Tough Times, Desperate Measures – The Failing Firm Defence as a Merger Control Tool During Times of Economic Challenges

The Swedish Competition Authority recently handed down its decision to block a transaction in the pharmacy market. The decision was not considered surprising, since the implementation of the contemplated transaction would have entailed a 3-to-2 merger, which are customarily subject to heightened merger control scrutiny. In light of the dire financial straits of the target company, the parties to the transaction argued via the so-called Failing Firm Defence that the target company was essentially a failing firm, an argument that the Swedish Competition Authority ultimately rejected, following the historically consistent trend of strict interpretation of the doctrine.

Under the Failing Firm Defence, a company is exceptionally allowed to proceed with an otherwise anticompetitive acquisition if financial issues were to force the target company out of the market and no less anticompetitive alternative purchaser is available. The Failing Firm Defence reflects the mainstream (albeit controversial) economic understanding that the failure of a firm and the exit of its asset from the relevant market would harm competition more than an ostensibly anticompetitive merger. Both the United States and the European Union recognise the Failing Firm Defence with substantially similar criteria, albeit differing somewhat in its application.

The Failing Firm Defence set out in the EU merger control rules prescribes specifically that the Commission may decide that an otherwise problematic merger is nevertheless compatible with the internal market if one of the merging parties is a failing firm. The overall criterion for the applicability of the Failing Firm Defence is that the deterioration of the competitive structure that follows the merger cannot be said to be caused by the contemplated merger, i.e. the competitive structure of the market would deteriorate to at least the same extent in the absence of the merger.

The Commission considers the following three cumulative criteria to be especially relevant for the application of the Failing Firm Defence:

1. the allegedly failing firm would in the near future be forced out of the market because of financial difficulties if not taken over by another company;
2. there is no less anticompetitive alternative purchase than the notified merger; and
3. in the absence of a merger, the assets of the failing firm would inevitably exit the market.

The Commission’s application of the Failing Firm Defence has a notoriously strict track record, one of its rare successes still being the airline industry decision in Case M.6796 Aegean/Olympic II (2013), which followed the initial rejection of the doctrine in Case COMP/M.5830 Olympic/Aegean Airlines (2011). In hindsight, it appears that one of the decisive factors among the changed circumstances leading to the Commission’s unexpected change of heart included the aftermath of the 2008 financial crisis. This indicates that the current economic climate may, in practice, play a decisive role in the application of the Failing Firm Defence, despite occasional academic arguments to the contrary.

Notwithstanding its history of strict application, the Failing Firm Defence has proven successful in a number of past cases and remains a workable tool for navigating ostensibly anticompetitive mergers when properly argued with the timely support of a top-tier legal team. Given the strict evidential hurdles of the defence and the inevitable time that any merger review in a concentrated market will take, advance planning and extensive documentation are crucial to success.

Borenius Attorneys are ready to assist our current and future clients in all aspects of merger control, including getting the deal through under the Failing Firm Defence in times of economic challenges. We would be pleased to discuss your preliminary deal concepts, to form an initial view as to the viability of the transaction under the Failing Firm Defence, and to determine the best course of action with maximum probability of success in merger review.