Pertinence Of The "Failing Firm Defence" In Light Of COVID-19

The COVID pandemic has crippled the world economy, bringing it to its knees. The "Lock – Down", being a measure to address the pandemic, has resulted in dire economical distress on businesses across different industries and sectors. Evidently, there has been a market disruption in supply / demand chains prompting the Competition Commission of India to release an advisory dated 19^th April 2020 for businesses to co-ordinate activities in order to achieve continued supply and distribution of health care products and essential commodities /services. It is needless to say that all such measures shall not to be in contravention of provisions of the Competition Act, 2002. The Confederation of Indian Industry, through a manual released on 25^th May 2020, has reemphasized the application of Anti Trust Laws in India during such periods and measures of business co-ordination with competitors should not violate the provisions of the Competition Act 2002. This advisory release of the regulator and the CII relate to the necessity of combined market co-ordination amongst competitors to deal with the present exigencies within the framework of law. There exists nothing specific to the combinations or acquisitions market, except to derive the fact that the provisions of combinations would continue to be in force.

M & A would happen post COVID, but not in the true sense:

The impact of the COVID pandemic on merger & acquisitions are irretrievable and could be assessed truly in an economic and financial sense only when markets are open to feel the genuine force of economics. It is plausible to presume that as long as the "Lock Down" subsists, its ramifications will paralyze the smooth functioning of every business house. Resultantly, such entities would be faced with insurmountable financial duress and challenges to make ends meet, wherein circumstances may dominate exits, failing which entities would be forced to go out of business and face bankruptcy. Such foreseeable market conditions having unassailable impact on the existence of businesses will inevitably pave way for a glut of distress sales in the M&A market in the coming future. Hence, never in the history of the legislation would there be a need of vigilant regulation and investigation of any anti-competitive practices in relation to proposed combinations and acquisitions by players who have weathered the storm during these arduous times. This being a probable economic scenario which may pan out, more than ever, would now there be the adoption of the principle of "Failing Firm Defence" by acquirers seeking the nod of the regulators for any stressed combinations or acquisitions which cross the threshold prescribed under the Competition Act 2002 ?

The Failing Firm Defence – What does it mean?

In simple terms, a transaction seemingly anti-competitive, in the nature of a combination or acquisition would be exempted and allowed by the regulator, if the acquirer can invoke and substantiate the "Failing Firm Defence" principle. In normal parlance, it can be said that a combination or acquisition which may be possibly Anti-Competitive, can be allowed or permitted by the regulator if the acquirer can prove that firstly, the target corporation, due to financial difficulties would be forced into bankruptcy and there is no alternative means of survival, secondly, there are no alternative purchasers of the business, thirdly, in the absence of the combination or acquisition, the assets of the target would exit the market space and fourthly, that no less anti-competitive alternative to the proposed combination or acquisition is available.

The Failing Firm Defence – Context and Relevance

The 'Failing Firm Defense' is an exception to the general rule. The general rule is intended to protect fair competition and eliminate anti-anticompetitive actions from monopolists. However, in an uncommon circumstance, such as the present economic crisis, a financially distressed business house may be subject to a combination or acquisition. In such a case, a strict application of the general rule may result in the business house being insolvent.. To combat such a peculiar scenario, the jurisdictions across the globe have devolved the 'Failing Firm Defense' to legitimize a transaction which would otherwise be anti-competitive. The conditions to satisfy the 'Failing Firm Defense' may be similar in all jurisdictions but the approach may have a variance depending upon the regulators.

The United States of America

The International Shoe v FTC^[1] was considered as the first case in the United State of America wherein the doctrine of the "Failing Firm" defence was accepted. In the Citizen Publishing^[2] case, the Supreme Court rejected the "Failing Firm" defence and laid down a three-level test which also finds itself in the United State Horizontal Merger Guidelines^[3] which are firstly, that "the allegedly failing firm would be unable to meet its financial obligations in the near future", secondly, that "it would not be able to reorganize itself successfully" and thirdly that "the firm has made unsuccessful good faith efforts to elicit reasonable alternative offers and pose a less severe danger to competition than does the proposed merger". The progress of the principle has been such that parties would now have to "provide evidence that their financial difficulties are serious and would affect long time competitiveness, and can be resolved only by merger."^[4]

The European Union:

The first case wherein the principle of the "Failing Firm" was invoked was before the commission in the case of Aerospatiale-Alenia/De Havilland^[5]. The case pertained to an airline industry acquisition which would have resulted in an increased market share and assuming of a dominant position by the acquirer. The Commission prohibited the transaction on the ground that there was no evidence that the target would be imminently failing and there were other buyers who expressed interest. In the year 1993, in the Kali und Salz^[6] case, the Commission accepted the "Failing Firm" defence and laid down three pointers. The three pointers accepted under European Merger Control were firstly that "the acquired undertaking would in the near future be forced out of the market if not taken over by another undertaking, secondly that "the acquiring undertaking would take over the market share of the acquired undertaking if it were forced out of the market" and thirdly that "there is no less anticompetitive alternative purchase". Since the Commission did not consider "the merger to be the cause of reinforced dominant position, the concentration was held to be compatible with the common market"^[7]. The EC Horizontal Merger Guidelines^[8] set out principles of their "failing firm" doctrine which are firstly that the allegedly failing firm will in near future exit the market because of its financial difficulties, secondly, there is no less anticompetitive alternative to the notified merger and thirdly, absent the merger, the assets of the failing firm will inevitably exit the market. The principles laid down in the Kali and Salz case continued to be used along with a counterfactual analysis, wherein a merger scenario is compared with a scenario where a firm would exit.

