TALLINN, 5 July 2006 - The National Audit Office expects the Government to quickly come up with an effective solution as to how to prevent local authorities from running into insolvency problems as is the case with the rural municipality of Sonda in Ida-Viru County, and what to do with local authorities that are in financial difficulties and how the financial status of local authorities should be organised in general.

An audit report prepared by the National Audit Office on the EU-financed HASCO environmental project in the rural municipality of Sonda in Ida-Viru County refers to the need for attending to the problems of insolvency of local authorities. (The exact title of the project is 'Oil-Shale Semi-Coke Processing into Soil Improver, Soil Improver Used to Stabilise Slurry and Restore Damaged Soils for Foresting Mainly with Hybrid Aspen.')

Due to various violations the European Commission is reclaiming from the rural municipality an amount of nearly 8 million Estonian kroons that it allocated to the project. The rural municipality also has to repay a loan of nearly 4 million Estonian kroons that it took from the Environmental Investment Centre. The failure of the project has lead to a situation where the obligations assumed under the support project – 11.7 million Estonian kroons – almost equal the annual budget of the rural municipality as a result of which it is unlikely that the rural municipality will be able to repay the money on its own. So far the rural municipality has not commenced repayment of the 11.7 million Estonian kroons. The Eastern Police Prefecture has initiated an investigation into the use of the project funds.

The purpose of the HASCO project was to mix oil shale ash (semi-coke) and agricultural slurry by using a new technology and thus reduce the negative impact on the environment, re-cultivate the open pits of the abandoned mine in Ida-Viru County by planting hybrid trees and thereafter use the expertise obtained from the trial project more extensively. According to the project plan the total cost of the project was 55.5 million Estonian kroons of which 19.9 million was to be contributed by the European Commission and 35.7 million was to be allocated by the beneficiary and partners as the self-financing.

The Commission and the rural municipality of Sonda entered into an agreement on the implementation of the project on 2 August 2002. The agreement stipulated the amount of the financial support, the procedure for financing and supervision. The agreement specifically stated that the rural municipality of Sonda is responsible for implementation of the project.

According to the project approved by the European Commission the duration of the project was 35 months, i.e. from 1 February 2002 to 31 December 2004, the beneficiary was the rural municipality of Sonda and the project partners included eight enterprises. One of the partners, a Finnish company, that according to the project was the recipient of the largest amount of funds from the Commission, withdrew from the project in the summer of 2003. The partner indicated that considering the events that have occurred over the last six months they find it impossible to continue cooperating with the beneficiary and added that having experience in several such projects they cannot accept the activities that are conducted under the name of the project.

To launch the implementation of the project the European Commission allocated 505,994 euros (7.9 million Estonian kroons), which also remained the only payment to the rural municipality by the Commission. In addition to the amount the rural municipality of Sonda applied to the Environmental Investment Centre for a loan of 3.8 million Estonian kroons for bridge financing of the loan (short-term coverage of the self-financing). The Environmental Investment Centre acceded the application.

During implementation of the project the rural municipality had the following mayors: Peedu Erm (until 18 December 2002), Ivo Teder (from 18 December 2002 to 30 August 2004) and Andrea Eiche as of 30 August 2004.

The European Commission terminated the HASCO project on 23 February 2005 because the reports of the rural municipality or the visit of the representatives of the Commission in November 2004 did not allow for assessing which results have been achieved upon implementation of the project. The European Commission filed the claim for repayment of the money over a year ago and as long as the money has not been repaid an interest rate of 5.5% a year is charged on the amount.

Before filing the claim for repayment of the money the Commission had repeatedly warned that if the rural municipality did not submit correct reports on using the money, the money would be reclaimed. In addition to the repayment obligation before the European Commission the rural municipality must repay a loan received from the Environmental Investment Centre, because the project for which bridge financing was allocated, has failed.

The National Audit Office finds that the demands of the European Commission were reasoned, because the rural municipality of Sonda had violated the European Commission's rules for receiving aid: it did not submit the required reports; it did not prevent a conflict of interests; it did not enter into due contracts with the partners; it did not preserve the documentation certifying the implementation of the project.

