On June 23, we hosted a webinar on the failing firm defense, focusing on defining the defense and offering tips on complying with it. We also tried to demonstrate that, sometimes, the antitrust agencies will not demand strict compliance with the defense, such as when we are dealing with firms facing financial challenges due to the COVID-19 pandemic. In fact, we can now offer an update that reinforces our conclusion.

Our webinar was prompted in part by a blog post by Ian Conner, the Director of the Bureau of Competition at the Federal Trade Commission (FTC).[1] Mr. Conner seemed to demand total compliance with the defense, stating, “[T]he Bureau rarely finds that the facts support a failing firm argument,” and adding, “[Y]ou had better actually be failing, and able to prove it.” He insisted, “[W]e have not relaxed, and will not relax, the intensity of our scrutiny or the vigor of our enforcement efforts.”

Nevertheless, we showed in our webinar that the antitrust enforcement agencies can be flexible. This is particularly important given the nature of the pandemic, where firms may rapidly fail, the competitive landscape may quickly change, and there is little or no time to meet all the failing firm requirements. There may even be less time to prove to the reviewing agency that such requirements have been satisfied. The agencies simply will not be able to take a year to investigate, which they often do when reviewing a merger pursuant to a second request.

The failing firm defense was the product of another crisis, the Great Depression. In International Shoe Co. v. FTC, 280 U.S. 291 (1930), the Supreme Court created the defense. The defense has been recognized by the Department of Justice and the FTC in the Horizontal Merger Guidelines.[2] The defense requires proof of the following three elements:

First, the firm would be unable to meet its financial obligations in the near future.

• The firm must establish, based on past performance, that it would not be able to meet future obligations.
• Declining sales and net losses are not sufficient.
• Mismanagement is not sufficient if the mismanagement can be corrected.

Second, the firm would not be able to reorganize successfully under Chapter 11 of the Bankruptcy Act.

• The firm must establish that it attempted and failed to resolve its debts with creditors.
• The firm could not emerge from bankruptcy after discharging its debts.

Third, the firm has made unsuccessful good faith efforts to elicit reasonable alternative offers that would keep its assets in the relevant market and pose a less severe danger to competition than does the proposed merger.

• The firm must prove that it made a genuine effort to find an alternative buyer that does not present the competitive issues of the proposed buyer.
• This requires due diligence at least as thorough as the firm would normally use to sell itself or some of its assets.
• Any offer above liquidation value to purchase the firm or its assets must be accepted even if substantially less than the offer of the proposed buyer (“the liquidation value requirement”).

The last bullet holds the key to the thinking behind the defense. The courts and the antitrust agencies believe that consumers are better off if the assets continue to operate in the market than if they are diverted to other markets in a liquidation sale.

Our update involves this requirement and is based on a recent BakerHostetler representation of an acquirer of a company though a bankruptcy proceeding. The FTC investigated the matter. One issue in the investigation was whether the FTC would adhere to the liquidation value requirement. Sometimes, a party filing for bankruptcy can only make it to a bankruptcy auction that preserves going concern value if lenders put up additional capital to allow operations through the auction process. There is an obvious disincentive for any particular lender to put up that capital if the lender will only get cents on the dollar as a result of a successful auction. Better to just free ride, hoping that others will offer the capital. To incentivize lenders, bankruptcy courts may use special provisions of federal bankruptcy laws to allow distribution of the auction proceeds to the lenders that put in the additional capital before distribution of any proceeds to other parties that did not put in additional capital.

But, of course, there may not be much in the way of proceeds to incentivize the lenders that stepped up if the bankrupt firm had to be sold at a penny above liquidation value. Hence, one of the requirements of the bankruptcy auction may be a minimum bid above liquidation value.

If the FTC demanded an auction satisfying the liquidation value requirement, there could be times when lenders would refuse to put in additional capital to keep the bankrupt firm going through the bankruptcy process. This could potentially result in a Chapter 7 liquidation, or liquidation through non-bankruptcy means, when more flexibility on the part of the FTC could have resulted in a sale that kept the business operating.

Given the policy implication of insisting on satisfying the liquidation value requirement, the staff investigating the particular acquisition did not object to a minimum auction bid above liquidation value. Of course, this result was at a staff level and it did not set policy for the Commission itself. Indeed, the staff emphasized that it was not setting a policy precedent. Nevertheless, it does demonstrate that the staff can be practical rather than hidebound when appropriate.

