationalised have rarely been out of the headlines.

Within the next two weeks it's expected that the new Act (which is still a Bill at the moment) nationalising Northern Rock will be put to Brussels for approval. Alistair Darling told a news conference that: 'The conditions under which Northern Rock will do business have to be approved under the [EU's] state aid rules, which are deliberately designed to stop there being unfair competition from something that has the state standing behind it.'

But what is 'state aids' law? It is, in effect, EU law and it affects lots of areas of English law. It prohibits cartels and abuses of market power, for example, and, more importantly, it forbids governments from providing aid to their own industries (except in limited circumstances). Otherwise, how could companies in the other EU member states freely compete if companies in one state were given an unfair advantage?

As the EU Commission states: 'A company which receives government support obtains an advantage over its competitors. Therefore, the EC Treaty generally prohibits state aid unless it is justified by reasons of general economic development'. The Commission assesses whether a company is gaining state aid by checking whether there have been any grants, guarantees, etc. made to the company. It also wants to know whether the assistance has given the company an advantage, whether the competition has (or may be) distorted, and whether it's going to affect trade with other members of the EU.

In the case of Northern Rock, the state is clearly intervening and conferring an advantage (by virtue of the buy-out and the earlier state guarantee of funds which was issued to stop the run on the bank). What the government will seek to do is ensure that competition won't be distorted. It's this aspect which is particularly interesting.

Individuals interviewed outside a Northern Rock branch on 19th February, who were depositing money, were quoted as saying that they wouldn't invest anywhere else as Northern Rock's top rate for deposits was the best on the market - 6.4% on a one-year savings bond - beaten only by one other institution, 6.49% for the over 50s. The national savings rate only goes up to 4.05% for a one-year bond.

The new executive for the bank, Ron Sandler, who has been put in place on a salary of £90,000 a month and who is non-domiciled for tax purposes, will have to try to ensure that the concerns the British Bankers' Association and others have expressed about free competition hereafter are quelled. The bank owes the Bank of England £55 billion at present and will need to be reasonably competitive to repay this sum, but it will also have to stay the right side of both state aids law and UK and EU general law on competition.

It appears that Northern Rock will continue to trade and compete rather than simply run down its mortgage book and assets in the way Equitable Life has done, but such competition will need to be fair and on a reasonably equal footing with other banks and building societies. However, nothing will remove the assurance savers and borrowers have that, unlike other institutions, Northern Rock is government backed and that their savings are safe. But the shareholders are not in such a good position and solicitors firms are already considering group actions to recover damages.

Has competition been distorted?
It will be very difficult to ensure that Northern Rock doesn't give a government guarantee to its investors which other institutions don't have. If it continues to offer better rates and 125% mortgages, which other lenders don't offer, this may well distort competition and it could lead to the EU intervening under state aids legislation. Ultimately, the EU can ask the state to take back the state aid that it offered. In December 2007, such an instance occurred when a Polish steel company was obliged to pay back 2 million euros it had received of state aid.

However, the government is well advised by competition lawyers and other advisors, so it's likely that the aid, and the terms on which it's given, are made on the basis that it falls on the right side of the line in terms of anti-competitive effects. It will make sure that Brussels has been consulted and ask it to approve the Bill. If the European Commission wants to make changes to the Bill, the government will adhere to these requests so that it will be hard for the Commission to challenge the nationalisation at a later date. The Conservatives are urging the government to ensure that the Office of Fair Trading (the UK competition regulator) provides an annual report into the competition situation in relation to the bank, but whether this will be included in the Bill remains to be seen.

It has been reported that the EU has said that if the government continues to support Northern Rock after 17th March, which is very clearly going to happen, then it must show that the money is 'restructuring aid' and not 'rescue aid'. In the Guardian, a spokesman for Neelie Kroes, the Competition Commissioner said: 'This requires the company to be restored to viability so it can survive in the future without any further injections of public money. There must be compensatory measures to offset the distortion of competition caused by the subsidy and normally that's a reduction of capacity'.

Usually there are some lay-offs necessary, which are often required when a merger is notified to competition authorities and, as a condition of the approval, the buyer is required to divest itself of some of the assets acquired. The EU has said: 'This is probably the biggest ever state aid case dealt with by the Commission. We are keeping a very close eye on the situation'. 

In 2004 a restructuring of the industrial giant Alstom was approved by the EU, but only if 1.6 billion euros of businesses were sold and investment and decisions had to be shared 50/50 with other new partners in the private sector before it could go ahead. The EU may well impose similar conditions here. The challenge for Northern Rock now will be to ensure that it doesn't offer more favourable terms to investors than would otherwise be the case if it were not in state ownership.

It's likely that job cuts may be necessary and branch closures will be made before 17th March to meet this requirement. Whether any political advantage was gained by the government having an interim period of state guarantee at the start, rather than nationalising Northern Rock from the outset, or leaving it to its fate in a free market, remains to be seen. If EU state aids law means that lay-offs and branch closures are necessary, there could be as much political fallout as if the government had let it go to the wall in the first place, except, of course, we, as taxpayers, wouldn't be footing the bill.

About the author
Susan Singleton runs her own commercial law firm, Singletons, in London and is an expert on EU and UK competition and intellectual property law advising a wide range of clients from the UK and abroad. She is author of 30 books including Lawpack's 'Standing up to Rogue Traders'.

Find out more
More information on EU state aids law
If you want to complain about alleged breach of the law on state aids, then complete the EU form
Find out more about recent EU state aids
More information on the Alstom state aid case
Get advice on EU law from the author Susan Singleton