The global financial crisis has seen competition enforcement authorities come under some pressure to relax their interpretation of competition laws in order to help companies ride the current storm. A headline-grabbing example of this was the UK Government’s decision to override competition law concerns in order to force through the merger between Lloyds TSB and HBOS. However, whilst the EU authorities have responded to the financial crisis by adapting the State aid control regime, generally, competition authorities have made it clear that, in the context of merger control and anti-competitive behaviour, it is more important than ever that companies do not engage in anti-competitive conduct. In this article, therefore, we discuss the approach adopted by the competition authorities to enforcement during the downturn in the following areas: discuss the approach adopted by the competition authorities to enforcement during the downturn in the following areas:
- UK merger control - the “failing firm defence”;
- anti competitive agreements - government-sponsored initiatives; and
- State aid - helping companies survive the credit crunch.
UK merger control - the “failing firm defence”
The current financial crisis has made life more difficult for almost all businesses, and as demand for goods and services falls and the availability of credit dries up, an increasing number of firms are failing. However, one firm’s crisis may be another firm’s opportunity, and in the world of merger control this is particularly the case for firms in concentrated markets.
The UK’s Office of Fair Trading (OFT) has made it clear that it does not intend to change its approach to UK merger control during the downturn. In concentrated markets in particular, notwithstanding the Lloyds TSB/HBOS merger, the scope for further consolidation may be severely limited and attempts to acquire competitors may be prohibited by the competition authorities. In such circumstances, the only way for larger firms to increase market share may be to grow organically and encourage the customers of rivals to switch suppliers. However, the prospect of the financial demise of a target firm and its exit from the market can change a competition authority’s analysis of a proposed transaction, and firms with market power may be permitted to acquire less fortunate competitors by virtue of the failing firm defence.
According to this defence, a merger that would lessen competition in a particular market should be permitted if without the merger the target firm would fail and exit the market and competition would be reduced to a similar extent anyhow.
In December 2008, the OFT restated its position regarding the application of the failing firm defence in UK merger control proceedings. It stipulated two conditions that must be satisfied for the defence to apply:
- the inevitable exit from the market of the target business absent the merger with no serious prospect of reorganisation; and
- no realistic and substantially less anti-competitive alternative to the merger.
The first of these conditions is necessary to demonstrate that the target firm is indeed failing. As such the merging parties must be able to demonstrate that the firm is in a “parlous financial situation, even if not yet in liquidation”, although evidence of liquidation or insolvency proceedings would likely satisfy this requirement. They must also demonstrate that any attempts to reorganise the failing firm have been or would be fruitless.
The second condition requires a demonstration that compared to any realistic alternative to the proposed merger, such as allowing the target firm to fail or selling it, or its assets, to an identified alternative purchaser, the proposed merger would not result in a substantial lessening of competition. The OFT must also be satisfied that the target has made sufficient but unsuccessful attempts to find an alternative purchaser. Otherwise, the OFT may not be in a position to carry out a proper competitive assessment of the effects of the proposed merger, which could result in the OFT deciding to refer it to the Competition Commission for in-depth review.
The defence was most recently successfully applied in April 2009 in the OFT’s HMV / Zavvi decision. In that case, HMV planned to acquire a number of shop premises previously operated by Zavvi, its rival high-street music retailer that had gone into administration as a result of the failure of EUK, Zavvi’s sole supplier of stock and a subsidiary of the doomed Woolworths. The OFT consulted Zavvi’s administrator, which confirmed that there was no prospect of Zavvi successfully emerging from administration, even in a reorganised form. It was without doubt a failing firm and therefore the first condition was satisfied.
The second condition was also satisfied. First, allowing Zavvi to fail would not result in a substantially better outcome for competition, since the acquisition by HMV of Zavvi stores would not reduce the number of competing music retailers compared to the post-merger alternative. Second, there were no realistic alternative purchasers to HMV. Even though Head Entertainment had attempted to buy the Zavvi stores, which ultimately may have been better for competition, its offer had been rejected by the landlord and therefore did not constitute a realistic alternative. Therefore, the OFT allowed application of the defence to clear the proposed acquisition.
The OFT has emphasised however that the current economic crisis will not prompt it to relax its requirement of “sufficient compelling evidence” that the two conditions are satisfied. A recent reminder of this is contained in its 28 May 2009 decision to refer the completed Stagecoach / Preston Bus merger to the Competition Commission for indepth review. The OFT accepted that Preston Bus was in severe financial difficulties, but the parties failed to convince the OFT that there was no serious prospect of it being successfully reorganised. The OFT accepted that any proposed downscaling of Preston Bus’ activities would face opposition from its employees, which were also its shareholders, but in the OFT’s opinion reorganisation of the business had not been considered in any detail. Therefore the OFT could not conclude that Preston Bus’ failure was inevitable, and the first condition was not satisfied.
