vertical 1996-2004

E.C.L.R. 2004, 25(1), 11-24
European Competition Law Review
2004
Failing firm defence and lack of causality: doctrine and practice in Europe of two closely related concepts
Vincenzo Baccaro
© 2011 Sweet & Maxwell and its Contributors
Subject: Competition law
Keywords: Competition policy; EC law; Mergers; United States
Legislation cited: Regulation 4064/89 on the control of concentrations between undertakings Art.2
Commission Notice on the appraisal of horizontal mergers under the Council Regulation on the control of
concentrations between undertakings 2002 (CEC)
Cases cited: France v Commission of the European Communities (C68/94) [1998] E.C.R. I-1375 (ECJ)
Rewe / Meinl (IV/M.1221) [1999] OJ L274/1 (CEC)
Ernst & Young / Andersen Germany (COMP/M.2824) (Unreported, August 27, 2002) (CEC)
Kali und Salz / Mitteldeutsche Kali / Treuhand (IV/M.308) [1994] OJ L186/38 (CEC)
BLU (Unreported, August 5, 2002) (CEC)
Ernst & Young France / Andersen France (COMP/M.2816) (Unreported, September 5, 2002) (CEC)
NewsCorp / Telepiu (COMP/M.2876) (Unreported, April 2, 2003) (CEC)
BASF / Eurodiol / Pantochem (COMP/M.2314) [2002] OJ L132/45 (CEC)
Deloitte & Touche v Andersen (UK) (Comp/M.2810) [2002] OJ C200/8 (CEC)
*11 Introduction
The “failing firm defence” is a concept often used by practitioners to claim the supposedly neutral effect on
competition of concentrations where one (or both) of the merging parties (the acquirer and/or the target) are
flailing or will fail, due to poor financial performance.1 This concept is handled with much care by competi-
tion authorities. In Europe, it was seldom used by the European Commission to allow such mergers other
than in very exceptional and nearly self-explanatory circumstances. In effect, the said defence has been
shaped and applied by the European Commission in a very stringent way.
Although the EC Merger Regulation2 and its implementing legislative package do not explicitly include a
“failing firm defence” concept within their rules,3 the idea of “rescue mergers” has long had a presence in
merger control law of the European Union, through its practical existence and the pragmatic approach taken
by the Commission in some cases. This article analyses some cases in which the Commission has made use
of this concept directly and other cases in which some of its basic elements are referred to in situations in
which its “legal” criteria were not stricto sensu met. In these latter cases in particular, a more general prin-
ciple of “lack of causality” is at the heart of the Commission's reasoning rather than a specific “failing firm
defence”.
E.C.L.R. 2004, 25(1), 11-24 Page 1
(Cite as: )
© 2011 Thomson Reuters.
The focus of this article is practical rather than theoretical. After a short presentation of the framework of
the failing firm defence in the US and in the EU, the focus turns to European case law. In chronological or-
der the main cases are presented where the failing firm defence was addressed by the Commission and by
the Court of Justice. Finally, some interesting developments are illustrated by analysing recent mergers
where the centre of gravity of the Commission's reasoning is, as mentioned earlier, “lack of causality” rather
than “failing firm defence”. In addition, in one case (concerning a “remedy” to a merger posing competition
problems) not even a “lack of causality” appears at stake; nevertheless, the Commission's reasoning follows
a path similar to *12 that in cases where a “neutral effect” type of analysis is applied. All in all, regardless of
labels attached to concepts, in the various cases a broad common line can be recognised. This shows the
pragmatic attitude of the Commission as regards such mergers where the issue of causality is at stake due to
the possible/actual disappearance of one of the parties to a merger.
