Consolidation and merger control in times of crisis
Financial crises inevitably lead to industrial consolidation. Companies in distress will end up for sale and shrunken demand will in many instances make competitors the only willing takers. The wave of bank mergers during the financial crisis of 2007 – 2009 was a good example, and the COVID-19 pandemic will likely lead to similar consolidation in several sectors.
During the coming months, competition authorities will play a more important role than ever before. How do you get the right mergers through on time? How do you set the limit for acceptable consolidation when markets as we know them have been reshaped in a matter of weeks? And how do you get the work done when more or less everyone involved is working from home?
Merging companies face similar challenges: what can be done to assist the authorities in reaching a swift and beneficial outcome?
Tools available in EU merger control
There are tools available in EU merger control for firms engaging in consolidation deals, or rescue deals, and while those tools require exceptional circumstances, these are exceptional times.
The European Commission likes to refer to itself as the guardian of the EU Treaties and has done so even more forcefully in times of crisis. There will be no difference this time around. Nevertheless, just like in recent State aid cases, the Commission will need to adapt merger control assessment to unprecedented market conditions, and recent events such as huge sales drops and unprecedented speed of switching production (alcohol companies starting to produce hand sanitizers and paper and pulp companies producing face masks). The basic test will, however, stay untouched; any flexibility in merger control is expected to be on the procedural level.
Firms engaging in consolidation or rescue deals should be aware of two key concepts. Both concepts are built on the idea that the merger should be assessed against the most likely scenario(s) absent the proposed merger. These concepts are known as the “failing firm defense” and the vaguer “flailing firm defense”. Both may, in exceptional circumstances, lead to the approval of mergers that would otherwise have been prohibited. Based on current expectations, these concepts are presumed to be in more frequent use by the Commission in the present crisis than they were at the time of the financial crisis.
The failing firm defense is described in the European Commission’s guidelines on the assessment of horizontal mergers. The reasoning is essentially that the competitive structure of the market would deteriorate to at least the same extent in the absence of the merger. The European Commission has outlined three necessary criteria for a successful “failing firm defense”:
- The allegedly failing firm (or division) would in the near future be forced out of the market because of financial difficulties if not taken over by another undertaking.
- There is no alternative purchaser presenting a less anti-competitive alternative.
- In the absence of a merger, the assets of the failing firm would inevitably exit the market.
These criteria, or similar ones, are to a large extent applied also by the various national competition authorities in the EU, and by competition authorities around the world.
The flailing firm concept is a less acknowledged variant of the failing firm defense. The flailing firm defense is typically the most relevant when a firm has not yet failed but is on the brink of doing so, i.e. is “flailing”, and because of this unlikely to pose a significant competitive restraint in the future. The concept derives from the U.S. and although never formally acknowledged by the European Commission, flailing firm reasoning has paved the way for clearances of e.g. the older Newscorp/Telepiù (2003) and KLM/Martinair (2008) mergers.
It is unlikely that the flailing firm defense alone will suffice to clear a merger in the EU. It could, however, be the decisive factor in combination with one or several “plus” factors such as if a market no longer allows for more than a certain number of firms to operate, or if strong competitive forces on neighboring markets discipline the acquirer more than the flailing firm, as well as pro-competitive/consumer effects of the merger.
The burden of proof to show a failing or a flailing firm defense rests on the acquirer(s). Thus, it is key to secure internal documents of the target. A good working relation with the target and its owner(s) is therefore key to a successful pursuit of a failing or flailing firm defense.
Procedural aspects to keep in mind when dealing with complex mergers
Maintaining momentum is often crucial in a merger procedure, and likely even more so in consolidation and rescue mergers during times of crisis. If use of the failing or flailing firm defense is anticipated, the merger assessment is very likely under normal circumstances to veer into a complex in-depth investigation spanning several months, sometimes more than a year.
During these exceptional times, competition authorities are pressured on multiple fronts. Essentially all competition authorities currently work remotely with ensuing practical obstacles. Many competition authorities, in particular the European Commission, have also experienced a significant spike in workload due to increased activity in the field of State Aid. In addition, it is at the moment difficult for competition authorities to collect the necessary market information from third parties.
For these and other reasons, the European Commission and several other competition authorities are encouraging parties not to notify mergers at this time. While this does not mean that the door is entirely closed, it is now significantly harder to obtain a swift process and the risk of delays is prominent.
According to recent comments from the Commission, only parties presenting “very compelling reasons” may escape delays, and several investigations conducted in the EU have already been paused. This may even sound as an upfront failing/flailing requirement applied in the pre-notification phase to prioritize between rescue and less time critical deals.
Competition authorities are no doubt working hard to limit delays, and there are great (but few) fast-track precedents such as the 2008 BNP Paribas/Fortis deal, which was cleared by the European Commission two weeks before the expiry of the normal deadline. Engaging the competition authorities in a dialogue about the urgency of completion will be key to ensuring efficient handling of the contemplated transaction.
Implementation before approval may be a possibility in some jurisdictions
The European Commission and many other competition authorities may exceptionally allow the parties to implement a merger, fully or partly, pending the outcome of the review. However, competition authorities have historically been hesitant to grant such derogations given the difficulty to undo an already merged entity.
The big question with expected congestion and delays at the authorities – when time is of the essence more than ever – is whether the authorities are willing to be more lenient with granting derogations, also in less alarming situations, in order to limit delays. For obvious non-complex cases, it would be rational to do so.
Transactions that involve failing/flailing firms and that result in consolidation typically represent a potentially significant threat to competition in the eyes of the competition authorities. For this reason, it may be even more difficult than usual for the parties to obtain a derogation from the obligation not to implement the transaction before approval.
One way to improve the chances of obtaining derogation is to structure the deal so that the assets are kept separate pending merger control approval. This would mean that the acquirer takes control and perhaps pools supplies and/or implement other cost-reducing measures, but keep the units sufficiently separate so as to make it possible to undo the merger in case the relevant competition authority ultimately decides to prohibit the deal. Such a set-up may greatly improve the chances of obtaining a derogation.