Our series of articles considering the distressed M&A landscape continues, with a look at the application of UK merger control to distressed M&A transactions.
There is no doubt that the coronavirus crisis and imminent reduction and eventual withdrawal of government support has put many businesses at risk of failure. Others will see opportunities from a distressed market. We anticipate we will see consolidation in certain sectors as a result, with merging parties potentially citing the so-called 'failing firm defence' in order to gain merger control clearance where one of the parties is financially distressed. We set out below a summary of the UK merger control regime and some recent developments on the failing firm defence.
UK merger control
The UK merger control regime is a voluntary regime and there is no requirement to notify transactions to the UK Competition and Markets Authority ('CMA'). However, the CMA has the jurisdiction to review or 'call in' transactions that are not notified where (i) the target’s UK turnover is more than £70 million; or (ii) the transaction results in the creation or enhancement of at least a 25 per cent share of supply of goods or services in the UK, known as the 'share of supply test'. The CMA has the power to review completed transactions within 4 months from the later of completion of a transaction or material facts about the transaction being made public.
The CMA’s review period should always be factored into deal timing and this is particularly relevant in the case of a financially distressed business, where limited funding and concerns over directors’ duties often mean that an M&A transaction needs to be carried out on an accelerated basis. The Phase 1 review period can last up to 40 working days and the CMA’s pre-notification period can last around 4 – 8 weeks (or longer) which means that the overall process may take 3 to 4 months or longer (in addition to the time required to prepare the merger notice). The CMA has recently published guidance on the application of UK merger control rules during the pandemic. The guidance confirms that the timescales under which the CMA is required to operate have not been altered. However, it notes that the pre-notification process in some cases will take longer than usual because of difficulties in obtaining information from the merging parties and third parties. In addition, the CMA may not be able to start the 40-working day clock where third parties are unable to engage meaningfully with the CMA’s investigation.
As an alternative to a full merger notice, parties may consider submitting a short briefing paper to the CMA, explaining why the parties do not propose to submit a formal notification and why the transaction does not give rise to substantive competition concerns. Following receipt of the paper, the CMA may request further information from the parties, confirm that it has no further questions, or alternatively it may open a Phase 1 investigation where is considers that there may be competition concerns. Confirmation from the CMA that it has no further questions does not preclude the CMA from opening an investigation at a later stage. However, parties to an accelerated or distressed sale may consider this option given that the CMA usually responds within around two to four weeks. Our recent experience has shown that this process can sometimes be a useful tool in distressed situations, depending on the specific transaction.
The failing firm defence
The failing firm defence is an argument that can be employed when parties are seeking UK merger control clearance where one of the parties is failing financially. The defence is subject to three strict criteria, which have been satisfied in relatively few cases. The CMA’s recent guidance includes a 'refresher' guide on how it will approach failing firm claims during the pandemic and broadly mirrors the guidance set out in its general merger assessment guidelines. The CMA confirms that in order to establish that the ‘failing firm’ scenario is applicable, the CMA requires ‘compelling evidence’ to demonstrate that the criteria below are met:
- Would the firm have exited the market absent the transaction? – The parties must show that the failing firm would have exited due to financial reasons. The CMA will consider whether the firm is unable to meet its financial obligations and whether it is unable to restructure itself successfully.
- Would there have been an alternative purchaser for the firm or its assets? – The CMA will consider whether there were alternative purchasers that would produce a better outcome for competition than the merger under consideration. It will also consider available evidence supporting any claims that there was genuinely only one possible purchaser. The CMA advises that businesses should carefully consider the implications of choosing to try to sell to a close competitor and, in particular, merger control risks should be carefully considered in conjunction with other commercial considerations.
- What would the impact of exit be on competition compared to the competitive outcome that would arise from the acquisition? – The CMA is likely to consider the impact that the exit of the failing firm would have on competition within the markets at issue (looking at the overall market structure and the relevant parameters of competition) compared to the competitive outcome that would arise from the acquisition. The defence is only likely to succeed if the firm’s exit from the market is worse for competition and consumers, than if the acquisition took place.
The latest CMA guidance states that it needs to ensure its decisions are based on evidence and not speculation, and will carefully consider the available evidence in relation to the possible impacts of the COVID-19 pandemic on competition on a case by case basis.
Is COVID-19 a free pass for the failing firm defence?
On 17 April 2020, the CMA provisionally cleared Amazon’s minority investment in Deliveroo based on the failing firm defence. This was the first time that the CMA had provisionally cleared a transaction under the defence during the COVID-19 pandemic. The ‘lockdown’ in the UK had resulted in the closure of a large number of the key restaurants available through Deliveroo, and a significant decline in Deliveroo’s revenues. The CMA therefore provisionally cleared the transaction on the basis that Deliveroo’s exit from the market would be inevitable without access to significant additional funding, which only Amazon would be willing and able to provide at that time. The CMA considered that the imminent exit of Deliveroo would be worse for competition than allowing Amazon’s investment to proceed.
On 24 June 2020, the CMA revised its provisional findings and concluded that Deliveroo would no longer be likely to exit the market in the absence of the transaction. This revision was based on further examination of the financial information provided by Deliveroo, which showed that its financial position had in fact improved, based on changes that were not foreseeable during the early stages of the pandemic. In the CMA’s final report, which was published on 4 August 2020, the CMA concluded that Deliveroo’s improved financial position meant that it would not exit the market absent the transaction, despite the COVID-19 outbreak, and that Deliveroo could also attract alternative funding. The CMA ultimately cleared the transaction on competition grounds and found that, given Amazon’s low shareholding of 16 per cent, the transaction would not affect its incentives to compete independently with Deliveroo in the market.
The CMA’s guidance and the recent Deliveroo case confirms that the COVID-19 pandemic has not brought about any relaxation of the standards by which mergers are assessed or the CMA’s investigational standards. It also confirms that the statutory timescales under which the CMA is required to operate have not been altered. Whilst the pandemic and the withdrawal of government support may bring urgent financial and time pressures for some merging parties, it is clear that the evidential burden on parties has not lessened and the COVID-19 crisis does not offer parties a free pass for the failing firm defence.