Competition law is an increasingly important consideration for any potential investment by private equity houses. In the latest of our monthly updates looking at topical issues affecting the private equity sector, this bulletin summarises the key merger control considerations that affect private equity transactions by highlighting the application of EU and UK merger control regimes to three types of transaction. It also contains some points of particular relevance to private equity firms which need to be taken into account in evaluating the impact of merger control rules.
Companies undertaking corporate or business acquisitions are often well aware that, alongside all the other legal issues to be considered, they will also need to factor merger control rules into their timetable and, in some cases, their risk assessment of the transactions which they undertake. The significance of merger control rules is sometimes underestimated in the context of private equity buyouts.
Private equity buyouts vary in their structure from case to case. In order to illustrate the potential application of merger control rules, we look at three different kinds of transaction:
- First, an outright acquisition by a private equity house of 100% of the issued share capital of a company carrying on an existing business (the target company);
- Secondly, a consortium bid for 100% of the issued share capital of the target company, where the consortium members include two or more private equity houses, who conclude a consortium agreement to regulate how they will exercise their rights in respect of the proposed investment; and
- Thirdly, an acquisition by a private equity house of a minority shareholding interest in a target company.
The first question to be considered in respect of each of these acquisitions is whether the transaction gives rise to a “merger” falling within merger control laws in any relevant jurisdiction. In deciding which are the potentially relevant jurisdictions, it will often be necessary to start with a full list of all the jurisdictions where any of the parties to the transaction is established, carries on business, or effects sales of goods or services.
For ease of reference we will refer to "private equity buyer" throughout the rest of this briefing, as the identity of the acquirer for the purpose of merger control will vary from buyout to buyout. In its jurisdictional notice the European Commission recognises that control is normally exercised by the investment vehicle which has set up the fund (usually the general partner itself), but also makes clear that in some cases control may be exercised by the fund itself. A careful analysis of the facts and structure of each buyout will need to be carried out in order to determine which is the relevant body subject to merger control.
In the first case outlined above, the potentially relevant parties would be the private equity buyer, and other companies which it already owns or controls, on the one hand, and the target company and other companies which it owns or controls, on the other.
In the second case outlined above, the potentially relevant parties would be the consortium members who may, by virtue of their consortium agreement, jointly exercise control (whether directly or indirectly) over the target company, and other companies which any of the consortium members already owns or controls, on the one hand, and the target company, and other companies which it owns or controls, on the other.
In the third case outlined above, the potentially relevant parties would be the private equity buyer, and other companies which it already owns or controls, on the one hand, and the target company and other companies which it owns or controls, on the other.
Once the potentially relevant parties have been identified, it will be necessary to examine, by reference to the applicable laws of the jurisdictions in which they are established, carry on business or effect sales, which national or international authorities claim merger control jurisdiction over the transaction and what procedural and substantive rules they apply to evaluate whether the transaction should be allowed to proceed.
In most jurisdictions, merger control rules define the categories of transaction which fall within their jurisdiction by reference to the following criteria:
- The nature of the transaction: does it entail two previously independent parties coming under common ownership or control in some specified way?
- The scale of the transaction: are the parties large enough (in terms of their assets or turnover) to justify a merger control review?
- The nexus between the jurisdiction and the transaction: do the parties to the transaction have sufficient nexus with the jurisdiction for their transaction to risk causing damage to consumers or other private parties within the jurisdiction?
Different systems of merger control apply different tests in respect of each of these matters. So, for example:
- EU merger control defines a merger (referred to as a “concentration”) as arising where two separate undertakings merge, or where one or more undertakings acquires “decisive influence” over another undertaking. In order for a merger to be large enough to qualify for investigation by the European Commission, the parties to the merger must meet certain thresholds in terms of their worldwide turnover; and, in order to demonstrate a sufficient nexus with the EU, the parties must generate a specified level of turnover within the EU. If the preponderance of their EU turnover arises in just one Member State, then jurisdiction will generally fall to relevant Member States, rather than to the European Commission. However where the merger falls within the jurisdiction of the European Commission, this will usually override the need for any national clearances.
- In contrast, UK merger control rules apply to a potentially wider class of transactions: a merger may arise where one party merely acquires an “ability materially to influence the policy” of a target company. If the target company generates UK turnover of £70 million +, then the transaction is regarded as large enough to merit review, and to exhibit a sufficient nexus with the UK to justify such review.
Because these two merger control regimes apply different substantive definitions of what amounts to a “merger”, some transactions will fall within the scope of one regime, but not the other. For example:
- Where a fund acquires a shareholding of, say, less than 20% in a target company, and cannot thereby exercise decisive influence in practice, its acquisition will probably not give rise to a merger for the purposes of EU merger control.
