The failing firm defence during and post-COVID-19: policy and the evidence required
John Bruce
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Mat Hughes
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Gemma Smith
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Governments in developed countries have responded to the COVID-19 pandemic with an almost unprecedented level of government support, thereby preserving many firms and jobs. However, this government support will be progressively withdrawn, and coupled with recent, and expected further, increases in interest rates and the market impacts associated with changes in consumers’ and firms’ behaviour, there is likely to be restructuring in many sectors. This raises the public policy question as to the appropriate balance between government support facilitating and ameliorating this restructuring and the role played by merger control, including how the COVID-19 pandemic and its aftermath affects the application of the so-called ‘failing’ or ‘exiting’ firm defence or scenario under UK and EU merger control. To consider these questions, this article: addresses the policy considerations underpinning the failing firm defence under UK and EU merger control; describes the extensive government support and State aid provided in the UK in response to COVID-19 and the impact of COVID-19 on various sectors; and provides an overview of the evidence required for the ‘failing firm defence’, given these policy and factual considerations.

Abstract

Governments in developed countries have responded to the COVID-19 pandemic with an almost unprecedented level of government support, thereby preserving many firms and jobs. However, this government support will be progressively withdrawn, and coupled with recent, and expected further, increases in interest rates and the market impacts associated with changes in consumers’ and firms’ behaviour, there is likely to be restructuring in many sectors. This raises the public policy question as to the appropriate balance between government support facilitating and ameliorating this restructuring and the role played by merger control, including how the COVID-19 pandemic and its aftermath affects the application of the so-called ‘failing’ or ‘exiting’ firm defence or scenario under UK and EU merger control. To consider these questions, this article: addresses the policy considerations underpinning the failing firm defence under UK and EU merger control; describes the extensive government support and State aid provided in the UK in response to COVID-19 and the impact of COVID-19 on various sectors; and provides an overview of the evidence required for the ‘failing firm defence’, given these policy and factual considerations.

1. Introduction

The COVID-19 pandemic has caused an unprecedented shock to the global economy over the last two years, and governments in developed countries have responded with an almost unprecedented level of government support. This support has undoubtedly preserved many firms and jobs. However, this government support will be progressively withdrawn, and coupled with expected recent, and expected future, increases in interest rates and the market impacts associated with changes in consumers’ and firms’ behaviour, there is likely to be restructuring in many sectors. This raises the public policy question as to the appropriate balance between government support facilitating and ameliorating this restructuring and the role played by merger control, including how the COVID-19 pandemic and its aftermath affects the application of the so-called ‘failing firm’ (or ‘exiting firm’) defence or scenario (FFD) under UK and EU merger control.

To consider these questions, this article:

  • addresses the policy considerations underpinning the FFD under UK and EC merger control;

  • describes the extensive government support, State aid and subsidies provided in the UK in response to COVID-19 and the impact of COVID-19 on various sectors; and

  • provides an overview of the evidence required for the FFD, given these policy and factual considerations.

2. The policy considerations underpinning the failing firm defence

The central policy consideration underpinning the FFD is that, where it applies, a reduction in competition is inevitable regardless of the merger in question. This is because one of the parties would, in the absence of the merger, have exited the market in any event. In other words, the merger counterfactual is not the pre-merger situation (or ‘business as usual’), but that some reduction in competition would have occurred regardless. In these circumstances, this reduction in competition is not a consequence of the merger, and the merger may not cause harm (or additional harm) to customers.1

This policy consideration naturally leads to the FFD having two main limbs under the Competition and Markets Authority’s (CMA) Merger Assessment Guidelines2 and the European Commission’s (Commission) Horizontal Merger Guidelines:3

  • Limb 1: whether the firm would have exited (through failure or otherwise) absent the transaction; and

  • Limb 2: whether there would have been an alternative (i.e. less anti-competitive) purchaser for the firm or its assets.4

The policy debate relates to the appropriate balance between resolving the issues associated with failing firms using merger control, as opposed to other forms of government support in response to economic and market shocks (such as State aid or non-selective government support that does not constitute State aid).

On the one hand, Padilla and Petit5 argue that public aid risks undermining the pro-competitive effects of recessions, since this may lead to the exit of less profitable, inefficient firms that ‘crowd out’ growth opportunities for more efficient companies, including start-ups. They emphasize that the Commission’s application of competition policy during the COVID-19 pandemic deserves praise as it has prevented panic and protected jobs, but they suggest that the optimal policy response may be to reduce the barriers to exit for inefficient firms. They argue that this response might justify a more proscriptive approach to State aid, and a ‘more permissive’ policy as to mergers.

Wider arguments can also be made against State support, or at least that there may be adverse effects on competition as the level of such support increases. For example, Kominos, Jeram and Sarmas raise the question of whether it is appropriate for taxpayers to fund bailouts, rather than the consumers of the goods and services in question.6 There are costs of State support to businesses in that it reduces the funds available to other government activities (such as for health services or education) and/or as this support needs to be funded by higher taxation.

Padilla and Petit do not, in fact, propose that merger policy becomes more permissive. They advance no proposals to amend the scope of the FFD or evidential burdens for its application, bar reasonably observing that structural presumptions (i.e. based on market shares or the number of firms) that mergers are likely to be anti-competitive, or against there being merger efficiencies, are likely to be socially inefficient. Indeed, rather than making merger control more permissive, Padilla and Petit argue that mergers by inefficient firms should be subject to stricter merger scrutiny, and that merger (and State aid) approval should be conditional on reorganizational and managerial efficiencies.

