BUSINESS BEYOND COVID
As firms fail, focus will be on competition authorities’ handling of mergers
Companies with robust balance sheets will seek acquisition targets in friendly or hostile takeovers
In the Business Beyond Covid series, CEOs and other business leaders and experts in their sectors look to the future after Covid-19. What effect have the pandemic and resulting lockdown had on their industries and the SA economy as a whole? Which parts will bounce back first and which will never be the same again? Most importantly, they try to answer the question: where to from here?
The Covid-19 pandemic is already having a far-reaching effect on local, regional and global economies, with many firms facing severe financial constraints due to the limitations and government interventions introduced to tackle the global pandemic.
As humanitarian efforts are generally being placed ahead of commercial economic interests some firms are severely affected by the economic slowdown and it is likely that the financial and economic effect of these interventions will have a long-lasting impact on businesses.
In the wake of this, many firms will probably be placed in a distressed position and will explore merger opportunities to avoid business rescue, or even liquidation. Similarly, firms with more robust balance sheets will doubtless seek acquisition targets in friendly or hostile takeovers. Consolidation in many sectors is inevitable and will take place through a blend of attrition due to the lockdown and mergers in which either or both firms seek to merge to survive in a far more spartan market than that which existed before.
The question that arises is how mergers involving one or more distressed firms will be dealt with by the competition regulators. Any post-lockdown mergers will have to be assessed by the competition authorities through the lens of the economic apocalypse that is already taking hold in many sectors and will inevitably spread.
Merger assessment will not be “business as usual” regarding assessing the competition and public interest effects of mergers involving distressed firms and where at least a substantial part of the merger rationale is corporate survival after the pandemic.
The existing legal framework for merger assessment will remain in place and will be the starting point. The Competition Act already makes provision for merger assessment if the target of a merger transaction is a so-called “failing firm”.
The competition authorities have previously considered the failing firm doctrine or “defence”. The Competition Tribunal has held that the failing firm doctrine is not used as a “defence” to a merger that has been found to be likely to yield anticompetitive outcomes but is rather recognised as one of the list of “factors” that is considered to determine whether a merger is anticompetitive.
A successful reliance on the failing firm doctrine may nevertheless result in the approval of a merger that might otherwise be prohibited as anticompetitive because the exit of the firm from the market would leave the market with less productive capacity, and thus more inefficient, while the supply-demand balance shifts, which may place upward pressure on prices.
Pre-lockdown competitive dynamics may be of very little relevance in predicting how a merger will affect competition post-lockdown, simply because competition in that market will not be the same as before
The tribunal has noted that the underlying rationale for the approach adopted in assessing mergers involving failing firms lies in the fact that the post-merger state of the market should not be less competitive because the acquiring firm would gain a greater market share on acquisition of the failing firm than it would have if the firm exited the market.
But the competition authorities may have a somewhat different approach in the pale light of the economic dawn that will follow in the immediate aftermath of the pandemic. The commission and tribunal will have to forecast the effects of mergers on competition in markets making assumptions about the levels of competition in markets that will have indelibly changed in a very short time.
Pre-lockdown competitive dynamics may be of very little relevance in predicting how a merger will affect competition post-lockdown, simply because competition in that market will not be the same as before. But in the case of horizontal mergers, mere concentration should not be a basis for prohibition without a forward-looking prediction about the likely longevity of either firm absent the merger.
This is not necessarily the exercise mandated by the tribunal regarding the failing firm doctrine. Rather, this would entail considering the need to ensure that in future healthy industry participants will emerge to play an ongoing role in, and make a contribution to, an economy in a state not seen before. This will require both deftness of action and a willingness to accept that any dogmatic orthodoxies of the past are inappropriate and may be even destructive.
Transactions involving distressed firms must still be subject to pragmatic scrutiny to ensure that the claims of distress are not opportunistic shams to achieve clearance for mergers that should not be permitted in any circumstances.
Effects of mergers on the public interest will likely ascend to become the more prominent feature of assessment (relative to competition effects) when regulators consider transactions involving financially unhealthy firms short on other options. It is often a misconception that the failing firm doctrine can be relied upon in instances in which, absent the proposed merger, the target firm may have to rationalise its business and retrench employees. Public interest considerations, especially whether a transaction would result in job losses, are vital in merger assessment, but this factor cannot be relied upon in support of a failing firm doctrine to allow an otherwise anticompetitive merger.
This does not mean that public interest considerations could not otherwise be highly persuasive factors, since after recent amendments to the Competition Act competition authorities are obliged to accord equal weight to competitive effects and public interest considerations in merger assessment. A merger that presents a likelihood of chilling competition may nevertheless be approved, with appropriate conditions, if it is also likely to guarantee or enhance employment levels.
Even before the Covid-19 pandemic, the competition authorities emphasised the importance of saving jobs, particularly in our socio-economic circumstances. This is even more imperative in current circumstances and the competition authorities are likely to look to protect jobs even more than before.
If a merger involving a distressed firm may result in jobs being saved, the merging parties should be able to rely on this public interest benefit to obtain approval of the merger.
Other public interest factors, such as ensuring the promotion of economic participation by previously disadvantaged people, will also be assessed and if the merger results in further concentration in the market that could be viewed as detrimental to transformation objectives, these factors may be relied upon to argue that the merger should not be approved.
In our view, the promotion of employment and protection of jobs would likely carry more weight in assessing a merger involving a distressed firm as the public interest benefits in approving such a merger are clear and have an immediate impact.
Other competition regulators have already had to deal with such cases. The UK Competition and Markets Authority has provisionally approved the acquisition by Amazon of Deliveroo, an online food delivery service, relying on the failing firm doctrine.
It should be hoped that our authorities will similarly be willing to redefine the parameters of the failing firm doctrine or, absent that, be willing to readily accept that there must be a “new normal” for merger assessment, before Covid-19 notches up a higher corporate mortality count than can be prevented through a revised perspective.
• The authors are with the competition, regulation & trade practice of Herbert Smith Freehills Johannesburg. Research assistance for this article was provided by Lauren Paxton.