By Louise Caffrey, a student enrolled in her second year in the Economic Law Masters at Sciences Po Paris’ law school.
I- Background on the “failing firm defence”
According to the OECD’s Glossary of Industrial Organisation Economics and Competition Law, the concept of a “failing firm” is defined as follows:
“A firm that has been consistently earning negative profits and losing market share to such an extent that it is likely to go out of business.”
In the context of merger and acquisition proceedings, an acquiring entity may therefore rely on the “failing firm defence,” arguing that the notified transaction will not substantially lessen competition, in light of the “failing” nature of the target entity and its lack of current and future competitive significance. In other words, as the alternative to the acquisition would be the liquidation of the target entity, the acquisition of the “failing firm” would not lessen any viable competition.
This defence was first seen in American case law in 1930, with the case International Shoe Co. v. Federal Trade Commission, whereby the Supreme Court permitted the merger of two shoe companies. The Court ruled that the acquisition of one corporation, with depleted resources and dire prospects of rehabilitation, facing probable business failure sure to result in “loss to its stockholders and injury to the communities where its plants operated” by another competing corporation, did not violate Section 7 of the Clayton Act, because this transaction did not substantially lessen competition. Indeed, the acquired entity’s financial condition required “liquidation or sale, and, therefore, the prospect for future competition or restraint [had been] entirely eliminated.”
The requirements for such a defence to be accepted are clearly outlined in the Department of Justice and Federal Trade Commission US 1992 Horizontal Merger Guidelines, as follows:
- “The allegedly failing firm would be unable to meet its financial obligations in the near future;
- it would not be able to reorganise successfully under Chapter 11 of the Bankruptcy Act;
- it has made unsuccessful good-faith efforts to elicit reasonable alternative offers of acquisition of the assets of the failing firm that would both keep its tangible and intangible assets in the relevant market and pose a less severe danger to competition than does the proposed merger; and
- absent the acquisition, the assets of the failing firm would exit the relevant market.”
These conditions complement US case law treating the subject. For example, the United States v. General Dynamics Corp. case of 1974 laid out a “weak competitor claim,” stating that the current market shares of the target entity overstated its future market-shares in relation to other competitors on the market. Therefore, the future combined market shares resulting from the transaction would be smaller than the current combined market shares. This approach illustrated the court taking a long-sighted approach in its analysis of the transaction and its assessment on whether a target entity qualified as a failing firm.
The failing firm defence also resonates with another defence used when seeking the clearance of a transaction: the efficiency defence, by which parties argue that, though there may be significant anti-competitive effects in the relevant market, the transaction will generate efficiencies and should be cleared. These two defences converge where the failing firm defence can be argued as efficient, mitigating competitive issues that would arise in the scenario alternative to the transaction, i.e. the “failing firm” exits the market resulting in the risk of strengthening a dominant position, or causing welfare losses as the entities left on the market will need to meet the increase in demand from the exited entity’s leftover customers with a rise in production costs and prices.
Development of the defence in the European Union: scarcely accepted, scarcely argued.
Although originating in US case law, the failing firm defence also developed in European Union case law. Its first appearance was in 1991 in the Aerospatiale/Alenia/De Havilland case, concerning the acquisition of a division of Boeing De Havilland by Aerospatiale and Alenia. The parties argued the defence, but the Commission considered that it did not apply and left the question of whether this concept was relevant pursuant to Article 2 of the Merger Regulation 4064/89 open. The first successful use of the failing firm defence in EU case law was seen shortly after in 1994, in the Kali and Salz/MdK/Treuhand case. In light of the acquired entity being on the verge of bankruptcy, the Commission stated that a concentration “which should normally be considered to lead to the creation or reinforcement of a dominant position on the part of the acquiring [undertaking] can be regarded as not causing such a position on the market if, even in the event of the [concentration] being prohibited, the [acquiring undertaking] would inevitably achieve or reinforce a dominant position.” The Commission then set out the conditions for a concentration to be considered as not being the “cause of the deterioration of the competitive structure,” namely, if it is clear that:
- “the acquired undertaking would in the near future be forced out of the market if not taken over by another undertaking,
- the acquiring undertaking would take over the market share of the acquired undertaking if it were forced out of the market, [and]
- there is no less anticompetitive alternative purchase.”
