Post Covid-19: The merger control landscape for distressed firms
JOHANNESBURG - Once the Covid-19 pandemic has come to an end and the world enters a phase of recovery and renewal, the buying and selling of distressed businesses may be a way to foster consolidation in markets to ensure business survival.
From a competition law perspective, are the competition authorities sympathetic towards these transactions?
Under South African competition law, firms may avail themselves of the "failing firm defence". This defence is invoked in circumstances where an otherwise concerning transaction from a competition law perspective may nevertheless warrant a green light (whether conditional or otherwise) in order to salvage the deteriorating business. A concerning transaction is one that, for example, gives rise to consolidation in a concentrated market in which the purchaser may inevitably obtain a degree of market power.
In assessing the credibility of the firms' defence, the authority would seek to juxtapose the notional world in which the distressed firm fails (absent the transaction) against the world in which the merger is approved and results in the failing firm having a chance at survival. In order to undertake this assessment, the South African competition authority requires evidence that:
- The target firm is financially distressed or insolvent according to normal accounting principles;
- There is no possibility of reorganising the target firm into a viable entity; attempts have been made at identifying and finding an alternative purchaser that presents less severe competition concerns. This is relevant where the market shares of the parties to the transaction are sizeable; and
- In the event that the transaction is blocked, the target firm will exit the market.
A firm imperilled by the prevailing global circumstances may not necessarily be able to demonstrate escalating and enduring financial distress over a period of time, pre-Covid-19. It will be necessary to nevertheless demonstrate the following:
- The target firm's short to medium term exit from the market is inevitable absent the merger;
- It would be commercially unviable to restructure the target firm in a manner that ensures long-term sustainability;
- There are no realistic purchasers other than the acquiring firm, given the weakened economic climate.
Further, while not expressly legislated under South African competition law, it is interesting to observe the concept of the "flailing firm defence", which is applicable in other antitrust jurisdictions.
This concept allows parties to demonstrate that prevailing economic conditions have resulted in serious and durable financial difficulties (for example higher costs, reduced output, lack of access to capital, cancelled contracts, accumulated debts, low sales, etc), which will adversely affect the ability of the target business to maintain long-term competitiveness and which could only be resolved through the proposed merger.
In the current unprecedented economic climate, the adoption of this approach by authorities may well be warranted in order to foster business sustainability, market competitiveness, maintenance of employment and the prevention of market exits.
Reliance on the failing firm defence and potentially the flailing firm defence as a persuasive approach may, therefore, be a more consistent feature of merger proceedings before the South African competition authorities going forward.
Lerisha Naidu, is a partner, Sphesihle Nxumalo associate and Thando Thabethe, candidate attorney, competition and antitrust practice, Baker McKenzie Johannesburg.