The guidance refers to several procedural changes, particularly in relation to information-gathering, the timing of investigations, the conduct of meetings and hearings, and interim measures, being made in response to COVID-19-related restrictions. Regarding the substantive assessment of mergers, the CMA clarified that the pandemic will not lead to a relaxation of investigative or assessment standards. Because the CMA’s merger investigations are forward-looking and evidence-led, the impact of COVID-19 will be factored into the substantive assessment of mergers where necessary or appropriate. The CMA states that, despite the uncertainty regarding the duration and full impact of the crisis, even “significant short-term industry-wide economic shocks” would not necessarily be enough in themselves to override competition concerns that a “permanent structural change in the market brought about by a merger” could raise.
The ‘failing firm’ test
The guidance includes an annex on the application of the ‘failing firm’ test, serving as a ‘refresher’ regarding the legal test.
The ‘failing firm’ test is usually considered when a firm involved in the merger is said to be failing financially, and would exit the market, absent the merger. The CMA has previously found that, where the ‘failing firm’ counterfactual is sufficiently evidenced, mergers should be unconditionally cleared. However, the ‘failing firm’ test is strict and only two cases have met the criteria since the CMA’s formation in 2014, namely East Coast Buses/First Scotland East and Alliance Medical Group/IBA Molecular UK.
In the guidance, the CMA notes that COVID-19 might lead to additional submissions from entities involved in mergers that are failing financially and would exit the market absent the mergers. However, the CMA reiterates that such submissions will always be considered on a case-by-case basis, applying the three-limb test for assessing ‘failing firm’ situations set out in the Merger Assessment Guidelines. Specifically, the CMA will consider whether (i) the target’s exit is inevitable without the transaction, (ii) there is an alternative (less anti-competitive) purchaser, and (iii) the transaction is less anticompetitive than the target’s exit.
The first question is whether the target’s exit is inevitable absent the transaction. As noted in the guidance, where a firm may be exiting because of financial failure, the CMA considers both whether the firm is unable to meet its financial obligations in the near future and whether it is unable to restructure itself successfully. These questions are assessed using a broad range of evidence, including internal documents, such as management accounts, and external documents, such as analysis from external advisors.
The second question is whether there would have been substantially less anti-competitive purchasers for the business – are there other buyers whose involvement would produce a more competitive outcome than the transaction being assessed. The CMA will, again, assess this question based on a broad range of evidence, and the fact that there were no other bids at the relevant time is not, in itself, enough. In the same vein, the unwillingness of potential alternative purchasers to pay the asking price or the price ultimately agreed between the parties does not show that there would have been no alternative purchaser.
The third question relates to the impact of the business’ failure on competition, compared to the impact of the transaction in question. While the wording of the Merger Assessment Guidelines suggested a particular focus on the merger’s “impact on sales”, the guidance notes that, in practice, this test is applied “less mechanistically”, such that the CMA might consider the effects on competition more broadly.
Where a firm’s financial circumstances do not meet the conditions of the ‘failing firm’ counterfactual, financial difficulties are still considered in the competitive assessment.
The CMA’s application of the ‘failing firm’ test in recent cases
Consistent with its guidance, the CMA’s recent decisions show that COVID-19 has not led to a relaxation of the CMA’s standards of review.
Amazon’s acquisition of a minority 16% shareholding in Deliveroo was recently cleared by the CMA. In April, the CMA initially provisionally cleared the investment on the basis that, as a result of COVID-19, Deliveroo would have been likely to exit the market without the additional funding available through the transaction, and that this would have had a more detrimental impact on competition than the transaction under review. However, in its Revised Provisional Findings and its Final Report, the CMA found that the conditions for the failing firm test were not met. Instead, it cleared the transaction on substantive grounds relating to Amazon’s incentives to compete in online restaurant food delivery and online grocery delivery.
In applying the first limb of the test, the CMA reversed its conclusion between the April Provisional Findings, on the one hand, and the Revised Provisional Findings and the Final Report, on the other hand. In the April Provisional Findings, the CMA provisionally found that COVID-19 had substantially affected Deliveroo’s financial position as it experienced both a decline in supply (due to restaurant closures) and a decline in demand. Accordingly, in the April Provisional Findings, the CMA provisionally concluded that the first limb of the test was met, given that Deliveroo would have been likely to exit the market, as a result of COVID-19, without the additional funds. In contrast, in the Revised Provisional Findings and the Final Report, the CMA found, based on updated financial information, that the impact of COVID-19 on Deliveroo’s business had not been as severe as anticipated, and that it would not have exited the market absent the transaction.
