News
When failing = winning
First published in Competition Matters, NZLawyer, 6 March 2009
For firms facing closure in these tough economic times, the prospect of recouping some of the losses by selling to another industry player is likely to be welcomed. This article discusses the scope to achieve Commerce Commission blessing for such a sale, even when it might result in the purchaser gaining a very high market share (or even a monopoly).
The theory behind what competition lawyers call the "failing firm" argument is that the acquisition of a business that will otherwise exit the market has no detrimental impact on competition – no matter how large the acquirer becomes as a result – because that exit would have meant it would not be a competitor in any event.
That's the theory. It's not quite as simple in reality because, in the formal clearance context, the Commission needs to be "satisfied" the business will fail, there are no alternative buyers and the target's assets will not otherwise constrain the firm seeking a clearance. Indeed, there have been only a handful of successful failing firm applications since the 1990s.
However, the current economic climate suggests that we may see more in the short term. This is not because the Commission is likely to relax the threshold it applies, but because: (a) for many firms the prospect of failure is now more acute than it has been for some time; and (b) the pool of potential bidders for such firms is likely to be smaller (i.e. there is a much reduced prospect that another bidder will acquire the firm and continue to compete with the applicant firm). No doubt in recognition of this, the Commission has said it is gearing up for more failing firm applications and is in the process of preparing guidelines for how it will assess these applications.
The Commission's clearance for Fletcher Building to acquire certain masonry assets from Stevenson Group is a very recent example of the Commission accepting the "failing firm" argument. The Commission cleared the transaction on the basis there was no real prospect of a third party acquiring the masonry division as a going concern, or acquiring the masonry assets on closure and using them to compete in the relevant markets. The Commission's full written reasons, which are yet to be released, are likely to provide useful guidance for firms contemplating similar applications.
Irrespective of those full reasons, what is clear is that firms advancing the failing firm argument should be prepared to provide the Commission with:
- evidence of previous attempts to restructure or otherwise turn the business around – this being relevant to the question of whether, absent the deal, there is a realistic prospect the firm will be able to trade its way out of its current predicament;
- details of the sales process undertaken, and in particular whether any firms other than the applicant made bids for the business; and
- the firm's assessment of any such bids, and why none represent a true alternative to the acquisition by the applicant (which involves measuring those alternative bids against the benefits of liquidating the assets upon closure).
The Commission will also be interested in associated management reports, board papers and board minutes.
The importance of a robust assessment of closure benefits should not be underestimated. It is the closure benefits that form the threshold against which to measure alternative bids from third parties, not the amount the firm seeking clearance is willing to pay. If an alternative bid is more attractive than liquidation (taking into account monetary and non-monetary considerations such as transaction certainty, a "clean exit", etc.) the Commission is unlikely to be satisfied the business will close absent the acquisition by the applicant firm, meaning the failing firm argument is likely to fail.
The fact third parties are willing to buy the business or its assets is not necessarily fatal to the argument – so long as their offers are less attractive than the firm's liquidation benefits (which typically accrue from selling off inventory, scrapping the assets, putting the assets to alternative use or selling the assets off-shore). Furthermore, it is not necessary to show that the entire target company will fail, only that the particular division for which clearance is sought will fail or otherwise exit the market.
Time is invariably of the essence in the failing firm context, which can create a tension with the Commission's statutory obligation that it be "satisfied" in the clearance context that a substantial lessening of competition is not likely. Firms seeking a swift outcome will do well to ensure they at least meet, and where possible beat, Commission timeframes for providing information and comment on various issues. Understandably, the Commission will be far less willing to divert resource from elsewhere to achieve an urgent decision if it does not believe the parties themselves are making similar sacrifices. This will largely be in the hands of the target, not the applicant, because it is the target's information that is key to the failing firm argument. Fortunately, targets that meet the "failing firm" grade tend to be incentivised to achieve a timely clearance.
Torrin Crowther is a corporate partner at Bell Gully specialising in competition law. Bell Gully acted for Stevenson Group in successfully advancing the failing firm argument.
