The European Court of Justice (ECJ) has ruled in favour of making EU cash handouts conditional on a country's respect for rule of law.
The so-called rule of law or conditionality mechanism could see money withheld if a member state does not respect the bloc's core values.
These include democracy, equality, respect for human rights, non-discrimination and justice.
"Compliance with those values cannot be reduced to an obligation which a candidate state must meet in order to accede to the European Union and which it may disregard after accession," the judges said.
The ruling, delivered on Wednesday morning, paves the way for the European Commission to apply the mechanism for the very first time and request the freezing of EU funds, a process that could take between five and nine months.
The novel instrument "was adopted on an appropriate legal basis, is compatible with the procedure laid down in Article 7 TEU and respects, in particular, the limits of the powers conferred on the European Union and the principle of legal certainty," the ECJ wrote.
In doing so, the court dismissed an attempt by Hungary and Poland -- whose governments have been repeatedly accused of flouting the EU's core values -- to discredit the mechanism, cast doubt over its legal validity and delay its execution.
How did the ECJ case come about?
Budapest and Warsaw brought the legal action against the European Parliament and the EU Council, the bloc's two co-legislators, in early 2021.
During the legal case, the institutions were supported by interventions from the European Commission, which drafted the original proposal, as well as from Belgium, Denmark, Germany, Ireland, Spain, France, Luxembourg, the Netherlands, Finland and Sweden.
The judgement from Luxembourg delivered an unequivocal endorsement of the conditionality mechanism, making no concessions to the grievances put forward by Hungary and Poland.
"The sound financial management of the Union budget and the financial interests of the Union may be seriously compromised by breaches of the principles of the rule of law committed in a Member State," said the court.
"Those breaches may result, inter alia, in there being no guarantee that expenditure covered by the Union budget satisfies all the financing conditions laid down by EU law."
What has been the reaction to the ruling?
Poland and Hungary quickly condemned the ruling after its publication.
"We need to defend ourselves against an attack on our sovereignty, Poland has to defend its democracy against blackmail that aims to take away our right to decide about ourselves," said Poland's Deputy Justice Minister Sebastian Kaleta.
Hungary's Justice Minister Judit Varga called it "a politically motivated judgment" and "living proof that Brussels is abusing its power".
European Commission President Ursula von der Leyen welcomed the judgment and said her team will incorporate the court's findings into their strategy.
"I promised that no case will be lost. And I have kept that promise," von der Leyen said in a statement.
"Where the conditions of the regulation are fulfilled, we will act with determination. Today's judgments confirm that we are on the right track."
The main political groups of the European Parliament -- the European People's Party (EPP), the Socialists and Democrats (S&D), Renew Europe and the Greens/EFA -- called on the Commission to apply the instrument without further delay.
"The EU is not a cash machine," said the EPP.
Representatives from other member states also reacted to the news, with Belgian Prime Minister Alexander De Croo calling the ruling "a vital step towards protecting the rule of law in Europe".
"This is good news," tweeted Finland's Minister for European Affairs Tytti Tuppurainen. "Everybody must adhere our treaty based common values."
What's the conditionality mechanism?
The mechanism was designed in parallel to the negotiations over the €1.1 trillion multi-annual EU budget and the €750 billion coronavirus recovery fund.
The increase in financial power led to renewed calls to strengthen compliance with the rule of law, a debate that was already raging well before the health crisis erupted.
Following negotiations in late 2020, which included failed threats of veto, the system entered into force in January 2021.
Hungary and Poland brought their legal actions shortly after.
So far, the system has never been activated, despite dramatic developments in recent months.
In early October, the Polish Constitutional Court delivered an extraordinary ruling that directly challenged the primacy of EU law, one of the bloc's cornerstone principles, and the ECJ's competence.
The verdict sent shockwaves and enraged many heads of government and MEPs, who demanded immediate action from the European Commission.
But von der Leyen said her team would wait until the ECJ issued its verdict and confirmed the instrument's legal validity. The executive also argued it was drafting a series of guidelines to help officials implement the tool.
The explanations were not enough for MEPs, who had sued the Commission for inaction.
How powerful is the mechanism and how will it work in practice?
The mechanism's rules give the European Commission, often referred to as "guardian of the treaties", the power to initiate the procedure to freeze EU funds.
First, the executive has to build a legal case against a member state suspected of breaching EU law and endangering the common budget. The accused country can reply to the executive's accusations, exchange information and attempt to correct the unlawful situation.
If the European Commission believes the wrongdoing persists, it can formally issue a recommendation to freeze EU funds. The decision then goes to member states, which have to approve it by a qualified majority (55% of EU countries representing at least 65% of the total EU population).
Potential punitive measures include a suspension of payments, termination of legal commitments, an early repayment of loans or a prohibition to enter new financial agreements. The measures can be later lifted if the disciplined country corrects the situation.
In total, the whole procedure can take up from five to nine months, according to EU officials.
Besides the protracted duration, experts have raised the alarm over the regulation's narrow scope. The European Commission can only act when EU law breaches pose a "serious risk" on the bloc's financial management or financial interests.
"Such a breach must concern a situation or conduct that is attributable to an authority of a Member State and relevant to the proper implementation of the Union budget," the ECJ underlined.
The direct link could prove hard to demonstrate and exclude violations that do not concern the EU budget. The regulation, however, lists dangers to the judicial independence as one of the potential scenarios that could merit the mechanism's application.
What happens now?
All eyes turn now to von der Leyen, who will have to make the final call on whether to activate the budgetary procedure. Hungary will hold its national election on 3 April, a politically sensitive circumstance that could influence her thinking.
Speaking on Wednesday, a Commission spokesperson insisted the adoption of guidelines was an indispensable step before launching any formal procedure and refrained from providing any specific timeline on how long this will take.
In recent months, Commission officials have been exchanging letters with Hungarian and Polish authorities regarding certain aspects the executive considers damaging to the rule of law, such as alleged corruption in Hungary and accusations of a lack of judicial independence in Poland.
These letters do not amount to an official start of the conditionality mechanism but imply a legal case is being built against both countries, who are net beneficiaries of EU funds.
In 2020, Poland received €18 billion from the bloc's budget, while Hungary got €6 billion.
Given the untested nature of the instrument, it's still unclear how effective it could be in practice. If eventually approved, the suspension of EU funds would affect government entities and public authorities at the national, regional and local levels.
While the regulation includes provisions to ensure the final beneficiaries of EU funds, such as NGOs and farmers, do end up receiving the money and don't pay the price, triggering the process could fuel anti-EU sentiment inside the punished country.
Both Poland and Hungary are still waiting for the approval of their national recovery plans, which will allow them to tap into the €750 billion fund. The Commission has refused to give its green light to their programmes as long as rule of law concerns are not addressed.
Speaking on Wednesday, a Commission spokesperson said the mechanism could apply to funds coming from the general EU budget and the coronavirus recovery package.
Meanwhile, the two countries remain under the Article 7 procedure, which could deprive them of voting rights on EU policy. The process has been stalled for years because it requires the unanimity of all member states (minus the accused country). Poland and Hungary have vowed to block each other's vote.