Businesses around the world continue to grapple with the effects of the Covid-19 outbreak. In the coming months and years, many struggling businesses may need to seek merger partners, while acquisitive companies in better financial condition may be looking for bargains. However, would-be merger partners with significant European activities must be prepared to run the gauntlet of European Union (EU) merger review, which is notoriously strict especially in concentrated markets.
The pandemic has focused attention on the EU’s “failing firm defence” (FFD), which can justify approval of transactions that would normally be prohibited under the EU’s Merger Regulation (EUMR). Similar discussions arose during the 2008 financial crisis, when the OECD debated whether the FFD criteria should be loosened in times of economic downturn. The delegates concluded that there was no need for such a change and warned that excessively lax merger standards could harm consumers (see OECD Policy Roundtables: The Failing Firm Defence (2009), p. 13).
Similarly, European Commission (Commission) representatives – echoed by antitrust authorities in other jurisdictions – have recently stressed that the pandemic will not lead to a relaxation of EU merger review standards. Commission Executive Vice-President Vestager stated that it was not necessary to relax the normal merger control rules, despite the “uncertain times” (as reported by MLex: Lewis Crofts, “Failing firms won’t get more EU leeway to plead for mergers, Vestager says”, 24 April 2020).Vestager emphasized that the crisis “shouldn't be a shield to allow mergers that would hurt consumers and hold back the recovery” (as reported by MLex: Nicholas Hirst, “Crisis no “shield” for anticompetitive mergers, Vestager says”, 24 April 2020).
But whether the pandemic will or should lead to revision of the FFD is arguably the wrong question. Instead, merging parties need to consider whether the criteria for a merger’s approval based on the FFD are more likely to be satisfied because of the pandemic and what other analytical tools– such as assessment under realistic counterfactuals – may be available to win approval of mergers facing significant antitrust hurdles.
The Commission first recognized the FFD in the 1993 Kali and Salz transaction, which created a de facto monopoly on the German markets for potash and magnesium products, and further developed it in the 2001 BASF/Eurodiol/Pantochimcase.The Commission’s 2004 horizontal merger guidelines (the Guidelines) state that the Commission" may decide that an otherwise problematic merger is nevertheless compatible with the common market if one of the merging parties is a failing firm. The basic requirement is that the deterioration of the competitive structure that follows the merger cannot be said to be caused by the merger. This will arise where the competitive structure of the market would deteriorate to at least the same extent in the absence of the merger."
The Guidelines identify three cumulative criteria as being especially relevant to the application of the FFD.
- 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
To satisfy this criterion, a would-be buyer needs to show that the target lacks access to financing it needs to stay in the market. Bankruptcy or similar proceedings need not have been initiated, but the buyer needs to show that, absent the transaction, the target is likely to enter into such proceedings. This criterion may be difficult to satisfy where the target is part of a larger group with sufficient resources to keep the target in the market if it chose to do so.
- There is no less anti-competitive alternative purchaser
To satisfy this criterion, the seller needs to show that it has given alternative investors an opportunity to enter into negotiations to acquire the failing business (though not necessarily through a formal tender procedure).
- Absent the proposed transaction, the assets of the failing firm would inevitably exit the market
This criterion addresses the possibility that bankruptcy may be less anti-competitive than a proposed transaction, because bankruptcy may result in third parties taking over the target’s production assets and keeping them in the market in competition with the proposed buyer.
The FFD in the time of Covid-19
The Covid-19 outbreak has prompted discussion about whether the FFD criteria are too rigid and should be relaxed. So far, however, the Commission has shown little appetite for relaxing these conditions.
As mentioned, the 2008 financial crisis led to similar debates, with no consensus to relax the FFD reqiurements. In that crisis, in fact, the expected surge in FFD cases did not materialize. In the subsequent sovereign debt crisis, however, two Greek airlines Aegean and Olympic Air sought approval of their proposed merger based on the FFD. The Commission rejected this argument in 2011 (see COMP/M.5830), but approved a merger of the same airlines two years later (see COMP/M.6796). The Commission concluded that, “in contrast to its situation 2 years ago, Olympic [was] simply not able to continue operating outside of Aegean”. In particular, the Commission found that in light of “both the on-going economic crisis in Greece and Olympic's very difficult financial situation, Olympic would be forced to leave the market soon, with or without merger” (see Joaquín Almunia, Statement on Aegean/Olympic Air merger, 9 October 2013).
