Maintaining Competition: The Failing Firm Defense in Indian M&A Transactions
[Shivek is a student at Amity Law School, Delhi.]
The disastrous impact of the COVID-19 on domestic businesses is widely documented. In order to stay afloat, many failing businesses may be forced to consider a merger or an acquisition by another entity. Such parties would require a clearance from the Competition Commission of India (CCI), if the proposed transaction meets the financial thresholds under Section 5 of the Competition Act 2002 (Act).
In case the transaction raises anti-competitive issues, parties may employ the ‘failing firm’ defense in order to improve their chances of getting the transaction approved by the CCI. In this post, the author delves into the essential elements of a failing firm defense and its viability in India post COVID-19.
What is a failing firm defense?
In a failing firm defense, the target firm is at the brink of a financial crisis. The acquiring firm argues that a proposed combination with such a firm is not likely to have an appreciable adverse effect on competition, since in the absence of the combination, the target firm would inevitably exit the relevant market. Thus, the argument in such cases is that such a combination is not likely to strengthen its dominant position or facilitate its exercise; rather its post-merger performance would help maintain the competition / a status quo position in the relevant market. In other words, the competition in the relevant market may suffer instead of being protected, if the transaction is blocked and the target firm exits the market altogether.
In India, Section 20(4)(k) of the Act recognizes 'possibility of a failing business' as a factor in regulating combinations. Thus, a failing firm is not an absolute defense to approve a transaction, but one of the factors that the CCI may consider to determine whether or not a combination would have an appreciable adverse effect on competition in the relevant market.
The reason for listing 'possibility of a failing business' as a factor can be found in the report of the S.V.S Raghavan Committee (Raghavan Committee Report) on competition law. The report suggested that no social welfare loss would occur, if the assets of a failing business were combined / taken over by another firm.
The failing firm defense in India is at a nascent stage. The Act does not clarify what constitutes a failing business, nor does it clarify how such a claim should be evaluated by the CCI. However, parties may be able to take guidance from the European Union Guidelines on Horizontal Mergers (Paragraph 89) and the United States Horizontal Merger Guidelines (Section 11). A combined reading of the relevant provisions in these jurisdictions highlights the following essential elements to employ this defense –
the failing firm is not / will not be able to meet its financial obligations in the near future;
the failing firm is incapable of a financial reorganization to make its business viable again;
the failing firm in good faith has exhausted every other alternate recourse;
the failing firm is (a) likely to initiate voluntary insolvency proceedings; or (b) likely to be petitioned into insolvency proceedings; or (c) currently involved in insolvency proceedings; and
in case the transaction is blocked, the failing firm would inevitably exit the market.
Highlighting ‘efficiencies’ in a failing firm defense in India
Apart from proving the elements detailed above, one possible approach to succeed in a failing firm defense in India can be to additionally highlight the efficiencies that may emerge as a result of the proposed combination. Efficiencies refer to the benefits that may arise in the relevant market, in case the combination is cleared.
The tenet of this approach can also be traced back to the Raghavan Committee Report. The Raghavan Committee Report members agreed that mergers that may lead to an anti-competitive outcome should not be out-rightly rejected, if they result in certain “efficiencies” that exceed the anticipated welfare loss from the proposed combination.
Even Section 20(4)(n) of the Act states that in case the efficiencies in a proposed combination are significant, and they outweigh the threat of adverse effect on competition, it can act as a factor in favor of non-interference by the CCI.
A few examples of cognizable efficiencies can be -
1. Lower cost products: In the case of a horizontal merger, the transaction can help combine two high-cost competitors to become one lower-cost competitor. This would reduce the cost of goods and services provided in the relevant market, and overall enhance the competition.
2. Job creation: The proposed combination can help increase employment in the combined firm, or the distribution or supply chain, depending on the nature of the transaction.
3. Economies of scale: A combination of the assets of the two firms can increase the production of goods and services, while reducing the cost of production which can subsequently help achieve economies of scale.
4. Economies of scope: In case of a horizontal merger, the combination of the assets of the two firm will help in reducing the cost of production, by increasing the volume of production of complementary goods and services. This will help achieve economies of scope.
5. New and innovative products: A case can also be made that the combination of the assets of two firms is likely to enhance research and development in the organization, which will lead to new and better quality products and services in the relevant market.
The importance of the failing firm defense post COVID-19 in India
India is facing an economic slowdown caused by the pandemic. As a result, the CCI will face a unique problem in balancing market competition and saving essential failing businesses. While it is important to err on the side of caution and prevent possible problematic mergers to promote and protect competition, it is equally important to protect businesses that are financially distressed due to unprecedented and unforeseeable factors and prevent adverse market reactions arising from their exit.
The impact of a national economic crisis on failing businesses has earlier been considered and allowed in the case of Aegean/Olympic II (Case M. 6797). Here, the European Commission (EC) cleared the merger of Olympic Air with Aegan Airlines (a rival competitor in the aviation market), after it qualified the criteria mentioned in the European Horizontal Merger Guidelines (supra) of a failing firm. It is interesting to note that two years before this decision, the EC had blocked a similar transaction between the same parties. However, it approved the transaction after taking note of the Greek economic crisis and its consequent financial impact on Olympic Air.
Further, blocking a combination involving a failing business can have an adverse impact on the price, choice and accessibility of goods and services. Recently, the Competition and Market’s Authority (CMA) in the United Kingdom had an opportunity to analyze the failing firm defense in Amazon’s acquisition of a minority stake in Deliveroo, a food delivery start-up. While analyzing the impact of COVID-19 on the food delivery business, the CMA held that blocking the transaction could result in higher prices, reduced quality, reduced choice or a complete cut off from food delivery for customers. The loss of the food delivery application would have been more detrimental to the relevant market and the consumers, than permitting the proposed combination.
In view of the above, while considering the failing firm argument, the CCI also ought to consider factors such as price, choice and accessibility that presently have a heightened relevance for consumers. Even if a combination appears to strengthen a firm's dominant position or facilitate its exercise, to prevent fueling the economic slowdown, the CCI should not block a combination if (a) it maintains competition in the market and not lessens it or (b) if it is resulting in large scale efficiencies or (c) in comparison, the exit of the failing firm would adversely impact the competition more than if the transaction were to take place.
Thus, the failing firm argument whenever employed, will play an important role in deciding the fate of a proposed combination in India post COVID-19.
In India, the lack of statutory guidance and precedents pose a considerable challenge in successfully employing a failing firm defense. However, the COVID-19 pandemic and the domestic economic slowdown form a conducive environment for the CCI to appreciate such a claim. To gain clarity on its application, interested parties can opt for a pre-filing consultation with the CCI regarding required information, or relating to any interpretation issues with the Act.
Parties can also take a cue from the Canadian Merger Enforcement Guidelines, which extensively deal with the procedure to be followed and the evidence required to succeed in a failing firm defense. These guidelines suggest that parties can rely on projected cash flows, audited financial statements and proof of continuing operating losses to prove that a firm is failing and is likely to exit the market. Additionally, the failing firm can also rely on its internal communication, such as the minutes of board meetings, financial analysis memorandums and documented negotiations with other competitors to show that the subject business is incapable of being reorganized, and that there is no less-competitive alternative to the proposed combination.
In light of the recent decisions of the government and courts to protect the interests of failing businesses, it is hopeful that the CCI will not be easily dismissive about the ‘failing firm’ defense. At the same time, it is imperative for parties to provide relevant and a high degree of evidence to ensure the CCI that the combination is not being pursued with anti-competitive interests.