[Parina Muchhala is a 3rd year student and Ira Pandya a 4th year student, both at the Maharashtra National Law University Mumbai]
The effects of the COVID-19 outbreak has led to interruption of supply chains, reduction in consumer demand and disruption of economies. It has also led many companies to file for bankruptcy worldwide. This indicates that while COVID-19 has also negatively impacted most pending mergers and acquisitions (M&A), there remains the possibility of an increase in the number of M&A transactions related to rescue deals and restructuring. The OECD acknowledges that in times of financial distress, it is natural for firms to safeguard their long-term survival through mergers with direct, healthier competitors.
Such acquisition deals in India are undertaken through the mechanism provided in the Insolvency and Bankruptcy Code, 2016, since the companies are financially distraught. This depends on the resolution plan chalked out by the insolvency resolution professional. Essentially, this deal thus becomes a “combination” under section 5 of the Competition Act, 2002, insofar as it involves the acquisition of the corporate debtor by another firm. Recognising this within the IBC, the proviso to section 31(4) requires resolution applicants to obtain necessary approvals from the Competition Commission of India (CCI) with respect to this combination before the approval of the committee of creditors is obtained. Whilst this would have otherwise been a cumbersome and long process, the CCI in 2019 amended its Combination Regulations, 2011 to add regulation 5A, legitimising the concept of “Green Channel Clearance” for M&A filings, which is largely based on self-assessment by parties.
Naturally, since these firms are on the brink of extinction that has itself led to the process of insolvency, they qualify as “failing firms” under section 20(4)(k) of the Competition Act, which is a defence against the automatic assumption that such a merger would constitute an “appreciable adverse effect on competition.” In economic literature, a failing firm is denoted through factors such as poor management, declining productivity, financial problems, and the presence of greater liabilities than assets. Thus, the starting point of the inherent link between the invocation of the “failing firm defence” in mergers and a resolution plan under the IBC is the filing of an application under section 7, 8, or 10 of the IBC, which naturally warrants an examination into the financial position of the firm.
In a bid to provide respite to the economy, the Government has recently promulgated an Ordinance to suspend the application of the IBC for a year. This would imply that any combination filing reaching the CCI in the upcoming year would not have gone through the rigour of the IBC to determine whether it was actually “failing.” Thus, it leaves the responsibility of such determination entirely with the CCI in cases where the parties propose a combination with the objective of protecting a failing firm. This raises interesting questions with respect to (a) the manner in which such examination must be carried out, and (b) whether the cause of failure (COVID-19 or otherwise) would have any impact on this examination. This post seeks to answer these questions by examining general practice across jurisdictions to present suitable suggestions.
Jurisprudence on the identification of “failing firms”
In the European Union (EU), the Kali und Salz case is the first instance of the defence being taken, where the European Commission held that its invocation is premised on satisfaction of the following criteria: (i) the failing firm would be forced out of the market if not taken over by another entity, (ii) this was the least anti-competitive measure, and (iii) the assets of the failing firm would leave the market in the absence of the said merger, now reflecting in the 2004 Merger Guidelines. A similar test is applicable in the United States (US) through section 11 of its 2010 Horizontal Merger Guidelines.
Reference to the EU’s Olympic/Aegean Airlines case is important because it involved a merger citing the failing firm defence in the wake of the 2007-08 worldwide financial crises. The Commission initially rejected the parties’ use of the defence, since the conditions of the test were not met and sufficient evidence to show actual bankruptcy was not submitted. It observed that in times of financial crisis, temporary losses were a common feature which did not warrant an inference that the firm was “failing.” Furthermore, it held that the parties did not provide adequate information about alternate negotiations carried out with other potential buyers or demonstrating how the failing firm, in the absence of the proposed transaction, would exit the market.
Interestingly, however, the Commission approved the same transaction when filed again two years later in Aegean/Olympic II. Understanding the dismal state of the Greek economy through reports submitted to it, the Commission found that Olympic (whose parent company was also nearing bankruptcy by this time) would most likely have to exit the market. It also concluded that the merger was not likely to negatively impact competition as it stood then, thus holding that the failing firm defence could “apply to this case.” Competition regulators in EU are still accepting the defence as a ground for legitimising mergers, such as the acquisition of Deliveroo by Amazon UK.
The American position is even stricter, with the Free Trade Commission rarely allowing for mergers in such cases. There is a further distinction between the “failing” and “flailing” firm, the latter indicating those firms that have simply become “weaker competitors.” This indicates that the parties have the higher burden of establishing that the firm is close to bankruptcy, rather than merely weakened by the market competition, as being the sole cause of the merger. Even during times of financial crisis in the past, the US Department of Justice has been unwilling to compromise on the standards of this defence, only easing the process through expedited reviews. However, they make considerations in terms of applicable standards by assessing the nature of the industry within which the merger is stated to occur. This month, the US has already allowed for an acquisition in the milk industry. The Indian and Chinese positions may be regarded as slightly similar to this regime, insofar as it processes mergers through their domestic bankruptcy regimes.
