Antitrust aspects of M&As involving companies in financial distress

Even in times of economic stability or growth, indebted companies may be at risk of insolvency or experience liquidity problems. They often need to be bailed out financially or restructured, and stakeholders need to be aware of the implications of these measures in the competitive environment.

Two aspects deserve more attention: (i) the need to obtain clearance from the Brazilian antitrust authority, the Administrative Council for Economic Defense (Cade) in advance of the company's rescue or financial restructuring transaction; and (ii) the argument of imminent insolvency as justification for the approval of a transaction that would otherwise be blocked.

a) Need for pre-merger approval by Cade and alternatives

The first aspect is relevant for two main reasons. First, it is a matter of compliance, given the need to verify whether there is a statutory obligation to obtain pre-merger approval and avoid possible sanctions for non-compliance. Second, this can impact the schedule of the transaction, an essential aspect in situations involving a liquidity crisis.

If a pre-merger approval is mandatory, it will have to be obtained in advance and the transaction cannot be closed until Cade's approval becomes final. Any delay resulting from a long merger review by Cade may cause the financial situation of the company in distress to deteriorate significantly.

The good news is that more than 85% of the more than 500 transactions annually filed before Cade are reviewed under a fast-track system and approved in less than two months. Such period considers both the 30 days for the analysis by Cade’s lower unit, the General Superintendence, and the following 15 days, during which any appeal by third parties or request by Cade's Tribunal to review the case must be awaited.

Even so, there may be more complex cases from an antitrust perspective that make it impossible for Cade to review the transaction under the fast-track system, thus significantly increasing the review time by Cade. There may also be situations in which even the abbreviated review time under the fast-track system is incompatible with the urgency for capital injection of a company in a serious financial distress.

The solution in these cases may be to use structures that do not require pre-merger clearance by Cade, such as: (i) capital injections by those who are already part of the company's shareholding structure, without significant changes to its shareholding percentages; (ii) injection of funds through debt instruments, even if convertible into equity after Cade's approval, including contingent convertible bonds (CoCo's); or (iii) hybrid investment instruments, in which equity interest is acquired up to the percentage immediately below that which would require Cade’s approval and, simultaneously, debt securities convertible into shares are subscribed in the remaining amount.

If the acquisition of equity interest in a percentage higher than that which would require Cade’s approval is essential to the parties and the above structures are not a viable option, there is the possibility of stipulating a down payment that resolves the situation of illiquidity of the target company, with the remainder being paid after Cade's approval.

An additional alternative would be to request a derogation from Cade, to allow closing of the transaction even before the approval by the agency becomes final. The problem with this option is that Cade has been extremely restrictive in granting this type of derogations, having done so only once in the 11 years of the law that created the current pre-merger review system (Law No. 12,529/11).

b) Imminent insolvency as justification for approval

The above solutions are designed for cases in which there is clearly no competitive problem or reasonable doubt as to the unconditional approval of the transaction by Cade. For cases in which the transaction generates a relevant market concentration or a vertical integration involving a company with market power, the analysis will probably take longer, and the transaction may even be blocked by Cade.

In the case of companies in crisis, however, the parties can invoke the “failing firm defense”, which requires that Cade balance the need to preserve competition with the economic reality of companies in financial distress.

The defense considers that, when it comes to mergers involving failing firms, any reduction in the number of competitors in that market should not be attributed to the transaction itself. Rather, authorities should consider, as the counterfactual, that the failing company and its assets would exit the market in the absence of the transaction.

The theory of the failing firm is not, however, a free pass to allow anticompetitive mergers involving companies in financial crisis. Its application usually depends on the presence of two other requirements in addition to the imminence of bankruptcy:

a) proof that there is no competitively preferable alternative to save the company (such as the economic unfeasibility of acquisition by a new entrant, given the absence of synergies, for example); and

b) demonstration that the bankruptcy of the company would effectively eliminate the offer of its products or services from the market (without, for example, the timely entry of new company(ies) using the assets of the bankrupt company acquired in a bankruptcy court).

The only case in which the failing firm defense was used as a significant basis for allowing a merger to be cleared by Cade was in the review involving the acquisition, by Votorantim Metais Zinco S/A (“Votorantim”), of the assets of Mineração Areiense S.A., a company undergoing bankruptcy proceedings (AC n. 08012.014340/2007-75). In that case, Cade concluded that all elements of the theory were present. Still, the transaction was not cleared exclusively based on this theory because, in the end, Cade concluded that it was unlikely that the parties would be able to exercise market power post-transaction due to existing market conditions, rivalry between market participants and low entry barriers. However, it was clear in that case that the failing firm theory had significant weight in the final decision.

Cade has never cleared a merger exclusively based on the failing firm defense. Whenever Cade analyzed the defense, it ruled out its application as the exclusive basis for approving the merger in question, as in the Mataboi/JBJ (AC n. 08700.007553/2016-83) and Petrobras/Petrotemex (AC n. 08700.004163/2017-32) cases. In both cases, Cade concluded that the parties had not proven that the two elements mentioned above were present in the specific case.

Another important caveat is that the application of the failing firm theory, even if accepted after verifying the presence of the above requirements, does not imply automatic unconditional approval of the transaction by the antitrust authority. It is possible, if not likely, that behavioral obligations, or even divestments, will be imposed as a condition for the approval of the transaction. In these cases, the negotiation skills of the companies involved and their representatives are essential for the conclusion of the process in a timeframe that is compatible with the urgent need for capital to keep the company in distress in the market.

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