When does the failing firm defense succeed in Brazil?
Times of economic crises usually bring with them a rising number of firms in financial distress. Given the global scope of the current Covid-19 related crisis, its effects can be expected to be widespread and far-reaching. In this context, one can expect an increase in the use of the failing firm defense in mergers that are subject to the review of competition authorities.
The failing firm defense applies when one party to a transaction is “failing” and therefore likely to exit the market in the near future. 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 Brazilian Competition Law does not address whether the failing firm scenario should factor into CADE’s merger review. However, CADE’s Horizontal Merger Guidelines describes the circumstances in which the failing firm defense can be successfully applied in Brazil. In summary, it requires parties to demonstrate that two elements are met:
(1) if the transaction is blocked, the failing firm and its assets would exit the market; and
(2) the firm has made efforts to pursue alternatives that are less harmful to competition and there is no other solution besides the proposed transaction.
For the first element, CADE considers the financial situation of the firm, whether it would be able to honor its financial obligations, whether a restructuring would be able to save it, and whether the assets would leave the market in case of bankruptcy. For the second, CADE considers parties’ efforts in finding an alternative solution that is preferable from a competition perspective.
From CADE’s case law, it is possible to identify when CADE considers the parties’ efforts to find a better alternative insufficient. In the Mataboi/JBJ case, CADE stated that the burden of proof is on the parties. However, in most precedents where this issue was raised, CADE concluded that parties did not sufficiently demonstrate that the merger was the best alternative to market exit. In the Mataboi/JBJ case, CADE stated that this could be done by presenting CADE with evidence that the parties reached out to a reasonable number of potential buyers with letters of credible sales offer, together with proof that these had been rejected by the potential buyers, or, alternatively, that parties advertised the sale of the assets in a far-reaching news media vehicle but received no reasonable purchase offers.
When reviewing the acquisition of assets of Mendes Júnior Siderurgia S.A., CADE decided that it was not sufficient for parties to send private letters to a few potential buyers, suggesting that parties must be more proactive and thorough in their attempt to find alternatives.
Although CADE has never cleared a transaction solely based on the failing firm defense, it has, on two occasions, found that the second element of the failing firm test had been fulfilled. In the Votorantim case, involving the purchase of mining rights in bankruptcy court, CADE found that this requirement was met because the buyers had purchased the assets through a public auction which was open to all interested parties, but no other potential buyer had appeared.
In the Petrobras/Petrotemex case, CADE’s General Superintendence found that Petrobras had undertaken sufficient efforts to find an alternative buyer because it had sold the subsidiaries in accordance with a robust sale process but, in the end, only the claimants and one other competitor had submitted proposals.
One Commissioner, however, proffered a dissenting opinion in this case which, though not adopted by the Tribunal, sheds some light into how controversial this issue is. The Commissioner believed that the parties had not sufficiently proven that there were no other interested buyers for the assets because the sale process imposed excessively restrictive criteria for the participants, therefore eliminating some potential buyers. The Commissioner also pointed out that an auction process is not ideal for identifying the best buyer from a competition perspective. As competitors tend to have greater knowledge of the market, they often attribute greater value to the Transaction and consequently, their purchase offers tend to be higher than that of other potential buyers. This, he claimed, also discourages other possible purchasers from participating in the auction even if they would be willing to purchase the asset at a lower price. The Commissioner believed that CADE should not consider as viable alternatives only the buyers that are willing to pay the most.
CADE’s case-law suggests that the bar high for this defense to be applied. However, the precedents above shed some light into what steps parties should take when this is a defense they intend to invoke.