ALERT: Acquisitions of Distressed Companies: Obtaining Antitrust Merger Clearance Using the Failing and Weakened Firm Defenses

What follows is the second part of an alert from Akin Gump’s corporate practice. See the first part here.

For more information regarding this alert, please contact—

• Mark Botti, 202.887.4202, Washington, DC
• Anthony Swisher, 202.887.4263, Washington, DC

Will the current distressed economic environment make securing antitrust approval for mergers or acquisitions easier than it otherwise might be?  We deal here with mergers between historically significant competitors that, under normal circumstances, might raise more than passing antitrust concern.  The short answer, as discussed below, is that antitrust principles will take into account the weakened financial condition of a merging party.  There is some precedent, in the form of the Depression-era Appalachian Coals[1] case, which supports the proposition that overall economic malaise might help a deal get through that would not otherwise pass muster.  A more predictable analysis, however, would focus on the condition of the individual firms involved in the merger or acquisition, as well as on the impact of the financial crisis on competition in the relevant market, not merely on the overall state of the economy.  The latter might perhaps make the enforcement agencies less skeptical in reviewing a claim that one of the companies is so distressed or the market so dysfunctional that a merger or acquisition cannot be anticompetitive.  However, the acknowledgment by the Federal Trade Commission or the Justice Department’s Antitrust Division that the country is in an overall economic crisis will not be a “get out of jail free” card for any particular merger.  Rather, economic distress will be taken into account (if at all) on an individualized basis under one of three related sets of principles:  (1) the failing firm defense, (2) the General Dynamics defense and (3) the flailing firm defense.

Failing Firm Defense. The financial distress of one party to a transaction most readily factors into the antitrust analysis under what is called the “failing firm” doctrine.  The Supreme Court’s decision in Citizen Publishing Co. v. United States, 394 U.S. 131, 136-38 (1969) provides a leading example of its application.  The court in Citizen held that a merger (through creation of a monopoly joint selling arrangement) between the only two daily newspapers in Tucson, Arizona would not be unlawful if one of the companies was “failing,” and satisfied the following criteria: (1) the company was in imminent danger of failure, (2) the failing company had no realistic prospect for a successful reorganization and (3) there was no viable alternative purchaser that posed a less anticompetitive risk.  The antitrust enforcement agencies have incorporated these considerations directly into their merger enforcement guidelines.  See U.S. Dept. of Justice and Federal Trade Commission, Horizontal Merger Guidelines ¶ 5-5.2 (1997 rev.).  The basic point of the failing firm analysis is that, if a company would exit the market but for its acquisition, stopping the acquisition will not protect any future competition.

General Dynamics Defense. What of the case where a firm is struggling but does not meet the strict requirements of the “failing firm” defense?  Merging parties have, with varying degrees of success, attempted to rely on the financial distress of a company, under what is known as the General Dynamics defense, relying on the Supreme Court’s decision in United States v. General Dynamics Corp., 415 U.S. 486 (1974).  In that case, the court concluded that, even if a company was not going to exit the market, if the company lacked resources to be able to engage in new competition in the future (as opposed to merely fulfilling existing contractual commitments), acquisition of that company would not be unlawful.  The court in General Dynamics found that one of two merging coal producers was unlikely to play a significant competitive role in the future because future competition “would depend on uncommitted [coal] reserves, and one of the acquired firms had no uncommitted reserves.”  Id. at 503-04.  In short, without any uncommitted reserves, the acquired firm had no ability to compete for new customers.

Flailing Firm Defense. The so-called “flailing firm” defense is often invoked as a General Dynamics variant, where a merging company is in financial distress, but it is not exiting the market (as required for the failing firm defense) and it would likely have some competitive influence going forward (unlike the factual situation in General Dynamics).  The argument is that the company is in such a weakened state that its competitive influence is reduced to the point that its elimination from the market will not have a significant impact.  The defense has met with some degree of skepticism and resistance from the antitrust enforcement agencies and is not incorporated explicitly into the Merger Guidelines.  Some courts, moreover, have failed to recognize the flailing firm defense as an appropriate expansion of the failing firm defense.  See United States v. UPM-Kymmene Oyj, 2003-2 Trade Cas. (CCH) ¶ 74,101 (N.D. Ill. 2003) (distinguishing “weakened competitor” argument from failing firm and failing division defenses and declining, on policy basis, to extend defenses where the division was “noncompetitive simply because its parent had not decided to compete.”).  Nonetheless, the weakened financial condition of a merging company can play a significant role in the evaluation of a merger, even where it is not a complete defense.  See, e.g. FTC v. Arch Coal, Inc., 329 F. Supp. 2d 109, 146-47 (D.D.C. 2004) (acquired firm’s financing obligations and high costs prevented it from competing aggressively on price).

We believe that, whatever views the agencies might hold generally regarding these defenses, the current economic crisis might cause them to be more receptive to the factual proposition that a merging company is possibly failing or flailing.  The economic crisis is not something the agencies are likely to question, and its very real impact on the financial viability of U.S. businesses is not open to debate.  Thus, merging parties who have well-grounded arguments that one of them is failing or flailing should have an open-minded audience in the agencies.  This is likely to remain true even in the upcoming Obama administration.  Moreover, if the merging parties are able to link the financial crisis to evidence that the market in which they compete is undergoing substantial change such that an anticompetitive effect from the merger is unlikely, they gain greater traction with these arguments.  Consider, for example, the Supreme Court’s Appalachian Coal decision.  Many modern-day observers attribute the outcome in that case to the backdrop of the Great Depression.  The court allowed competing coal producers who controlled 73 percent of the commercial production in their area of competition to form a joint sales agency, despite the fact that the trial court found that prices were likely to stabilize or rise as a result.  Important to the court’s decision was an analysis of the severe financial distress facing the industry as a whole, with capacity far outstripping demand, and the consolidating producers facing substantial competition for a large volume of their sales.

Despite Appalachian Coals and the judicial precedent involving failing and flailing firms, parties considering a merger of substantial current competitors should not think that the financial crisis will readily carry the day in the antitrust review of their merger.  Indeed, the Appalachian Coals decision is questioned today, and it is important to recall that the Justice Department in fact filed the challenge despite the economic crisis at the time.  We similarly expect a modern Justice Department not to accept the economic crisis as a sufficient basis to clear an otherwise anticompetitive merger, but instead would want to ground its decision in established antitrust doctrine as applied to the specific facts of the particular merger. 

So, what does all of this mean to parties considering a merger or acquisition in the current distressed economic environment?  While the distressed financial markets will not guarantee that a failing firm or flailing firm defense will work, and the parties still have to satisfy the factually specific inquiry and technical requirements of the law, we expect the antitrust agencies not to turn too jaundiced an eye on such claims, but rather be more receptive to them then they’ve been in a long time.  Parties in these circumstances should therefore consider these arguments as potentially viable components of the antitrust tool kit and marshal carefully the facts linking the financial crisis to an analysis of why a merger is positive for the market, not anticompetitive.  These are not one-size-fits-all solutions, but a failing or weakened firm argument in today’s tough economic environment may make a merger or acquisition more plausible from an antitrust point of view than it would have been before the financial crisis.