The ACCC's 2008 Merger Guidelines make it clear that a poor financial position, a poor profitability prognosis and/or a firm's intention to exit the market may constitute sufficient grounds to clear a proposed merger which would otherwise substantially lessen competition (SLC). This is sometimes called the "failing firm" defence in merger control analysis.
However, merger parties should be aware that the evidentiary burden to obtain ACCC informal clearance in these circumstances is very high. A recent case in the steel packaging sector provides the clearest indication for some time of the required standard of proof. If the ACCC can establish through independent expert evidence (for example forensic accounting data) that a firm is in danger of exiting the market, it may be willing to apply the failing firm defence.
The rules on SLCs and market exits
Transactions contravene section 50 of the Competition and Consumer Act 2010 (Cth) and may be prohibited by the Federal Court of Australia if they would have the effect, or be likely to have the effect, of an SLC.
If two competitors in a concentrated sector were to merge, the ACCC would pay close attention. The ACCC considers that there is a major risk of an SLC where transactions reduce the number of firms in a market from three to two (and clearances of two-to-one transactions are very rare indeed, for obvious reasons).
To assess whether an SLC would be likely to result from a deal, the ACCC compares and contrasts the likely future competitive environment where the proposed merger would proceed, to the likely future competitive environment if the proposed merger would not.
So, if the ACCC is able conclude that a target business would exit the market absent the transaction, the ACCC may be able to issue an approval for a transaction that would otherwise raise competition risks. In short, if the relevant business or assets would disappear in any event, it is unlikely that an SLC could occur out of a transaction, even where there is significant concentration.
The ACCC's 2008 Merger Guidelines set out stringent conditions which must be established where parties put to the ACCC that a market exit is likely to occur:
- the firm is in imminent danger of failure and is unlikely to be successfully restructured;
- absent the transaction, the assets associated with the firm, including its brands, will leave the industry; and
- the likely state of competition after the deal is implemented would not be substantially less than the likely state of competition after the target has exited.
The VIP/NCI acquisition
The ACCC recently concluded a public review of a proposed acquisition by VIP Steel Packaging Pty Ltd (VIP) of assets used for the production of large steel drums from National Can Industries Pty Ltd (NCI).
VIP and NCI both supplied a variety of plastic and steel packaging providing products, including drums, cans and pails. NCI's steel drum operations had been plagued by financial difficulties and had experienced declining demand. The business had been unprofitable since NCI purchased it in 2012.
The ACCC was concerned that the acquisition would remove the only alternative supplier of new large steel drums in Australia. However, NCI’s large steel drum operations had failed to achieve profitability and the ACCC concluded that, with or without VIP’s proposed acquisition, there would only be one supplier of new large steel drums remaining on the market.
How the ACCC came to give approval to the acquisition
This case is particularly interesting because the ACCC appears to have itself appointed a forensic accountant to examine the financial accounts for NCI’s large steel drum operations. This forensic accountant’s independent analysis appears to have assisted the ACCC’s conclusion that NCI’s large steel drum operations were not viable, either historically or in the future.
In addition, the ACCC also carefully reviewed confidential information and internal documents from NCI in relation to its sales process for these assets. This material supported NCI’s submissions to the ACCC that there was no alternative acquirer of these assets and the assets would leave the market in the absence of the proposed acquisition. We understand that NCI’s receivers also supported this position.
Finally, there was evidence of significant excess production capacity on the market, and that NCI had attempted to restructure its large steel drum operations, such as by closing its Queensland plant and discontinuing production at its NSW plant, leaving only one of its facilities, in Victoria, operational.
In granting approval, the ACCC said that: "in this case there was clear evidence that the relevant assets would leave the market if VIP Steel’s proposed acquisition does not go ahead. In these circumstances, the opportunities for competition in the supply of new steel drums would be the same with or without the proposed acquisition."
Key lessons for future application of the failing firm defence
Three key lessons emerge from the analysis of the VIP/NCI merger:
- the use of a forensic accountant shows that ACCC requires granular and independent evidence of financial position and likely exit;
- parties' internal materials must be consistent with any available independent evidence; and
- the threshold is whether the opportunities for competition in the relevant market would be the same with or without the proposed acquisition.
This is the standard which merger parties will have to reach to obtain approvals using the failing firm defence. It is a very high bar indeed, but it is possible to overcome with granular, independent and corroborated evidence.