The UK’s Competition and Markets Authority (CMA) has provisionally cleared Amazon’s proposed acquisition of a stake in Deliveroo relying – in part – on the finding that Deliveroo would have been likely to exit the market without Amazon’s injection of funds [1].

With many other firms citing financial difficulties due to the impact of COVID-19, this may become the weapon of choice when seeking clearance of mergers by competition authorities.

In this context, the CMA has now provided further guidance on how it will deal with the failing firm defence in the context of the current pandemic [2], [3]. The competition authorities will consider three questions:

1. Would the firm continue to exist without the merger?
2. Is there a less anti-competitive alternative to the merger?
3. Would the firm exiting be more detrimental to competition than the potential merger?

Given the high hurdles to clear, the failing firm defence has rarely been argued successfully.

While the pandemic might put more firms into a situation in which a rescue merger might be considered, the significant uncertainty around the post-COVID-19 economic environment adds considerable complexity in gathering evidence in support of any potential transaction.

Taking each question in turn:

1. Would the firm continue to exist without the merger?

Claims of financial distress that would lead to the inevitable exit by a firm will need to be supported by strong evidence—for example, internal documents, board minutes, financial statements, business plans etc. The competition authority will want to see expert opinions substantiating the likely failure and exit of the firm in question and the inability to turn it around. This could include third party opinions (legal and financial) regarding insolvency, to determine whether the firm would likely exit without the transaction.

Indeed, the competition authority is unlikely to presume that a firm will fail based on the difficulties posed by the COVID-19 situation alone – the burden of proof lies on the ‘failing’ firm. While the sharp drop-off in economic activity makes it easier for firms to pass this first test, the availability of government support for firms in response to the crisis need to be factored in.

Across Europe, governments have introduced business interruption loan programmes, furlough schemes, and direct cash grants to businesses. Direct cash injections by governments have been simplified by the temporary state aid framework recently published by the European Commission [4].

Finally, changes to regulations around insolvency need to be taken into account. As an example, the UK government introduced changes to insolvency law aimed at providing firms in financial distress with additional time to explore options for rescue [5].

2. Is there a less anti-competitive alternative to the merger?

The CMA also considers whether a less anti-competitive outcome could be achieved if a different buyer, for example a smaller competitor, acquired the failing firm. Similarly, competition authorities will consider whether a piecemeal acquisition of the firm’s assets by other market participants could be a better outcome (for example, a failing airline’s aircrafts, airport slots, etc.).

In the current market environment, many firms are cash-stripped and more risk-averse, potentially leaving fewer alternative buyers for a failing firm (or its assets). In addition, access to finance is restricted.

While current market conditions are conducive to arguing that there are fewer plausible alternatives to a merger, there is also more uncertainty. It is harder to assess the likelihood of alternative buyers when the ‘lockdown’ is gradually relaxed, and the number of transactions rise.

In its Amazon/Deliveroo provisional findings, the CMA attempts to show that broad-brush arguments about the impact of COVID-19 on financial markets are unlikely to be sufficient to pass this second test.

The CMA argued that an exit of Deliveroo would be the most likely outcome based upon “the particular structure of Deliveroo’s business and its need for external funding, the effects of Coronavirus, and the particular point in Deliveroo’s funding cycle that Coronavirus occurred”.

3. Would the firm exiting be more detrimental to competition than the merger?

The final test in a failing firm defence is the one that is most complicated by Covid-19.

Competition authorities have to deal with the fact that market conditions are drastically different from those pre-COVID-19. Currently, the duration of many of the measures taken in response to the pandemic cannot be easily predicted and even after the loosening of restrictions, there are likely to be long term changes in consumer behaviour and market structure.

As any “rescue mergers” will have permanent effects on the competitive landscape, it is necessary to consider the medium - to longer-term view on the impact of COVID-19, including the ability of the market to scale capacity in response to demand changes, through entry and exit

Consider a simple example based on the characteristics of the airline industry. Pre COVID-19, Airline A and Airline B compete against each other, both using leased aircraft and airline slots. As a result of Covid-19, both airlines are grounded, and there is currently no competition in the market. Airline A fails and is the subject of a rescue bid by Airline B. The competition authority must decide whether consumers will be ‘less worse off in the merger scenario rather than allowing Airline A to exit.

