Dorit McCann: Using the ‘failing firm defence’ to justify mergers in a post COVID-19 world
Dorit McCann, partner at Beauchamps, considers whether firms emerging from the COVID-19 crisis with access to financing can use the “failing firm defence” to justify acquisitions of competitive businesses.
COVID-19 has turned our world upside down but, while it presents great challenges to many businesses, it also presents opportunities for others.
Businesses which emerge from the current crisis with access to financing may have a unique chance to acquire a competitive business which has not survived the crisis so well. The saying “Never let a good crisis go to waste” has perhaps never been more true.
This article looks at whether the ‘failing firm defence’ can be used to justify mergers and acquisitions in a post COVID-19 world which would ordinarily be problematic from a competition law perspective.
What is the test under Irish merger control?
Irish merger control law prohibits acquisitions and mergers which substantially lessen competition in the relevant market. Mergers and acquisitions which meet the turnover thresholds in the Competition Act 2002, as amended, must be notified to the Irish Competition and Consumer Protection Commission (CCPC).
The CCPC determines whether any competition concerns arise as a result of the transaction and, if so, whether the lessening of competition is substantial. This occurs where the independent competitors remaining in the market after the transaction would not be sufficient to constrain the merged entity from raising its prices or reducing its quality.
What is the Failing Firm Defence?
The essence of the failing firm defence is that the target business would have failed if the acquisition had not gone ahead, and that there can therefore be no loss of competition as a result of the transaction. (Note that it is possible, at least in theory, that the acquiring firm is the failing firm or that both the acquiring firm and the target are failing firms.)
The test is not easy to satisfy and the following four limbs must be met in order for the defence to be successful:
- The firm must be unable to meet its financial obligations in the near future;
- There must be no viable prospect of reorganising the business through the process of receivership, examinership or otherwise;
- The assets of the failing firm would exit the relevant market in the absence of a merger transaction;
- There is no credible less anti-competitive alternative outcome than the merger in question.
The successful reliance on the failing firm defence is rare as there is a high bar for proof of the inevitability of the exit of the failing firm (and its assets) from the market. The CCPC requires extensive evidence in support of the failing firm’s financial distress, including financial statements, projected cash flows, credit status, off-balance sheet financing and changes in the share price or debt.
In addition, the CCPC will require briefing materials prepared for the Board and/or senior management, documents prepared prior to the proposed transaction, details of the sales process and time lines of critical events and decisions, e.g. alternative bids, the bidding processes, due diligence, final offer and acceptance. In essence, the evidence must show that consumers will be worse off than if the firm and its assets had left the market.
Has the Failing Firm Defence been successfully invoked in Ireland before?
The first and only case in which the CCPC cleared a notified merger where the failing firm defence was used was in 2015 in relation to the acquisition of Fannin Limited by Baxter Healthcare Limited (M/15/026 – Baxter Healthcare Limited / Fannin Compounding). The transaction was cleared following an extensive 2-phase investigation.
The parties submitted evidence that Fannin Compounding was a failing division of Fannin Limited. The CCPC undertook an in-depth review of the failing division argument submitted by the parties, including seeking evidence from relevant third parties and obtaining advice from external accountants to independently examine financial information pertaining to Fannin Compounding.
The CCPC concluded that the competitive structure of the relevant market would deteriorate to at least the same extent in the absence of the transaction and that the transaction would therefore not, of itself, substantially lessen competition in any market for goods or services in Ireland. On that basis, the CCPC approved the merger.
In particular, the CCPC noted that Fannin Limited’s parent company did not have the incentive to meet Fannin Compounding’s financial obligations in the future, that Fannin Compounding had been loss-making for some time and that there was no prospect of returning Fannin Compounding to profitability in the near future. In addition, internal documentation indicated that the parent company had been considering the possibility of exiting the compounding business for some time and that Baxter was the only credible purchaser.
Has the Failing Firm Defence been rejected by the CCPC before?
The failing firm defence has been invoked on a number of other occasions, most notably in the acquisition of the Superquinn grocery retail business by Musgrave (M-11/022 – Musgrave / Superquinn).
In that case, the CCPC was not convinced that all of the limbs above had been met as there was a strategy to sell Superquinn on an all or nothing basis even though market enquiries had confirmed that alternative buyers would have been interested in buying some, but not necessarily all, of the Superquinn assets. In addition, it was not possible to say with certainty that all Superquinn assets would exit the market in the absence of the transaction. A viable alternative could have involved the sale of at least some assets to competitors and/or new entrants. Finally, the fact that Superquinn had entered the receivership process did not in itself imply that Superquinn was a failing firm for the purposes of merger review. The Musgrave / Superquinn merger was approved on different grounds.
When acquiring a business in difficulty, purchasers may be able to take advantage of the failing firm defence to undertake acquisitions that would otherwise substantially lessen competition in a market.
However, a failing firm argument will be scrutinised carefully by the CCPC and must therefore be supported by robust evidence to be successful. While the economic conditions have changed as a result of the COVID-19 pandemic, it is unlikely that this will lead to a more lenient application of the failing firm defence by the CCPC.