On appeal of the case in 1998, the ECJ confirmed the pertinence of the defence and upheld its application by the Commission.
However, the Commission went on to accept the failing firm defence quite sparingly and did not rely on another failing firm defence argument until 2002 in another landmark case, BASF/Pantochem/Eurodial, whereby the Commission broadened the scope of its application of the defence. Indeed, instead of relying on the 3 criteria outlined in the Kali and Salz case and mentioned above, the Commission deviated from the second criterion stating that it would rather consider whether “the assets of the failing firm would definitely exit from the market” if not taken over by another. Thereafter, these evolved cumulative conditions for the application of the defence were integrated in the Commission’s Horizontal Merger Guidelines in 2004, a non-binding, but significant tool in the clarification of the application of European Merger Regulation. These Guidelines provide for a case-by-case analysis by the Commission in identifying the target entity as a failing firm.
But, the aforementioned criteria are not exhaustive, and other factors may be mentioned in establishing the characteristics of the failing firm, with the burden of proof laying with the merging parties. In this regard, Dr. Jurgita Malinauskaite remarked that such a “high burden of proof to demonstrate that the deterioration of the competitive structure following the transaction is not caused by the merger is overwhelming,” causing parties to struggle in successfully claiming the failing firm defence, even in times of crisis. Furthermore, these probative efforts are actually particularly difficult to satisfy in times of crisis. For example, as the parties must prove no less anti-competitive alternative credible purchaser exists in order to satisfy the third criterion, this is challenging in light of an undertaking’s rapidly deteriorating financial situation: what could have been considered to be an alternative purchaser may not be a credible interested purchaser in the near future.
Both the Commission’s scarce acceptance of the defence and the high burden of proof, seem to have dissuaded many parties in relying on the defence in cases at the EU level (as seen with the cases GE/Alstom in 2015, H3G/Wind in 2016, and T-Mobile/Tele2 in 2018).
II- The failing firm defence in past times of crisis
In 2009, the former European Commissioner for Competition Policy, Neelie Kroes, stated that “today’s softness is tomorrow’s nightmare,” implying that leniency in times of crisis can possibly do more good than harm. However, economists Mason and Weeds have upheld that even though the “rescue merger transactions” permitted by the successful application of the failing firm defence may “lead to a more concentrated market structure and therefore lower consumer welfare, the possibility of mergers in years of financial distress increases the expected profitability of operating in a market” and therefore encourage the entry of new undertakings onto the market and in the long term increase consumer welfare. In this way, they conclude, “a more lenient merger control policy [allowing for] mergers at an early stage of financial distress” can lead to long term benefits for the consumer.
Despite such support of the failing firm defence by economists, the Commission continued to apply this defence in a very limited way. Besides the aforementioned cases, Kali and Salz in 1994, and BASF in 2002, the Commission accepted the defence only 2 other times in 2013, amidst the aftermath of the 2008 financial crisis.
In the Nynas/Shell/Harburg Refinery case, the Commission accepted the defence in light of a large group’s failing division, the Harburg refinery operated by the Shell group. The Harburg refinery met the 3 aforementioned conditions necessary to characterize the failing firm: (1) the Harburg refinery assets would be forced to exit the market if not acquired by another undertaking, as proved by the refinery’s loss over the past 5 to 10 years and Shell’s public announcement of closure in the absence of a divestiture, (2) there was no less anti-competitive purchase than the notified merger, as, out of the only potential buyers identified (Nynas and its main competitor Ergon), only Nynas was found to have credible continued interest in acquiring the refinery, and (3) the Harburg assets would inevitably exit the market, in the absence of an alternative credible buyer. In this way, the merger was cleared by the Commission.
Another illustration of the Commission’s past approach to the failing firm defence in times of crisis can be seen in the Aegean/Olympic I and II cases, referred to the Commission by the competition authorities of the Hellenic Republic and of the Republic of Cyprus, in the wake of the Greek sovereign debt crisis, following the Great Recession of 2007-2009. At first, the Commission did not accept the failing firm defence as it assessed it with an assumption that the Greek GDP was “expected to become positive again in 2012” and that air transport demand was rising at the time. However, this was mistaken, as the parties returned to the Commission in 2013 with a similar transaction against the backdrop of Greece’s devastated economy.
