News
The correct way to fail
First published NZLawyer, 21 August 2009.
The Commerce Commission has recently released draft supplementary guidelines on how merger and acquisitions applications involving the 'failing firm' argument will be treated.
In competition law-speak the 'failing firm' theory refers to situations when clearance is sought on the basis the vendor is failing or has a failing division, and absent an acquisition its assets will leave the market. The argument is that the "factual" (the world with the acquisition) and the "counterfactual" (the world without the acquisition) will be the same and hence there will be no substantial lessening of competition as a result of the acquisition.
The theory sounds simple enough but in the formal clearance context, the Commission needs to be "satisfied" the business is likely to fail, there are no alternative buyers and the target's assets will not otherwise constrain the firm seeking a clearance. Moreover, the Commission's position is that in order for a clearance to be granted on this basis, it must be satisfied that this outcome will occur under each "likely" counterfactual, of which there may be more than one.
While there have only been a few successful failing firm applications since the 1990's – the most recent in February this year when the Commission granted a clearance for Fletcher Building to acquire certain parts of Stevenson's masonry business – the expectation was that there would be an increase given the economic climate. Although the Commission's current Mergers and Acquisitions Guidelines outline a general approach to failing firms in the clearance context, an expected increase in the number of failing firm applications prompted the Commission to provide more specific guidance for the business community on how it would assess these applications, and in particular around what information should be provided to the Commission. As it has turned out there have been no failing firm applications since the Stevenson transaction earlier this year although that's not to say we won't see any more in the current economic cycle.
Commerce Commission Chair Dr Mark Berry has said that normal competition analysis will still apply to deals involving failing firms and the Commission will not be relaxing its standards when considering such cases. "However, the Commission recognises that it is useful for businesses to have clear guidance on the supporting evidence that the Commission will need to assess this type of application," he said.
The guidelines state that when considering a failing firm argument, the Commission will take into account a number of factors in assessing whether, on the evidence, failure appears to be actual, imminent or probable. This will include an assessment of whether the firm is actually failing based on negative cash flow trends over time and whether any attempts have been made to restructure or rescue the business. It will also involve consideration of whether there is an alternative third party purchaser and whether, on closure, the assets of the firm will exit the market.
The Commission acknowledges that if a firm is genuinely failing, time will be of the essence. The guidelines state that: "Providing relevant, complete and robust information when a failing firm argument is made would assist the Commission in making this assessment quickly."
They are intended to lay out the range of information that the Commission would need in order to make a timely assessment. Consistent with the Commission's current approach of requesting, and placing substantial weight on, internal company documents (in 'normal' as well as failing firm applications), the guidelines state that the Commission will be assisted by the provision of material such as management accounts, board papers and minutes and internal strategic plans concerning the viability of the business, and evidence of bona fide efforts to sell the business as a going concern or its assets on closure.
While the speed with which a failing firm will need to find a suitor will often mean there is insufficient time to undertake a traditional full sales process (i.e. involving a detailed information memorandum, indicative bids, full due diligence etc.) firms should nevertheless expect to be required to show that, having regard to the circumstances, they made proper efforts to find an alternative buyer. Internal company documents, as well as clear analysis as to why any potential bidders were dismissed as realistic buyers by the vendor, will be important. This is particularly so given that many firms will often express an 'interest' in acquiring a business, notwithstanding that there may be little prospect of them actually being inclined (or able) to conclude a transaction when it comes to signing on the dotted line.
While firms can expect that internal documents will be afforded significant weight – particularly where they relate to the company's intentions in the counterfactual – the Commission will invariably want to separately test any such analysis.
The new guidelines bring greater transparency in terms of the information that businesses need to proactively provide (and if not, be prepared to provide when it is requested) when advancing a failing firm argument. However, as is standard with all guidelines, the failing firm guidelines include the caveat that the circumstances around claims that a firm is failing will be varied and each case must be assessed on its own facts.
The Commission is currently reviewing feedback from interested parties on the draft guidelines after which a finalised version will be published.