India has also allowed mergers based on the failing firm defence, such as Bhushan Steel’s takeover by Tata Steel. This has only increased since the application of the IBC, with over 97% mergers being approved by the CCI within a year without any objections. This indicates a proactive and facilitative outlook towards increasing the ease of doing business in the country, which will benefit the CCI even in absence of the IBC.
Steps taken by competition regulators worldwide in lieu of the COVID-19 crisis
Competition regulators have issued advisories specifically addressing the application of antitrust provisions to firms during such times. For instance, the European Commission has published a ‘Guidance Note’ on the forms of assistance obtainable to firms from States, implying that firms must have had to take such assistance before approaching the Commission. American, Hong Kong and Chinese authorities have called for expedited merger reviews of “failing firms”, which may prove to be beneficial to ailing parties by providing them an anticipated timeline to base their transaction upon without undermining overall consumer welfare ensured through sizeable competition in the market.
Interestingly, however, the Advisory issued by the CCI makes no specific mention of mergers, and only seeks to generally warn businesses to refrain from violating any provisions of the Competition Act. With respect to “failing firm” mergers, this provides no clarity to parties with respect to the intended timeline, mitigating factors, and any other pertinent information that may assist them in their filings. It also provides no clarity on the extent to which the firms failing due to the economic effects of the COVID-19 crisis will be considered when evaluating reasons for mergers.
Factors that can be considered by the CCI when evaluating such mergers
At the outset, it is to be noted that since the CCI has acknowledged the negative impact of COVID-19 on supply chains in its Advisory and been generally liberal with respect to such mergers, it is likely that they will follow authorities worldwide and consider economic failure due to COVID-19 as a defence under section 20(4)(k) of the Act. However, the absence of the IBC also indicates that the CCI is tasked with the additional responsibility of conducting relevant independent investigations. Whilst doing so, care must be taken to ensure that the CCI does not dilute the higher threshold for justifying a merger based on financial distress, as followed by competition regulators worldwide.
A balance can be carved out by asking parties to submit comprehensive evidence in line with the factors mentioned in the Olympic/Aegean case. This gives parties the opportunity to justify their case by adducing any material that demonstrates a near-bankrupt state, evidence of alternative negotiations with other buyers, and the possibility that the firm would leave the market if not for the impugned merger. Parties can also be allowed to attach financial forecasts that they have derived through independent think tanks or economists. Thus, when evaluating this, it will provide the CCI with a holistic perspective of the true intention and effect of the merger. It can now juxtapose this with its own independent investigation into the projected recovery time of the economy as a whole, the financial standing of the “failing firm”, and enquiries with respect to the sector-specific anti-competitive effects of the merger. This will allow it to give due consideration to the impact of COVID-19 within the context of larger considerations of anticipated economic growth, whilst also honouring the welfare mandate of the IBC in the meantime.
Another important factor that can be considered by the CCI is the industry-specific impact of COVID-19. This would help in effective differentiation between “failing” and “flailing” firms to prevent anti-competitive effects from the merger. It is not unknown that industries such as airlines, hospitality and tourism have been, and will continue to be affected at a greater level than others. Acknowledging this can not only help in understanding the intention of the merger but also allow the CCI to be flexible in terms of devising different thresholds for specific industries (much like its American counterpart). A similar approach and reasoning was given by the South Korean Free Trade Commission when relaxing its merger guidelines to aid the aviation sector. In parallel, the CCI can endeavour to provide “expedited reviews” in a manner similar to other jurisdictions to ensure that the consumer choice, and overall welfare, is not compromised in these industries.
Lastly, care must be taken to ensure that in the longer run, parties filing another application for merger within a few years of their initial application being rejected are given benefit of the doubt in terms of re-evaluation of the economy and overall demand in the market at that time rather than outright refusal. Another alternative is to issue an Advisory allowing competitors merging due to COVID-19 to file under the “Green Channel” regime in regulation 5A. Here, the overall pro-investment outlook of the CCI will come to its rescue. Whilst it is likely that the IBC will otherwise resume application within a year, from a regulatory perspective, this will nevertheless go a long way towards sending a positive message to foreign investors.
The impact of COVID-19 is likely to reverberate for a while, making the future of many businesses uncertain. In lieu of the suspended applicability of the IBC, it is best that the CCI adopts a proactive role to balance out competing considerations of “failing firms” and consumer welfare to evaluate the future of mergers filed during this time.
– Parina Muchhala & Ira Pandya