In this second case, the Commission cleared the notified transaction by which Aegean Airlines intended to acquire sole control over Olympic Air by way of purchase of shares. Indeed, the failing firm defence was evoked and the Commission identified the presence of its 3 necessary conditions: (1) the target undertaking would be forced out of the market because of financial difficulties in the absence of the takeover, in light of its generation of losses exclusively, and inability to turn to profitability, and preference for its parent company to cease its activities and close it down, (2) there is no less anti-competitive purchase than the notified merger, in the absence of any other substantiated interest for the purchase of Olympic, and (3) in the absence of the takeover, Olympic’s assets would inevitably exit the market, as no alternative acquirer was identified apart from Aegean.
Though these cases exemplify instances where the failing firm defence succeeded in the context of a financial crisis, their rarity also once again demonstrates the restriction with which the Commission accepted the defence, even during a time of crisis.
III. The failing firm defence in the present Coronavirus crisis
Because of the Commission’s high standards for accepting the defence in the past, in addition to the aforementioned high burden of proof borne by the parties, especially in times of crisis, parties have not often relied on the defence. However, it is predicted that parties will likely evoke the failing firm defence more often, in the context of the current economic crisis resulting from the Coronavirus pandemic.
The crisis we presently find ourselves in differs greatly in nature from the 2008 recession, in that it disrupted the global economy quite abruptly, instead of gradually, and is expected to be of shorter duration than the 2008 crisis. Despite this difference, there are lessons yet to be learned from past successful uses of the failing firm defence, for example concerning the temporal factor of the failing firm defence argument. According to the members of the White & Case team that argued the Aegean/Olympic II case in 2013, as the current crisis is expected by many to be shorter, we can expect particular difficulty in relying on the losses suffered during the crisis to characterize the failing firm, as the Commission has in the past considered such losses to be only temporary and “not necessarily indicative of unsustainability of operations,” as determined in the Aegean/Olympic I case. However, the Commission may also learn from its past and remind itself of its mistake in dismissing this case based on similar short-sighted assumptions: assuming the losses were only temporary and the crisis would be short-lived, the case returned before the Commission only two years after to be reversed and obtain a clearance.
At the global level, at least two merger clearances have successfully relied on the failing firm defence during the pandemic. Indeed, the UK’s Competition and Markets Authority (the “CMA”) provisionally cleared the proposed acquisition of a stake in Deliveroo by Amazon in April of 2020. In its reasoning, the CMA considered that Deliveroo was a failing firm as it “would be likely to exit the market as a result of the onset of Coronavirus (COVID-19) without additional funds,” that “third party funding is very unlikely” given the context of the pandemic, and that the alternative to the transaction, in which Deliveroo would exit the market would have more anti-competitive effects than if the transaction were to be cleared. However, as the CMA reassessed its analysis after April 2020, it concluded that Deliveroo’s financial situation had changed and the company could no longer be considered as a failing firm. It then relied on other factors to clear the transaction, assessing that it would not substantially lessen competition. Though this is an example of a failing firm defence contributing to a transaction’s clearance, its success was ultimately temporary.
IV- Concluding remarks: a future for the failing firm defence?
In light of the Covid-19 pandemic, multiple actors have voiced guidelines on the application of the failing firm defence in today’s context. Overall, we note a general wariness in relaxing the standards of application of the defence by authorities, but we also witness several proposals for both adaptation of and alternatives to the defence.
The Italian Competition Authority (the “ICA”) cleared in December 2020 the acquisition of sole control of a competitor by the postal firm Poste Italiane, applying a new temporary legislation enacted in the context of the pandemic. In this way, while the acquisition could result in the creation of a monopoly, the ICA derogated from Italian merger control rules as the merger was notified, did not have an EU dimension, remedies were approved, and it involved “undertakings that are either active in labour-intensive markets or provide services of general economic interest […], provided that those undertakings have registered losses during the past three years and may stop their activities ‘also as a result of’ the COVID-19 pandemic.” The parties evoked the failing firm defence, but the ICA seemed to limit the basis for its clearance of the transaction to the application of the new legal provision. While the failing firm defence is not explicitly accepted by the ICA in its decision, its reliance on the new legal provision demonstrates an adherence to a logic similar to that of the failing firm defence: a merger can be cleared if it involves a target entity facing unrecoverable losses, likely to exit the market.