The parties also failed to satisfy the second condition. Although it was evident, given the size of Preston Bus’ pension deficit, that there would be no alternative purchasers of Preston Bus as a going concern, the OFT also considered the possibility that rival bus operators may seek to expand their operations into the Preston area with the purchase of Preston Bus’ liquidated assets (127 buses and a bus depot). In fact, one bus operator, Go Ahead, had indicated as much to the OFT. In carrying out its competitive assessment on the basis of this alternative outcome, the OFT concluded that given the large combined market share (in excess of 75%) of a merged Stagecoach / Preston Bus, the purchase of Preston Bus’ liquidated assets by a rival operator, such as Go Ahead, would be a substantially better outcome for competition, and therefore the second condition was not satisfied, and the failing firm defence did not apply.
Therefore, whilst companies in concentrated markets might usefully take advantage of the failing firm defence to acquire financially weak competitors, the OFT has not relaxed the test to accommodate more mergers and wouldbe acquirers of failing firms should not expect to benefit from a more liberal regime. However, acquirers that pay close attention to the requirements of the test will stand a far greater chance of receiving a favourable decision from the OFT.
Anti competitive agreements - government-sponsored initiatives
The OFT's robust approach to the application of the failing firm defence in mergers and its refusal to soften its interpretation of that defence during the recession reflects its wider approach to competition law enforcement. In a succession of speeches in 2009, senior OFT officials have emphasised that the OFT will resist calls for greater flexibility in interpreting competition law principles and, in fact, will re-double its efforts to crack down on anticompetitive behaviour. In particular, the OFT has suggested that, when times are hard, competitors may be more likely to collude with one another so as to ensure that each of them survives the downturn. The OFT's key message is that whilst there may be short term advantages to collusion, consumers are best served in the long term by ensuring that businesses continue to compete with one another.
One area in which the OFT might have been expected to adopt a more flexible approach to interpreting UK competition law, but on which in fact it has sounded a note of caution, relates to government-sponsored voluntary agreements, whereby government departments, or bodies funded by and reporting to the government, seek to achieve a public policy objective by bringing together major players in a particular sector to agree to a voluntary course of conduct. For example, in recent months government-led initiatives have sought to address the pricing and availability of alcohol; the use of plastic bags by retailers; the supply of incandescent bulbs; the volume of packaging waste sent to landfill; and the level of salt and fat in food products. The OFT has commented internally to a number of government departments about such initiatives. Whilst it has made it clear that it will not relax the competition rules to accommodate them, it has also indicated that in contrast with the usual practice of insisting that companies make their own assessments, in conjunction with external counsel, as to the compatibility of agreements with competitors under UK and EU competition law, it is willing to discuss such initiatives with the parties in order to provide (nonbinding) guidance.
Such initiatives raise competition law concerns because they effectively amount to agreements between competitors as to how to act on a market, which would be likely to infringe section 2 of the UK’s Competition Act 1998 (Competition Act) and/or Article 81(1) of the EC Treaty. In such circumstances, they would only be lawful if they fulfil the criteria set out at section 9 of the Competition Act/Article 81(3) of the EC Treaty by demonstrably leading to efficiencies and will entail long term consumer benefits. The criteria are as follows:
- contribute to an improvement in the production or distribution of goods or services or promote technical or economic progress;
- allow consumers a fair share of the resulting benefit;
- only impose restrictions that are indispensable to attaining the legitimate underlying objective of the collaboration; and
- no elimination of competition in respect of a substantial part of the products or services in question.
In practice, it would be very difficult for companies to justify a price fixing arrangement, even if instigated by the government. So, for example, it is likely that any attempt by the government, in the absence of new legislation, to persuade retailers to charge a minimum price for alcohol, or to persuade pubs and bars not to reduce prices for alcohol in happy-hour promotions, would be unlawful, since it is not clear how such price fixing would be absolutely necessary to attain the underlying public health objective of reducing alcohol abuse.
