The Federal Trade Commission (FTC) has reminded us that the “failing firm defense” is much harder to pull off than might be imagined, and that the antitrust agencies will closely analyze all “failing company” claims even during the coronavirus pandemic. 

In its May 27 blog post, "On “Failing” Firms — and Miraculous Recoveries," the FTC emphasized that the defense is difficult to make and, even more to the point, often not true.

[D]espite many claims [by companies that they are failing] and much time spent assessing the financial health of numerous firms, the Bureau rarely finds that the facts support a failing firm argument. Saying it doesn’t make it so: if you want the Bureau to accept such an argument in your case, you had better actually be failing, and able to prove it. . . . [I]t has been striking to see firms that were condemned as failing rise like a phoenix from the ashes once the proposed transaction was abandoned in light of our competition concerns. 

Against that history, the FTC also reminded us that “candor before the agency remains paramount,” a warning that applies equally to the clients and to the attorneys, and suggested that “[c]ounsel who make too many failing-firm arguments on behalf of businesses that go on to make miraculous recoveries may find that we apply particularly close scrutiny to similar claims in their future cases.”

Companies of all sizes in all industries are facing rapidly declining revenue, while costs have either stayed constant or declined only modestly. Some of those companies may be thinking about a merger or an acquisition as a way to survive by combining revenues while eliminating duplicative costs. And many of those companies will recognize that the ability to reduce duplicative costs is greatest when they are combining with a horizontal competitor.

The U.S. antitrust agencies have long recognized that a merger or an acquisition between direct rivals that otherwise might be seen as anticompetitive–because it would reduce the number of direct rivals in the market–may actually be procompetitive if one of those companies would fail without the transaction. This failing firm defense has been a feature of U.S. merger enforcement for decades.

But it’s important to remember that the defense is valid only if the companies claiming it for their transaction can meet two difficult thresholds. 

First, the defense works only if “failing” means the company is actually failing, and not just struggling. In the parlance of the agencies’ Horizontal Merger Guidelines, a “failing” company would be unable to meet its financial obligations in the near future and be unable to reorganize successfully under Chapter 11 of the Bankruptcy Act.

Second, the purportedly failing company must have made “unsuccessful good-faith efforts to elicit reasonable alternative offers that would keep its tangible and intangible assets in the relevant market and pose a less severe danger to competition than does the proposed merger.” 

Thus, the defense works only if the business of the company claimed to be failing would otherwise be removed from the market, meaning not only that the failing company itself would close up shop but also that its assets would be liquidated and removed from the market. As the FTC put it, “failing is equated with reducing the acquired firm to nothing–not only does the business no longer exist, but the productive assets are also dismantled or redeployed for use outside the relevant market.”

The key to successfully making the failing firm defense is what the FTC described as “a serious effort to assess the standalone future of the company.” In practice, this analysis will need to be supported–ideally undertaken–by a third party with expertise and a reputation in the discipline. It will involve not only closely examining the company’s audited financials but also subjecting the company’s stand-alone projections to rigorous skeptical analysis, all in preparation for the probing analysis the company will face from the antitrust agency reviewing the transaction. In addition, as noted above, the purportedly failing company must be able to demonstrate that it had made good-faith efforts to find an alternative purchaser, and that those efforts were unsuccessful. As the blog post makes clear:

We will continue to apply the test set out in the Guidelines and reflected in our long-standing practice, and in doing so we will require the same level of substantiation as we required before the COVID pandemic. . . . [W]e have not relaxed, and will not relax, the intensity of our scrutiny or the vigor of our enforcement efforts. Consumers deserve the protection of the antitrust laws now as much as ever. 

In other words, as we have pointed out before, antitrust does not shelter in place during a pandemic.

To see our prior alerts and other material related to the pandemic, please visit the Coronavirus/COVID-19: Facts, Insights & Resources page of our website by clicking here.