As many businesses look for solutions to weather the economic impact of the COVID-19 pandemic, one potential avenue for distressed companies is to seek to be acquired by a more stable firm looking to expand. The antitrust regulators have made clear that all types of mergers – even during a global crisis – will be subject to ordinary antitrust scrutiny. As those principles are applied, merging companies may look more frequently to the “failing firm” defense to convince regulators that their deal should pass regulatory hurdles when it otherwise might not. However, the requirements for meeting the failing firm standard are high, and merging parties should not assume that financial struggles during the pandemic will provide a free pass through merger review.
The objective of the failing firm defense is to prevent the failing party’s assets from completely leaving the market. Section 11 of the Department of Justice (DOJ) and Federal Trade Commission’s Horizontal Merger Guidelines sets out failing firm defense as part of the United States’ framework for determining whether mergers are anticompetitive. The Horizontal Merger Guidelines state that “a merger is not likely to enhance market power if imminent failure, as defined below, of one of the merging firms would cause the assets of that firm to exit the relevant market.” That is, a failing firm may be acquired by another even where such a merger would raise anticompetitive concerns because such concerns are overridden by the fact that the failing firm would have exited the market entirely. Thus, consumers would not be worse off following the acquisition.
The Horizontal Merger Guidelines require merging companies invoking the failing firm defense to prove the allegedly failing firm
- would be unable to meet its financial obligations in the near future;
- would not be able to reorganize successfully under Chapter 11 of the Bankruptcy Act; and
- has made unsuccessful good faith efforts to elicit reasonable alternative offers that would keep its tangible and intangible assets in the relevant market and pose a less-severe danger to competition than does the proposed merger.
The burden is on the parties to prove that these conditions have been met. The Horizontal Merger Guidelines caution that “[t]his is an extreme instance,” and rather than showing that one of the firm’s market share is merely declining, the parties must show that “the projected market share and significance of the exiting firm is zero.” Indeed, the failing firm defense has been upheld in only a few court decisions since it was introduced in the International Shoe case in 1930. However, if all three conditions are proved, the failing firm defense is a complete defense, and the transaction will be permitted to proceed.
Parties that cannot meet the criteria for the failing firm defense may try the less stringent “flailing firm” defense, which requires one of the parties to prove its competitive significance is significantly declining and that other procompetitive factors exist.
Historically, regulators have not expanded or loosened the requirements of the failing or flailing firm defenses during economic downturns, but they have acknowledged that periodic times of economic uncertainty may be relevant to merger review. During the 2008–2009 recession, the assistant attorney general for antitrust at the DOJ stated that “[w]hile there is no theoretical or empirical basis for departing from the basic principles of competition policy during general economic downturns, financial distress at the industry or company level is certainly relevant to antitrust analysis. … [A]ntitrust enforcement should take account of real-world economic conditions.”
The real-world economic conditions of the COVID-19 pandemic may lead more companies to believe that their financial situation warrants special consideration as they try to exit through a merger. And many firms may believe that they have few options for remaining in the market without being acquired. Firms must be cognizant, however, that the standards for the complete failing firm defense are high, and thus parties should continue to focus on traditional procompetitive effects to withstand antitrust scrutiny.