Considering how the agencies and courts actually have applied the failing firm defense in recent years, including during exigent circumstances such as those being experienced now, our webinar reviewed several actions a failing firm should consider.

• Record-Building: A failing firm’s board of directors and management should build a robust record, if possible, that other strategic alternatives besides a putatively anticompetitive transaction were fully considered. Keep good and accurate minutes reflecting that the board and management directed advisers (such as investment bankers, lawyers and consultants) to pursue and explore alternatives and that the board determined those alternatives were unavailable or unrealistic.
• Shopping the Target: To the extent possible, a failing firm should attempt to market itself and its assets widely to relevant strategic and financial buyers (and especially those that may present fewer competition concerns than the ultimate buyer does). A wide marketing effort is generally advisable in any M&A transaction.
• Take Care with Exclusivity and Deal Protection: An exclusivity provision that limits a failing firm’s ability to conduct a “market check” either before or after the exclusivity period could be problematic in arguing that the failing firm conducted a genuine search for an alternative firm. Similarly, common deal protection devices (such as “no shop” provisions and termination rights with termination fees) could, if too tightly drafted, undercut the failing firm defense. When negotiating these provisions, a failing firm should be mindful that a “locked up” transaction could present problems in asserting the failing firm defense.

During the pandemic, the most difficult requirement to meet may be the shopping requirement. However, the agencies have shown flexibility regarding this requirement (in the webinar, we offered several such examples) when the reviewing agency has been convinced that the firm will soon fail and the assets will exit the market. The most recent example is Dean Foods,[3] where during the pandemic the Antitrust Division may have accepted less relief than it would have demanded pre-pandemic in order to allow the parties to consummate.

An alternative approach is to apply the flailing firm defense. The flailing firm defense may be apropos when the firm is unlikely to be a significant competitor even if it were able to reorganize or sell itself to a buyer outside the market. In the webinar, we offered Boeing’s acquisition of McDonnell Douglas as an example of a successful flailing firm defense.[4] McDonnell Douglas was not failing, but it did not have much of a competitive future. We also offered the example of the recent state attorneys general challenge of the T-Mobile/Sprint merger, where the district court, considering a “dynamic and rapidly changing” consumer mobile phone operating market, determined Sprint’s weakening financial prospects sufficiently supported a flailing firm defense inasmuch as Sprint appeared unlikely to remain a viable competitor in the future.[5] Firms that can show they are flailing should take the steps outlined above and reviewed during our webinar.

Whether failing or flailing, the parties to the merger may still have to file their Hart-Scott-Rodino (HSR) notifications. There is a narrow exception to an HSR notification, and there are shortened waiting periods under certain circumstances. The exception is the acquisition of collateral in foreclosure after a default. The shortened waiting periods are applicable to a sale pursuant to Section 363(b) of the Bankruptcy Code, which is typically a bid/auction procedure. The bankruptcy court approves the procedure and then approves the sale. Under HSR, the waiting periods for a fileable transaction are shortened and only the buyer is required to comply with a second request if the antitrust agencies issue such a request.

[1] See Ian Conner, Federal Trade Commission, On ‘Failing’ Firms – and Miraculous Recoveries, May 27, 2020, available at https://www.ftc.gov/news-events/blogs/competition-matters/2020/05/failing-firms-miraculous-recoveries.
[2] See U.S. Department of Justice and Federal Trade Commission, Horizontal Merger Guidelines ¶ 11 (2010), available at https://www.justice.gov/atr/horizontal-merger-guidelines-08192010.
[3] See U.S. Department of Justice Press Release, Justice Department Requires Divestitures as Dean Foods Sells Fluid Milk Processing Plants to DFA out of Bankruptcy, May 1, 2020, available at https://www.justice.gov/opa/pr/justice-department-requires-divestitures-dean-foods-sells-fluid-milk-processing-plants-dfa.
[4] See Statement of Chairman Robert Pitofsky and Commissioners Janet D. Steiger, Roscoe B. Starek III and Christine A. Varney in the Matter of the Boeing Company/McDonnell Douglas Corporation, July 1, 1997, available at https://www.ftc.gov/public-statements/1997/07/statement-chairman-robert-pitofsky-commissioners-janet-d-steiger-roscoe-b.
[5] See State of New York, et al. v. Deutsche Telekom AG, et al., Case No. 1:19-cv-05434 (S.D.N.Y. Feb. 11, 2020), available at https://www.law360.com/articles/1242797/attachments/0.