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Legal Developments in The Legal 500 United Kingdom 2012

The ‘failing firm’ defence in merger control

November 2008 - EU & competition. Legal Developments by Berwin Leighton Paisner LLP.

More articles by this firm.

In the current economic climate, distressed companies may be acquired by competitors (eg Lloyds TSB/HBOS), especially as other buyers are finding funding difficult to obtain. Acquisitions by competitors often raise merger control issues. One potential argument in these circumstances is the ‘failing firm’ defence – ie that the target is going out of business and the only way to save it is for the buyer to take it on. However, the UK and European competition authorities apply this defence very narrowly, as purchases by competitors can concentrate markets into fewer hands, leading to greater market power, higher prices for consumers and less consumer choice. Both the UK authorities and the European Commission have provided extensive guidance, showing just how narrowly they apply the ‘failing firm’ defence. 


guidance from UK competition bodies


Competition Commission


In its 2003 Merger References Guidelines, the UK’s Competition Commission (CC) stated that:


‘for a firm to be considered a failing firm, the CC will need to be satisfied that: 


  • the firm is unable to meet its financial obligations in the near future; and 

  • the firm is unable to restructure itself successfully.’

Office of Fair Trading (OFT)


Where the parties run a ‘failing firm’ argument, the UK’s Office of Fair Trading (OFT) will assess what would otherwise happen to the assets and business of the allegedly failing firm without the merger. The OFT is required to check whether there will be any ‘substantial lessening of competition’ (SLC) and therefore examines competition both before and after the transaction. In its mergers guidance, the OFT has set out three conditions to satisfy to counter findings of an expected SLC:


‘First, in order to rely on a failing firm defence, the firm must be in such a parlous situation that without the merger it and its assets would exit the market and that this would occur in the near future. Firms on the verge of administration may not meet these criteria whereas firms in liquidation will usually do so. Decisions by profitable parent companies to close down loss-making subsidiaries are unlikely to meet this criteria.


‘Second, there must be no serious prospect of reorganising the business. Identifying the appropriate counterfactual [that is, what would happen if the merger did not go ahead] in these types of situation is often very difficult. For example, even companies in receivership often survive and recover.


‘Third, there should be no less anti-competitive alternative to the merger. Even if a sale is inevitable, there may be other realistic buyers whose acquisition of the plant/assets would produce a better outcome for competition. These buyers may be interested in obtaining the plant/assets should the merger not proceed: that could indeed be a means by which a new entry can come into the market. It may also be better for competition that the firm fails and the remaining players compete for its share and assets than that the failing firm’s share and assets are transferred wholesale to a single purchaser.’


European Commission


In its Horizontal Merger Guidelines, the European Commission has given equally strict views, setting out three key criteria:


‘First, the allegedly failing firm would in the near future be forced out of the market because of financial difficulties if not taken over by another undertaking.


‘Second, there is no less anti-competitive alternative purchase than the notified merger.


‘Third, in the absence of a merger, the assets of the failing firm would inevitably exit the market.’


EXAMPLES


Two recent cases illustrate how strictly the UK competition authorities apply these guidelines.


In December 2007 the OFT published its decision on the purchase by Tesco of five former Kwik Save stores. The OFT concluded (for only the second time under the current legislation) that: ‘… the stringent criteria for the failing firm defence are clearly met in respect of the failing stores’. The stores had been marketed to national and local supermarket chains by a property agent and there were no other bidders for four of the stores. There was one other bid for the fifth store by a grocery retailer who had not been recognised by the CC as an effective competitor. A management buyout by Kwik-Save executives did not include those stores, which were not being properly restocked, and, in the absence of a sale, the administrators at KPMG would have either shut down the stores and sold on the leases, or surrendered them to their landlords. Other than Tesco, there were no other realistic buyers.


In May 2007 the CC issued a report into Thermo Electron’s acquisition of GV Instruments (GVI) in July 2006. Thermo had argued that, were it not for its acquisition of GVI, the company would have imminently failed and gone into liquidation. The CC agreed that GVI would have imminently failed, but instructed an insolvency expert who found that GVI was most likely to have been marketed on an accelerated basis and then sold out of administration. He considered the likelihood of GVI being put immediately into liquidation to be ‘remote’. The CC concluded that administration was the most likely outcome. 


Other parties suggested that there would have been a number of businesses interested in purchasing GVI as a whole, or some or all of its assets, had it gone into administration. The CC considered a range of outcomes and judged that:


‘… any of the possible purchasers of these assets… would have been able to retain a substantial proportion of GVI’s pre-merger market share and would have maintained a substantial competitive constraint on Thermo’. 


In other words, the CC believed a sale to a different buyer, producing less detriment to competition, would have been the outcome if Thermo did not buy GVI.


The CC concluded that the merger ‘may be expected to result in a substantial lessening of competition’ and required divestiture of GVI as a whole. The CC appointed a monitoring trustee to counter any incentives to run down or neglect the business or assets of a divestiture package and reduce future competitive impact.


On 26 February 2008 the CC announced that Thermo had completed the sale of two businesses owned by GVI, which it had acquired in 2006. The CC had concluded that Thermo should either sell the whole of the acquired business or, if this did not prove feasible, the two individual businesses concerned. In the event, separate buyers were sought for the two businesses. Both purchasers were approved by the CC.


Taken together, the guidelines and examples above demonstrate that the ‘failing firm’ defence is quite limited, even in a tougher economic climate. If a company is considering purchasing a struggling competitor, expert merger control advice should be taken as early as possible.


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