Théophile and Faber, in their aforementioned article, seem to conclude that where authorities will uphold the strict and rare application of the failing firm defence, they will prioritize state aid as a “more appropriate remedy than a merger between companies.” Indeed, according to some, the agencies are “unlikely to ease the standards of the failing firm defence” and competition authorities will prioritize “alternative funding such as government support” rather than mergers to save distressed firms. For example, the CMA, in its guidance on the failing firm defence published on April 22nd 2020, declares not to relax any of the standards in their merger assessment. Furthermore, the Austrian Competition Authority (the “AFCA”) published a Position Paper on the Macroeconomic Effects of Mergers in the Context of the Covid-19 Crisis in July of 2020, also considering state aid as a viable alternative to “shutdown mergers.” The AFCA specifically highlights that “a relaxation of the criteria for rescue mergers is […] not called-for from a macroeconomic point of view.”
Finally, while the OECD upholds that competition authorities should keep their careful approach in accepting the failing firm defence in their merger assessments, they should also be willing to adapt, by considering “whether substantive, investigative or procedural changes might be justified to ensure an appropriate and speedier review.” The Ecuadorian Competition Authority (the “ECA”) for example has provided for a fast-track merger review proceeding for undertakings that meet at least one of several criteria, including its risk of bankruptcy, i.e. “the target company shall not be able to meet financial obligations in the near future; there shall not be alternatives that are less restrictive of competition; absent the merger, the target company would cease to participate in the market”). This is an innovation for the ECA, as this reform acknowledges the possibility of a failing firm defence, even to remain in force after the pandemic.
To conclude, despite rich origins and developments at the global level, the failing firm defence has been scarcely accepted and scarcely argued in cases appearing before the European Union courts, even in past times of crisis. In the current context of the Coronavirus pandemic, the defence’s near future also seems bleak, due to the crisis’ expected short duration and authorities’ preference for alternatives to transaction clearances, such as state aid, in efforts to mitigate the anti-competitive effects of the crisis. However, there are also efforts to adapt and further adopt the defence, as seen in Italy and Ecuador, implying that the defence may have a future yet.
 OECD, Glossary of Industrial Organisation Economics and Competition Law, para. 86.
 280 U.S. 291 (1930).
 Ibid. § 5: “In the case of a corporation with resources so depleted, and the prospect of rehabilitation so remote, that it faces the grave probability of a business failure, with resulting loss to its stockholders and injury to the communities where its plants are operated, the purchase of its capital stock by a competitor (there being no other prospective purchaser), not with a purpose to lessen competition, but to facilitate the accumulated business of the purchaser and with the effect of mitigating seriously injurious consequences otherwise probable, is not in contemplation of law prejudicial to the public and does not substantially lessen competition or restrain commerce within the intent of the Clayton Act.”
 Codified in 15 U.S.C.S. § 18.
 Opinion of the Court, delivered by Justice Sutherland. 280 U.S. 294.
 11 U.S.C. §§ 1101-1174 (1988).
 The Department of Justice and Federal Trade Commission US 1992 Horizontal Merger Guidelines. § 5.1.
 415 U.S. 486 (1974).
 Zwirska, A. Failing firm defence, Lund University: Faculty of Law, 2003. 20-22.
 Case IV/M.53 Aerospatiale/Alenia/De Havilland (1991).
 Pertaining to the appraisal of concentrations.
 Case IV/M.308 Kali and Salz/MdK/Treuhand (1994).
 Ibid. Para. 71.
 Joined cases C-68/94 and C-30/95, France v Commission (1998) E.C.R. I-1375.
 Case M.2314 BASF/Pantochem/Eurodial (2002).
 Ibid. Para. 151.
 Guidelines on the assessment of horizontal mergers under the Council Regulation on the control of concentrations between undertakings (2004) (the “Horizontal Merger Guidelines”). Para. 89, 90.
 Regulation 139/04 on the control of concentrations between undertakings (2004).
 OECD Competition Committee, Roundtable on Failing Firm Defence (2009). Note by the services of the European Commission Directorate-General for Competition. 183.