Collaborative arrangements brought about to address an underlying environmental concern may be easier to justify than price fixing. Indeed, the European Commission (Commission) has in the past indicated that it may be willing to adopt a wide interpretation of the four part test outlined above where the collaboration genuinely seeks to address environmental concerns. So, for example, a voluntary agreement between suppliers and retailers to take measures to reduce the amount of packaging that is sent to landfill could be permitted, so long as the parties to the agreement do not share detailed information with one another as to how they achieved individual targets, do not agree collectively to boycott suppliers whose packaging does not meet commonly agreed objectives or standards and so long as membership of any body discussing such initiatives is open to all who meet certain qualitative criteria. It goes without saying that meetings held between participants must not be used as a cover for discussing the parties' strategic plans and other sensitive commercial information.
Even where parties engaged in government sponsored initiatives are satisfied that they meet the pro-consumer criteria listed above, they must satisfy themselves that the initiative does not infringe Articles 28 and 30 of the EC Treaty which prohibit restrictions on the free movement of goods throughout the common market. Such restrictions may arise if the initiative gives rise to a de facto boycott of suppliers based outside the UK. Therefore, where the government passes legislation to support any collaboration which may make it more difficult for undertakings elsewhere in the European Union to supply their goods within the UK, such initiatives and legislation should first be notified to and discussed with the Commission.
All companies, therefore, considering becoming involved in government-sponsored initiatives that involve collaboration with competitors and/or suppliers for worthy objectives such as environmental or public health goals should nevertheless ensure that their actions comply with competition law. The mere fact that such initiatives may be led by the government or government-funded bodies does not provide protection against possible infringements of competition law.
State aid - helping companies survive the credit crunch
As a general rule, therefore, whether under merger control or the assessment of potentially anti-competitive agreements and practices, the OFT and indeed the Commission have made it clear that they will not relax their rules or interpretation of those rules. One notable exception to this stance towards competition policy enforcement has occurred in the area of State aid.
"State aid" is defined at Article 87 of the EC Treaty as "any aid granted by a Member State or through State resources in any form whatsoever which distorts or threatens to distort competition by favouring certain undertakings or the production of certain goods insofar as it affects trade between Member States". State aid can take many forms, ranging from capital grants to loans and guarantees, risk capital finance or targeted tax breaks. Member States must notify aid measures to the Commission, and obtain clearance before implementing them, unless they comply with the terms of a “block exemption”. To assist Member States, the Commission has published a wide range of guidance as to when State aid is likely to be compatible with Community law.
The purpose of the State aid rules is to help preserve a level playing field for trade throughout the common market and to dissuade Member States from engaging in a subsidy race with one another whereby each favours national champions and the production of goods within their national territories to the disadvantage of producers in other Members States.
In 2008, as the financial crisis took hold, the Commission’s State aid control regime came under considerable pressure as Member States took rapid, urgent action to rescue financial and other institutions from collapse. The Commission's response to date has been a notable success and has demonstrated that where appropriate, it is willing to adapt competition law principles and enforcement in a way that aims to meet the European economy's needs without dispensing with the fundamental principles of Community competition law. It has done this by revising existing guidelines on what aid measures may be acceptable, by introducing new, temporary guidelines to take into account, in particular, the difficulties that businesses may be encountering in obtaining credit and by reorganising its own internal operation and procedures so that it can be responsive to Member States’ needs and assess State aid applications in a short time frame.
The Commission's first significant step was to clarify its guidance on the compatibility of measures being taken by Member States to provide guarantees for bank liabilities. The Commission's banking communication of 13 October 2008 (October Communication) established common principles for Member States to follow when intervening to support banks in difficulty and to maintain consumer confidence in the banking system. Those common principles are as follows:
- there should be non-discriminatory access to national schemes by ensuring that eligibility for a support scheme is not based on nationality (this condition was used to force Ireland to alter its state guarantee system to ensure that all banks operating in Ireland would benefit and not just those owned by Irish companies);
- the support must be limited in time and can be provided only as long as is necessary to cope with the current turmoil in financial markets; • the support must be clearly defined and limited to what is necessary to address the crisis without providing unjustified benefits for shareholders at the taxpayers’ expense;
- the private sector should remunerate Member States for general support schemes; and
- beneficiaries of support must be subject to strict behavioural rules, in particular ensuring that they cannot expand or engage in aggressive market strategies on the back of a State guarantee.
The October Communication was followed in December by new guidelines governing the recapitalisation of banks and how Member States may help businesses to access finance during the downturn.
First, the Commission addressed the re-capitalisation of banks. Key principles arising from this communication were that beneficiaries must pay the State in return for funding in order to limit the distortive effect of such State's support; and that the Member States providing support must also present an exit strategy from reliance on state capital for fundamentally sound banks and they must present an indepth restructuring or liquidation plan for distressed banks.