In our view, it is entirely reasonable for Padilla and Petit to favour case-by-case economic assessments of mergers, rather than relying on presumptions. In addition, competition authorities may legitimately wish to assess whether market leaders eliminating small, efficient rivals by acquiring them is anti-competitive if there is clear evidence that these small rivals would otherwise grow into material competitive threats (and bearing in mind that recessions might increase barriers to entry and expansion). However, Padilla and Petit’s proposal to apply different standards to mergers according to the efficiencies that the parties can achieve may be difficult to implement well. Indeed, competition authorities may lack the expertise to assess the relative efficiency of different suppliers (which may well change over time, including as a result of mergers or management changes), or to specify or require efficiency improvements as a condition for merger approvals. In particular, competition authorities are unlikely to be well placed to pick efficient winners and inefficient losers.

Fumagalli, Motta and Peitz7 take a contrary view as to the appropriate balance between merger control and Sate aid. They are in favour of State aid measures, particularly where support is not available to firms that were in financial difficulties prior to 31 December 2019 (i.e. pre-COVID-19), rather than relaxing merger policy as regards potentially failing firms. They advance two arguments in support.

First, they observe that inefficient firms do not necessarily exit during recessions, but instead inefficient firms may survive if they have superior access to liquidity, as during recessions banks may particularly prefer not to write-off loans to unprofitable firms in order to avoid recognizing losses.

In addition, firms’ exit decisions – or decisions not to renew investments – may be influenced by factors other than firms’ relative efficiency. For example, it may be costly for larger firms to close down loss-making divisions if this leads to high exit costs, such as those associated with redundancy payments, or costs in renegotiating and exiting long-term leases, or environmental site clean-up costs.8 In these circumstances, exit decisions may be delayed until material replacement investments are required (the timing of which may vary across firms), because finance providers will wish to be satisfied that these new investments will be profitably repaid and this may not be the case for businesses that are already unprofitable.

Nonetheless, the fact that recessions may not perfectly sort efficient and inefficient firms does not mean that there are no sorting effects associated with recessions, and the management of loss-making firms may be incentivized to improve their efficiency if alternative sources of funding are not available absent efficiency improvements.

Moreover, State aid and other government support may worsen the extent to which inefficient firms can access funding. Indeed, Fumagalli, Motta and Peitz acknowledge that there is a ‘big risk’ that State intervention may distort competition if less wealthy countries cannot afford the same levels of support as wealthier ones.9 This will be the case even if the support provided is available in richer countries on a non-selective basis, which is less likely to distort competition between firms.10 Padilla and Petit make this point in similar terms, and also argue, reasonably, that it is not simple to distinguish between financial distress due to inefficiency as opposed to external factors or bad luck. They speculate that the difficulties faced by many large firms seeking government support are due to inefficiency.11

Secondly, Fumagalli, Motta and Peitz argue that permitting anti-competitive mergers to proceed would worsen efficiency, because effective competition between firms will generally lead to efficient firms winning market share off their less efficient rivals.12 However, it seems more likely that economy-wide government intervention poses greater risks to economy-wide efficiency than minor flexes to merger control policy.

In relation to industries facing a long-term decline, Fumagalli, Motta and Peitz accept that State support may be inappropriate as excess capacity will need to exit the market. They argue that merger control should remain strict in such markets, because future entry is less likely to be a competitive constraint, firms might otherwise improve their efficiency, and customers may benefit from continued rivalry prior to the exit of a failing firm.13 These are all reasonable observations, and these considerations should be part of the assessment of whether a FFD applies and the appropriate remedies that should be required by a competition authority. However, they also argue that exit might have beneficial and pro-competitive effects on other markets as exiting assets and staff may switch to other markets.14 However, economy-wide State intervention is more likely to delay the exit of assets and staff from declining markets than merger control policy, not least as the FFD is rarely accepted. Moreover, assets and staff that are not specific to particular industries (i.e. which are valuable elsewhere) are generally likely to be in less scarce supply than market-specific assets and staff intellectual capital, and exit processes can lead to the long-term exit of assets and staff.

3. The impact of the COVID-19 pandemic

3.1. Overview

The pandemic has resulted in significant financial distress for many businesses and industries in the UK, even if various parts of the economy have performed strongly over the last two years, notably several digitally focused sectors. The unprecedented crisis, and the government actions taken in response, have resulted in considerable uncertainty when restructuring distressed businesses. Any application of the FFD will need to take this into account.

Understanding what the position and outlook for the target business was, and the potential change that could have been made to make it sustainable, prior to the merger taking place, are critical inputs into building any FFD. The short to medium-term economic outlook during the pandemic, both on a macroeconomic basis and for individual industries and companies, has been highly uncertain and has been impacted by multiple factors, including:

  • economic recession and the impact on overall demand, which will in turn be influenced by factors such as virus mutations, the continued efficacy of vaccines, the take-up of vaccines and the development and efficacy of virus treatments;

  • social distancing measures, and wider impacts on consumer habits (e.g. as regards on-line shopping);

  • broader structural economic changes in the relevant industry; and

  • the extent and success of government support measures for businesses, including furlough and emergency loans.

In short, restructurings during the pandemic have needed to be implemented with an unprecedented degree of uncertainty as to what a sustainable business would look like in the medium-term. In addition, the dynamics of restructurings have been hard to predict due to, amongst other factors, changes to insolvency and restructuring legislation, including directors’ duties, and the pressure on banks to give forbearance to businesses impacted by the pandemic. These issues will probably need to be considered to evidence that the requirements of the FFD are satisfied.

The next sub-section summarizes the key government support schemes implemented in the UK in response to the pandemic, and the following sub-section outlines key financial and economic trends in selected industries. Understanding these, and their impact on the relevant business, is necessary to understand how a restructuring of the target business may have unfolded but for the merger.

