Australia: Mergers and acquisitions: The "failing firm" defence for companies in financial difficulty

Recent merger decisions by the European Commission and UK competition authorities indicate a more sympathetic approach to acquisitions of companies in financial difficulty

The "failing firm" defence applies in the context of competition authorities scrutinizing mergers and acquisitions – that is, merger control – where the rescue of a company in financial difficulties and on the verge of insolvency is involved. Under the "failing firm" defence, the argument is made that, although the transaction might seem to reduce competition, the fact that the target company is on the verge of insolvency and about to exit the market anyway means that, in fact, there is no reduction in competition – i.e., in the absence of the transaction, the target would not have remained a competitor.

As was explained in Competition World a year ago ( Competition World, January 2013, "Mergers and acquisitions – The 'failing firm' defence: How should competition authorities treat acquisitions of companies in financial difficulty?"), antitrust and competition authorities are generally reluctant to accept the failing firm defence. However, the failing firm defence can succeed (and the transaction can gain competition clearance) if three stringent criteria are all satisfied:

  • In the absence of a takeover, the target company would be forced out of the market because of financial difficulties "in the near future".
  • Without a takeover, the target company's assets would inevitably exit the market.
  • There is no less anti-competitive alternative purchase than the particular transaction under consideration – i.e., the target could not realistically have been taken over by another business that either is not a competitor of the target or has a lower market share than the acquirer in the transaction being considered.

A year ago, the difficulties of running the "failing firm" defence were highlighted by a couple of merger cases before the UK and French competition authorities – the acquisition by the US greetings card manufacturer American Greetings of Clinton Cards,15 a UK greetings card retailer in financial difficulties (in which the UK antitrust authority considered, but rejected, the failing firm defence, but nevertheless cleared the transaction on the grounds that it did not raise sufficient competition issues to cause concern); and the acquisition by the Channel Tunnel operator Eurotunnel of certain assets of the insolvent cross-Channel ferry company SeaFrance (in which the UK authority prohibited the merger, rejecting the failing firm defence on the basis that there was a less anti-competitive alternative purchaser,16 while the French competition authority cleared it but made no mention of the "failing firm" defence).17

However, the past three months have shown that it is possible for the "failing firm" defence to be pleaded successfully. Both the EU and the UK competition authorities have recently allowed transactions to proceed on the basis that the target company could not have continued to operate as an economically sustainable business and that the transaction in hand was the least anti-competitive option.

Aegean Airlines / Olympic Air

The most interesting decision is the European Commission's October 2013 decision, whereby it unconditionally approved the acquisition of the Greek airline Olympic Air by its main domestic rival Aegean Airlines, even though the acquisition created monopolies on a number of routes, on the basis of the "failing firm" defence. The European Commission's decision was all the more remarkable because, just 33 months earlier, the European Commission had prohibited the acquisition by Aegean of Olympic and had explicitly rejected the failing firm argument.

The 2011 decision – rejecting the "failing firm" defence

In January 2011, the European Commission announced that it would prohibit Aegean's proposed acquisition of Olympic on the grounds that – in the words of the European Commissioner for competition, Joaquín Almunia – it

"would have led to a quasi-monopoly in Greece and thus to higher prices and lower quality of service for Greeks and tourists travelling between Athens and the islands. It is the duty of the Commission to prevent the creation of monopolies when applying the EU merger control powers...".18

In the January 2011 prohibition decision, the Commission explicitly rejected the failing firm defence. It did not consider that the three criteria listed above were met.

Specifically, the European Commission refused to accept that:

  • Without a takeover, Olympic would inevitably exit the market – the Commission felt that there was a possibility of restructuring Olympic through a combination of retrenching from international operations and entering significant cooperation agreements, allowing it to carry on in business while retaining its domestic operations;19 or
  • There was a less anti-competitive alternative purchase – since, in the auction process for Olympic, several bidders had been interested in acquiring the business.20

The 2013 decision – accepting the "failing firm" defence

Less than three years later, the European Commission, considering a fresh proposal for Aegean to acquire Olympic, reversed its position and unconditionally cleared the merger on the basis of the failing firm defence.

This was in spite of competition concerns clearly remaining. Indeed, the European Commission had in April 2013 launched a full "Phase 2" investigation into the transaction on the grounds that it

"raises serious competition concerns on a number of Greek domestic routes where Aegean and Olympic currently compete or are well placed to compete".

The European Commissioner, Joaquín Almunia, was aware that Olympic, and indeed the Greek economy as a whole, now faced financial and economic difficulties, but it nevertheless launched the Phase 2 investigation on the grounds that it was important that passengers should be able to travel at competitive air fares, "even more so during challenging economic times".21

Nevertheless, at the end of the Phase 2 investigation, the European Commission decided to clear the proposed transaction unconditionally in October 2013. The Commission accepted that:

  • In the absence of the proposed transaction, Olympic would be forced out of the market: "Olympic has never been profitable since its privatisation in 2009 and has received considerable financial support from its sole shareholder... ever since... The company is highly unlikely to become profitable in the foreseeable future under any business plan. [The sole shareholder] had therefore decided to discontinue its support of Olympic... This would lead to Olympic's permanent shutdown in the short term"; and
  • Moreover, there was no anti-competitive alternative purchaser: "There has been... no expression of any credible interest in the acquisition of Olympic's assets including its brand."

