COVID-19 and Failing Firm Defense: An Upcoming Challenge For CCI
Authors: Sahil Bhatia & Abhijeet Srivastava
The authors are students at the School of Law, University of Petroleum and Energy Studies, Dehradun
The novel Coronavirus, which is well known as COVID-19, is drastically changing our lives, in ways that none of us could ever have imagined. Undisputedly, this pandemic has altered the dynamics of the Indian economy and has brought unprecedented challenges to people across the world. The competition authorities are no exception. It is anticipated by various research institutions that the current pandemic could lead to a 4% permanent loss to Indian GDP and Gross NPA could rise from 9.5% to 11%. Moreover, we may also see an increase in the number of insolvency cases in the coming months. Consequently, many corporations may have to fight for its survival and some of them may even face closure.
To overcome these unprecedented challenges, various scholars anticipated a rise in Merger & Acquisition (‘M&A’) activity. However, we must not forget that many times, M&A may also lead to anti-competitive effects. These are assessed by Competition Commission of India (CCI) after examining the factors enumerated under Section 20(4) of the Competition Act, 2002 (Competition Act). One of these factors is the ‘possibility of failing business’ (also known as Failing Firm Defence), usually raised by failing enterprise at the time of the M&A transaction. It will be interesting to see how CCI will strike a merger approval balance between anti-competitive effects and Failing Firm Defence (‘FFD’) invoked during these financial crises. This article thus aims to explore the notion of FFD.
II. The Failing Firm Defence: International Scenario
FFD can be described as a way to protect a weak or failing entity by allowing it to merge with the established strong player in the market. Generally, a merger/combination which causes or is likely to cause an anti-competitive effect is considered as void. But a transaction that would otherwise be blocked due to its anti-competitive effect may be allowed to proceed when the entity to be acquired is a failing firm, and it has no other viable solution to avoid dissolution.
Till date, there is no uniform standard which determines the criteria for applying this defence. It is assessed differently by every jurisdiction. However, the document produced in OECD Roundtable Discussion on the Failing Firm Defence, 2009, enunciates three factors which are widely used for the implementation of this defence. The proponent is required to show, firstly, absent the merger, the failing firm will exit the market in the near future, as a result of its financial difficulties; secondly, there is no alternate transaction which is less anti-competitive than the proposed merger; and thirdly, absent the merger, the assets of the failing firm would inevitably exit the market.
However, the question always remains; how the Competition regulators and in particular CCI should approach this defence in the upcoming times, i.e. what factors CCI should take into consideration; and whether CCI should use this defence as an absolute factor or as one of the factors. To find these answers, it is necessary for CCI to analyse various jurisdictions that have recognised this defence in their Competition law jurisprudence, along with the Indian scenario.
A. European Union
The EU Horizontal Merger Guidelines, under paragraph 89, recognises the notion of FFD when assessing the post-merger effect of a transaction. They have formulated a three-factor test, each part of which must be fulfilled for a successful FFD. These conditions are similar to those discussed above, and the EU Commission has applied these conditions in an ample amount of decisions including the famous Aegean/Olympic II merger, where the EU Commission has also interpreted all the three parts of FFD in a detailed manner.
The Commission observed that to satisfy the first condition, the notifying party should demonstrate the existence of financial difficulties; that would force failing entity out of the market. For instance, internal documentation, bank statements, and other financial analyses that show that the company was denied needed finance could be sufficient to satisfy this condition. In the Aegean/Olympic- II merger the drastically changing market conditions, along with Olympic inability to get appropriate finance, was considered sufficient for satisfying the first condition.
To satisfy the second condition, the notifying party must demonstrate that there is no credible alternate buyer, and the emergence of one in the near future is also sufficiently unlikely. In this regard, it normally requires the demonstration of serious and credible affords to find alternate buyers.
Lastly, paragraph 683 and 830 of the decision, respectively, states that under the third condition, the notifying party is required to show that the assets of 'failing firm' shall inevitably exit the market or its market shares will go the notifying party. Where the acquirer would be the sole remaining market player capable of supplying the failing firm’s customers, a merger would not produce an anti-competitive effect because the failing firm’s market share would go to the acquiring party anyway without a merger.
It is pertinent to mention here, that the EU has recognized this defence as an absolute defence which means that if the essential criteria are fulfilled, then it would act as a blanket exemption. However, the Commission has accepted this defence only in very rare and exceptional cases.
B. United States of America
The FFD constitutes an integral part of the US Merger law. It was first recognised in 1930 in the leading case of International Shoe v. Federal Trade Commission, by allowing the merger of two large shoe manufactures, one of which was facing grave financial difficulties. This defence was further evolved in the case of Citizen Publishing Co. , wherein the Supreme Court laid down certain conditions for this test. Based on these decisions, 1997 Horizontal Merger Guidelines, has recognised four conditions for invoking FFD.
The notifying party is required to establish firstly, that the allegedly failing firm would be unable to meet its financial obligation in the near future; secondly, it would be unable to reorganise successfully under chapter 11 of the Bankruptcy Act; thirdly, it has made unsuccessful good faith efforts to elicit reasonable alternate offers of acquisition of the assets of the failing firm, and lastly, absent the acquisition, the assets of a failing firm would exit the relevant market. The USA has a high threshold for availing FFD in comparison to jurisdictions discussed in this article. Moreover, the US antitrust agencies suggest that the FFD are rarely invoked and even when invoked, they have rarely succeeded.
C. South Africa
The South African Competition Commission recognizes FFD under section 12A (2) (g) of the Competition Act, No. 89 of 1998. It states- “whether business or part of the business of a party to the merger or the proposed merger has failed or is likely to fail.” It is noteworthy that, South Africa does not treat this defence as an absolute factor but rather as one of the factors while assessing the effects of a merger.
