Merger Remedy Rationales
Divesting the Right Assets
Finding an Acceptable Buyer
Reviewing the Divestiture Agreement
Additional Provisions in a Divestiture Order
Divestiture Application
Implications
On April 2 2003 the Federal Trade Commission (FTC) released a Statement on Negotiating Merger Remedies which provides guidance to companies and their antitrust counsel when divesting assets pursuant to a consent decree or when buying such assets. (A copy of the statement can be found at www.ftc.gov/bc/bestpractices/bestpractices030401.htm.) The new FTC statement serves as a partial roadmap to help streamline what is often a lengthy divestiture approval process. Both companies selling assets required by a divestiture order and potential buyers of divested assets can use the FTC statement as a resource to improve their chances of successfully navigating the review process.
When the FTC or the Department of Justice requires a merger remedy, the goal is to maintain or restore the competition that may be reduced by the merger. As a result, the agencies focus on:
- ensuring that all appropriate assets are divested;
- evaluating the ability of the buyer to manage the assets effectively and compete in the relevant market; and
- assessing whether the divestiture agreement meets the requirements of the divestiture order.
Only when all of those hurdles are met will the agencies approve a remedy. The FTC's new statement adheres to these basic principles and draws on an August 1999 study conducted by the FTC that reviewed the success or failure of all of the FTC-ordered divestitures between 1990 and 1994.
The first step in the FTC's merger review process is to ensure that the proper assets are divested. The FTC wants to know that the buyer will have adequate resources to maintain pre-merger levels of competition in the relevant market. Often, when antitrust counsel foresees a competitive problem, the merging companies can propose to divest a package of assets. Whether the merging parties or the FTC initiates a discussion of divestitures, the FTC statement highlights several factors companies should consider:
- Divesting an autonomous business unit, rather than a collection of independent assets, is preferred. If the assets have been successfully run as a unit by one of the merging parties, the FTC is more likely to be satisfied that a buyer can be an effective competitor with those assets.
- If the assets do not comprise a coherent business unit - for example a package of intellectual property - the parties should be prepared to explain how those assets will allow a prospective buyer to compete successfully. This may require that the parties identify an upfront buyer so they can demonstrate how the divested assets would be integrated with the buyer's existing assets.
- When combining assets that were not previously operated together, the parties must take the extra step of demonstrating how these assets will allow the buyer to provide adequate competition.
No matter how complete the package of divested assets, the agencies will not approve a divestiture if they have concerns as to whether the prospective buyer can operate those assets effectively and restore lost competition. In looking for a buyer, the FTC statement indicates that the merging companies should consider the following:
- The FTC wants to ensure the buyer has the financial resources to acquire the assets, and the ability and incentives to be competitive over the long term. The FTC will therefore be concerned with the financial strength of the buyer and any prior experience it has in the line of business. The FTC will also inquire into the buyer's rationale for acquiring the assets. Failure to show, for example, likely long-term profitability or a strategy for integrating the assets with the buyer's existing lines of business could cause the FTC to reject a proposed divestiture.
- Buyers that are active in related product markets or adjacent geographic markets, or those which are involved in upstream or downstream markets, are often good candidates. The FTC may also look favourably on buyers which have expressed an interest in entering the market before the FTC required divestiture.
- Large incumbent competitors will rarely be considered acceptable buyers, because their purchase of the assets will raise independent competitive problems.
- Presenting an upfront buyer - one which has already agreed to purchase the assets the merging parties propose divesting - can often help to streamline the process. When the assets being divested are not an autonomous business unit, the FTC may require an upfront buyer.
- If the buyer needs to obtain financing to purchase the assets, the FTC must be assured that those arrangements can be made. Seller financing is generally discouraged since it promotes continuing ties between the seller and buyer.
- In evaluating the buyer, the FTC will conduct its own research, which will likely include interviewing the buyer, customers, suppliers, competitors and other possible buyers. The FTC will also request the buyer to provide a business plan and other financial information that demonstrates its ability and incentive to purchase the assets and competitively manage them.