3.2. Summary of government support schemes for businesses

To support businesses with the employment of staff throughout the pandemic, the UK Government introduced the Coronavirus Job Retention Scheme, colloquially known as ‘furlough’. Through the scheme, government provided employers with grants covering 80% of wages for employees who were furloughed, up to a monthly maximum of £2,500 per employee. The scheme began tapering off from 1 July 2021, with the support provided by government reduced to 70% for July 2021, then stepping further down to 60% in the months of August and September 2021 and ending on 30 September 2021.15

Measures in place since the beginning of the pandemic to prevent eviction of commercial tenants have been extended to 25 March 2022.16 The use of statutory demands and winding-up petitions was restricted for a total of 18 months. However, from 1 October 2021, creditors (other than commercial landlords) have had the ability to take such actions regardless of whether COVID-19 had financially impacted the company.17 In addition, legislation is anticipated to be enacted in March 2022 with the objective of ensuring that outstanding unpaid rent that has built up in periods when a business has had to remain closed during the pandemic will be ring-fenced.18 Landlords are expected to make allowances for the ring-fenced rent arrears from these specific periods of closure and share the financial impact with their tenants, whilst tenants who are able to pay without borrowing or restructuring are expected to pay such arrears in full.19

Business rates are charged on non-domestic properties in England and Wales, with similar charges applicable in Scotland and Northern Ireland. Full relief from business rates was granted to businesses in the retail, hospitality and leisure sectors in England and Wales to alleviate cost pressures. The full relief ended on 30 June 2021, with 66% relief applicable until 31 March 2022.20

The deadline for the payment of VAT for the quarters ended 29 February 2020 (if not already paid by 20 March 2020), 31 March 2020 and 30 April 2020 was extended to 31 March 2021. Businesses were given the option to either pay in full by 31 March 2021 or to join a scheme allowing payments to be made in instalments.21

The Bounce Back Loan Scheme (BBLS) offered loans to businesses of between £2,000 and 25% of their turnover, up to a maximum amount of £50,000. Whilst businesses have been required to make capital repayments throughout the term of the loan, interest payments due in the first 12 months of the loan term were paid by government. Businesses are now liable for both capital and interest repayments, with the specific timing dependent upon the date on which the loan was provided.22

The Coronavirus Business Interruption Loan Scheme (CBILS) offered loans of up to £5 million for businesses with an annual turnover under £45 million. CBILS loans are 80% backed by government. As with BBLS loans, businesses have been required to make capital repayments throughout the term of the loan, with interest payments due in the first 12 months of the loan being paid by government. Full capital and interest repayments are beginning to fall due, with specific timing dependent on the date on which the loan was provided.23

The Coronavirus Larger Business Interruption Loan Scheme (CLBILS) extended the standard CBILS approach to larger businesses with turnover in excess of £45 million. CLBILS loans have a three-year term and businesses have been required to make interest and capital repayments from the date the loan was provided.24

The COVID Corporate Financing Facility (CCFF) is a joint HM Treasury and Bank of England lending facility. Under the CCFF, the Bank of England has purchased short-term unsecured debt from large companies in the form of a commercial paper of up to one-year maturity. The CCFF will continue to hold companies’ commercial paper until the final maturities in March 2022.25

3.3. Overview of the impact of COVID-19 on selected sectors

a. Retail

The retail sector was already undergoing significant change prior to the onset of the COVID-19 pandemic. Lockdowns and resultant forced closures of shops have accelerated pre-pandemic trends in the sector, with 27.3% of all retail sales conducted online in October 2021, the lowest level since March 2020, but still substantially higher than pre-pandemic levels of 19.7% in February 2020.26

The increase in online sales and the associated decline in traditional ‘bricks and mortar’ retailing is likely to be here to stay. With work from home guidance reintroduced in December 2021, latest footfall figures (which are for the week prior to the guidance to work from home if possible) dropped by 1.1%.27 This will be of concern for those retailers with large store estates and high rent liabilities, who have endured stilted trading with lockdowns and gradual re-openings for almost two years. The guidance of work from home ended in January 2022, but many firms have introduced hybrid working over the last two years, which is likely to persist and this will reduce weekday retail demand in city centres.

Well-known retailers Arcadia and Debenhams were acquired by online-only retailers ASOS and boohoo.28 In each acquisition, all stores were retained by the administrators and subsequently closed, highlighting the increasingly advantageous position of retailers that are not encumbered with large store estates. Whilst market commentators had speculated that a purchaser of Arcadia might have chosen to retain flagship stores,29 the eventual outcome is further evidence that those operating in the fast-fashion industry are not ascribing value to physical store estates, even in prime shopping locations such as London’s Oxford Street.

Retailers with a physical store presence have, for a number of years, been seeking rent reductions using a variety of means, such as informal negotiations and use of insolvency procedures such as Company Voluntary Arrangements (CVAs).30 More recently, turnover-based rent terms are becoming increasingly common as tenants ask landlords to share the financial burden of COVID-19.31 While linking rental payments to the tenant’s financial performance provides the tenant with a better platform to compete with online-only retailers, landlords are faced with a drastic change to what has been their traditional means of operating: having a known income for a given period of time.

b. Hospitality and leisure

The hospitality and leisure sector has been impacted by both COVID-19 and Brexit, with the effects of both intertwining. Following prolonged closures and a phased reopening of hospitality businesses as a result of COVID-19 restrictions, the industry is once again facing turmoil as the UK has been through a further wave of COVID-19 infections. Significant disruption to operations during the critical festive period and a lack of government support measures to aid impacted businesses could be devasting for the sector.32

Since COVID-19 restrictions eased in the Spring of 2021, shopping centres have suffered the largest decline of all retail locations in the UK, as stated above, with footfall 22% lower in November 2021 compared to November 2019.33 With a number of hospitality and leisure businesses located within shopping centres, such as casual dining restaurant chains, the drop in consumers visiting these locations will be of concern. It remains to be seen whether we are witnessing a fundamental shift in where consumers choose to spend their time and money, with retail parks and high streets seeing less drastic reductions in footfall in comparison, down 15.8% and 3.6% respectively.34

