A recent merger decision by the UK competition authorities may indicate a changing – and possibly more sympathetic – approach to acquisitions of companies in financial difficulty.
Parties to a transaction may plead the 'failing firm' defence where a transaction seems to raise potential competition concerns, but involves the acquisition of a company that is in financial difficulty and on the verge of insolvency. Under this defence, the parties argue that although the transaction might seem to reduce competition, it should nevertheless be cleared because the target is on the verge of insolvency and about to exit the market, so in the absence of the transaction, the target would not remain a competitor in any event.
Generally, competition authorities are reluctant to accept the failing firm defence. The difficulties of pleading the defence were highlighted by two cases before the UK authorities last year:
- American Greetings' acquisition of Clinton Cards, a UK greetings card retailer in financial difficulties, in which the Office of Fair Trading rejected the failing firm defence on the basis that there were possible alternative less anti-competitive purchasers (although it nevertheless cleared the transaction on the grounds that it did not raise sufficient competition issues to cause concern); and
- Channel Tunnel operator Eurotunnel's acquisition of certain assets of insolvent cross-Channel ferry company SeaFrance, which was prohibited by the Competition Commission, rejecting the failing firm defence on the basis that there was a less anti-competitive alternative purchaser.
In the United Kingdom, the failing firm defence will only succeed if three narrowly applied criteria are satisfied:
- In the absence of a takeover, the target would be forced out of the market because of financial difficulties in the near future. While this should be the most straightforward of the three criteria to prove, a common problem is the often conflicting information provided by the acquirer condemning the target to failure and the target itself painting a more optimistic picture to appear an attractive investment.
- There is no substantially less anti-competitive alternative transaction than the particular transaction under consideration – that is, the target could not realistically have been taken over by another business that either is not a competitor of the target or has a lower market share than the acquirer in the transaction being considered.
- The transaction under consideration is not substantially more anti-competitive than any natural diversion of sales occurring in the event of the target exiting the market. This requires the parties to show what would happen to the target's sales if it were to exit the market, so that the authorities can contrast the effects on the market arising from the transaction with those resulting from the target's possible insolvency. From the parties' perspective, a high diversion to the potential acquirer in the event of exit is advantageous, because it shows that the hypothetical exit scenario would not be very different from the situation post-transaction – although such an argument is at odds with any argument normally put forward in support of a proposed transaction.
Despite the stringent criteria, it is possible for the failing firm defence to succeed, as is shown by the recent Optimax Clinics/Ultralase transaction.
In November 2013 the Competition Commission allowed the merger between Optimax Clinics and Ultralase, two of the three largest providers of laser (refractive) eye surgery in the United Kingdom, to proceed on the basis that Ultralase could not have continued to operate as an economically sustainable business, and that the already completed transaction was the least anti-competitive option.
Following an in-depth investigation, the Competition Commission concluded as follows:
- Ultralase would have failed financially. The Competition Commission based its view on evidence submitted by accountants and financial advisers, and Ultralase was indeed put into administration during the in-depth investigation.
- Ultralase would have exited the market had it not been acquired by Optimax Clinics, since when compared with the other bidders that had expressed a possible interest in acquiring Ultralase, Optimax Clinics was the only credible bidder.
- The distribution of sales in the hypothetical exit scenario would not have differed significantly from that in the post-transaction situation.
The competition authorities therefore ultimately concluded that the transaction had not led to a less competitive outcome in the UK market for refractive eye surgery than Ultralase's exit from the market would have done.
The Optimax Clinics/Ultralase transaction shows that in the appropriate circumstances, the failing firm defence can succeed despite the stringent criteria attached to it. However, it remains to be seen whether the UK competition authorities' decision heralds a generally more sympathetic approach to this rarely accepted defence or whether the decision was specific to the facts before it.
For further information on this topic please contact Joosje Hamilton at Norton Rose Fulbright by telephone (+44 20 7283 6000), fax (+44 20 7283 6500) or email (firstname.lastname@example.org). The Norton Rose Fulbright website can be accessed at www.nortonrosefulbright.com.