Many merger control proceedings involve the acquisition of a firm, or the assets of a firm, that is in financial difficulties, or has decided to exit a particular market. If such an acquisition takes place in a market(s) that already has a small number of competitors, there is a reasonable possibility that the merger could be referred to a detailed Phase II investigation because there is a realistic prospect that the anticipated merger would lead to a substantial lessening of competition in the relevant market(s). There is also a possibility that the merger could be blocked following a Phase II investigation because the anticipated merger would be likely to lead to a substantial lessening of competition on the relevant market(s).
In such situations the merging parties may consider making use of the failing firm defence to gain merger clearance at the earliest possible opportunity. However, satisfying a competition authority that the three elements of the failing firm defence are met is far from straightforward, and a competition authority may be more receptive to its use during Phase II proceedings, where it can review and test the evidence it is presented in greater detail.
The three elements of the failing firm defence are as follows1. The merging parties must prove that each of these three elements are met for the failing firm defence to be accepted by the competition authority:
1. Would the ‘failing firm’ have exited the market if the merger did not take place.
Whilst this will most commonly be considered in cases where a firm is in financial difficulty, it may also be assessed in cases where a firm has taken a decision to stop operating in the market(s) under consideration. An example is the CMA’s decision in DHL/Carlsberg2. In this case DHL Supply Chain Limited agreed to acquire certain assets from Carlsberg for the purpose of providing porterage contract logistics services3 to Carlsberg. The CMA came to the conclusion that Carlsberg had made a decision to stop offering such services, without analysing whether it was inevitable that Carlsberg would have had to stop offering such services for financial reasons.
In a situation where it is claimed that the target would have left the market had the merger not taken place due to acute financial difficulties, a Competition Authority will usually not simply limit its review to an analysis of the company’s accounts. It would also want to look closely at internal documents prepared before the specific merger was under consideration. It will typically want to see high-level evidence, for example in minutes of Directors’ meetings, that the firm had taken alternative strategies to a merger into consideration but had rejected them on reasoned grounds.
For example, in the CMA’s recent decision in East Coast Buses/First East Scotland4, which the CMA cleared on the basis of the failing firm defence, the CMA undertook a detailed review of the target’s contemporaneous documents, such as board minutes, management accounts and strategic plans, in addition to a review of its financial information. Reviewing such documents allowed the CMA to conclude that the first element was met, as they contained sufficient evidence that First East Scotland had planned to exit its east coast business for some time before selling it to East Coast Buses, and had attempted to exit this business through alternative means (by selling bus depots to a property developer) independently of any consideration of selling it to East Coast Buses.
2. Was there a realistic less anti-competitive purchaser for the ‘failing firm’.
This element has two element limbs:
- Whether there are realistic alternative purchasers.
- Whether any acquisition by a realistic alternative purchaser would result in a less anti-competitive outcome.
A realistic alternative purchaser does not necessarily need to already be operating in the same market. If a firm operating in a neighbouring market had expressed interest in a purchase and would, with the purchase, have sufficient assets and know-how to operate in the market(s) under consideration then it could be considered to be a credible alternative purchaser.
With regard to the second limb, it may be that the only realistic alternative purchaser(s) already operates in the same market as the merging parties. If this alternative purchaser(s) has a larger market share than the actual purchaser, then it is unlikely that it would be considered a less anti-competitive purchaser.
3. Whether the loss of the firm and its assets would have a less anti-competitive effect on the relevant market(s) than the merger.
If the first two elements are met, a competition authority will want to determine that it would not be less anti-competitive to accept a reduction in the number of competitors on the relevant market(s).
When assessing whether this third element is met, the CMA will usually focus its analysis on what would happen to the exiting firm’s sales if the merger were to not take place. If there were evidence that the customers of the exiting firm would mainly switch to purchasing from a firm with a smaller market share than the merging parties, or would switch to purchasing from the remaining firms in roughly equal volumes, then a conclusion that the loss of the firm and its assets would have a less anti-competitive effect on the relevant market(s) than the merger would be more likely.
On the other hand, if it were determined that the exiting firm’s customers would mainly switch to buying from the acquiring firm or a firm with a larger market share than the merging parties, then a conclusion that the loss of the firm and its assets would have a less anti-competitive effect on the relevant market(s) than the merger would be less likely.
The European Commission takes a different approach to this third element, and will usually assess what would happen to the assets of the exiting firm in the absence of the merger. If the assets of the failing firm can be usefully re-deployed on the market, then the Commission may determine that the loss of the firm and its assets would have a less anti-competitive effect on the relevant market(s) than the merger.
In general meeting all three elements is difficult, and failing firm defences are often rejected by competition authorities. Merging parties may have to produce a significant amount of evidence to support their case. In addition, it is likely that a competition authority will request evidence and comments from third parties, including potential alternative purchasers and customers of the target, and the merging parties will not have control over this. Nonetheless, in situations where there is a risk that the merger could be blocked, or only approved on the basis of the merging parties offering significant commitments, it is worth considering whether a failing firm defence can be made out.