A further notable consequence of both COVID-19 and Brexit is a rising shortage of hospitality staff.35 In October 2021, it was estimated that approximately one in six hospitality roles were vacant.36 Whilst industry body UKHospitality has published an action plan to deal with the staffing shortage,37 it raises the question as to how hospitality businesses will maximize revenue and profits without the necessary staff levels to cope with customer demand. Again, the multiple pressures on businesses operating in this sector may result in increasing levels of uncertainty and distress.

c. Travel and tourism

The last sector considered in our overview of sectors heavily impacted by the pandemic is the travel and tourism sector, which has seen an unprecedented reduction in activity, with varying travel restrictions in place since March 2020.38 Whilst the challenges in travelling abroad boosted domestic tourism in the UK when rules have permitted, the level of total annual spend by domestic tourists is forecast to be far lower than pre-pandemic levels, estimated to be worth £51.4 billion in 2021 compared to £91.6 billion in 2019.39 With international travel restrictions in place, spending by foreign tourists is forecast to be less than a quarter of 2019 levels, estimated at £6.2 billion for 2021.40 Businesses in the sector are expected to face a long period of demand disruption, as some in the industry predict that international leisure travel will not recover to 2019 levels until 2023.41 This will require careful cash management and adapting of business models in the coming months and years.

Another factor driving current decreased spending in the sector is the significant reduction in business travel, with a total of $710 billion lost revenue worldwide in 2020 as a result of restrictions.42 It remains to be seen whether this suppressed demand will continue, as the time and cost saved by use of video conferencing (and environmental benefits) are weighed up against the value of in-person meetings.43

The financial viability of hotels and the ancillary tourist-dependent businesses, including leisure attractions in major cities, is also in question. We expect to see an uptick in restructuring activity as government support tapers off and the threat of further COVID-19 outbreaks continues to deter consumers from travelling.

4. The evidence required for a successful FFD

This section considers the factual evidence that will be necessary to advance a compelling case that the FFD applies, focusing on Limb 1 (i.e. the inevitability of exit) and Limb 2 (i.e. whether there is a less anti-competitive purchaser of the target firm or its assets).

Perhaps the key point to emphasize at the outset is that a claim that the FFD applies usually fails. The last case in which the Commission accepted the FFD was Aegean/Olympic II,44 although a variant of this defence was accepted in Nynas/Shell,45 which was cleared on the basis of a variant of this defence and due to merger efficiencies.

The position is similar in the UK, although the FFD has been considered more frequently. The Office of Fair Trading and CMA have considered the FFD in 74 Phase 1 cases between 1 April 2010 and 31 March 2020 (all of which predated the COVID-19 pandemic) and there have only been two further Phase 1 cases considering the FFD since then, namely Bellis/Asda46 and CHC/Babcock.47 The FFD has only been accepted in seven of these 76 cases. The FFD was provisionally accepted in Amazon/Deliveroo at Phase 2,48 but was rejected by the CMA in its Final Report.49

The CMA’s Merger Assessment Guidance indicates that detailed information on the exiting firm is required, including its profitability over time, cash flows, balance sheets and steps taken by management to improve the prospects of the business. This process requires a review of contemporaneous internal company documents, as well as reports by external advisers and the firm’s auditors, as well as, potentially, evidence from shareholders and finance providers.50

To be able to produce evidence to support a successful application of the FFD, it is necessary to understand restructuring processes, including the likely actions taken by different participants, including management, shareholders, lenders and auditors.

4.1. Understanding a restructuring process

In order to illustrate the sort of evidence that is required to substantiate the FFD, this sub-section provides a high-level overview of a generic restructuring process. Whilst each situation is unique and fact-dependent, certain analyses and steps tend to happen during a restructuring process, including those in which the company exits the market. Understanding these steps will help the process of building a compelling counterfactual where the relevant merger did not happen.

When a company suffers financial distress, it is common for a restructuring adviser to be engaged to review the business and its financial outlook, as well as what could be done to improve its performance and ensure its medium-term viability. Such analysis could also be done internally by the business, with the nature of the analysis remaining the same.

The analysis undertaken will include an assessment of:

  • the expected short to medium-term outlook for the business (pre-restructuring), with a particular focus on cash outflows (A);

  • what a sustainable business would look like, from a profit and loss, cash flow and balance sheet perspective (B); and

  • the actions required to get the business from (A) to (B), including cost cutting, business model changes, increases in working capital funding and adjustments to the capital structure.

Whilst it is usually possible to theoretically identify a sustainable version of a business in distress, implementing the steps required to deliver it can often be onerous and expensive. As such, a key output from the above analysis is the cost of delivering the required changes, or the ‘funding requirement’. This is critical, as, with the possible exception of the government, a party would usually only be willing to fund a restructuring of the business if they anticipate achieving a financial return on this funding (or other financial objectives, such as preserving historical investment).

As a result, if the business’s distress is severe, the required changes may need to be drastic (for example exiting loss-making product lines or geographies or closing stores) in order to reduce financial losses and therefore the funding requirement. Options may also include the use of insolvency tools to reduce costs, in particular when a business has long leases, such as a retailer. Evidencing steps such as these could form part of a successful ‘flailing firm’ argument, in which it is shown that although the business wouldn’t have exited entirely but for the merger, it would have had a significantly reduced competitive presence.

4.2. Pre-merger evidence

When looking for evidence to support the application of the FFD, the CMA’s practice is to attach considerable weight to contemporaneous, pre-merger internal and external documents.51 Relevant documents include:

  • management documentation (e.g. presentations, board minutes and emails) highlighting stress/distress and any mitigation strategies considered or taken;

  • management documentation discussing strategic options or M&A, including any assessments of potential buyers of the business;

  • adviser reports;

  • audit discussions, including sensitivity analyses and going concern considerations;

  • correspondence and meetings with lenders; and

  • finance function documents, including budgets and presentations.

