Covid-19 crisis highlights ‘failing firm’ defence in merger reviews

Jonathan Watson, IBA Finance CorrespondentMonday 5 October 2020

Before the onset of the Covid-19 crisis, UK competition regulator the Competition and Markets Authority (CMA) said it had ‘serious competition concerns’ about Amazon’s £442m investment in food delivery start-up Deliveroo. The deal gives Amazon a 16 per cent stake. The CMA was worried about possible future competition between Amazon and Deliveroo, which would be lost as a result of the investment.

In April, however, the regulator announced it was provisionally approving the deal. Its approval was then confirmed in early August.

The impact of Covid-19 led Deliveroo to claim at one point that it could collapse without the additional backing – an argument known as the ‘failing firm’ defence (FFD).

Companies seeking to rely on the failing firm defence will need to produce a substantial body of probative evidence to prove that the different elements of the defence are satisfied

Veronica Roberts
Partner at Herbert Smith Freehills

The CMA cast aside its previous doubts because ‘wholly unprecedented circumstances have meant reassessing the focus of [the] investigation, reacting quickly to the impact of the coronavirus and deciding what it would mean for the businesses involved in this transaction and, in turn, for customers’.

The verdict was delayed until August because of the CMA’s need ‘to take full account of representations received from the Parties and third parties in response to the provisional findings and to reflect the impact of Coronavirus (COVID-19) in its assessment.’

Some third parties were distinctly unimpressed by the CMA’s ultimate decision.

For example, rival takeaway company Domino’s Pizza said in comments submitted to the CMA that ‘The effect of the transaction is to reinforce the dominance of the Amazon ecosystem and opens up the real possibility of this dominance being leveraged into restaurant home delivery to the detriment of consumers’.

Responding to the CMA’s decision, Deliveroo stated it ‘will use the investment to increase choice and value for customers, support for restaurants and will be able to offer more riders the flexible work they value as the company expands.’

Despite the obvious reservations, there are sure to be more merger applications that rely on the FFD, according to Trevor Soames, Managing Partner of the Brussels office at Quinn Emanuel Urquhart & Sullivan. ‘The question will be whether the tests will be loosened up for public policy (industrial protection) reasons,’ he says.

‘Companies seeking to rely on that defence will need to produce a substantial body of probative evidence to prove that the different elements of the defence are satisfied,’ says Veronica Roberts, a partner at Herbert Smith Freehills.

It won’t usually be enough for the defence to be raised in merger submissions. Instead, the competition authorities will expect the key issues – such as genuine financial distress of the target – to be reflected in the company’s own contemporaneous internal documents. ‘For example, the CMA, in its recent “refresher” guidance on FFD, has said that it won’t accept speculation when considering the defence,’ says Roberts. ‘It needs to see relevant evidence.’

That guidance, published in April, was interpreted as a statement that it was ‘business as usual’ in terms of the ability of parties to notify mergers and engage with the CMA, but that the CMA was ready to adapt within the framework of its existing rules to the specific circumstances of the pandemic.

‘Regulators will always scrutinise an FFD very carefully and of course the tests for this do vary from jurisdiction to jurisdiction,’ says Charles Martin, Vice-Secretary of the IBA Private Equity Subcommittee and a partner at Macfarlanes in London.

‘The fact that jobs may be saved is most unlikely to be enough,’ explains Martin. ‘Regulators will always look to see if there is an outcome that could produce a better result from a competition perspective.’

Martin adds that regulators will never give stronger players carte blanche to sweep up weaker ones though a ‘fading firm’ argument can be successful: a weak company will not be an effective competitor if a deal is not done.

The last time the FFD was used successfully was in Aegean/Olympic II, when two Greek airlines were allowed to merge in the aftermath of Greece’s sovereign debt crisis. The European Commission concluded that if Olympic was not acquired by Aegean, it would ‘simply shut down’. Brussels reached that verdict ‘in part […] due to the economic situation in Greece’.

In April, Brussels regulators issued their first ‘comfort letter’ in almost 20 years concerning a cooperation project designed to avoid shortages of critical hospital medicines. ‘We would probably not have accepted this in normal times,’ said Olivier Guersent, the European Commission’s Director-General for Competition, in a video call organised in April by the American Bar Association.

Up until 2003, companies could notify the Commission of a cooperation agreement with a view to receiving an individual exemption from the application of European Union competition rules, provided certain conditions were satisfied, via a written ‘comfort letter’. Since the reform of the EU merger regime in 2003, this has not been possible, save in exceptional circumstances.

‘In this case, there was a need to increase production by some 15-20 per cent,’ Guersent said. ‘That could only be achieved by specialising the various production units and that needed to be coordinated.’

In April the Commission also issued antitrust guidance to companies cooperating in response to urgent situations related to Covid-19. It stated that competition laws were still very much in force and that it would continue to closely and actively monitor relevant market developments for breaches of competition law.

However, the pandemic has slowed down merger review times. Some countries have introduced formal extensions to merger control timings. Others, such as the United Kingdom, have indicated they will make use of more informal delay mechanisms, such as ‘stopping the clock’ after a request for documents.

Guersent said it has been ‘pretty much business as usual’ for the Commission, but market investigations have been a challenge. Companies are struggling with the impact of Covid-19 and do not have much time to deal with requests for information from regulators. ‘Low response rates make it difficult to proceed with an investigation,’ Guersent said.

Roberts says this is also a trend in the UK. ‘Feedback from third parties on general market characteristics, as well as views on the merger under review, are an important part of a competition authority’s assessment and in some sectors, where companies don’t have easy access to relevant data, they are finding it harder to comply with information requests,’ she says.

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