Having analysed the materials of the HASCO project, which were submitted to the National Audit Office and the explanations given it has to be admitted that due to the insufficient documentation it was difficult and in several instances virtually impossible to assess the exact chronology of the events and the content of transactions. The rural municipality and the partners may have performed the planned work during the project, but due to poor documentation the National Audit Office has it difficult to assess what work and to what an extent exactly. The National Audit Office does not question the importance or goals of the project. However, the beneficiary, i.e. the rural municipality of Sonda, should have taken into account that in the case of projects financed out of foreign aid the rules established by the provider of the aid have to be followed. The beneficiary must organise its work respectively from the very beginning, incl. documentation of activities, reporting, etc.

In a letter sent in the summer of 2004 the European Commission drew attention to the problem of independence and a conflict of interests in connection with a person who performed an important coordinating role in the project and was connected with several partner enterprises of the project and was the sole shareholder in one of them. Although the European Commission drew the beneficiary's attention to the conflict of interest several times, the rural municipality did nothing to solve the problem. Having analysed the economic interests of the persons connected with the HASCO project the National Audit Office found that there was also a conflict of interest in the case of one member of the council of the rural municipality.

The National Audit Office also finds that the financial condition of the companies participating in the project through self-financing was not good enough in order to be certain whether they are able to perform the obligations assumed. For instance, the auditor of the rural municipality drew attention to the tax arrears of one partner. The National Audit Office finds that before involving companies in large-scale projects their financial capacity to perform the obligations must be analysed thoroughly.

In the framework of the HASCO project the rural municipality had entered into several contracts for services, but these contracts did not specify for which the money was paid and what was received for the payment.

The National Audit Office finds that the supervision exercised by the council of the rural municipality of Sonda over the government of the rural municipality was not sufficient, because the council did pay sufficient attention to the implementation of the project or the problems indicated in the memorandum of the auditor of the rural municipality.

The rural municipality submitted to the European Commission only three out of the requested nine reports. The last one, of December 2004, where the rural municipality claimed that most of the goals of the project had been achieved, was poorly made. The project results given in the report had not been certified by source documents; the report accounted for costs which had not been incurred or which were not backed by any source documents.

The National Audit Office compared the expense receipts submitted to it with the cost report submitted to the European Commission on 17 December 2004 and the approved project. As a result of the audit it became evident that the costs incurred did not always correspond to those planned in the project or the tasks of the participant; upon incurring costs the limits had not been followed; the report partially contained costs that have never been incurred; the indicated costs did not always correspond to the amounts specified in the expense receipts; the content of the expense receipts did not always match the content of the costs given in the report. The auditors found that some expense receipts were not received because the documents were not preserved as required or they never existed.

The National Audit Office is not certain that the rural municipality submitted to the National Audit Office all the materials that the project partners gave to the rural municipality, because in several instances the partners claimed that they have already submitted the materials requested by the National Audit Office to the rural municipality in the course of the project. The National Audit Office is also not certain that all the partners have submitted to the National Audit Office the entirety of the documentation pertaining to the project.

The audit on the National Audit Office was initiated on the basis of an inquiry by Andrea Eiche, the current Mayor of the rural municipality of Sonda, where she asked the National Audit Office to audit the circumstances of repayment of the aid. Since the decision of the European Commission to reclaim the money was known at the time of commencement of the audit, the National Audit Office could do nothing but confirm the shortcomings identified upon implementation of the project. However, the National Audit Office hopes that other applicants for European Union aid can make use of the conclusions drawn.

According to the State Audit Act, the National Audit Office audits the use of the funds of the European Union allocated through the state and local authorities and the performance of the liabilities assumed before the European Union in this respect. With respect to the end users of the funds of the European Union and the persons having obligations before the European Union the National Audit Office has the right to conduct proceedings in order to identify the truthfulness of the circumstances, which were the prerequisites for receiving the funds of the European Union and the legitimacy of the use of the funds and the performance of the obligations.

In her reply to the draft audit report of the National Audit Office the Mayor of the rural municipality of Sonda agreed with the suggestions of the National Audit Office. In his reply the Minister of Financed promised that he would submit the draft acts regulating the financial management and insolvency of local authorities to the Government by October 1 this year. The Minister of the Environment found that the work of the National Audit Office upon identifying the circumstances pertaining to the HASCO project has been very effective and found that the observations made in the report can be taken into account upon updating and drafting the procedures for using the money of the Structural Funds in the future.

Toomas Mattson
Communication Manager of National Audit Office
Telephone: 6400 777
Mob: 51 34900
E-mail: [email protected]

• Posted: 7/5/2006 12:00 AM
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