Merger control and failing firms (Part 2)
Merger control and failing firms (Part 2)
In a recent article (accessible here), we discussed an anticipated increase in reliance on the failing firm doctrine in the context of merger assessments. We surmised that the competition authorities were unlikely to relax the strict failing firm doctrine requirements solely to cater for COVID-19. This article continues the discussion by engaging more substantially with the doctrine’s requirements.
Inability to meet financial requirements
At the heart of this failing firm doctrine requirement is a firm’s dire financial position which is leading the business into imminent failure, and which the proposed merger serves to remedy. If it is not made clear that the firm will actually fail, despite parlous circumstances, this requirement will not be met. Example can be drawn from the United Kingdom Competition and Market Authority’s (CMA) provisional clearance of Amazon’s investment in Deliveroo (Amazon/Deliveroo), initially based on a ‘deterioration’ in Deliveroo’s financial position caused by the coronavirus outbreak. The CMA’s provisional finding was recently revised due to the precarious financial position of Deliveroo having improved since its initial finding, and the CMA having found that the failing firm defence was no longer satisfied on the facts of the case.
In South Africa, for example, in Iscor Ltd & Saldanha Steel (Pty) Ltd (67/LM/Dec01), it was highlighted that the relevant firm must either be failing, or likely to fail in the imminent future. On the facts of that case, it was found that, without the financial restructuring of the acquirer, the target firm would have failed since “no independent firm would have provided the finance necessary to bail it out of its debt obligations given its past [financial] performance and its less than certain future”.
In Phodiclinics (Pty) Ltd and Others & Protector Group Medical Services (Pty) Ltd (in liquidation) & Others (122/LM/Dec05), despite attempts of reorganisation, the failing firm had no cash flow or overdraft facilities to pay its staff salaries, debts or rent. In aggravation of this was the fact that management had left the company. The firm was eventually placed in liquidation which reinforced the conclusion that it was undoubtedly failing. A firm however need not have necessarily already crossed the Rubicon into liquidation to successfully invoke the failing firm doctrine. Rather, an analysis of a firm’s financial position must evidence actual or imminent failure in the short to medium term without intervention.
Good-faith efforts to elicit reasonable alternative offers
Failing firms must elicit good faith alternative offers and interrogate whether any would raise less competition and public interest concerns, in comparison to the merger at hand.
For example, in K2018239983 (South Africa) (Pty) Ltd & The Business of Hernic Ferrochrome (Pty) Ltd (LM141Jul19), the business rescue practitioners conducted a bidding process for the sale of the target firm and identified five compliant bids. Regarding the losing four bids, two were competitors of the merging firms, already thought to have higher market shares than the combined post-merger market share of the merged entity, and the other two firms had no presence in South Africa and thus no BEE offering. The final bidders were evaluated on their stated intention and ability to ensure the sustainability of the target firm’s business, including the retention of employees. On this basis, it was found that reasonable, good faith efforts were made to find an alternative purchaser, with the acquiring firm being the most suitable bidder.
In CTP Ltd and Another v Competition Commission (IM232Feb16), the market characteristics were key considerations in justifying the acquirer’s failure to attempt to find a suitable alternative purchaser. In this case, the relevant market for the manufacture and replication of CDs and DVDs was in fast decline and termed a potentially dying market, such that it was unlikely that there would be another willing buyer. In certain markets, hard-hit by COVID-19, this may be particularly relevant insofar as the pool of viable prospective acquirers practically able to sustainably save a failing firm may have shrunk.
Reasonable expectation that, but for the merger, the failing firm’s assets would exit the market
Although the fact that the failing firm’s assets would exit the market, but for the merger, is not necessarily a prerequisite in South Africa; an ability to prove this may support the successful invocation of the failing firm doctrine.
In JD Group Ltd & Profurn Ltd (60/LM/Aug02), the market in question comprised dominant players who would likely acquire the market share of Profurn if it failed. On this basis it was held that JD Group’s acquisition of Profurn “at worst shifts the calculus in favour of JD”, which was less detrimental to competition than its acquisition by the dominant players in the market.
In Schumann Sasol South Africa Pty Ltd & Price’s Daelite Pty Ltd (23/LM/May01), the parties alleged that, should the failing firm and its assets exit the candle market, competition would be diminished by exerting upward pressure on prices. However, it was ultimately found that the failing firm’s exit would likely rather result in other competitors gaining access to the market and competition being better supported.
In conclusion, a firm’s potential exit may be even more significant in the reconfigured COVID-19 landscape, with some markets having sustained more severe economic battering than others. COVID-19 is likely to have had a substantial impact on, for example, barriers to entry and levels of countervailing power.
While the failing firm doctrine may now be viewed through a pandemic-tinted lens, each requirement must still be satisfied, with appropriate regard to past precedent.
The notion that firms need not rely on the failing firm doctrine to justify approval of a complex merger was recently evidenced by the CMA’s revised provisional approval of Amazon/Deliveroo, wherein despite the CMA abandoning reliance on the failing firm defence, it still recommended that the merger be approved.
In South Africa, the failing firm doctrine does not serve as an absolute defence and is but one factor in a merger assessment. Even if the failing firm doctrine is properly invoked, the effect of the merger must still be considered in the light of other competition and public interest considerations. The public interest considerations which include, for example, the impact on small and medium size businesses or firms controlled or owned by historically disadvantaged persons (HDPs), the risk of job losses, and the ability of the merger to increase the levels of ownership by HDPs and workers, will bear equal importance as the competition factors in the analysis. It will be interesting to see how our competition authorities balance these potentially conflicting factors on the merger analysis scales.
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