Antitrust Clearance of Distressed Transactions: Don’t Assume It Will Be Easy

In fact, there is little basis for concluding that antitrust agencies in major jurisdictions will take an approach to transactions involving distressed firms that is radically different from the approaches they have taken in similar situations in the past. As discussed below, antitrust authorities faced a plethora of bankruptcy-related issues during the dot-com crash in 2000-01 and during the financial crisis in 2008-09. During these prior periods the agencies made clear that they would continue to apply their regular modes of analysis to transactions and would (and did) seek to block transactions that raised competitive concerns, just as they have always done in the bankruptcy context. Only if the very stringent conditions for application of the so-called “failing firm defense” are met will a transaction that would otherwise be considered anticompetitive receive a pass from a reviewing agency. 

United States

All transactions between actual or potential competitors are reviewed pursuant to the 2010 Horizontal Merger Guidelines (Guidelines) issued jointly by the Antitrust Division of the U.S. Department of Justice and the Federal Trade Commission.¹ The Guidelines analysis starts by looking at the market shares of the parties, and if their combined share is above a threshold level, the agencies will preliminarily conclude that there may be serious competitive concerns and that a detailed examination of the transaction’s likely competitive effect is warranted.

The agencies, in the course of that examination, will take into account the financial condition of the parties, but the fact that a seller or merging party may be in financial distress does not, without more, provide a defense to an otherwise anticompetitive transaction. The Guidelines and case law, however, identify two circumstances in which the financial condition of one or both of the parties may affect the analysis: (i) the “failing firm” defense and (ii) the “flailing firm” (or weakened competitor) defense.

Failing Firm Defense

Some in the general business press have seized on the phrase “failing firm defense” to conclude that any transaction between actual or potential competitors, no matter how anticompetitive, will receive clearance if one of the parties appears to be on the brink of failure. This is, at best, misleading. The Guidelines do expressly recognize a failing firm defense to otherwise anticompetitive transactions, but to qualify for it the parties must meet extremely strict requirements.² The allegedly failing firm must show all of the following:

1. It would be unable to meet its financial obligations in the near future;
2. It would not be able to reorganize successfully under Chapter 11 of the U.S. Bankruptcy Code; and
3. It has made unsuccessful good-faith efforts to elicit reasonable alternative offers that would keep its assets in the relevant market and would pose less severe danger to competition than the proposed transaction; in other words, there is no other offer above liquidation value from a less anticompetitive buyer.³

These requirements apply regardless of whether the distressed firm is already in Chapter 11 proceedings, and the burden is on the parties to prove — not just assert — that each condition has been met. If all the conditions are met and proven, then the failing firm defense is a complete defense, and the transaction will be permitted to proceed. Not surprisingly, though, the defense is rarely successfully invoked.

Flailing Firm Defense

The antitrust agencies also recognize that in some circumstances a seller that cannot meet the strict requirements of the failing firm defense is nonetheless so financially hampered as an ongoing entity that its future competitive significance will likely be far less than it has been.⁴ For example, in a high-tech industry, a seller may be able to show that it will be unable to generate, borrow or raise sufficient funds to support the level of research and development needed to continue to compete effectively and will be limited to the products it currently is producing or has under development and thus be a far less significant competitive force. Again, it falls to the parties to show conclusively the extent of the seller’s financial distress and the efforts it has made to remedy this condition before entering into the otherwise anticompetitive transaction. Parties seeking to use the flailing firm defense should assume that the reviewing agency will undertake a thorough, and likely lengthy, review of its claims. Further, while the failing firm defense provides a complete defense to an otherwise anticompetitive transaction, the flailing firm defense does not. The agency may conclude that though the seller is likely to be less competitively significant in the future, it will still have sufficient market presence for the transaction to result in competitive harm.

Past Financial Crises

During both the 2000-01 dot-com crash and the 2008-09 financial crisis, the U.S. antitrust agencies faced questions as to whether they would change their level of scrutiny due to the distress faced by certain industries or companies. The answer consistently was no.⁵ The Department of Justice and the Federal Trade Commission expressly stated in 2009, “Setting aside competition law during times of crisis has proven unwise. Indeed, doing so is likely contrary to the public interest.”⁶ As the defenses described above make clear, the financial condition of the parties is relevant to the analysis of the proposed transaction. Accordingly, transactions that might be prohibited if both parties were financially healthy and had bright futures as standalone entities may be permitted when economic conditions result in uncertain futures for one or both parties. But that does not indicate a weakening of the analysis, only that the analysis is highly fact-specific and highly detailed.

It is worth noting that the agencies have been able to speed reviews where there is a critical need to do so. For example, in the fall of 2008 as the banking industry faced a nearly unprecedented crisis, the Department of Justice was able to review proposed bank mergers on a highly expedited schedule to prevent bank failures, often completing the necessary investigations in a week or less.⁷ If parties have true timing exigencies, they must make them clear to the reviewing agency at the earliest possible moment and be in a position to provide all the information the agency needs as soon thereafter as possible.  

