As previously discussed in our Refresher on the Failing Firm Defence, many companies will be facing insolvency or bankruptcy in the aftermath of COVID-19. This could lead to a situation in which financially stronger companies want to purchase struggling competitors. In this context, it is likely that the Competition Bureau will be asked to approve otherwise "problematic" mergers on the basis of what is commonly known at the "failing firm" defence.
On April 29, 2020, the Bureau issued a Position Statement providing additional guidance on the failing firm defence and, in particular, the types of information that are most relevant for a timely and efficient analysis of a failing firm. The key aspects of this guidance are summarized in this blog post.
In early November 2019, the Bureau was advised that American Iron & Metal Company Inc. ("AIM") was proposing to acquire Total Metal Recovery Inc. ("TMR"). As AIM and TMR were the two largest scrap metal processors in Quebec, the Bureau initiated a formal inquiry into the transaction on December 5, 2019.
Prior to closing the transaction on December 20, 2019, the merging parties submitted to the Bureau that TMR had suffered financial losses and was in financial distress. As a result, a significant aspect of the Bureau's investigation focussed on whether TMR was a failing firm in the context of paragraph 93(b) of the Competition Act and Part 13 of the Bureau's Merger Enforcement Guidelines ("MEGs"). To assist with its analysis, the Bureau retained a financial expert to review the submissions received from AIM's financial expert. The Bureau also obtained documents and data from the merging parties and numerous industry stakeholders, both voluntarily and pursuant to court orders.
Following a three-month inquiry, the Bureau closed its investigation after concluding that the transaction was not likely to result in a substantial prevention or lessening of competition. Specifically, the Bureau found that TMR was a failing firm whose assets were likely to have exited the market in the absence of the merger.
A Factor for Consideration
When the Bureau reviews mergers to determine whether they are likely to result in a substantial prevention or lessening of competition, it considers a number of factors as part of its analysis, including "whether the business, or a part of the business, of a party to the merger or proposed merger has failed or is likely to fail". Thus, probable business failure is not a defence to an otherwise anticompetitive merger. Rather, it is just one of many factors that the Bureau considers as part of its analysis.
Failing Firm Analysis
In carrying out its failing firm analysis, the Bureau generally considers two issues:
- whether the firm's imminent failure is probable and, in the absence of a merger, the assets of the firm are likely to exit the relevant market; and
- whether alternatives to the merger exist and are likely to result in a materially greater level of competition than if the proposed merger proceeds.
Where there is likely failure and exit of the target with no competitively preferable alternative, the merger can be permitted on the basis that the loss of the actual or future competitive influence of a failing firm is not attributed to the merger.
(a) Business Failure and Exiting Assets
As noted in the MEGs, a firm is considered to be failing if it is insolvent or is likely to become insolvent; it has initiated or is likely to initiate voluntary bankruptcy proceedings; or it has been, or is likely to be, petitioned into bankruptcy or receivership.
The Bureau requires detailed information from the parties in order to assess whether a firm is failing. For example, as stated in the Position Statement, "[a]ssessing whether a firm is failing or is likely to fail requires a careful analysis of that firm's financial information such as audited financial statements, liquidity reports and forecasts, business plans, correspondence to and from creditors, as well as documents related to plans to initiate bankruptcy proceedings or seek creditor protection under the Company Creditors Arrangement Act". The Bureau analyzes this information using various methodologies, such as balance sheet solvency tests, ability to pay solvency tests and statistical bankruptcy prediction models that have been established in the accounting industry.
(b) Alternatives to the Merger
An otherwise anti-competitive merger will not be allowed to proceed simply because a firm is failing. Rather, the Bureau also examines the likelihood of various counterfactual scenarios to the merger and the expected levels of competition in the market under such scenarios. These counterfactual scenarios include the sale of the firm to a competitively preferable purchaser, the restructuring or retrenchment of the failing firm, and liquidation of the failing firm's assets.
Acquisition by a Competitively Preferable Purchaser
The Bureau assesses whether there exists a third-party whose purchase of the failing firm is likely to result in a materially higher level of competition in the market (a "Competitively Preferable Purchaser"). Where it is determined that a Competitively Preferable Purchaser exists, it can generally be expected that, if the proposed merger under review cannot be completed, the failing firm will either seek to merge with that Competitively Preferable Purchaser or remain in the market.
As noted in the Position Statement, "[t]he first step in determining whether such a purchaser exists is an assessment of whether a thorough search for a purchaser has been carried out". Detailed documents and information will need to be produced to the Bureau to establish that a thorough search for alternate buyers has been conducted. This includes a complete list of potential buyers that were approached, together with contact information for those potential buyers, information related to the distribution of a Confidential Information Memorandum or similar document describing the operations of the target company to other firms, as well as responses to requests for expressions of interest. If the Bureau is not satisfied that a thorough search has been conducted, the Bureau may require the involvement of an independent third-party (such as an investment dealer, trustee or broker who has no material interest in either of the merging parties or the proposal in question) to conduct such a search before the failing firm rationale is accepted.