Does the paucity of FFD cases in the financial crisis indicate that the FFD will in fact not be invoked in pandemic-driven M&A transactions? No. The financial crisis primarily affected the financial sector, which was relatively unconcentrated. Moreover, many troubled financial institutions were saved by government interventions. The Covid-19 outbreak, by contrast, affects companies in many economic sectors, some of which are already concentrated. Mergers involving competitors in such sectors may raise significant antitrust issues.
Indeed, several non-EU antitrust authorities have already cleared or considered transactions under the FFD since the beginning of the Covid-19 outbreak. For example, on April 23, 2020, the Korea Fair Trade Commission cleared Jeju Air’s acquisition of a majority stake in Eastar Jet in light of the crisis conditions.The UK Competition and Markets Authority (CMA) initially accepted an FFD in the Amazon/Deliveroo case, though the CMA later revised those findings due to improvements in Deliveroo’s financial position (the CMA still cleared the transaction, though based on the size of Amazon’s shareholding (16%).
While each case will of course be assessed on its own merits, some observations on the application of the Commission’s three FFD criteria can already be made. With many companies facing possible insolvency owing to the pandemic, the first FFD criterion – that financial difficulties would likely force the target to exit the market absent the transaction – may seem easy to meet. On the other hand, EU Member States and the EU itself have taken dramatic steps to support local companies. A would-be acquirer defending a proposed acquisition based on the FFD will need to show that the target cannot survive by drawing on available sources of aid and/or its parent company’s resources. Perhaps counterintuitively, the first FFD condition may be easier to satisfy after the pandemic subsides, when current sources of State assistance dry up but markets have not yet fully recovered.
The second FFD criterion – the absence of a less anti-competitive buyer – may often be met in pandemic-driven transactions. Competitors that could normally be viable alternative purchasers may be suffering similar market stresses as the target, while a target’s reduced revenues and uncertain prospects may limit interest from potential financial buyers.
The third FFD criterion – that the target’s assets would inevitably exit the market absent the transaction – may be the most difficult to satisfy. To satisfy this criterion, a buyer would be required to show that no buyers would be likely to acquire the target’s productive assets in a bankruptcy sale and continue to operate them. Unless the target is already in bankruptcy, the speculative nature of this criterion may make it difficult to satisfy..
In sum, the 2008 financial crisis did not generate the expected wave of EU merger approvals based on the FFD. While the breadth and depth of the pandemic may lead to more notifying parties invoking the FFD, questions will likely arise as to whether a struggling target could access other resources to survive without the transaction and whether less anti-competitive buyers are available for the target as a whole or for individual productive assets in bankruptcy sales.
The Counterfactual alternative
Even under pandemic conditions, therefore, the Commission’s rigid FFD tests may be difficult to meet. But the FFD is not the only legal framework under which a transaction raising significant antitrust concerns can be approved based on the financial difficulties of the target.
As noted, the FFD is based on a recognition that a transaction must be approved if any deterioration of the competitive structure of a relevant market cannot be said to be caused by the merger. Even if the target is not a failing firm in the FFD sense, the Commission must approve a transaction if competition would deteriorate to at least the same extent in the absence of the merger.
Following this logic, in several cases the Commission has applied a “counterfactual” analysis to approve a transaction that did not meet all the conditions of the FFD. For example, in Nynas/Shell/Harburg Refinery, the Commission allowed Nynas to acquire Shell’s Harburg refinery on the basis that, absent the transaction, “the Harburg refinery assets will most likely exit the market, which would be much worse for the competitive structure of the relevant markets than the reasonably foreseeable effects of the concentration.”