US and EU approach to failing firm defence
The concept of failing firm defence4 appears in the joint US Department of Justice and Federal Trade Com-
mission merger guidelines, where the notion was born and developed.5 Section 5 of the Horizontal Mergers
Guidelines provides:
“A merger is not likely to create or enhance market power or to facilitate its exercise, if imminent failure, as
defined below, of one of the merging firms would cause the assets of that firm to exit the relevant market. In
such circumstances, post-merger performance in the relevant market may be no worse than market perform-
ance had the merger been blocked and the assets left the market ”.6 [emphasis added]
In the US, the concept is two-fold: this defence can both operate in favour of a failing firm in its entirety, or
may be applied to cases in which a simple “division” of a firm is failing. In essence, for a failing firm de-
fence to materialise, the US Agencies ask for the following circumstances to apply: “1) the allegedly failing
firm would be unable to meet its financial obligations in the near future; 2) it would not be able to reorganise
successfully under Ch.11 of the Bankruptcy Act; 3) it has made unsuccessful good-faith efforts to elicit reas-
onable alternative offers of acquisition of the assets of the failing firm that would both keep its tangible and
intangible assets in the relevant market and pose a less severe danger to competition than does the proposed
merger; and 4) absent the acquisition, the assets of the failing firm would exit the relevant market”.7 For a
failing division defence to apply, the requirements to be met are stricter.8
The tests appear to be rather tight: the burden of proof is on the parties and those criteria appear to be the cu-
mulative relevant requirements for a post-merger “no worse” situation to be demonstrated. Nevertheless, it
can be said that the US guidelines provide for a broad possibility of defence since, as mentioned, they do not
differentiate between which company has to be “failing” (the acquirer or the target) and they explicitly ad-
mit the “failing division” argument.9
In Europe the first codification of the “defence” has appeared much later than in the US, with the publication
of the Draft Horizontal Merger Guidelines in December 2002.10 The development of this concept closely re-
flects the practice of the European Commission case law and the relevant jurisprudence on this argument in
the recent years.11 Section VII of the 2002 Draft *13 Horizontal Merger Guidelines illustrate this concept as
follows:
“The Commission may decide that a merger, which creates or strengthens a dominant position, is neverthe-
less compatible with the common market if one of the undertakings is a failing firm being acquired by an-
other undertaking. The basic requirement is that the deterioration of the competitive structure that follows
the merger cannot be said to be caused by the merger. (emphasis added)
The Commission considers the following three criteria as relevant for the application of a ‘failing firm de-
E.C.L.R. 2004, 25(1), 11-24 Page 2
(Cite as: )
© 2011 Thomson Reuters.
fence’. First, the acquired undertaking would in the near future be forced out of the market because of finan-
cial difficulties if not taken over by another undertaking. Secondly, there is no less anti-competitive alternat-
ive purchase than the notified concentration. Thirdly, absent a concentration the assets of the failing firm
would inevitably exit the market. In such circumstances, the merger may be deemed not to cause the creation
or strengthening of a dominant position as a result of which effective competition would be significantly im-
peded in the common market if either the disappearance of the failing firm or its acquisition by any other
foreseeable potential purchaser would equally lead to the creation or strengthening of a dominant position.
It is upon the notifying parties to show that the three criteria described above are fulfilled and that the deteri-
oration of the competitive structure that follows the merger is not caused by the merger”.12
In essence, the Commission announces that in the “failing firm defence” (or “rescue merger”), the “lack of
causality” between the merger and the possible worsening of the competitive structure due to the merger is
at the heart of its analysis. This “worsening” could be assumed as being consistent with the legal standard
laid down under Art.2(3) of the Merger Regulation (i.e. the creation of a dominant position as a result of
which effective competition would be significantly impeded). It will be verified through the three criteria set
forth above. The core of the exercise appears to be a comparison between the competitive conditions occur-
ring due to the merger and the conditions that would prevail in the market, absent the merger. In so doing
the Commission would, most likely, take into account as relevant comparison the prevailing “failed firm”
scenario, i.e. the situation in which the failing firm would fail without being rescued (by the merger). This
would likely enable the Commission to better assess the likely effect in the marketplace of the exit of the
relevant firm.13
Mainstream application in European merger law
Kali und Salz: first setting by the Commission and the Court interpretation
Historically, the first application in Europe of the failing firm defence is the case M.308 Kali und Salz/
MdK/Treuhand (hereinafter Kali and Salz ), of December 14, 1993. The merger would have created a de
facto monopoly in Germany for potash-salt fertilisers.14 The Commission nonetheless considered that the
outcome of the concentration, i.e. the strengthening of Kali und Salz AG dominant position, would have oc-
curred anyway, with or without the merger.15
In recognising the applicability of the “failing company defence” in the context of that merger, the Commis-
sion stated16 that “as a general matter, a concentration is not the cause of the deterioration of the competit-
ive structure if it is clear that:
*14 -- the acquired undertaking would in the near future be forced out of the market if not taken over by an-
other undertaking,
-- the acquiring undertaking would gain the market share of the acquired undertaking if it were forced out of
the market,
-- there is no less anti-competitive alternative purchase.”
