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The failing firm defense is an argument used in merger and concentration analysis to approve a transaction, even though it poses, in principle, clear risks to competition.
Its application implies tolerating a problematic scenario for competition to avoid an even worse outcome. For this reason, competition authorities tend to admit it only in exceptional circumstances, and it is the parties’ burden to present evidence demonstrating that the company is in such a situation.
It is also referred to as “failing firm argument,” “failing firm exception,” “distressed firm defense,” or “financially weak firms.”
What is the connection between a company’s crisis and mergers? As explained by Kokkoris and Olivares-Caminal (2010), a strategic response for distressed firms —and one of the means to implement a successful debt restructuring process— is to combine with another entity to achieve the necessary efficiencies. A declining company or economic agents in crisis-stricken industries may prefer to merge, acquire or be acquired, or sell unprofitable divisions to ensure the firm’s viability. Thus, given these dramatic transformations, the application and importance of the failing firm defense and the failing division defense could be crucial (Kokkoris and Olivares-Caminal, 2010).
In competition law, the failing firm defense originates in U.S. case law. As early as 1930, the U.S. Supreme Court acknowledged in International Shoe v. FTC that a company’s severely deteriorated economic conditions, with slim chances of recovery and scarce alternative buyers, could justify its acquisition by a competitor without causing substantial harm to competition.
Years later, the same court in Citizen Publishing Co. v. United States (1969) expanded this line of reasoning. This case established the requirements for the admissibility of the failing firm exception —and its narrow scope— as it is known in contemporary practice. The doctrine was further developed in Greater Buffalo Press (1971) and General Dynamics Corp. (1974). These requirements were later incorporated into the 1982 U.S. Department of Justice Merger Guidelines and subsequent versions.
Today, most jurisdictions with merger control explicitly include the failing firm defense in agency guidelines or national legislation.
The evaluation of a merger from the standpoint of competition law consists of predicting its future effects. Therefore, to determine whether the authority will approve or reject it, the consideration of the “counterfactual” scenario to the merger —what would happen in its absence— is a fundamental element.
In the standard merger analysis, the counterfactual scenario is based on the present situation: it is assumed that the economic agents would continue operating their businesses separately, maintaining the competitive discipline they exert over each other and their other competitors up to that point. Accordingly, the evaluation typically consists of comparing how the market structure has operated up to the present with the future post-merger situation.
However, when the imminent disappearance of market agents is feared —for example, one of the firms involved in the merger —this counterfactual is altered. The authority’s analysis can no longer rely on the current situation at the time of review as a point of comparison (or benchmark), since the market structure will, with a high degree of probability, be altered regardless. In the case of the failing firm defense in particular, the analysis must consider that —should the transaction not go through— one of the merging parties will likely exit the market due to financial distress.
This modification of the counterfactual scenario is what the merging parties seek to invoke when using the failing firm defense. It is an exception because, in a strict sense, it allows the approval of mergers even if the authority has identified anticompetitive risks. In other words, even if a prima facie assessment of the transaction indicates that it would result in a reduction or substantial harm to competition, the merger must exceptionally be approved, since otherwise the assets of the distressed firm would disappear, resulting in competitive harm that is equivalent or even greater.
This rationale is also explained in the Guidelines on the assessment of horizontal mergers (European Commission, 2004), which state that a basic requirement to apply the exception is that the deterioration of the competitive structure following the merger must not be caused by the merger itself: “This will be the case where the competitive structure of the market would also have deteriorated to at least the same extent in the absence of the merger.”
As stated by the OECD (2009), the requirements in most jurisdictions tend to coincide. Once these criteria are met in a case, the authority will generally have no reason to oppose the transaction, as it will not pose a threat to the competitive landscape.
However, assessing whether these elements are present is far from straightforward, and the standard of review depends on each jurisdiction’s specific practice. Each requirement entails a different set of inquiries regarding the economic agent and the market, as well as projecting alternative scenarios based on the available evidence.
Without the merger, the failing firm will exit the market in the near future because of its financial difficulties.
Based on the projections made at the time the transaction is reviewed, the authority must be convinced that, absent the merger, the financially distressed firm will definitively leave the market.
According to the UK’s 2020 guidelines on failing firms (CMA, 2020), this requirement involves a careful examination of the firm’s historical profitability, cash flow, and balance sheets in order to assess the profile of its assets. The same applies to reviewing any actions taken by management to address the situation, including board minutes, management accounts, and strategic plans.
Any third-party documentation (such as financial or legal reports from external advisors and analysts) concerning the company’s current position may also prove useful in this regard.
There is no viable transaction or restructuring option that is less harmful to competition than the proposed merger.
This requirement entails analyzing whether there were other available options besides the merger. These may include potential capital injections —either from shareholders or external sources— or the possibility of third-party buyers other than the known acquirer.
The U.S. Department of Justice and Federal Trade Commission’s Horizontal Merger Guidelines require proof that the company has made good-faith efforts to seek out reasonable alternative offers that would be less detrimental to competition than the proposed merger.
Absent the merger, the failing firm’s assets would inevitably exit the market.
This is one of the most stringent requirements of the defense, since in most cases it is conceivable that both tangible and intangible assets could be repurposed, even if the company ceases to exist.
