While some businesses may choose to delay transactions in light of Covid-19, many transactions will continue, in particular if the target is in financial distress. In such scenarios, the "failing firm defence" may be an available option for obtaining merger control clearance for transactions which might otherwise raise concerns. Indeed, it seems that the UK Competition and Markets Authority ("CMA") will shortly accept that defence in the context of its ongoing Phase 2 review of Amazon's acquisition of a minority stake in Deliveroo.
| what you need to know - key takeaways |
- Merger control regimes are still in operation during the Covid-19 outbreak.
- In the context of transactions involving distressed targets, there are two key potential arguments which may be used to get clearance for deals which would ordinarily raise concerns, namely: (a) the "failing firm" defence; and (b) a weakened competitor, or "flailing firm" argument.
- Whilst the bar for satisfying either option is high, the failing firm defence is already being considered by the CMA in the context of Covid-19 in its review of the Amazon/Deliveroo transaction, providing some guidance on its application in the context of Covid-19.
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Merger control regimes are still in operation during the Covid-19 outbreak, although there have been some changes, in particular to encourage parties to delay notifications, and in some cases, merger control authorities have temporarily closed. For transactions that need urgent clearance, a number of potential options may be available for consideration - these are considered in our more detailed guidance The impact of Covid-19: Merger control in times of crisis.
In the context of transactions involving distressed targets, there are two particular options which merit consideration where the acquirer has significant overlapping businesses with those of the target (and therefore neither a speedy clearance, nor a derogation from applicable suspensory obligations is likely to be available), namely:
- the "failing firm" defence; and
- a weakened competitor, or "flailing firm" argument.
"Failing firm" defence
The "failing firm" defence is in principle accepted by many competition authorities globally. In broad terms, where one of the parties to a transaction is failing and will exit the market in the absence of the transaction, this reduction in the number of competitors should not be attributed to the transaction. Rather, the assessment of the effect of the transaction on competition should be assessed by reference to a world in which the restructured business did not exist as an independent entity. Key considerations in this regard include:
- Reliance on the failing firm defence will not result in a speedy clearance. The competition authority will still need to decide whether the transaction is otherwise likely to raise competition concerns and if so, whether the conditions for the failing firm defence are met.
- There are strict conditions for the application of the defence, which need to be demonstrated to the regulator with compelling evidence, namely:
- absent the merger, the target business (and its assets) would inevitably have exited the market in the near future and there is no serious prospect of a successful re-organisation; and.
- there is no less anticompetitive alternative to the transaction, such as the purchase of the failing firm (or its core assets) by an alternative buyer which raises fewer competition concerns or, potentially, the firm exiting and remaining players competing for its market share rather than all of its market share transferring to one competitor.
- Regulators are typically strict in their application of failing firm arguments. In many cases, the application of these arguments is rejected (including where a company enters into administration), often because the regulator concludes that there are alternative, less anticompetitive purchasers. It should also not be assumed that the current situation will make the defence easier to substantiate.
CMA's first use of failing firm defence during Covid-19?: Amazon/Deliveroo
Whilst the failing firm defence has a high bar, it has historically been accepted in some cases and this is also beginning to happen in the context of Covid-19. On 22 April 2020, the CMA published Guidance on the CMA’s approach to merger assessment during the Coronavirus pandemic (with an annex summarising the CMA’s position on mergers involving "failing firms") in which it confirmed that it will apply the same approach to the failing firm defence in the context of Covid-19 as in normal times and in particular that there will be no relaxation of evidential standards. Nevertheless, on 17 April 2020, the CMA announced in the context of its detailed Phase 2 investigation into the acquisition by Amazon of a minority stake in Deliveroo that it had provisionally found (CMA summary of provisional findings here) that the transaction was not expected to result in a substantial lessening of competition as a result of the failing firm argument. This followed the CMA's December 2019 Phase 1 decision that the transaction merited a detailed investigation due to the risks it posed to competition, in particular the transaction might have reduced the likelihood of Amazon re-entering the online restaurant delivery market (which it had exited in November 2018). Specifically, the CMA has provisionally concluded that, in light of Covid-19 and the resulting impact on Deliveroo's revenues:
- Deliveroo is likely to exit the market without receiving the additional funding available from Amazon through the acquisition, following significant declines in its revenue as a result of restaurant closures caused by the Covid-19 lockdown, at a time when Deliveroo has an urgent need for additional funding;
- no less anti-competitive investor than Amazon is likely to be available in the timescale needed. In particular, whilst potential alternative investors were available pre-Covid-19, that was no longer likely to be the case in light of the pandemic, and in any event, alternative sources of funding would not likely be available within the required timescale; and
- Deliveroo's exit would be more detrimental to customers and competition than the transaction, reflecting the fact that there are only three significant players in the online restaurant and online convenience grocery markets (of which Deliveroo is one). Deliveroo's exit (even if in due course followed by Amazon's re-entry) would therefore be likely to lead to higher prices and/or a lesser degree of expansion or innovation from the other two leading players (Just East and Uber Eats).
The CMA is aiming to reach its final decision by the end of May 2020.
"Flailing firm" argument
The "flailing firm" argument is based on the fact that regulators will typically be required to assess future competition in the marketplace by reference to historic data. The flailing firm argument applies where, although not in imminent danger of collapse or market exit absent the transaction, one of the parties has recently been weakened and thus its historic market share may overstate its current and future competitiveness.
Again, the success of this argument is likely to be based on the availability of compelling evidence as to the future competitiveness of the company in question and its prospects for successful rejuvenation. In this regard, the fact that the current crisis is generally seen as likely to be temporary means that liquidity issues caused by Covid-19 are unlikely to be seen as justifying a permanent change to the market structure which may be anticompetitive.