The three criteria defined by the Commission appear to be somewhat divergent from those in the 2002 Draft
Horizontal Merger Guidelines. In particular in Kali and Salz, the criterion of “market share absorption” was
part of the steps to be implemented before arriving at an appraisal of “no causal link”.
The Commission recognised that there would have been no causal link between the merger and the strength-
ening of the dominant position of Kali und Salz AG in Germany. In the absence of the merger, MdK (the
E.C.L.R. 2004, 25(1), 11-24 Page 3
(Cite as: )
© 2011 Thomson Reuters.
target) would have shortly withdrawn from the market and its market share would have accrued to Kali und
Salz AG. At the same time, it was ruled out that an undertaking other than Kali und Salz AG could have ac-
quired all or a substantial part of MdK.
In its ruling17 on the Kali and Salz decision, the Court of Justice recognised that the conditions set out by
the Commission for a “failing firm defence” were somewhat different from the conditions applied in the US
in connection with the same concept.18 This was not in itself a ground for invalidity of the contested de-
cision. “Solely the fact that the conditions set by the Commission were not capable of excluding the possib-
ility that a concentration might be the cause of the deterioration in the competitive structure of the market
could constitute a ground of invalidity of the decision”.19 [emphasis added]
It would appear that the Court focussed on the existence of a causal link, whatever the precise criteria for it.
In particular, the Court discussed at length the pertinence of the “market share absorption” criterion. The
French government, among its pleas against the Commission's decision, had contested that criterion. The
Court observed that, “in the absence of that criterion, a concentration could, provided the other criteria were
satisfied, be considered as not being the cause of the deterioration of the competitive structure of the market
even though it appeared that, in the event of the concentration not proceeding, the acquiring undertaking
would not gain the entire market share of the acquired undertaking. Thus, it would be possible to deny the
existence of a causal link between the concentration and the deterioration of the competitive structure of the
market even though the competitive structure of the market would deteriorate to a lesser extent if the con-
centration did not proceed”.20
According to the Court, the introduction of that criterion by the Commission appeared intended to ensure
that the existence of a causal link between the concentration and the deterioration of the competitive struc-
ture of the market can be excluded (and the merger be regarded as a “rescue merger”) only if the competitive
structure resulting from the concentration would deteriorate in similar fashion even if the concentration did
not proceed (i.e. even if the concentration were prohibited). In this context, “the criterion of absorption of
market shares, although not considered […] as sufficient in itself to preclude any adverse effect of the con-
centration on competition, therefore helps to ensure the neutral effects of the concentration as regards the
deterioration of the competitive structure of the market. This is consistent with the concept of causal connec-
tion set out in Art.2(2) of the Regulation”.21
From the above, it could be reasonably inferred that the approach of the Court is broader than the Commis-
sion's one in Kali and Salz. Beyond the formal criteria set out by the Commission, what ultimately matters
appears to be whether the concentration at stake can be deemed to be the cause of a deterioration of the com-
petitive structure (i.e. the creation or strengthening of a dominant position as a result of which effective
competition would be significantly impeded in the common market or in a substantial part of it). Its relevant
benchmark is the possible market structure scenario in case the concentration were not to proceed (for in-
stance due to it being prohibited).
On the other hand, the Court also tackled a concept of “neutrality” (“neutral effect of the concentration as
regards the deterioration of the competitive structure”). This neutrality does not appear to be an additional
*15 requirement of “no negative effects” of the merger. It rather appears to be the way in which the absence
of causation is manifested: i.e. “no causation” would require that a deterioration of the competitive structure
would have to occur in a similar fashion even in the absence of the merger. Only in such a situation a merger
could be deemed to have neutral effects on the market. In this perspective, it seems unlikely that a lesser re-
striction of competition (without the merger), compared to the restriction caused by the merger, would allow
a failing firm defence to overcome the standard for judicial review.