In relation to the second limb of the test, while the CMA’s Merger Assessment Guidelines and guidance require the assessment of potential “alternative purchasers”, the CMA adjusted the test because the transaction did not involve a transfer of a business or its sales but rather the acquisition of a minority shareholding. As a result, in its initial assessment of the second limb of the test, the CMA did not consider “alternative purchasers” stricto sensu but whether there were alternative investors, including funding that would have not entailed that acquisition of shares (as Amazon’s investment in Deliveroo contemplated). In particular, it considered three main options for alternative funding: funding from existing shareholders, external funding from new shareholders, and funding through debt. In the April Provisional Findings, the CMA concluded that Deliveroo had no alternative options available to it that would have preserved the business. In the Revised Provisional Findings and the Final Report, the CMA considered that, given Deliveroo’s improved financial situation, it would have had more scope to manage its funding needs and there was a materially greater likelihood that alternative sources of funding would have been available. It therefore concluded that the conditions for second limb of the test were not met.
In assessing the third limb of the test, the CMA noted that, while the transaction in question was not an acquisition, the general principle of the test can still be applied. It therefore considered whether the effect of the investment was substantially less harmful to competition than Deliveroo’s exit from the potential online restaurant food delivery and online convenience grocery delivery markets. In the April Provisional Findings, the CMA concluded that Deliveroo’s exit would have a more negative effect on competition than the investment would have. In its Revised Provisional Findings and its Final Report, the CMA did not assess whether the third limb of the test was met given that the conditions for the first and second limbs of the test were not, such that the transaction would in any case not be cleared applying the failing firm test.
The CMA’s change in approach during the Amazon/Deliveroo investigation highlights its commitment to rigorously applying the legal test, in particular in assessing whether the target would only suffer from short term shocks (related to a crisis such as COVID-19) or whether it would suffer from long term financial difficulties that would lead it to exit the market.
In its decision to clear Takeaway.com’s acquisition of Just Eat, the CMA did not consider applying the ‘failing firm’ test. Instead, the CMA’s decision was based on whether Takeaway.com would have re-entered the market for the supply of online food platforms in the UK absent the merger, and if so, whether the re-entry would have resulted in a more competitive situation than would exist after the merger.
Given that this decision was also taken during COVID-19, only a few weeks after the adoption of the April Provisional Findings in Amazon/Deliveroo, and that it related to one of the potential markets in which Deliveroo was also active, the decision highlights the CMA’s case-by-case approach. The CMA’s approach to Deliveroo in the April Provisional Findings was clearly driven by Deliveroo’s circumstances, not COVID-19 generally or even the impact of COVID-19 on online restaurant food delivery more broadly. This is highlighted by the Revised Provisional Findings that Deliveroo’s improved financial circumstances meant that the failing firm defence was not applicable.
JD Sports Fashion/Footasylum
In its Final Report, the CMA concluded that the merger between JD Sports and Footasylum would result in a substantial lessening of competition, and blocked the transaction. The CMA stated that neither party said they would go out of business absent the merger, so the CMA did not apply the failing firm test. Although much of the investigation was completed before COVID-19, the CMA did consider the impact of COVID-19 on its assessment. While the full impact of COVID-19 remains uncertain, the CMA noted that all retailers are experiencing the same change in market conditions. In addition, the CMA found that, while the sector was clearly being impacted, COVID-19 did not affect the parties in a way that it would make either party’s position weaker or their competitors’ stronger. The CMA did not consider that COVID-19 would “significantly increase the constraints” on the parties to such an extent that it would remove the competition concerns.
The CMA’s approach here is facially different to the approach it took to Deliveroo in its April Provisional Findings, in that it started its assessment with the impact of COVID-19 on the sector as a whole, and then concluded that the parties were not impacted by COVID-19 more than their competitors.
In its Phase 1 Decision, the CMA found that the completed acquisition of viagogo by StubHub gave rise to a realistic prospect of a substantial lessening of competition in the market for the supply of secondary ticketing exchange in the UK.
While the Parties did not claim that the failing firm test was met, they argued that COVID-19 had a significant adverse impact on revenue generation in the ticketing industry and reduced demand for tickets, market changes which should be taken into account in the CMA’s counterfactual assessment. In particular, the Parties claimed that there was no evidence that all ticketing players would be impacted in the same way by COVID-19. The CMA considered that, while COVID-19 had had a substantial short term impact on the live events and ticketing industries, there still was uncertainty about the duration and long-term effects of the crisis. In addition, similarly to its findings in JD Sports Fashion/Footasylum, the CMA concluded that there was no evidence that COVID-19 will have disproportionate effects on the Parties compared to their competitors or that StubHub would have exited the market, as a result of COVID-19.
COVID-19 has not led to the CMA relaxing its assessment or investigational standards. In the guidance, the CMA emphasised the need to base decisions on “a material body of probative evidence”, rather than speculation, noting that it will consider the impact of COVID-19 on a case-by-case basis. The CMA’s strict approach to the failing firm defence was highlighted by its change of course in the review of Amazon/Deliveroo, in response to updated financial information.