The potential consequences depend both on assumptions around post-crisis demand levels as well as the market’s ability to respond to demand changes.

If it is judged that demand levels will be permanently depressed, it is possible that both airlines might not be able to operate above minimum efficient scale, and a merger will not lead to detrimental effects post-COVID-19. If, however, demand is likely to recover at a future point, prohibiting the merger might be seen as the preferred course of action if the physical assets of the failing firm can easily transfer to potential new competitors at a later point in time.

The CMA underscored the importance of the ability of the market to quickly alter levels of productive capacity in its assessment of the Deliveroo/Amazon transaction

A key line of argument in the provisional findings concerns the substantial time it would take for Amazon (or other potential competitors) to establish the point-to-point delivery network currently operated by Deliveroo. This feature of the online delivery market makes it more likely that competition will be restricted for a significant time following an exit of Deliveroo and a recovery of demand levels.

Conclusion

The ‘failing firm’ claim has historically been a difficult argument to present by merging parties due to a high evidence bar. Where it has been accepted, this has been during times of recession and where the duration of losses is demonstrated to be more than transient [6]. The Aegean/Olympic II case in 2013 was the last time that the three criteria were successfully met before the European Commission.

The deepening of the COVID-19 crisis may lead to this argument being increasingly used by merging parties. However, competition authorities have been quick to communicate their commitment to the established practice in assessing the failing firm defence.[7].

While the pandemic might make it easier to show financial distress and a lack of alternative financing, COVID-19 adds an additional layer of complexity when assessing impacts on competition and consumer welfare.

How A&M Economics can help

A&M Economics is a specialist economics practice comprising professional competition economists and economic modellers with industry experience. Working alongside A&M’s restructuring practice, A&M Economics can support clients and their advisors during all stages of the merger review process:

• Pre-transaction: flag potential concerns, carry out a risk assessment, prepare appropriate responses and identify potential remedies addressing the issues at an early stage.
• Merger review process: provide support and expert advice during all phases of a competition authority’s investigation for the parties involved or interested third parties.
• Assistance in designing and testing the effectiveness and attractiveness of remedies to allow the transaction to be cleared by competition authorities.
• Modelling the impact of COVID-19 at the sector level to establish a credible evidence base for counterfactuals.

For further information on the areas in which A&M Economics can provide support, please contact one of the authors.

[1] CMA (2020). CMA provisionally clears Amazon’s investment in Deliveroo. https://www.gov.uk/government/news/cma-provisionally-clears-amazon-s-investment-in-deliveroo

[2] CMA (2020). Merger assessments during the Coronavirus (Covid-19) pandemic. https://www.gov.uk/government/publications/merger-assessments-during-the-coronavirus-covid-19-pandemic

[3] CMA (2020). Annex A: Summary of CMA’s position on mergers involving “failing firms”. https://www.gov.uk/government/publications/merger-assessments-during-the-coronavirus-covid-19-pandemic/annex-a-summary-of-cmas-position-on-mergers-involving-failing-firms

[4] European Commission (2020). Temporary Framework for State aid measures to support the economy in the current Covid-19 outbreak. https://ec.europa.eu/competition/state_aid/what_is_new/sa_covid19_temporary-framework.pdf

[5] https://www.gov.uk/government/news/regulations-temporarily-suspended-to-fast-track-supplies-of-ppe-to-nhs-staff-and-protect-companies-hit-by-covid-19?utm_source=a14f0cfa-8e72-4d3c-a7d6-f3e9f1580b07&utm_medium=email&utm_campaign=govuk-notifications&utm_content=immediate

[6] The dismissal of such arguments in Olympic/Aegean Airlines required the Commission to reverse itself only two years later

[7] For example, in addition to the CMA guidance, both EU Commissioner Vestager and US FTC Commissioner Slaughter have recently signalled that they are keen to see no relaxation of the applicable rules when assessing mergers.