Furthermore, in the merger analysis of, Iscor Limited and Saldanha Steel Pty (Ltd.), the tribunal set out the criteria for the application of FFD. The tribunal said that a merger with a failing firm would not be regarded as anti-competitive if it satisfies the rigorous test of the EU. However, even where it does not satisfy the EU test, failing firm consideration would still be relevant but must be weighed up against the likely anticompetitive effects. Hence in South Africa, the outcome depends upon the weight assigned to the FFD as compared with other competitive criteria.
III. India and the Failing Firm Defence
Unlike the other jurisdictions mentioned above, The Competition Act, 2002 (‘Competition Act’), lacks an adequate framework for FFD. Being at a nascent stage, our jurisprudence is not developed in comparison to the jurisdictions referred to in the preceding part of the article. However, we can see the traces of this issue under paragraph 4.6.4 of SVS Raghavan Committee Report, which has observed that: “if a firm is, indeed failing and likely to go out of business, it is not clear what social welfare loss would occur, if this firm’s assets were taken over by another firm.”
Based on the above recommendation, the legislature has adopted this concept under section 20(4)(k) of the Competition Act as the ‘possibility of a failing business’.
It is noteworthy that until now, no further explanation has been provided under the Competition Act or under the Combination Regulation, 2011, regarding the possible interpretation of the term ‘possibility of failing business.’ However, in Bhushan Steel merger, CCI permitted an M&A transaction based on the FFD, but it did not provide an explicit framework for applying it. Therefore, in the absence of any particular framework, the authors make a humble attempt to interpret this expression in light of the preamble to the Competition Act and international jurisprudence. While analysing a case of FFD, CCI is required to interpret three major expressions: ‘possibility’, ‘failing’, and ‘business’.
A. How the CCI Shall Interpret the Expression “Possibility”?
In common parlance, this expression denotes future probable failure of the alleged entity. This suggests that it is not necessary that the entity should be declared as a defaulter at the time of invoking this defence, but there is a possibility that in the near future entity shall become insolvent. Here, possibility does not mean a remote possibility for failure. The chances should very high for imminent failure. On this point, European Antitrust Authorities ensures that the availing entity has no option to reorganize itself and its exit is inevitable in the coming future.
B. When Would CCI Consider an Entity as “Failing”?
The legal test for FFD is the same pre-COVID and post-COVID. But where many firms suffer temporary hardship and may appear to border on insolvency, the question for the CCI is whether the entity is genuinely failing or not. For this due regard may be given to the approach adopted by Competition Bureau of Canada, which determines that “whether the proposed merger is likely to result in a substantial prevention or lessening of competition or not.” For this, the Bureau requires to assess "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".
Therefore, probable business failure is not an adequate defence to an otherwise anti-competitive merger. Rather, it is one of the many factors that the Bureau considers as a part of the analysis. In order to determine whether a firm is failing or not, Part 13.3 of the Merger Enforcement Guidelines set out three factors i.e. “a). if it is insolvent or is likely to become insolvent; b) it has initiated or is likely to initiate voluntary bankruptcy proceedings; or c) it has been or is likely to be, petitioned into bankruptcy or receivership.” According to the Position Statement, for analysing the former, Bureau also requires parties to share detailed information such as their financial statements, liquidity reports, business plan, correspondence to and from creditors etc.
Similarly, for determining whether an entity is failing or not, CCI should look into the provisions of Insolvency and Bankruptcy Code, 2016. In the past, CCI has considered this in Bhushan Steel case. While assessing the combination between Tata Steel Limited (TSL) and Bhushan Power and Steel Limited (BPSL) on the basis of FFD, CCI considered BPSL as a failing firm on the account that BPSL was undergoing corporate insolvency resolution proceeding under I&B Code, 2016.
(We have not interpreted the expression ‘business’ here, as for this purpose, we rely on the definition of Enterprise in Section 2(h) of the Competition Act, 2002.)
IV. Way Forward
Being a nascent competition jurisdiction, the jurisprudence of Indian Competition law is not still as developed as in the European Union and South Africa. We have something to learn from every jurisdiction. Though the Indian Legislature has recognized the notion of FFD by including it as one of the factors in Section 20(4) of the Competition Act; what we don’t have is an unambiguous explanation of what factors the CCI will take into account while assessing an FFD.
However, as Albert Einstein once said that “in the midst of every crisis, lies great opportunity.’ The present crisis of COVID-19 appears to be an appropriate time to revisit the application of FFD in India. This follows because there exists a great possibility that the CCI may be faced with many transactions that include an FFD defence. Furthermore, the CCI should also set guidelines as done by Canada, the EU, South Africa, and some other jurisdictions.
The authors believe that CCI should consider the approach adopted by South African competition regulators, i.e., by primarily relying on the three-factor approach of the EU, and where the failing firm does not satisfy the rigorous test of EU, weighing it against the likely anticompetitive effects that the merger may ensue in the future. This approach may provide for flexibility to accommodate both ordinary and extraordinary market conditions.
Finally, on 5 June 2020, the government passed an ordinance titled “Insolvency and Bankruptcy Code (Amendment) Ordinance, 2020”, which inserts section 10A in the code for suspending the applicability of section 7, 9 and 10 for six months. This ordinance will bring more challenges for CCI in upcoming times, because now CCI has to determine on its own that whether an entity is failing or not, rather seeking the assistance of section 7, 9 and 10 for the assessment. Therefore, to avoid any arbitrariness in the future, CCI should determine and announce an explicit framework for the use of FFD.