U.S. law prohibits mergers and acquisitions whose effect “may be substantially to lessen competition, or to tend to create a monopoly.” Clayton Act Section 7, 15 U.S.C. § 18. But a prima facie unlawful merger may occur where (1) the acquiree has “resources so depleted and the prospect of rehabilitation so remote that ‘it face[s] the grave probability of a business failure,’” there is (2) “‘no other prospective purchaser,’” and—in some cases—(3) the firm’s “prospects of reorganization” under the bankruptcy laws “would have had to be dim or nonexistent.” (Citizen Pub. Co. v. United States, 394 U.S. 131, 136-38 (1940) (quoting Int’l Shoe Co. v. FTC, 280 U.S. 291, 302-03 (1930))). Some U.S. courts have not required the third element. Compare U.S. Steel Corp. v. FTC, 426 F.2d 592, 608-09 (6th Cir. 1970) (concluding that Citizen requires reorganization element), with United States v. Black & Decker Mfg. Co., 430 F. Supp. 729, 778 (D. Md. 1976) (concluding the opposite). The burden of proof for this defence rests with the merging parties. (Citizen, 394 U.S. 138-39).
The United States’ Horizontal Merger Guidelines endorses a less rigorous version of this defence, (1) requiring that the failing firm “be unable to meet its financial obligations in the near future”—unlike the showing of insolvency that many U.S. courts require—and (2) characterizing the lack of an alternative purchase element as met when the firm proves it “made unsuccessful good-faith efforts to elicit reasonable alternative offers”—i.e., offers exceeding the failing firm’s liquidation value. (U.S. Dep’t of Justice & U.S. Fed. Trade Comm’n, Horizontal Merger Guidelines § 11 (2010)). The doctrine is “a ‘lesser of two evils’ approach, in which the possible threat to competition resulting from an acquisition is deemed preferable to the adverse impact on competition and other losses if the company goes out of business.” (United States v. Gen. Dynamics Corp., 415 U.S. 486, 507 (1974)).
The European Commission also recognizes the failing firm defence. Under the European Council Merger Regulation (COUNCIL REGULATION (EC) No 139/2004), an “otherwise problematic merger” may proceed if:
- First, the allegedly failing firm would in the near future be forced out of the market because of financial difficulties if not taken over by another undertaking . . . .
- Second, there is no less anti-competitive alternative purchase than the notified merger . . . .
- Third, in the absence of a merger, the assets of the failing firm would
- inevitably exit the market . . . .
(Commission Decision of October 9, 2013 in Case M.6796 Aegean/Olympic II, par. 683 (citing Horizontal Merger Guidelines, (OJ C 31, 5.2.2004, p 5), par. 90).
The third criterion is a “strict” requirement that the firm’s production assets could not be purchased by smaller competitors in liquidation or brought back into the market through reorganization. (OECD Competition Committee Meeting of 21 October 2009 Roundtable on Failing Firm Defence Note by the services of the European Commission Directorate-General for Competition, paras. 12, 21 (“EU Roundtable Note”)).
The EC views this defence as “a particular application of the general causality test under Article 2 of the Merger Regulation.” (Id. par. 15). Accordingly, “even if it cannot be shown that each of these indicative criteria are met, a counterfactual analysis of what would be the development of the market absent the merger could still lead to the conclusion that the deterioration of competition in the market is not a causal effect of the merger.” (Id.; see also Commission Decision of May 10, 2007 in Case COMP/M.4381– JCI/ Fiamm, paras. 711 & n. 405, 721, 736, 750, 796, 815 (assessing impact of merger as compared to liquidation after concluding the failing firm elements not met)). The merging firms bear the burden of showing that the merger would not cause the deterioration of the market. (Horizontal Merger Guidelines, (OJ C 31, 5.2.2004, p 5), par. 91).
Both the U.S. and the EU recognize the “failing division defence”—a more rigorous off-shoot of the failing firm defence—as well. Under the 2010 U.S. Merger Guidelines, the failing firm defence may apply to a discrete division of a firm facing imminent market exit only if:
- applying cost allocation rules that reflect true economic costs, the division has a persistently negative cash flow on an operating basis, and such negative cash flow is not economically justified for the firm by benefits such as added sales in complementary markets or enhanced customer goodwill; and
- the owner of the failing division has 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 acquisition.
Unlike a company raising the “failing firm defence,” a company raising the “failing division defence” in the EU bears the additional “burden of proving lack of causality between the merger and the creation or strengthening of a dominant position.” (Commission Decision of April 2, 2003 in Case COMP/M.2876 - NEWSCORP/ TELEPIUí, par. 212). “[T]he Commission’s scrutiny will be particularly strict in such cases.” (EU Roundtable Note par. 14).
The failing division defence presents special problems: although some commentators contend that “would be unfair to force parent companies to absorb losses that independent companies can avoid,” firms may, in some circumstance, manipulate their capital structure to invoke the defence were an attractive acquiror to arise. (Phillip E. Areeda & Herbert Hovenkamp, Antitrust Law: An Analysis of Antitrust Principles and Their Application paras. 953e (5th ed.2022 supp.))