- But a shareholding of less than 20% may be sufficient to give rise to “an ability materially to influence the policy” of the target company, so as to give rise to a merger falling to be reviewed under UK merger control rules. Indeed, in BSkyB/ITV, the Court of Appeal recently upheld the finding of the Competition Commission that a shareholding of 17.9%, without any board appointment or other special rights, could be enough to confer an ability materially to influence.
Thus, the third kind of transaction outlined above could give rise to a merger under UK rules, but probably not under EU rules.
The merger control regime applied by the EU and in each jurisdiction may also apply quite different procedures to the review of transactions. Thus, for example, EU merger control generally prohibits the implementation of transactions falling within EU jurisdiction until a merger control clearance has been obtained. In contrast, UK merger control rules allow the parties to complete their transaction without obtaining prior clearance, but the UK authorities may ultimately require the transaction to be unwound (or may impose other remedies) if they find the transaction to be damaging to competition. Many systems of merger control also provide for the imposition of financial penalties where parties complete a merger without first obtaining merger control clearance.
Where private equity buyers make substantial corporate acquisitions (including the acquisition of any assets acquired as a going concern), their transactions will often fall to be reviewed under several systems of merger control.
There are various points which are of particular relevance to private equity buyers which need to be taken into account in evaluating the impact of merger control rules:
- Private equity investments may be structured in a variety of ways. It will be necessary to look at the particular structure of the private equity vehicle and its management arrangements in order to decide who is a relevant party to the transaction for merger control purposes. For example, the general partner or fund manager of a private equity fund (and not the investing funds or the limited partners investing in those funds) may be treated as a relevant party to the transaction as they may exercise contractual control over the fund and its other investments. The general partner or fund manager’s own revenues (e.g. its fee income and commission income such as carried interest) may need to be taken into account in deciding whether turnover thresholds are met under particular systems of merger control.
- Where a private equity buyer holds a wide range of different investments, comprising companies operating in a variety of different markets, the acquisition by it of another company operating in yet another different market is unlikely to give rise to substantive merger control problems. At most, it may be necessary to make various merger control filings and await merger control clearance before completing.
- But, if the private equity buyer holds controlling investments in related markets, the competition authorities may well want to probe whether the common control of such investments could lead to adverse effects on competition. So, for example, in Blackstone/Hilton, before clearing Blackstone’s acquisition of the Hilton hotel group, the European Commission first wished to satisfy itself that Blackstone’s pre-existing ownership of Galileo and Worldspan (which offered distribution services for hotel accommodation) would not, when combined with the ownership of Hilton, lead to a restriction of competition. Such concerns may be more pronounced where the fund acquires a target company which competes directly with another company which it already owns. For example, in Terra Firma/UCI, Terra Firma acquired the UCI multiplex cinema business, on top of its existing Odeon cinema chain. The Office of Fair Trading cleared the transaction under UK merger control rules only on receipt of undertakings from Terra Firma to dispose of some of its cinemas, to avoid restrictions of competition in particular local markets.
- Similar issues may arise where a single private equity buyer manages a number of different funds, with different funds owning interests in competing businesses. Such issues are often more complex than those arising from the investments of a single fund, since it may be difficult to evaluate to what extent the fund manager would have the ability or incentive to co-ordinate the activities of the different underlying businesses, in circumstances where different classes of investor own the beneficial interest in the underlying assets, and the manager may owe different contractual obligations to the different funds and their investors. Under UK law, a problematic merger may arise where a single fund owns minority interests in two or more competing businesses, and might be able to exercise sufficient influence over each of the underlying businesses, to cause them to co-ordinate their activities.
- It is common for two or more private equity buyers to combine in a consortium to acquire a target company (as in the second type of transaction outlined above). In such cases, no single buyer may exercise full control over the target company, but the consortium agreement may provide for each private equity buyer to have a veto over certain key decisions, or to exercise their votes to achieve specified outcomes. It will be necessary to review the terms of the consortium agreement in each case to decide whether its effect is to confer joint control over the target company, or whether the consortium members are to be regarded as “associated persons” under UK merger control rules, with the result that – in effect – they are treated as one person for various merger control purposes.
In light of these considerations, it will be prudent for private equity buyers to consider at an early stage the potential application of merger control rules. Potential application of merger control rules in other jurisdictions should also be considered, i.e. outside the EU and if the EU merger regulation does not apply, also in individual member states. Thresholds for what constitutes merger control can be very low in some jurisdictions, for example, in Germany or Austria. Private equity houses will also need to be alive to the possibility that any subsequent deal syndication may in itself result in a new transaction that could be subject to clearance.
The above deals with the applicable merger control regime but private equity firms should however also be aware that there are other competition rules to be considered in the context of consortium deals being considered to be potentially anti-competitive bidding arrangements. Regulators are currently alert to the potential for bid-rigging in auctions involving private equity houses. It has been widely reported that the US Department of Justice is currently conducting an investigation into possible bid-rigging in relation to a number of previous auctions.