European Union

The European Commission (EC) has also developed clear criteria for assessing claims to a failing firm defense. The criteria, developed initially by the European Union (EU) courts, are now reflected in the EC’s 2004 Horizontal Merger Guidelines:⁸

1. The failing firm would, in the near future, be forced out of the market because of financial difficulties, unless it is acquired;
2. There must be no less anticompetitive alternative purchase than the proposed transaction; and
3. In the absence of the proposed transaction, the assets of the failing firm would inevitably exit the market.

As with the U.S. agencies, the EC has oftentimes appeared reluctant to accept the application of the failing firm defense. The criteria are tough to satisfy (exit in the “near” future, “no” less anticompetitive alternative, and the assets “inevitably” exiting the market). And the EC has applied the criteria strictly — indeed, the last full acceptance of the failing firm defense (relating to a merger of Greek airlines following the Greek sovereign debt crisis) dates back to October 2013.⁹ Further, EU Commissioner Margrethe Vestager is reported to have stated publicly on April 24, 2020, that the current crisis does not warrant a change to the longstanding test for establishing this defense.¹⁰

That said, as with the U.S. approach, there are alternative ways to deploy arguments regarding the financial status of a merging party before the EC. In essence, the EC assesses the competitive effects of a transaction against a counterfactual (i.e., the situation that would most likely prevail absent the transaction). In most cases, the counterfactual is simply that the parties remain independent of one another and continue to compete as they would pretransaction. But arguments regarding the financial status of a merging party can be used to influence how the counterfactual is framed (e.g.,, does the merging party have the resources and financial flexibility to make investments that might be required to remain competitive?). As with the “flailing firm” defense in the U.S., arguments along these lines can have a degree of influence on the assessment of a transaction, but they are not silver bullets, and merging parties should still expect detailed reviews. 

Where transactions do not have a sufficient EU nexus to be reviewed by the EC, they may still fall to be reviewed at a national level in one or more EU Member States. Although not all EU Member States have extensive national precedent on the “failing firm” defense, many do, and the applicable tests tend to be similar – if not identical – to the test applied by the EC.¹¹

Takeaways

Parties to distressed transactions between competitors should not assume that the current crisis will result in reduced antitrust scrutiny. If the parties believe they meet all the requirements of one of the available defenses, they should be prepared to provide comprehensive proof that they meet each such requirement and, if time is of the essence, to provide that proof expeditiously. The available defenses are strict and rigorously applied, and there is no indication that they will be applied less rigorously during the current crisis. To the contrary, experience from past financial crises indicates that antitrust authorities will look as carefully at such transactions as they would in other times.

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¹ The Guidelines are available at https://www.ftc.gov/system/files/documents/public_statements/804291/100819hmg.pdf. 
² The Guidelines also recognize a “failing division” defense whose requirements are similar, though not identical, to those for a failing firm. 2010 Merger Guidelines § 11.
³ 2010 Merger Guidelines § 11. See also Fed. Trade Comm’n, “Power Shopping for an Alternative Buyer,” (Mar. 31, 2015), available at https://www.ftc.gov/news-events/blogs/competition-matters/2015/03/power-shopping-alternative-buyer?utm_source=govdelivery.
⁴ The “flailing firm” defense arises from the Supreme Court’s decision in U.S. v. General Dynamics Corp., 415 U.S. 486 (1974), in which the Court concluded that a merger between two coal companies was not anticompetitive because the reserves of the seller were so low that it would not be a competitive force in the future absent the transaction.
⁵ See, e.g., Carl Shapiro, Deputy Assistant Att’y Gen. for Economics, U.S. Dept. of Justice Antitrust Division, “Competition Policy in Distressed Industries” (May 13, 2009), available at https://www.justice.gov/atr/file/519906/download. 
⁶ Organization for Economic Co-operation and Development, “Competition and Financial Markets – Note of the United States” (Feb. 11. 2009), available at https://www.ftc.gov/sites/default/files/attachments/us-submissions-oecd-and-other-international-competition-fora/09financialcrisis.pdf.  
⁷ See also U.S. v. SunGard Data Systems, Inc., 172 F. Supp. 2d (D.D.C. 2001) (government and parties completed investigation and preliminary injunction trial on highly expedited schedule to meet bankruptcy court schedule and preserve seller’s assets).
⁸ Available at https://eur-lex.europa.eu/legal-content/EN/TXT/PDF/?uri=CELEX:52004XC0205(02)&from=EN.
⁹ Commission Decision of October 9, 2013, in Case M.6796 Aegean/Olympic II, available at https://ec.europa.eu/competition/mergers/cases/decisions/m6796_20131009_20682_4044023_EN.pdf .
¹⁰ MLex Market Insight, “Failing firms won’t get more EU leeway to plead for mergers, Vestager says,” April 24, 2020. Similarly, the United Kingdom Competition & Markets Authority (CMA) has issued new guidance stating that the COVID-19 crisis has not caused it to relax its standards for assessing mergers and that “failing firm” claims are likely to be accepted only “where supported by a material body of probative evidence” that the CMA has tested thoroughly. CMA, Guidance: Merger assessments during the Coronavirus (COVID-19) pandemic, Annex A: Summary of CMA’s position on mergers involving ‘failing firms,’ April 22, 2020, available at https://www.gov.uk/government/publications/merger-assessments-during-the-coronavirus-covid-19-pandemic/annex-a-summary-of-cmas-position-on-mergers-involving-failing-firms.