Commissioner Almunia concluded with the classic statement of the implications of the failing firm defence – that the transaction does not reduce competition, because the competitor would not be there in any case:

"It is clear that, due to the on-going Greek crisis and given Olympic's own very difficult financial situation, Olympic would be forced to leave the market soon in any event. Therefore we approved the merger because it has no additional negative effect on competition."22

Acquisition of Shell's Harburg refinery assets by Nynas AB

The European Commission had come to a similar conclusion a month beforehand in relation to the proposed acquisition by the international petrochemical company Nynas AB of a base oil manufacturing plant in Harburg, Germany, which was owned by Royal Dutch Shell Plc.

Initially, the European Commission had a number of concerns about the proposed transaction, since the merged entity would become the only naphthenic base and process oil producer and the largest producer of transformer oils in the European market. The only competition faced by the merged entity would be from a US-based company that imported base oils into Europe. The Commission therefore opened an in-depth "Phase 2" investigation to consider the transaction in more detail.

However, during the investigation, Shell demonstrated that it would not continue to operate the Harburg refinery in its current economically unsustainable set-up, and it became clear to the Commission that there were no alternative buyers for the Harburg refinery assets other than Nynas.

The European Commission therefore approved the acquisition, since it considered that a closure of the Harburg refinery assets was the most likely scenario in the absence of the proposed transaction. Commissioner Almunia said:

"If this acquisition did not take place, the Harburg plant would simply close down, dramatically reducing production capacity in Europe for a number of specific oil products. We authorised this acquisition because it is the only way to avoid a price increase for consumers."23

The Commission also had a slightly more positive reason to approve the transaction. It found that an acquisition of the Harburg plant by Nynas was likely to result in Nynas achieving significant reductions of variable costs for its additional supplies, which were likely to be passed on to consumers to some extent.

Soon thereafter in the UK...

In November, the UK competition authorities allowed the merger between Optimax Clinics Limited and Ultralase Limited, two of the three largest providers of laser (refractive) eye surgery in the UK, to proceed - again as a result of a successfully pleaded "failing firm" defence.

At the time of the transaction, Optimax Clinics, Ultralase and the largest player in the market, Optical Express, accounted for the large majority of the UK laser eye surgery market, although Optical Express was considered to be nearly twice as large as Optimax Clinics and Ultralase combined. The UK Office of Fair Trading therefore referred the transaction, which had already been completed, to the UK Competition Commission for an in-depth investigation.

In assessing the transaction, the Competition Commission considered what was likely to have happened in the UK laser eye surgery sector if Optimax Clinics had not acquired Ultralase. Having assessed the parties' views and submissions by Ultralase's accountants and its banks, the Competition Commission concluded that the Ultralase business would have failed financially and would have exited the market. Indeed, during the Competition Commission's investigation, Ultralase was put into administration.25

The Competition Commission subsequently considered whether there were other buyers whose acquisition of Ultralase as a going concern (or of its assets) would have resulted in a less anti-competitive outcome than the transaction under consideration. However, having weighed up the evidence, the Commission concluded that Optimax Clinics was the only credible bidder and that the other bidders that had expressed an interest would have been highly unlikely to purchase Ultralase. The Commission therefore concluded that Ultralase would have exited the market, if it had not been acquired by Optimax Clinics.26

Finally, the Competition Commission assessed what would have happened to the sales of Ultralase if Ultralase had exited the market, and then compared that hypothetical situation with what had actually happened to the distribution of Ultralase's sales since the merger. The Competition Commission came to the view that the distribution of sales in the hypothetical "exit scenario" would not have differed significantly from that in the post-merger situation.27

The UK competition authorities therefore ultimately concluded that the acquisition of Ultralase by Optimax Clinics did not lead to a less competitive outcome in the UK market for refractive eye surgery than Ultralase exiting the market as a result of financial difficulties.

Practical lessons

These three recent cases show that it is possible for the "failing firm" defence to succeed, even though the criteria are stringent. Moreover, the Aegean / Olympic saga with the European Commission's volte-face demonstrates that, even when it is not successful at first, continuing deterioration in conditions can allow it to be run again successfully. Assuming it is not too late by then.


15 UK Office of Fair Trading merger decision, American Greetings / Clinton Cards Group, ME/5575/12, October 12, 2012 paragraphs 49-61.
16 UK Competition Commission merger report Groupe Eurotunnel / SeaFrance, June 6, 2013, paragraphs 5.1 to 5.27.
17 French Competition Authority (Autorité de la concurrence) merger decision, press release on Eurotunnel / SeaFrance, 12-DCC-154, November 8, 2012.
18 European Commission press release IP/11/68, "Mergers: Commission blocks proposed merger between Aegean Airlines and Olympic Air", January 26, 2011.
19 European Commission merger decision, Case COMP/M.5830 Olympic / Aegean Airlines, decision of January 26 2011, paragraph 2068.
20 European Commission decision, Olympic / Aegean Airlines, January 2011 (as above), paragraph 2076.
21 European Commission press release IP/13/361, "Mergers: Commission opens in-depth investigation into proposed acquisition of Olympic Air by Aegean Airlines", April 23, 2013.
22 European Commission press release IP/13/927, "Mergers: Commission approves acquisition of Greek airline Olympic Air by Aegean Airlines", October 9, 2013.
23 European Commission press release IP/13/804, "Mergers: Commission approves acquisition of Shell's Harburg refinery assets by Nynas AB of Sweden", September 2, 2013.
24 UK Competition Commission merger report Optimax Clinics Limited / Ultralase Limited, November 20, 2013.
25 UK Competition Commission merger report Optimax Clinics Limited / Ultralase Limited, November 20, 2013, paragraphs 5.22- 5.25.
26 UK Competition Commission merger report Optimax Clinics Limited / Ultralase Limited, November 20, 2013, paragraphs 5.35-5.45.
27 UK Competition Commission merger report Optimax Clinics Limited / Ultralase Limited, November 20, 2013, section 6.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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