Because this involves projecting a future scenario, it is once again critical to understand the specific market and industry in which the merger is taking place, in order to accept or reject different hypotheses.
A foundational case in the application of the failing firm defense in European case law is Kali und Salz, initially decided by the European Commission and later upheld by the European Court of Justice in 1998.
Following the economic collapse of Eastern Bloc countries in Europe, the German state-owned company Mitteldeutsche Kali (MdK), active in the fertilizer and mineral markets, faced severe financial difficulties. With the merger, Kali und Salz—a subsidiary of the BASF group—would acquire a stake in MdK, effectively creating a monopoly in the German agricultural potash market.
Despite this, the Commission approved the transaction. MdK was in the process of becoming privatized, and according to the Commission, it was neither expected nor viable for the state to continue supporting it. Without Kali und Salz stepping in as a private partner with management experience, a rescue of MdK was unlikely. Moreover, the Commission held that if MdK disappeared, its market share would in any case be absorbed by Kali und Salz.
The decision was criticized by the French government at the time, in part for allegedly misapplying the U.S. failing firm doctrine. However, the Court ruled that this did not undermine the substance of the Commission’s decision and upheld the merger approval.
Another case in which the failing firm defense was accepted was the merger between Greek airlines Aegean and Olympic, approved on a second attempt in 2013 (COMP/M.6796).
The merger had been blocked in 2011, partly because the Commission held that the parties had not demonstrated that Olympic, the failing firm, was unsustainable in the long term —beyond the short-term losses— and that its assets could not later be reacquired by the Greek state.
Two years later, however, the Commission approved the deal, given that the Greek economy had not recovered and Olympic’s financial situation had continued to deteriorate sharply. The requirement that the firm would likely exit the market was deemed fulfilled, as the holding company of Olympic could no longer cover its subsidiary’s losses indefinitely and had no projections of future profitability. Under these circumstances, the Commission reasoned that a rational investor would likely choose to shut down the company, making the application of the failing firm defense appropriate.
The acquisition of a stake in food delivery platform Deliveroo by Amazon is an interesting example of the modern application of the failing firm defense (CMA, Final Report).
In its report, the UK’s Competition and Markets Authority (CMA) stated that Deliveroo would not have exited the market but for the crisis triggered by the COVID-19 outbreak in 2020. Deliveroo’s business depended on restaurant demand, and many restaurants were forced to close during the pandemic, including major fast-food brands that accounted for a significant portion of its sales. Based on detailed cash flow projections and financial data submitted by Deliveroo —as well as an assessment of possible business restructuring to avoid insolvency— the CMA concluded that there was no viable financing alternative to Amazon’s investment that would enable Deliveroo to survive the effects of COVID-19.
This conclusion was reached despite Deliveroo’s previously strong performance in the food delivery sector.
The CMA also evaluated the feasibility of (i) financing from existing shareholders, (ii) new investors, or (iii) some form of external debt. To this end, the agency requested information from the company’s shareholders and third parties to assess potential capital injections, but all alternatives were deemed improbable or difficult to obtain within a reasonable timeframe, given Deliveroo’s financial situation and the extraordinary context of the pandemic.
In June 2020, Chile’s National Economic Prosecutor’s Office (FNE) approved a merger involving the acquisition of a fuel service station, marking the first time the failing firm defense had been applied in the country.
The operation involved Copec, the leading distributor of liquid fuels in Chile, signing a renewable 15-year lease for a commercial establishment that had operated as an independent station owned by CGL and Chajtur, located in the Bío-Bío Region.
In its clearance report (F216-2019), the FNE outlined the application of each requirement of the failing firm defense and the supporting evidence that led to the conclusion that they were met in this case.
Regarding the social unrest of October 2019 and the COVID-19 pandemic in 2020, the FNE stated that while neither event caused the company’s crisis, they did exacerbate the financial difficulties of the business group and the specific fuel station.
In its counterfactual analysis, the FNE found that the exit of the competitor would have the same or even worse impact on competition compared to the merger, as it would result in the complete disappearance of a fuel station serving consumers in the relevant geographic market.
For a full analysis of the case, see CeCo’s note here.
Kokkoris, Ioanis y Olivares-Caminal, Rodrigo, Antitrust amidst finantial crisis (Cambridge University Press: 2010), Chapter 3.
OECD, Policy Roundtables: The Failing Firm Defence (2009). See here
Argentina
Del Pino, Miguel y Boidi, Carla A. “Covid-19 y la defensa de la empresa en decadencia (failing firm defense). SAIJ (2020). See here
Colombia
Arboleda, Suarez “La excepción de empresa en crisis”, Revista de derecho de la Competencia CEDEC (2019). See here
Chile
Bórquez, Francisco “Debiera flexibilizarse la defensa de la firma fallida en época de crisis económica? La mirada desde el punto de vista de un usuario del sistema”, Investigaciones CeCo (junio, 2020), See here
CeCo UAI, “Covid 19 y la excepción de empresa en crisis en procedimientos de fusiones”, Investigaciones CeCo (mayo, 2020). See here
Reino Unido
CMA, Annex A: Summary of CMA’s position on mergers involving ‘failing firms (abril, 2020). See here