 Dr. Malinauskaite, J. The Failing Firm Defence in EU Merger Control: The Story of Sisyphus?, Research Gate (2012).
 Théophile, D., Faber, A. Failing firm defence — a tool in crisis?, Concurrences Nº 3-2020, (2020). Para. 34.
 Case M.7278 General Electric/Alstom (Thermal Power – Renewable Power & Grid Business) (2015).
 Case M.7758 Hutchison 3G Italy/Wind/JV (2016).
 Case M.8792 T-Mobile NL/Tele2 NL (2018).
 Kroes, N., (former) European Commissioner for Competition Policy, Opening address at 13th Annual Competition Conference of the International Bar Association, (2009).
 Mason, R. and Weeds, H., The failing firm defense: merger policy and entry, Royal Economic Society Annual Conference (2003). As cited by Dr. Jurgita Malinauskaite (supra note 21).
 Case M.6360 Nynas/Shell/Harburg Refinery (2013).
 Ibid. Paras. 28-37.
 Case M.5830 Olympic/Aegean Airlines (2011). Para. 369. As cited by Assimakis Komninos, Jan Jeram, Iakovos Sarmas in their 2020 article entitled “A Re-awakening of the Failing Firm Defence in the EU in the Aftermath of Covid-19?”.
 Case M.6789 Aegean/Olympic II (2013). Para. 833.
 Goldman Sachs, “SARS-Coronavirus-2 / COVID-19: An Update on Developments in Europe”, 26 March 2020, available at <www.goldmansachs.com/insights/talks-at-gs/03-26-20-update-coronavirus-europe-f/report.pdf>. As cited by Assimakis Komninos, Jan Jeram, Iakovos Sarmas in their 2020 article entitled “A Re-awakening of the Failing Firm Defence in the EU in the Aftermath of Covid-19?”.
 Komninos, A., Jeram, J., Sarmas, I., A Re-awakening of the Failing Firm Defence in the EU in the Aftermath of Covid-19?, White & Case, (2020).
 Case M.5830 Olympic/Aegean Airlines (2011). Para. 1999.
 These include the CMA’s provisional clearance of Amazon’s acquisition of a minority shareholding and other rights in Deliveroo, on April 16th 2020, and the South Korean Fair Trade Commission’s clearance of the Jeju Air/Eastar Jet merger, on April 23rd 2020.
 CMA, Provisional findings report on the Anticipated acquisition by Amazon of a minority shareholding and certain rights in Deliveroo, 16 April 2020. Paras. 26, 28, 45.
 CMA, Final Report on the Anticipated acquisition by Amazon of a minority shareholding and certain rights in Deliveroo. 4 August 2020. As described in the CMA’s Press Release “CMA clears Amazon’s 16% investment in Deliveroo” published August 4 2020.
 ICA, C12333 Poste Italiane/Nexive Group (December 22 2020).
 Pregno, G. The Italian Competition Authority applies a COVID-19 related provision to clear a merger in the postal sector (Poste Italiane / Nexive), 22 décembre 2020, e-Competitions December 2020, Art. N° 99253.
 Poste Italiane/Nexive Group. Para. 26.
 Théophile, D., Faber, A. Failing firm defence — a tool in crisis?, Concurrences Nº 3-2020, (2020). Para. 3.
 Müller, A., Chapman, A., Jensen, S. The EU Commission announces that, amid the current COVID-19 crisis, it stands ready to deal with cases where firms can show very compelling reasons to proceed with a merger notification without delay, 7 avril 2020, e-Competitions April 2020, Art. N° 94470.
 CMA, Merger assessments during the coronavirus (COVID-19) pandemic – Annex A: Summary of CMA’s position on mergers involving ‘failing firms,’ 22 April 2020.
 AFCA, Position Paper on the Macroeconomic Effects of Mergers in the Context of the Covid-19 Crisis, July 2020. Paras. 57, 47.
 OECD, Merger control in the time of COVID-19, 25 May 2020.
 Rubio Puente, A. The Ecuadorian Competition Authority publishes new merger review procedure due to COVID-19 crisis , 20 avril 2020, e-Competitions April 2020, Art. N° 94483.