In a number of cases, the Commission has also approved mergers based on a counterfactual analysis where the target’s ability to compete aggressively was impaired, even if it was not expected to exit the market. For example, in KLM/Martinair, the Commission’s assessment took account of Martinair’s financial difficulties, ageing assets, significant investment requirements and difficulties in obtaining such investment. The Commission found that, while the parties were competitors, Martinair’s specific situation made it likely that the competitive constraint it exerted would be eroded in the near future. The Commission concluded that the merger-specific anti-competitive effects of the transaction were likely to be limited. Similarly, in T-Mobile NL/Tele2 NL, the Commission concluded that Tele2 would likely remain in the market, but its competitive strength would be weakened.
The choice of the appropriate counterfactual can be a complex exercise. In normal circumstances, the Commission assesses transactions’ future effects based on historical competitive conditions (e.g., market shares over the previous three years). To convince the Commission to apply a counterfactual analysis, notifying parties must first show that historical conditions may not be an appropriate baseline for analysis going forward. They must then identify the specific counterfactual that should be applied instead. During and after the pandemic, the Commission will likely be open to arguments that a transaction’s competitive effects cannot simply be analysed based on conditions in 2017-2019. However, the complexity of the pandemic – in particular the likelihood that the target’s competitors will also be negatively affected – may make identifying a specific counterfactual or counterfactuals difficult.
The Covid-19 outbreak may trigger a global wave of merger and acquisition activity, as companies in financial distress seek merger partners and more fortunate acquirers seek potential opportunities. Merging parties with significant European businesses may need Commission merger approval for such transactions.
Mergers involving EU competitors, especially in concentrated industries, can expect scrutiny under the EUMR. The Commission has signalled that the pandemic will not lead to a loosening of merger control standards; indeed, there is considerable pressure on the EU to tighten its reviews further, especially in sensitive areas such as healthcare, food and agriculture and the digital sector.
Nonetheless, the Commission may be willing to approve some transactions that would otherwise not be cleared where the pandemic has undermined the target’s competitiveness. Indeed, the current pandemic seems more likely than the 2008 financial crisis to generate cases involving targets that are “failing or flailing” in the pandemic’s aftermath.
Such cases will be challenging for merging parties and their counsel.,. To a greater extent than after the 2008 financial crisis, merging parties may argue that challenging transactions should be approved based on the FFD. But the FFD criteria are strict, and the burden of proof is on the notifying party(ies). In some cases, merging parties may have greater flexibility to argue for approval of challenging transactions based on a counterfactual line of argument. Under this approach, merging parties will need to show that, because of the pandemic’s effects on the target and/or broader market conditions, the transaction will not lead to a deterioration in competition. This approach may be attractive especially where it would be difficult to show that the target would necessarily exit the market absent the transaction.
Apart from merger control, acquisitions of European businesses can be expected to face new hurdles in the coming months and years. EU Member States, actively encouraged by the Commission, have been tightening their foreign investment screening frameworks. These will be subject to new EU-level coordination as from October 2020. The EU has also proposed to introduce a new tool requiring prior approval of acquisitions of European businesses deemed to be facilitated by non-EU subsidies. The enormous public assistance awarded in response to the pandemic suggests that many transactions could be caught if this new tool is introduced.
|Jay Modrall||Violetta Bourt|
|James R. Modrall is an antitrust and competition lawyer based in Brussels. A US-qualified lawyer by background, he is a member of the bar in New York, Washington, D.C. and Belgium.Mr Modrall has extensive experience with EU financial regulatory reform, advising the world’s leading private equity groups in connection with the new EU directive on alternative investment fund managers and leading banks and investment firms on EU initiatives including EU regulation of derivatives, EU reforms in financial market regulation and the creation of a new EU framework for crisis management, among others||Violetta Bourt is an antitrust and competition lawyer based in Brussels. Violetta’s practice covers all aspects of EU competition law, with a focus on EU and international merger control.Violetta has particular experience in notifying mergers and joint ventures to the European Commission, as well as coordinating the notification of international transactions with multiple national competition authorities. Violetta also advises clients on abuse of dominance cases, anti-competitive agreements, global competition compliance issues, and other competition and general EU matters|