It may be that during the relevant period, advisers to lenders of the business had previously produced a review of the business similar to the one outlined above. This would potentially contain key evidence to support an assessment of the counterfactual absent the merger.

Coupled with the above, contemporaneous source data can be used to produce a hypothetical counterfactual restructuring analysis to show the likely outcomes absent the merger. As outlined, this would involve assessing both the short-term and the medium-term prospects of the business at the time of the merger and what a sustainable business would look like. Some of the challenges of doing this are outlined in the previous section of this article.

A key question may be when exit would occur absent the merger. In some cases, exit may be imminent, in others it may be delayed until fixed assets need to be replaced if such investment would not be profitable. If exit is delayed, then pre-merger competition might be preserved for a period of time, and the FFD may then be relevant to the consideration of appropriate and proportionate remedies, i.e. is it proportionate to prohibit a merger if the loss of competition is only temporary (i.e. exit would occur in the near future), or if other, lesser remedies exist?

Fumagalli, Motta and Peitz argue that competition authorities should look for genuine efforts by the allegedly failing firm or division to survive independently, whether this is through turnaround, restructuring or securing alternative funding, and showing that any shareholders or the parent company would not have the ability and incentive to provide such funding.52

Recessions change the calculus as to whether turnarounds and restructurings are viable, because the scale of existing losses may be greater, the scale of the funding required to finance more extensive restructuring may be greater, and the time before payback is achieved may be increased and also be more uncertain. In short, in restructuring terms, getting from loss-making state (A) to profitable state (B) is less likely to represent a profitable investment.

Whilst Fumagalli, Motta and Peitz emphasize that it is generally preferable to rely on pre-merger evidence, they accept that this may be more difficult at present because COVID-19 is ‘simultaneously the cause of the difficulty and of the merger’.53 In addition, failing businesses often have poor management information systems and thus may not be fully aware of the scale of any market and financial issues, and the fact of the merger may remove or reduce the need for the target to address these issues. A seller also has obvious incentives to downplay pre-merger difficulties in correspondence with prospective purchasers in order to maximize the purchase price.

The second limb of the FFD considers whether there would be a less anti-competitive purchaser of the failing business or its assets (such that its assets would not exit the market). In this regard, as emphasized by the CMA’s Merger Assessment Guidelines, it may be particularly important to understand ‘why the purchaser is acquiring a firm or its assets in the context of claims that it would have exited from the market’.54

In particular, if the purchase price exceeds the liquidation value of the business, then it is a legitimate question to ask why this outcome has arisen in the absence of less anti-competitive purchasers, who would operate the business or use its assets in the relevant market. Even if there are synergies for an in-market purchaser that other out of market purchasers would not enjoy, it is legitimate to ask why these would lead to business/asset prices being bid up if there are no alternative purchasers. (As noted above, the buyer may not know that there are no credible alternative purchasers.)

Again, in recessions there may be fewer alternative purchasers for otherwise failing businesses. Fumagalli, Motta and Peitz note this, adding that completing mergers may ‘require scarce management resources that could be better employed to steer a firm through difficult waters’.55 They raise the possibility that a lack of purchasers may nonetheless be temporary if the crisis is temporary – but this may be a big ‘if’.

Fumagalli, Motta and Peitz also state that purchasers with the deepest pockets – namely firms with market power – may be particularly well placed to acquire failing firms.56 However, on the other hand, there should be no bias against efficient firms acquiring their less efficient rivals – this may well increase productivity and thus lower costs and prices. In addition, the conditions of the FFD will not be met if there is a less anti-competitive purchaser willing to purchase the failing firm or its assets at any price (just) above the liquidation value.

5. Conclusions

In this article we are not seeking to advance the argument that the evidential bar for the FFD should be lowered, but instead that during recessions and crises (whether COVID-19 related or otherwise) the underlying facts may support the view that the FFD does apply such that an otherwise anti-competitive merger does not cause a SLC or SIEC as there would have been a reduction in competition absent the merger.

We also consider that the economy-wide risks of government support leading to greater inefficiency are considerably greater than those associated with FFD claims being given a sympathetic but evidence-based hearing – not least because the FFD will only rarely be accepted for clearing an otherwise anti-competitive merger.

In our view, as we have previously argued, the reason that attempts to apply the FFD usually fail is that there is a lack of compelling evidence. Nonetheless, the defence has been accepted in the UK in a number of cases since 2017, including at Phase 1 in East Coast Buses/First Scotland East57 and Aer Lingus/CityJet58 and in Phase 2 in Alliance Medical/IBA Molecular.59 The FFD may also be partly accepted in a variety of contexts, with this reducing the scope or nature of the competition concerns. For example, in Medtronic/Animas Corporation60 the CMA accepted that the target business had been extensively marketed without success (such that the vendor, Johnson & Johnson had taken the decision to exit the market), but could not exclude that other, less anti-competitive purchasers would have existed as regards the customer and patient records and limited other assets that were transferred as a result of the merger; however, the CMA accepted at Phase 1 that these limited transfers did not lead to a substantial lessening of competition. Similarly, in Euro Car Parts/Andrew Page61 having found that Andrew Page would likely have exited the market as a result of financial failure, the CMA accepted, at Phase 2, the application of the FFD in 49 local areas (for which there were no alternative bids for Andrew Page’s depots), such that the merger did not lead to a less competitive outcome than would have resulted from closure of those depots. In the remaining 52 local areas in which there was an alternative bidder for Andrew Page’s depots, the CMA found a substantial lessening of competition in only nine local areas, as compared to the situation in which an alternative bidder would have acquired the depots.

The challenge for the parties is to marshal the arguments and evidence properly and in a timely manner.62 This evidence will need to include the impact of the withdrawal of government support and the likely prospects of various sectors post-pandemic. We all wish that the pandemic ends soon, but COVID-19 is likely to have a long-lasting impact on some markets.

