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The Global Financial Crisis - will it affect merger review?

The global financial crisis has significantly impacted markets across the world, leading to corporate failures and market consolidation. In this context, there has been some debate in competition circles of the increased possibility of gaining merger clearance on the basis of a target company’s imminent failure.

In particular, it may be possible to gain clearance for transactions raising significant competition concerns on the basis that, absent the merger, the target would otherwise fail and exit the market, thereby leading to a diminution in competition. These so called ‘failing firm’ arguments may well become more common in the coming period as companies seek to acquire failing firms.

Development of the failing firm defence

The failing firm defence was first recognised by the United States Supreme Court in International Shoe Co. v FTC (1930) where the Supreme Court held that the target was facing “financial ruin” and that, in those circumstances, the least anti-competitive result would be to allow the target to be acquired, rather than to exit the market altogether. The failing firm defence was subsequently refined in Publishing Co. v United States (1969) and later adopted by the United States Fair Trade Commission and United States Department of Justice in their joint Merger Guidelines.

Scope and application of failing firm arguments in Australia

There is no failing firm defence in Australian law. Neither section 50 of the Trade Practices Act 1974 (Cth), nor the Australian Competition and Consumer Commission (ACCC) Merger Guidelines recognise a failing firm defence that might permit a merger that would otherwise result in a substantial lessening of competition. However, where a firm is failing (i.e. it is in imminent danger of failure, with the consequence that its assets would exit the market), the failing firm argument may be taken into account when conducting a merger review to determine whether there is likely to be a substantial lessening of competition if the merger does not proceed with the result that the failing firm exits the market.

In particular, the failing firm argument may form an essential element of the counterfactual analysis in which the ACCC determines the likely nature of competition in the market absent the merger.

Recent merger guidance - Primo/Hans

The ACCC’s position on failing firms has been recently highlighted in relation to the proposed acquisition of Hans Continental Smallgoods Pty Limited (Hans) by P&M Quality Smallgoods Pty Limited (Primo).

Despite the significant anti-competitive effects identified, the ACCC concluded that, given the imminent failure and market exit of Hans, and the absence of alternative purchasers, Primo’s acquisition would not “result in a substantially less anti-competitive outcome” than permitting Hans to fail (i.e. the relevant counterfactual).

However, the ACCC stated that it would assess any failing firm argument rigorously, and indicated that, in order to rely on the argument, the parties will be required to provide detailed and objective evidence clearly demonstrating that:

  • the target will fail and cannot be successfully restructured absent the merger;

  • its assets (including brands) will exit the market absent the merger;

  • an alternative purchaser is not likely to acquire the entity (this may well be easier to prove with the current withdrawal of private equity); and

  • permitting the acquisition would not be any more anti-competitive than allowing the target to fail.

“Flailing versus “failing” firms

Firms that have healthy long term prospects, but due to market or other circumstances have become less competitive than previously, are likely to constitute ‘flailing’ rather than ‘failing’ firms.

The ACCC addressed the topic of ‘failing’ versus ‘flailing’ firms to a degree in its assessment of the acquisition of BankWest and St Andrew’s Bank by Commonwealth Bank of Australia (CBA). Prior to its acquisition, BankWest was a wholly owned subsidiary of HBOS plc (HBOS), a major United Kingdom bank that faced imminent collapse in September 2008 as a result of its exposure to bad debts and inability to obtain short term funding on the global markets.

In assessing the proposed acquisition, the ACCC indicated that BankWest was unlikely to be a strong competitor absent the acquisition because of the impact of the global financial crisis on HBOS.

In particular, the ACCC accepted that BankWest's historically aggressive price competition had been underpinned by cheap wholesale funds from global debt markets accessed through HBOS. As a result of the global economic crisis, the ACCC formed the view that the financial condition of HBOS had deteriorated, such that, if the acquisition did not proceed, BankWest would not be supported in its continued growth, nor would its aggressive pricing strategies continue.

Consequently, although the failing firm argument was not of central importance in the CBA/BankWest merger, the ACCC assessed the future state of competition in the market absent the merger and concluded, in essence, that BankWest would certainly be a ‘flailing’ firm, and may become a ‘failing’ firm absent the merger, due to the financial difficulties of its parent.

What does this mean for future Australian bank mergers?

ACCC Chairman, Graeme Samuel, recently stated that the ACCC is “becoming increasingly concerned that the banking system is becoming less and less competitive…We would be looking at further mergers very, very closely We would not accept at first or second blush the proposition that to not allow this merger would lead to instability in the market”. In other words, as with the ACCC’s review of the Primo/Hans transaction, parties should expect a very vigorous ACCC merger analysis in future banking mergers and heavy reliance on the views of APRA and the RBA.

The ACCC’s unwillingness to clear bank mergers which may raise material competition issues, in order to underpin market instability, indicates a regulatory toughness which is likely to be supported in other jurisdictions, particularly by the United Kingdom, given the Government’s role in ensuring that Lloyds TSB plc’s acquisition of HBOS in late 2008 was not blocked on competition grounds. However, given the global scale of the financial crisis and the example set in comparable jurisdictions, the question remains whether the political realities would require further bank mergers to proceed irrespective of competition concerns, should Australia’s situation worsen.

Conclusion

Given the current economic climate, there is greater potential for the failing firm argument to be invoked in the context of merger reviews, though the relevant circumstances in which it will succeed would appear to be quite limited.

Acknowledgment

This article is derived from a paper presented at the Competition Law Conference, Sydney, May 2009, prepared by Dave Poddar with the assistance of James Marshall and Leisha Marasinghe. A full version of this paper will be published later in the year in the Trade Practices Law Journal.

Author
Leisha Marasinghe, Solicitor

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  • Leisha Marasinghe - Solicitor | Email
 

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