Rewe/Meinl: the “failing division” issue
E.C.L.R. 2004, 25(1), 11-24 Page 4
(Cite as: )
© 2011 Thomson Reuters.
In the Rewe/Meinl case (of February 3, 1999) the Commission discussed in detail the argument of “failing
division” defence.22 Unlike the US, it is not explicitly codified in the European merger law. Although the
Commission did not go as far as to indicate to which extent a “failing division” argument could represent a
valid defence under merger control law, it provided some valuable indications in that direction.23
The parties submitted that the operation would not have led to the creation of a dominant position on the part
of Rewe/Meinl in the Austrian food-retailing market, on the ground that, in its current state, Meinl (the tar-
get) suffered from major competitive disadvantages vis-à-vis larger competitors. If Meinl were to exit the
market or if it were to downsize its business, its market shares would have accrued mainly to Rewe. Nor was
there any less anti-competitive alternative to the sale, as the only other potential buyer was Spar, which oc-
cupied a similar position to Rewe in terms of market share in the Austrian market.
The Commission considered whether the criteria set out in Kali and Salz were met in this merger, conclud-
ing that this was not the case. In particular, unlike Kali and Salz, there was no question of possibly a whole
firm exiting the market. On the contrary, although the target's (Meinl) financial situation was indeed deteri-
orating, evidence suggested that the sale of Meinl's foodretailing activities in Austria (to Rewe) was based
on a strategic decision of the top management of the group rather than on the ground of its quasi insolvency.
Therefore, there was no evidence of the possible shutdown of the company, but for the merger.24 In this
scenario, according to the Commission, the burden of proof to be discharged by the parties as regards the
lack of causality between the merger and the possible deterioration of the competitive structure due to the
transaction was a particularly heavy one. Otherwise, every merger involving an alleged unprofitable division
could be justified under merger control law on the assumption that the division would stop trading, but for
the merger.25
Based on an a contrario interpretation, this case may suggest that, even in case of a management decision to
abandon an unprofitable business, there might be scope for a “failing division” defence under European mer-
ger control law. A lack of causality as regards a possible *16 deterioration of the competitive structure
would possibly occur if a “management decision” to shut down a division was not just part of a strategic
plan; it would have to be based on prospects of inevitable closure of the division in the absence of the mer-
ger. This element would have to be met in addition to all other criteria for the failing firm defence (bearing
in mind the need to show “neutral effects” as regards the deterioration of the competitive structure with and
without the merger). Should this interpretation be correct, beyond the actual wording of the Commission's
Draft Horizontal Merger Guidelines, the EU practice could be deemed to be not too far from the US ap-
proach to failing division defence.26
BASF/Eurodiol/Pantochim: the criterion of “inevitable exit of assets”
BASF (M.2314, dated July 11, 2001) represents a fundamental step in the development of the Commission
practice in respect of the failing firm concept prior to the publication of the Draft Horizontal Merger
Guidelines.27 The merger consisted of the acquisition by BASF Antwerpen N.V. (a BASF subsidiary) of
Eurodiol and Pantochim, two Belgian chemical companies, whollyowned subsidiaries of an Italian company
named SISAS Spa.28 The merger would have created a dominant position at the EEA level in various mar-
kets for chemical products. In the framework of this case, the failing firm defence foundations were dis-
cussed in detail by the Commission, which finally cleared the transaction on that basis.
The relevant criteria for the failing firm defence to apply were singled out as being essentially three: (a) the
acquired undertaking would be forced out of the market in the near future if not taken over by another un-
dertaking, (b) there would be no less anti-competitive alternative purchase, and (c) the assets to be acquired
would inevitably exit the market if not taken over by another undertaking.
E.C.L.R. 2004, 25(1), 11-24 Page 5
(Cite as: )
© 2011 Thomson Reuters.
The criterion of “exit of assets” is the innovation of this case, replacing that concerning the absorption of
market shares.29 The following rationale appears to be at the heart of the Commission's reasoning. In Kali
and Salz, given the specific features of the market and the situation of the parties (only two companies were
present on the market the acquirer an...