  • 1

    This policy issue is also a legal issue, namely that where the FFD applies there is no causal link between the merger (or concentration) and the substantial lessening of competition (SLC) or significant impediment to effective competition (SIEC), depending on whether one is considering UK or EU merger control, respectively. This point is made explicitly (as regards EU merger control) by

    K. Fountoukakos, C. Barraud and D. Barrio, ‘The Failing Firm Defense in Times of the COVID-19 Crisis: Is It Worth Revisiting?’, Competition Policy International (7 September 2020), which discussed recent UK cases, as well as the few EU cases, in which the FFD (or variants thereof) has been considered.

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  • 2

    CMA, Merger Assessment Guidelines (CMA129, 18 March 2021).

  • 3

    European Commission, Guidelines on the assessment of horizontal mergers under the Council Regulation on the control of concentrations between undertakings [2004] OJ C 31/5 (Horizontal Merger Guidelines).

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  • 4

    In April 2020, the

    CMA published a ‘refresher’ of its position on mergers involving failing firms: CMA, Merger assessments during the coronavirus (COVID-19) pandemic (22 April 2020), available at: https://www.gov.uk/government/publications/merger-assessments-during-the-coronavirus-covid-19-pandemic/merger-assessments-during-the-coronavirus-covid-19-pandemic (accessed 28 February 2022).

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    This ‘refresher’ contained a third limb, namely what the impact of exit would be on competition compared to the competitive outcome that would arise from the merger; see

    J. Bruce and M. Hughes, ‘COVID-19: Avoiding the failure of the failing firm defence’, in N. Parr (ed), Global Legal Insights Merger Control 2020 (2020), available at: https://www.alixpartners.de/veroeffentlichungen/insights/merger-control-2020-covid-19-avoiding-the-failure-of-the-failing-firm-defense (accessed 28 February 2022).

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    This third limb has been entirely abandoned in the CMA’s revised Merger Assessment Guidelines (fn 2), para 3.21. Fumagalli, Motta and Peitz are in favour of the FFD being restated to require that the assets in question would inevitably exit the economy, rather than the market altogether, and argue that the exit of the assets may not be bad for welfare:

    C. Fumagalli, M. Motta and M. Peitz, Which Role for State Aid and Merger Control During and After the Covid Crisis? (Discussion Paper No. 184, June 2020), available at: https://www.wiwi.uni-bonn.de/bgsepapers/boncrc/CRCTR224_2020_184.pdf (accessed 28 February 2022).

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    In our view, this sets the bar too high: the relevant question is whether the loss in competition in the relevant market is caused by the merger. In Section VIII of the Horizontal Merger Guidelines (fn 3), the Commission expresses, in similar terms to the CMA in its revised Merger Assessment Guidelines (fn 2), the core criteria for the FFD to apply and does not envisage any additional requirement to also assess the nature of competition absent the merger if the FFD otherwise applies.

  • 5

    J. Padilla and N. Petit, ‘Competition policy and the Covid-19 opportunity’, Concurrences N° 2-2020, pp. 26.

  • 6

    A. Assimakis, J. Jeram and I. Sarmas, ‘A Re-awakening of the Failing Firm Defense in the EU in the Aftermath of COVID-19?’, Competition Policy International (April 2020), available at: https://ssrn.com/abstract=3596794 (accessed 28 February 2022).

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    This article also contains a good review of the FFD and its application from an EU merger control perspective. It should also be noted that there is a ‘moral hazard’ argument against State aid, or at least moderating the magnitude of such aid, in that shareholders may not prepare sufficiently for shocks if they expect to be bailed out (e.g. in terms of avoiding excessive debt levels etc.), but this concern is reduced if shareholders also suffer material losses in the event of bail outs and the shocks cannot reasonably be expected (e.g. due to a pandemic).

  • 7

    Fumagalli, Motta and Peitz (fn 4), pp. 5–9.

  • 8

    It may be more profitable for the shareholders of a business to incur the losses associated with continuing to operate a loss-making business if this delays them incurring material exit costs, or potentially avoiding them altogether if the business were to become profitable in the future.

  • 9

    Fumagalli, Motta and Peitz (fn 4), p. 7.

  • 10

    Lord Tyrie (former chairman of the CMA) has observed that, in the UK, the overwhelming share of public sector support for businesses has so far been economy-wide and such non-discriminatory support is less likely to be distortive from a competition perspective than firm-specific bailouts:

    A. Tyrie, How should competition policy react to coronavirus?, Institute for Public Policy Research Discussion Paper (July 2020), available at: https://www.ippr.org/research/publications/how-should-competition-policy-react-to-coronavirus (accessed 28 February 2022).

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    However, this reasonable observation should be judged also by reference to the scale of the public support provided by some governments. In this regard, the National Audit Office estimates that, as at September 2021, the lifetime cost of UK government spending as a result of Covid-19 amounted to £370 billion, with £154 billion of this being support for businesses: see

    https://www.nao.org.uk/covid-19/cost-tracker (accessed 28 February 2022).

  • 11

    Padilla and Petit (fn 5), p. 5.

  • 12

    Fumagalli, Motta and Peitz (fn 4), pp. 8–9.

  • 13

    Fumagalli, Motta and Peitz (fn 4), p. 10.

  • 14

    Fumagalli, Motta and Peitz (fn 4), p. 10.

  • 15

    HM Revenue and Customs, Changes to the Coronavirus Job Retention Scheme, Policy Paper (12 June 2020, last updated 3 March 2021), available at: https://www.gov.uk/government/publications/changes-to-the-coronavirus-job-retention-scheme (accessed 28 February 2022).

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  • 16

    Department for Business, Energy and Industrial Strategy (BEIS) press release, Eviction protection extended for businesses most in need (16 June 2021), available at: https://www.gov.uk/government/news/eviction-protection-extended-for-businesses-most-in-need (accessed 28 February 2022).

