The Failing Firm Defense

With bankruptcies fanning out across the nation, we take a look at a special exception to antitrust merger prohibitions called the "failing firm defense." What is the failing firm defense, and how does it permit otherwise anticompetitive mergers or acquisitions? In this explainer, Joel sits down with antitrust specialist and former DOJ lawyer Julie Elmer to discuss the requirements of the failing firm defense and the challenges that it raises. Julie also explains the related legal doctrine known as the "flailing firm defense" and how it can be deployed to justify a merger. Finally, Julie weighs in on how the COVID-19 crisis is raising interest in this rather obscure legal doctrine. Julie Elmer is an antitrust partner at the global law firm Freshfields. ► http://www.talksonlaw.com for more legal explainers and interviews with the titans of law. ► Facebook: http://www.facebook.com/talksonlaw ► Instagram: http://www.instagram.com/talksonlaw ► Twitter: http://www.twitter.com/talksonlaw ____________________ TRANSCRIPT Interview with Antitrust Lawyer – Julie Elmer Joel Cohen (Host): What is the failing firm defense? Julie Elmer (JE): This is an argument that would allow a merger or an acquisition that might otherwise be deemed anticompetitive to occur. So it's something that's used when maybe firms that are competitors of each other, where ordinarily the US antitrust agencies might be very skeptical of allowing a merger, it might be an argument for allowing that merger to go through. And the rationale behind this argument is that it would be better to allow a potentially anti-competitive merger rather than allow a firm's assets to exit the market altogether. That's because you would have a drop in output and one less competitor and that's bad for consumers. Host: Let's imagine that there's an an otherwise anti-competitive merger on the table, but one side wants to make this failing firm defense, what do they have to show? What's the legal test? JE: It's actually a very tough test to meet because they have to show three things. They have to show that: (1) the target firm, that's the firm that would be purchased, faces the grave probability of imminent failure; (2) they also have to show that that target firm cannot reorganize under chapter 11 of the U.S. Bankruptcy Code; and (3) they have to show that the target firm has tried to find an alternative purchaser who would buy the target firm's assets for an amount equal or higher than liquidation value and be less harmful to competition. Host: That's the failing firm defense there is a related legal argument called the flailing firm defense. What is that? JE: That is an argument that's sometimes called the weakened competitor defense and it's not as strong of a defense as the failing firm defense. The failing firm defense is a get out of jail free card. If you can prove it, it is an absolute defense. It's a “government go away,” but that's why it's hard to prove. The crux of the flailing firm argument is that, hey government you're telling us that if you if this merger takes place the two of us are going to have 65 percent of the market and you can't allow that because that's anti-competitive and what we're here to tell you is that that 65 is not really 65. You're adding the 40% that the strong firm has plus the 25% that the weaker firm has but that 25% doesn't really accurately reflect the target firm's competitive strength going forward. JE: What I would say to firms that are really thinking about relying on these defenses is that they need to critically assess whether they can truly meet the high bar for proving the defense and undertake the preparation to do so. Hiring a financial expert to really evaluate the financial health of the company may help it to evaluate restructuring options and to run the auction process if the firm actually decides to sell. I think the target firm should also be mindful that the U.S. antitrust agencies are very practiced at testing defenses like these and if there's anything in the targets marketing documents or statements to investors or even tweets by its highly level executives that are touting how well it's doing, that the agencies will will look at those documents and view those documents as undermining these defenses. So, I think it really requires a truly critical self-assessment of whether the firm can meet that high bar. Host: Julie Elmer, thank you for joining us today at TalksOnLaw JE: Thank you, great to be here, Joel. [redacted due to description constraints]