Reviewing the Divestiture Agreement
FTC staff will closely review the divestiture agreement and in some cases the FTC may recommend revisions to the agreement. Counsel may be surprised by the detailed nature of the review and the questioning of exhaustively negotiated provisions. As a baseline, the divestiture agreement must transfer all of the assets subject to the divestiture order.
There are at least two kinds of clauses that the FTC will closely review and that may raise concerns. First, the FTC will often question any non-solicitation or non-compete clauses because they limit competition, particularly when they continue for a long period of time. Second, any provisions that require third-party consents or approvals (eg, other regulatory approvals) will be scrutinized. The FTC will generally require the parties to obtain these consents before it will approve the divestiture.
Additional Provisions in a Divestiture Order
Divestiture orders often include additional requirements geared toward maintaining competition. In some cases the FTC will require that the seller provide certain transition services, technical assistance with intellectual property, temporary supply agreements, or incentives to encourage the transfer of key employees. In this instance the FTC is trying to ensure that the buyer becomes an effective competitor as quickly as possible. However, the FTC will also want to minimize the ongoing relationship between the buyer and seller.
If the assistance will create an ongoing relationship between the buyer and seller, the FTC may appoint an independent third-party monitor to ensure compliance with the divestiture order. The monitor reports to the FTC, but is compensated by the parties.
When the merger is likely to close prior to completion of the divestiture, the FTC may also insist on an 'order to hold separate'. To preserve competition, these orders require the divesting party to maintain an independent entity to operate all of the assets to be divested. The FTC's main concern here is a weakening of the assets to be divested and any resulting harm to competition. Even when there is little risk of such interim competitive harm, the FTC will often require an order to maintain assets, which essentially requires the seller to continue operating the assts in a competitive manner.
Orders to hold separate or maintain assets may include a requirement to invest a certain amount of capital or to make efforts to retain employees. These orders also generally appoint an independent third party both to monitor compliance with the order and to oversee the operation of the held-separate business.
The FTC statement also discusses the requirements of the divestiture application. While there is no specific format for the application, there are several important things that the divestiture application must include:
- The application should represent that all of the assets that must be divested are part of the divestiture agreement. A copy of the final divestiture agreement and all exhibits should be included;
- The application should include a description of the buyer's business and copies of the buyer's recent annual reports, Form 10Ks and financial statements. The FTC must be satisfied that the buyer has the ability and incentives to compete successfully, and the financial resources to buy the assets and manage them effectively; and
- The buyer should also be prepared to submit a detailed business and financial plan for operating the assets as part of the divestiture application.
Following receipt of the divestiture application, FTC staff will conduct due diligence on the proposed divestiture and the buyer, including interviews with the buyer.
The FTC's new Statement on Negotiating Merger Remedies does not represent a significant change in the FTC's standards for divestitures. It does, however, provide a clearer guide to the key issues the FTC analyzes when negotiating a remedy. If fully implemented, the FTC statement could streamline the divestiture review process, which may benefit merging companies facing business and regulatory deadlines for closing. Companies should still be prepared for an intensive review and for the possibility that the FTC staff will substitute their judgment for that of businesspeople when reviewing the agreement to sell the required assets.
The FTC statement can also be used to head off a lengthy review. If a divestiture is likely to be necessary, an upfront proposal can be prepared, which can expedite the process. In some cases the problematic assets can be sold prior to announcing the deal or filing pre-merger notification, thereby bypassing the divestiture review process entirely.
A potential acquirer of divested assets can also refer to the FTC statement to maximize the chance that the FTC will accept the company as a suitable buyer.
For further information on this topic please contact Janet L McDavid or Andrew J Graziani at Hogan & Hartson LLPby telephone (+1 202 637 5600) or by fax (+1 202 637 5910) or by email ([email protected] or [email protected]). Alternatively, contact Michele S Harrington at Hogan & Hartson's McLean office by telephone (+1 703 610 6100) or by fax (+1 703 610 6200) or by email ([email protected]).