Provisional clearance during COVID - The United Kingdom

The Competition and Markets Authority^[9] ("CMA") had provisionally cleared Amazon's investment in Deliveroo^[10]as recent as 17^th April 2020. The CMA held that COVID was having a significant impact on the business of the target wherein the target would have been forced to exit without additional funds. It was also presented before the CMA that there being no assurance of future funding, insolvency would have been certain. The CMA held the transaction to be a "combination of exception circumstances" as alternative funding would not have been available to the Target within the time as which was required. The CMA concluded holding that Deliveroo's exit would be more detrimental to the customers and prevalent competition than the acquisition. This order of the CMA has had a significant impact on the "Failing Firm Defence" principle, as the failure of the target, would have disrupted market forces and caused competition to be significantly weekend.

India

As the Indian Anti Trust Law is still in the nascent stage, the Competition Commission of India and the Constitutional Courts has not directly dealt with the "Failing Firm" defence at length. However, it is noteworthy to mention that the S.V.S. Raghavan Committee Report^[11] that laid the foundation for the Competition Act, 2002 has made a specific observation on the said defense. The Report observed thus;

"The case can be made that even mergers that lead to an uncompetitive outcome could result in certain "efficiencies" that more than make up for the welfare loss resulting from this. The Russian law has such a provision. The US law has generally been balanced in favour of competition. However, the "failing firm" defence has, at times, been accepted by courts. If a firm is, indeed failing and likely to go out of business, it is not clear what social welfare loss would occur, if this firm's assets were taken over by another firm."

Competition Law in India may not have such specific principles laid down through judgments as compared to various other competition law jurisdictions. However, the Competition Act 2002 has a glance of the "Failing Firm" defence principles at section 20 (4) (i) & (k), which are amongst others, are factors which the Competition Commission of India would have to inquire while approving a combination. Section 20 (4) (i) refers to the "likelihood that the combination would result in the removal of a vigorous and effective competitor or competitors in the market" and section 20 (4) (k) refers to the "possibility of a failing business". The "Failing Firm" defence and principles would more so be applicable in cases where in a company undergoing Corporate Insolvency Resolution Process ("CIRP") ordered by the provisions of the Insolvency and Bankruptcy Code 2016 ("Code"). In such circumstances, the very fact that a Company is under CIRP, would establish insolvency/bankruptcy, eclipsing majority of the explanations laid down by the various Competition Law jurisdictions. A company under insolvency most definitely would be unable to meet its financial obligations, insolvency would be vindicated evidence of financial difficulties, the Company is definitely forced out of the market and has failed to reorganize itself paying way for the necessity of a Resolution Plan^[12] by a successful Resolution Applicant^[13]. A Resolution Plan contemplating a combination by virtue of the proviso at section 31(4) of the Code would require the prior approval of the Competition Commission of India before the approval of the Committee of Creditors. The fact that such an entity is going through the resolution process would be evidence that the principles governing the doctrine of "Failing Firm" defence have been achieved by default. However, there being discussions and proposals of the effective provisions of the Code being suspended, this principle of exception can be used for pending cases of CIRP and also extend to direct market transactions which would surface once the diabolical economic impact of COVID is assessed in the true economic sense.

Conclusion:

The continuance of the COVID crisis is only deepening and escalating the financial uncertainties which businesses may face during these testing times. It is inevitable that this principle would gain impetus before regulators as consolidation of all sectors of business through combinations and acquisitions would be prevalent not due to robust market conditions but due to the spiraling and dire financial crisis which the global economy is facing..Furthermore,, it would be even more incumbent on the regulators to be observant and there would inevitable increase of focus with respect to transactions crossing the thresholds specified under the Competition Act 2002. The Competition Commission of India has also introduced 'Green Channel Filings' which would provide the necessary fillip for such transactions and reduce timelines significantly. The Indian Legal regime may possibly adopt various principles laid down in other Competition Law jurisdictions, imbibe counterfactual practices and simultaneously also consider the duress/impact caused by the COVID pandemic on the entire business community while approving combinations.

• This article is written by Mr. Pawan Jhabakh and Mr. Salai Varun, Advocates practising in the High Court of Judicature at Madras. The views expressed are personal