Against these principles, Commission case teams worked closely with Member States to agree bank rescue plans and approve them in a short period of time. Indeed, whereas once such approval plans could be expected to have taken several months, between October 2008 and March 2009, the Commission adopted more than 50 decisions in the context of the financial crisis including 12 comprehensive guarantee schemes, 5 major re-capitalisation schemes, 5 framework schemes combining both of these measures and a substantial number of ad hoc measures concerning particular banks, with many of these measures cleared in a matter of weeks.
Secondly, in December 2008 the Commission outlined new, temporary measures providing additional opportunities for Member States to increase the amount of State aid granted until the end of December 2010. These were set out in the Commission's Temporary Community Framework of 17 December 2008, which was updated on 25 February 2009 (Temporary Framework). The Temporary Framework covers a number of measures that Member States may wish to implement and, whilst Member States must still notify them in advance to the Commission, so long as the measures comply with the guidance set out in the Temporary Framework, in practice the Commission has shown that it is able to approve them in a matter of days.
The UK government has taken advantage of the Temporary Framework to obtain clearance for a number of aid schemes aimed at helping companies in the UK:
- One scheme enables government agencies to give socalled “de minimis” aid up to the value of €500,000 over a rolling three year fiscal period (an increase from the previous €200,000). Beneficiaries must not have been in financial difficulty as at 1 July 2008 and there are limits in place as to the extent to which such funding can be combined with other forms of State aid. The UK may spend up to GBP 1 billion helping companies under this scheme.
- A second scheme enables the UK government to provide loan guarantees to companies throughout the UK up to 90% of the value of the loan. The premium to be paid for the guarantee can be reduced by up to 25% for certain companies. As with de minimis aid, this scheme is not available to companies that were in financial difficulty as at 1 July 2008. The UK anticipates granting such guarantees for a maximum amount of GBP 8 billion in 2009 and 2010.
- A third scheme enables the UK to subsidise the interest rate paid for loans obtained to invest in the production of green products, being products which significantly improve environmental protection and which go beyond Community standards or involve the early adaptation of such standards. • A fourth scheme is aimed at encouraging banks in the UK to lend to UK companies. The UK Treasury is offering banks a guarantee of up to 50% of working capital loans to sound, creditworthy UK companies with an annual turnover of up to GBP 500 million. The government anticipates providing such guarantees up to a value of GBP 10 billion, thereby supporting up to GBP 20 billion of working capital financing.
- The UK has also obtained approval for help to UK home-owners. Its mortgage support scheme will allow householders who find themselves unable to meet their mortgage repayments following a temporary drop in income to defer all of their principal and up to 70% of their interest repayments for up to two years. In return, the UK will provide the lender with a guarantee in respect of the deferred interest. The guarantee runs for four years after the borrower has exited the scheme, to guard against any incentive on the lender to repossess the property before the guarantee expires.
- The final, most high profile UK State aid scheme approved by the Commission in response to the current financial crisis covers the measures put in place to recapitalise banks, provide them with funding guarantees and offer short term liquidity measures. This is the scheme that has enabled the Treasury to acquire GBP 15 billion of ordinary shares and GBP 5 billion of preference shares (since converted into ordinary shares) in Royal Bank of Scotland and GBP 13 billion of ordinary shares, GBP 4 billion of preferences shares in the Lloyds banking group (also since converted into ordinary shares). The limit on recapitalisation spending is GBP 50 billion. The guarantee part of the measure will allow the UK to guarantee issue of GBP 250 billion. To date, more than fifty institutions have received a certificate to obtain a guarantee under the scheme. The number actually obtaining such guarantees has not been made public.
What does this all mean?
The key message to take from the approach being adopted by competition enforcement authorities is that just because times are hard, companies should not expect more lenient treatment under competition law. Companies should take advice before entering into cooperation arrangements/collusion with their competitors, even if such behaviour is actively encouraged by well-meaning governmental bodies. They should also continue to invest time and resources in preparing merger clearance applications, in particular if they are active in concentrated markets and are looking to acquire a competitor. Our experience in the last nine months has been that the OFT (and indeed the Commission) are as demanding as ever in their requirements for detailed information about the merging parties and the dynamics of the affected markets. There has been no let up in this regard and the OFT has demonstrated that the financial crisis has not led it to alter its approach towards the application of the failing firm defence. The one area of competition law where the rules have been adapted in light of the global financial crisis is State aid. In this regard, UK businesses struggling for credit or investment should be aware that the government, supported by the Commission, has put in place a wide range of measures to help them through the downturn.