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  • 17

    T. Symes and M. Read, Winding up petitions return with a vengeance (22 October 2021), available at: https://www.stewartslaw.com/news/winding-up-petitions-returns-without-heavy-restrictions-from-22-october-2021 (accessed 28 February 2022).

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  • 18

    BEIS press release (fn 16).

  • 19

    BEIS press release (fn 16).

  • 20

    Ministry for Housing, Communities and Local Government, Business rates: expanded retail discount 2021 to 2022 – local authority guidance (4 March 2021), available at: https://www.gov.uk/government/publications/business-rates-expanded-retail-discount-2021-to-2022-local-authority-guidance/business-rates-expanded-retail-discount-2021-to-2022-local-authority-guidance (accessed 28 February 2022).

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  • 21

    HM Revenue and Customs, VAT deferred due to coronavirus (COVID-19) (26 March 2020, last updated 27 July 2021), available at: https://www.gov.uk/guidance/deferral-of-vat-payments-due-to-coronavirus-covid-19 (accessed 28 February 2022).

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  • 22

    British Business Bank, Bounce Back Loan Scheme (BBLS), available at: https://www.british-business-bank.co.uk/ourpartners/coronavirus-business-interruption-loan-schemes/bounce-back-loans (accessed 28 February 2022).

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  • 23

    British Business Bank, Coronavirus Business Interruption Loan Scheme (CBILS), available at: https://www.british-business-bank.co.uk/ourpartners/coronavirus-business-interruption-loan-scheme-cbils-2 (accessed 28 February 2022).

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  • 24

    British Business Bank, Coronavirus Large Business Interruption Loan Scheme (CLBILS), available at: https://www.british-business-bank.co.uk/ourpartners/coronavirus-business-interruption-loan-schemes/clbils (accessed 28 February 2022).

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  • 25

    Bank of England, Covid Corporate Financing Facility (CCFF), available at: https://www.bankofengland.co.uk/markets/covid-corporate-financing-facility (accessed 28 February 2022).

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  • 26

    Office for National Statistics, Retail sales, Great Britain: October 2021 (19 November 2021), available at https://www.gov.uk/government/statistics/retail-sales-great-britain-october-2021 (accessed 28 February 2022).

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  • 27

    G. Wright, ‘UK footfall dips as Plan B restrictions hit high streets’, Retail Gazette (14 December 2021), available at: https://www.retailgazette.co.uk/blog/2021/12/uk-footfall-dips-as-plan-b-restrictions-hit-high-streets (accessed 28 February 2022).

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  • 28

    ‘Boohoo and Asos take over UK fashion retail with acquisitions of Debenhams and Arcadia’, Retail Insight Network (21 January 2021), available at: https://www.retail-insight-network.com/comment/boohoo-asos-debenhams-arcadia-acquisitions (accessed 28 February 2022).

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  • 29

    I. Fish, ‘Next was ‘only hope’ for Arcadia stores’, Drapers (22 January 2021), available at: https://www.drapersonline.com/news/next-was-only-hope-for-arcadia-stores?tkn=1 (accessed 28 February 2022).

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  • 30

    Herbert Smith Freehills LLP, Retail CVAs: Trends and future direction (2018), available at: https://www.herbertsmithfreehills.com/lang-es/insight/retail-cvas-trends-and-future-direction (accessed 28 February 2022).

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  • 31

    ‘Retailers and landlords do battle over the future of leases’, Financial Times (29 July 2020), available at: https://www.ft.com/content/638d3ffb-411f-465a-8de6-531c982e197d (accessed 28 February 2022).

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  • 32

    T. Buckley and D. Hipwell, ‘Omicron’s Surge is turning London into a ghost town’, Bloomberg (17 December 2021), available at: https://www.bloomberg.com/news/articles/2021-12-15/london-bars-suffer-as-lockdown-mentality-drives-cancellations (accessed 28 February 2022).

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  • 33

    ‘November Footfall falls short’, Retail Destination (2 December 2021), available at: https://www.retaildestination.co.uk/november-footfall-slackens-off (accessed 28 February 2022).

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  • 34

    ‘November Footfall falls short’ (fn 33).

  • 35

    ‘Hospitality “struggling to fill thousands of jobs”’, BBC News (28 May 2021), available at: https://www.bbc.co.uk/news/business-57285428 (accessed 28 February 2022).

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  • 36

    M. Willems, ‘UK hospitality crisis, CityA.M. (4 October 2021), available at: https://www.cityam.com/uk-hospitality-crisis-75-per-cent-of-pubs-and-restaurants-are-hiking-pay-to-attract-new-staff (accessed 28 February 2022).

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  • 37

    P. Thomsen, UKHospitality unveils 12-point plan to tackle sector staffing crisis (18 June 2021), available at: https://www.ukhospitality.org.uk/news/570832/UKHospitality-unveils-12-point-plan-to-tackle-sector-staffing-crisis.htm (accessed 28 February 2022).

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  • 38

    Foreign and Commonwealth Office, Travel Advice against all non-essential travel: Foreign Secretary’s statement (17 March 2020), available at: https://www.gov.uk/government/news/travel-advice-foreign-secreatary-statement-17-march-2020 (accessed 28 February 2022).

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  • 39

    ‘UK tourism spending “worth just half of pre-pandemic level”’, BBC News (25 May 2021), available at: https://www.bbc.co.uk/news/business-57230018 (accessed 28 February 2022).

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  • 40

    ‘UK tourism spending “worth just half of pre-pandemic level”’ (fn 39).

  • 41

    J. Kollewe, ‘EasyJet urges UK to extend green list as it increases flights to 60% of pre-Covid levels’, The Guardian (20 July 2021), available at: https://www.theguardian.com/business/2021/jul/20/easyjet-flights-covid-malta-green-list-countries (accessed 28 February 2022).

