Given the state of the economy, much M&A activity in the near future may involve companies in dire financial straits, raising the issue whether the federal antitrust enforcement authorities will be more sympathetic to acquisitions of failing firms. The answer so far appears to be no. We recently achieved clearance for Fidelity National Financial, Inc. (Fidelity) in its acquisition of the title insurance subsidiaries (the Subsidiaries) of one of its main competitors, LandAmerica Financial Group, Inc. (LandAmerica). That experience, involving a textbook example of a failing firm, suggests that obtaining clearance on such a theory will remain extremely difficult.
Fidelity and LandAmerica were two of the largest title insurers in the United States. If you have ever purchased a home, you are probably familiar with title insurance – insurance against financial loss caused by defects in title. Usually these defects are the result of a fraudulent conveyance or an uncovered charge, such as a mechanics lien. A title company will search their indexed records, as well as public sources, to uncover these encumbrances, and then will insure the property against any liabilities it fails to uncover. Title insurance is also important for purchases of large commercial properties, which can present the potential for billions of dollars in claims. The latter category was an important focus of the investigation by the Federal Trade Commission (FTC).
Land America’s financial condition deteriorated significantly over the course of 2008, ultimately causing it to file for bankruptcy on November 26, and prompting the Nebraska Department of Insurance (NDOI) to seize the company’s title insurance underwriting subsidiaries and to place them in “rehabilitation.” The nomenclature is misleading at least as it relates to title insurers; no such entity has ever emerged from rehabilitation absent an acquisition. The normal course for a company in rehabilitation is liquidation.
Time was of the essence in order to maintain the viability of any acquisition. The Director of the NDOI was concerned that the Subsidiaries’ losses were accelerating and that she needed to move quickly to preserve sufficient reserves to insure her ability to keep existing policyholders whole. As a result, she was willing to allow the Subsidiaries to continue selling title insurance only for a very short time before she shut them down as going concerns. Once that happened (if not before), the employees responsible for producing (i.e., selling) the Subsidiaries’ policies would leave and the ability of Subsidiaries to continue in business would be eliminated. Thus, there would be no business to sell. The Director testified at the bankruptcy hearing that she would shut down continuing operations on December 22, 2008 unless an acquisition closed by then.
Not surprisingly, the FTC looked very closely at the failing firm defense, but was reluctant to conclude that the appropriate conditions had been met in spite of the likely imminent liquidation of the Subsidiaries. Under the Horizontal Merger Guidelines, an otherwise anticompetitive merger will be allowed to proceed if 1) the allegedly failing firm would be unable to meet its financial obligations in the near future; 2) it would not be able to reorganize; 3) it has made unsuccessful efforts to elicit reasonable alternative offers that would pose less of a danger to competition; and 4) absent the acquisition, the assets of the failing firm would exit the relevant market. U.S. Dep’t of Justice & Federal Trade Comm’n, Horizontal Merger Guidelines (rev. ed. 1997), available at http://www.usdoj.gov/atr/hmerger/11251.htm.
The NDOI rehabilitation proceeding effectively perfected Fidelity’s failing firm defense on the first two prongs. The FTC, however, had substantial questions regarding the third and fourth prongs. As to the third, an alternative bidder emerged. Stewart Title, the fourth largest competitor, put in a very late bid. But Stewart’s bid presented a thorny situation for the FTC. Stewart was likely concerned that Fidelity’s acquisition would enable it to achieve significant efficiencies and become an even stronger competitor. Stewart thus had an incentive to stop Fidelity’s transaction even if it were not going to consummate one itself. The timing was such that the bankruptcy court had to reach a determination on this issue before the FTC. After hearing the evidence on the Stewart bid, the court held that the Stewart transaction was neither credible nor capable of being closed by December 22. In re LandAmerica Financial Group, Inc., No. 08-35994 (KRH), at *13 (Bankr. E.D. Va. Dec. 17, 2008).
The fourth prong of the failing firm defense remained. There was some concern that competition might be better served by letting the LandAmerica subsidiaries go into liquidation so that their employees would be dispersed evenly throughout the market rather than concentrated in what would then be the largest firm, Fidelity. We were able to demonstrate, however, that industry capacity would be reduced in the absence of the transaction, and that title insurance consumers would have to replace existing policies that would remain in effect if the Subsidiaries continued as going concerns. Thus, liquidation of the Subsidiaries would have reduced consumer welfare. This appears to have been the basis upon which the transaction was finally cleared.
Both the FTC and the Department of Justice have historically been very reluctant to accept the application of the failing firm defense. That position appears to remain the case even in these challenging financial times.