If one or more alternative buyers expressed interest in purchasing the failing firm, documents and information must be provided to demonstrate the steps taken by the failing firm and the interested buyer in relation to negotiations and attempts to finalize a deal. This includes, among other things, all correspondence between the parties, draft purchase agreements, due diligence reports, internal correspondence related to a proposed transaction, as well as recommendations and decisions by senior management or shareholders of the parties.
Significantly, the Position Statement notes that "[e]ven when an alternative purchaser would likely be competitively preferable, its ability to finalize a transaction in a timely way is important in determining whether it would be a viable alternative to the potentially anti-competitive merger under review".
Retrenchment / Restructuring
The Bureau will assess whether the retrenchment or restructuring of a failing firm may prevent failure and enable it to survive as a meaningful competitor. Documents and information showing attempts to restructure the firm by narrowing the scope of its operations, employing cost-cutting measures or searching for strategic partners to solidify operations instead of selling the whole business will be requested to help the Bureau determine whether this is likely to be a viable alternative to the merger.
Where the Bureau is able to confirm that there are no Competitively Preferable Purchasers for the failing firm and that there are no feasible and likely restructuring or retrenchment scenarios, it will assess whether liquidation of the failing firm's assets would be a materially better competitive alternative to a merger that may raise competition issues. Liquidation can, in some cases, facilitate entry into a market by enabling actual or potential competitors to compete for the failing firm's customers or assets to a greater degree than if the failing firm merged with the proposed acquirer. Information and documents from the parties relating to potential alternate uses for the assets as well as the ease by which those assets can otherwise be obtained by other firms will be requested to help the Bureau assess whether liquidation may be a preferable alternative to the merger.
Significantly, the Position Statement notes that, "[b]ecause liquidation is disruptive to all parties involved and may not result in an efficient allocation of resources, there are very limited circumstances under which the Bureau may determine that liquidation is the preferable outcome".
The Bureau's review of the AIM/TMR transaction and the guidance provided in the Position Statement include several key takeaways for businesses.
First, as was the case with the Canadian National Railway Company / H&R Transport Limited transaction recently allowed on efficiencies grounds, the AIM/TMR transaction was not subject to pre-merger notification under the Act. This reinforces prior statements by the Commissioner that the Bureau will closely scrutinize non-notifiable transactions that may raise competition concerns. It also reinforces the importance of performing a pre-merger assessment of the potential anti-competitive impact of any proposed non-notifiable merger to avoid an unexpected review by the Bureau. Parties who fail to do so may find themselves involved in an unexpected Bureau review of their proposed or completed merger.
Second, the Bureau has not changed its approach to the analysis of failing firms in light of COVID-19. Merging parties that intend to invoke the failing firm rationale will be required to meet the same high bar that the Bureau has applied in the past. This is consistent with the Bureau's general messaging that the substantive competitive effects test remains the same and that businesses should not expect a "free pass" or a more lenient approach to merger review as the pandemic continues.
Third, as suggested in the Position Statement, merging parties should consider making failing firm submissions to the Bureau as early as possible. These submissions should include detailed information about the financial status of the failing firm, the steps taken to shop the failing firm's business and an explanation of why there are no competitively preferable alternatives to the merger. While the Bureau does not specifically require that the search for alternative purchasers be conducted by an independent third-party, failing firm claims will likely be viewed as more credible where the search has been undertaken by an external firm and detailed information concerning both the thoroughness of the search and the responses from other potential purchasers is provided to the Bureau.
Fourth, because the Bureau applies complex methodologies and models as part of its failing firm analysis, merging parties should consider retaining a financial or accounting expert at the outset.
Fifth, the AIM/TMR Transaction is a reminder that the Bureau is open to failing firm claims in appropriate cases. While the Bureau carefully reviews these claims, our experience is that the Bureau can complete its review relatively quickly provided that the necessary information is provided to the Bureau as soon as possible.
Finally, it is worth noting that failing firm claims are not unique to Canada. In fact, the United Kingdom's Competition & Markets Authority recently cleared Amazon's proposed investment in Deliveroo, a company that provides delivery services for its partner restaurants. According to its news release, the CMA concluded that "Deliveroo's exit from the market would be inevitable without access to significant additional funding, which ... only Amazon would be willing and able to provide at this time" and that "the imminent exit of Deliveroo would be worse for competition than allowing the Amazon investment to proceed".
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.