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  • 42

    A. Hancock and P. Georgiadis, ‘Business travel: “We don’t know how many people will choose to fly”’, Financial Times (14 January 2021), available at: https://www.ft.com/content/867a5342-c94c-43f6-9783-a817443c9471 (accessed 28 February 2022).

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  • 43

    E. Rosenbaum, ‘Will business travel return to normal with Covid vaccine? Top executives are split: Survey’, CNBC (17 December 2020), available at: https://www.cnbc.com/2020/12/17/will-business-travel-return-with-covid-vaccine-executives-are-split.html (accessed 28 February 2022).

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  • 44

    Case M.6796 Aegean/Olympic II (9 October 2013).

  • 45

    Case M.6360 Nynas/Shell/Harburg Refinery (2 September 2013).

  • 46

    Case ME/6911/20 Completed acquisition by Bellis Acquisition Company 3 Limited of Asda Group Limited (20 April 2021). The FFD was considered in relation to whether Euro Garages (which was jointly owned by the shareholders in Bellis) would have exited the auto-LPG market, but the CMA found that the conditions for the application of the FFD were not met: see paras 47–54.

  • 47

    Case ME/6932/21 Completed acquisition by CHC Group LLC of Offshore Helicopter Services UK Limited, Offshore Services Australasia Pty Ltd, and Offshore Helicopter Services Denmark A/S (18 November 2021). At Phase 1, the CMA considered whether, in the absence of the transaction, Babcock would, if it were unable to find another buyer, have closed the target business, but found that Babcock had not taken a decision to exit and close the target business: see paras 30–38. In its provisional findings, the CMA found that the conditions for the FFD were not satisfied. The CMA found that closure was only one of the options being considered at the time of the merger, and it then focused on Babcock’s incentives to close the business. In this regard, the CMA found the target business was continuing to contribute to Babcock’s overhead costs, its prospects might have improved in the future, and there were high costs associated with closure. As a result, the CMA considered that Babcock had a strong incentive to continue operating the business, and that in the short to medium-term it would have continued to tender for new contracts. The CMA also provisionally concluded that this outcome could either have happened under Babcock’s ownership, or if the business were to be sold to another buyer: CHC Group LLC of Offshore Helicopter Services UK Limited, Offshore Services Australasia Pty Ltd and Offshore Helicopter Services Denmark A/S (previously part of Babcock International Group plc), Provisional Findings (18 March 2022), paras 13–15. The merger has completed and the CMA’s notice of possible remedies indicates that divestiture is the only effective remedy, and the poor financial performance of the target business may raise issues as to the scope of the assets to be divested for the business to be sustainable: Notice of possible remedies (17 March 2022), paras 12 and 19.

  • 48

    Anticipated acquisition by Amazon of a minority shareholding and certain rights in Deliveroo, Provisional Findings Report (16 April 2020). The CMA had provisionally found that, as a result of the COVID-19 pandemic, Deliveroo would have failed financially and exited the market without significant additional investment, which, following the start of the pandemic, only Amazon was willing and able to provide.

  • 49

    Anticipated acquisition by Amazon of a minority shareholding and certain rights in Deliveroo, Final Report (4 August 2020). The CMA found that, following the publication of its Provisional Findings Report (fn 48), developments in the restaurant food delivery market which resulted in improvements in Deliveroo’s business and financial circumstances meant that it could no longer be considered to be a failing firm.

  • 50

    Merger Assessment Guidelines (fn 2), para 3.28. The importance of carrying out a sufficient investigation was also highlighted by the Competition Appeal Tribunal (CAT) in JD Sports’ appeal against the CMA’s prohibition decision relating to its acquisition of Footasylum: JD Sports Fashion plc v. Competition and Markets Authority [2020] CAT 24. The CAT concluded that, both in relation to the failure to follow up inquiries with suppliers and the failure to make direct inquiries of Footasylum’s primary lender, the CMA acted irrationally in that it came to conclusions as to the likely effects of the COVID-19 pandemic, that were of material importance to its overall decision, without having the necessary evidence from which it could properly draw those conclusions. The CAT reached a similar conclusion that the CMA did not have the necessary evidence as to the possible effects of the COVID-19 pandemic on the ability and incentives of Nike and adidas to increase their direct to consumer operations to the disadvantage of the merged entity.

  • 51

    The Merger Assessment Guidelines (fn 2) explicitly state that the CMA will usually give greater weight to evidence that has not been prepared in contemplation of the merger: see para 3.24.

  • 52

    Fumagalli, Motta and Peitz (fn 4), p. 11.

  • 53

    Fumagalli, Motta and Peitz (fn 4), p. 12.

  • 54

    Merger Assessment Guidelines (fn 2), para 3.24.

  • 55

    Fumagalli, Motta and Peitz (fn 4), p. 13.

  • 56

    Fumagalli, Motta and Peitz (fn 4), p. 13.

  • 57

    Case ME/6642/16 Completed acquisition by East Coast Buses Limited of the east coast operations of First Scotland East Limited (23 January 2017).

  • 58

    Case ME/6782/18 Completed agreement between Aer Lingus Limited and CityJet Designated Activity Company (21 December 2018).

  • 59

    Alliance Medical and IBA Molecular, Final Report (15 August 2014).

  • 60

    Completed acquisition by Medtronic plc of certain assets of Animas Corporation, Final Report (30 May 2018).

  • 61

    Euro Car Parts and Andrew Page, Final Report (31 October 2017).

  • 62

    See further, Bruce and Hughes (fn 4).

Contributor Notes

Director, Turnaround and Restructuring, AlixPartners (UK) LLP, London, UK.

Managing Director. Economic Consulting, AlixPartners (UK) LLP, London, UK.

Senior Vice President, Turnaround and Restructuring, AlixPartners (UK) LLP, London, UK. The authors are grateful for the comments of Ben Forbes, Director, Economic Consulting, AlixPartners (UK) LLP, London, UK.