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Distressed Deals Ripe for ‘Failing Firm’ Antitrust Exemption (1)

April 28, 2020, 2:37 PMUpdated: April 28, 2020, 5:51 PM

Distressed companies seeking to merge could find that the ongoing coronavirus makes it easier for them to clear antitrust scrutiny.

Companies seeking to win antitrust approval can cite their poor finances to invoke the failing firm defense and claim a deal that wouldn’t otherwise pass anti-competitive reviews is necessary to prevent a company from going under.

“We’re already seeing an uptick in bankruptcies and I think in a similar vein, we’re going to see more consolidation among competitors who are struggling to survive on their own,” Fiona Schaeffer, an antitrust partner at Milbank LLP, said.

The rigorous standards to gain government approval under the failing firm defense, which include having to show that a company is unlikely to successfully reorganize in bankruptcy, are expected to remain in place during the pandemic, Scott Schaeffer, antitrust counsel at O’Melveny & Myers LLP, said.

FTC Commissioner Rebecca Kelly Slaughter said antitrust enforcers “can’t relax” high thresholds for approving the failing firm defense even as the issue is expected to come up more often.

“We’ve had a run of failing firm defenses that the commission has not found particularly persuasive before this crisis happened and I would expect a lot more of those to come up,” Slaughter said Tuesday during an American Bar Association antitrust conference broadcast via webcast.

What’s different now is that companies are more likely to be able to meet the requirements, Schaeffer of O’Melveny & Myers said.

“You’re more likely to actually have a firm that’s on the verge of failure,” he added.

Rarely Credited

Antitrust enforcers at the Justice Department and Federal Trade Commission rarely credit a company’s poor finances as a reason to approve a deal given that the result is a merger that would limit competition in an industry.

For the defense to work, the failing company has to prove that it’s unable to meet its financial obligations in the near future, that it can’t reorganize under bankruptcy, and that it has made unsuccessful “good-faith” efforts to find alternative offers that don’t pose as severe competition problems.

Companies can also attempt to cite a less stringent argument, called the ‘flailing firm’ defense in which a company may not be on the verge of bankruptcy, but it isn’t a very strong entity and likely can’t compete effectively in the future. Such arguments are typically coupled with other benefits the merger is expected to offer, such as lower prices for consumers.

Typically, companies plead such financial defenses during confidential investigative proceedings. If either the DOJ or FTC credits such a defense, the government would make it known when announcing a deal has cleared antitrust scrutiny.

The failing firm defense has worked though, most notably for American Airlines Inc.'s 2001 acquisition of Trans World Airlines, as the DOJ cited TWA’s bankruptcy as a reason it did not challenge the deal.

Companies can also invoke such defenses in court if the government doesn’t buy it.

Since 1930, the defense has been asserted roughly 50 times in antitrust litigation and has succeeded, at least in part, 18 times, according to an analysis by O’Melveny & Myers.

T-Mobile US Inc.'s deal with Sprint Corp. defeated a state antitrust merger challenge given that a federal judge partially credited Sprint’s poor financial outlook as a reason to rule in favor of the telecom deal.

Given the pandemic, “the failing firm defense is going to be invoked when possible 100% of the time and it’s not going to be frivolously evoked,” said John Newman, a former attorney at the DOJ’s antitrust division, who is now an antitrust professor at The University of Miami School of Law.

Even if the government doesn’t credit such a defense, “I can see the court’s buying it,” Newman added.

Different Times

In vetting buyers, antitrust enforcers typically seek acquirers that have experience in the same industry in order to ensure that the firm being acquired has a greater chance of succeeding post deal closing, Scott Schaeffer of O’Melveny said.

But since the virus is impacting firms across every industry, the pool of potential buyers is shrinking, leaving struggling firms with few options, Schaeffer added.

Those two factors make the failing firm defense more likely to succeed “not because the standards are lower, but because the facts of this current situation are so extreme,” he said.

As companies seek to advance such arguments in front of the DOJ or FTC, firms should try to demonstrate how the deal would make a firm a better competitor that in turn could lower costs and compete more effectively in a given industry, Milbank’s Fiona Schaeffer said.

“Competitors seeking to merge will need to show more than that the merger benefits shareholders and alleviates their financial distress,” she said. “They will also need to show how the merger benefits their customers, she added.

(Updated to include comments from FTC commissioner. )

To contact the reporter on this story: Victoria Graham in Washington at vgraham@bloomberglaw.com

To contact the editor responsible for this story: Seth Stern at sstern@bloomberglaw.com

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