Merger Enforcement Guidelines

Draft for Consultation
March 2004

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Part 9 - Failing Firm

Business Failure and Exiting Assets

9.1 Among the factors that are relevant to an analysis of a merger and its effects on competition, section 93(b) lists "whether the business, or a part of the business, of a party to the merger or proposed merger has failed or is likely to fail."

9.2 Probable business failure does not provide a defence against a merger that is likely to prevent or lessen competition substantially. Rather, the loss of the actual or future competitive influence of a failing firm is not attributed to the merger if imminent failure is probable and, in the absence of a merger, the assets of the firm are likely to exit the relevant market.

9.3 A firm is considered to be failing if:

• it is insolvent or is likely to become insolvent;
• it has initiated or is likely to initiate voluntary bankruptcy proceedings; or,
• it has been, or is likely to be, petitioned into bankruptcy or receivership.

9.4 Technical insolvency occurs when liabilities exceed the realizable value of assets, or when a firm is unable to pay its liabilities as they come due.

9.5 In assessing the extent to which a firm is likely to fail, the Bureau typically seeks the following information:

• the most recent, audited, financial statements, including notes and qualifications in the auditor's report;
• projected cash flows;
• whether any of the firm's loans have been called, or further loans/line of credit advances at viable rates have been denied and are unobtainable elsewhere;
• whether suppliers have curtailed or completely eliminated trade credit;
• whether there have been persistent operating losses or a serious decline in net worth or in the firm's assets;¹¹⁹
• whether such losses have been accompanied by an erosion of the firm's relative position in the market;
• the extent to which the firm engages in "off balance-sheet" financing (such as leasing);
• whether the value of publicly traded debt of the firm has significantly dropped;
• whether the firm is unlikely to be able to successfully reorganize pursuant to Canadian or foreign bankruptcy legislation, the Companies' Creditors Arrangement Act, or through a voluntary arrangement with its creditors.

9.6 These considerations are equally applicable to failure-related claims concerning a division or a wholly owned subsidiary of a larger enterprise. However, in assessing submissions relating to the failure of a subsidiary or a division, particular attention is paid to: transfer pricing within the larger enterprise, intra-corporate cost allocations, management fees, royalty fees, and other matters that may be particularly relevant in this context. These allocations are generally assessed in relation to the values of equivalent arm's length transactions.

9.7 Objective verification of matters addressed in financial statements are ordinarily considered to be substantiated when these statements have been audited or prepared by a person who is independent of the firm that is alleging failure. The Bureau's assessment of financial information includes a review of historic, current and projected income statements and balance sheets. The reasonableness of the assumptions underlying financial projections is also reviewed in light of historic results, current business conditions and the performance of other businesses in the industry.

Alternatives to the Merger

9.8 Before concluding that a merger involving a failing firm or division is not likely to result in a substantial lessening or prevention of competition, the Bureau assesses whether any of the following alternatives to the merger exist and are likely to result in a materially greater level of competition than if the proposed merger proceeds.¹²⁰

Acquisition by a Competitively Preferable Purchaser

9.9 The Bureau assesses whether there exists a third party whose purchase of the failing firm, division or productive assets is likely to result in a materially higher level of competition in a substantial part of the market.¹²¹ Where it is determined that such a third party (a "competitively preferable purchaser") exists, it can generally be expected that if the proposed merger under review cannot be completed, the acquiree will either seek to merge with that competitively preferable purchaser, or remain in the market. If the Bureau is not satisfied that a thorough search for a competitively preferable purchaser has been conducted, the Bureau requires the involvement of an independent third party (such as an investment dealer, trustee or broker who has no material interest in either of the merging parties or the proposal in question) to conduct such a search.

Retrenchment

9.10 Where it appears that the firm is likely to remain in the market rather than sell to a competitively preferable purchaser or liquidate, it is necessary to determine whether this alternative to the proposed merger is likely to result in a materially greater level of competition than if the proposed merger proceeds. The retrenchment or restructuring of a failing firm may prevent failure and enable it to survive as a meaningful competitor by narrowing the scope of its operations, for instance, by downsizing or withdrawing from the sale of certain products or from certain geographic areas.

Liquidation

9.11 Where the Bureau is able to confirm that there are no competitively preferable purchasers for the failing firm and that there are no feasible and likely retrenchment scenarios, it assesses whether liquidation of the firm is likely to result in a materially higher level of competition in a substantial part of the market than if the merger in question proceeds. In some cases, liquidation can facilitate entry into a market, or expansion in a market by enabling actual or potential competitors to compete for the failing firm's buyers or assets to a greater degree than if the failing firm merged with the proposed acquiror.

Timing

9.12 While the time required to assess the extent to which a firm is likely to fail if the merger in question does not proceed varies from case to case, the Bureau generally requires up to six weeks to complete its analysis. Merging parties intending to invoke the failing firm rationale are therefore encouraged to make their submissions in this regard as early as possible.

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¹¹⁹ Persistent operating losses may not be indicative of failure, particularly in a "start-up" situation where such losses may be normal and indeed anticipated.

¹²⁰See: Notice of Application, Canada (Director of Investigation and Research) v. Cast Group Ltd. (20 December 1996 (Comp. Trib.), file no. CT96/2) CT-96/002; Canada (Director of Investigation and Research) v. Air Canada (1989), 27 C.P.R. (3d) 476. (Comp. Trib.); Canada (Director of Investigation and Research) v. Air Canada (1993), 49 C.P.R. (3d) 7 (Comp. Trib.); News Release 89-22, "No challenge to Wardair and PWA merger", April 24, 1989; News Release, "Competition Bureau Announces It Will Not Oppose Acquisition of Canadian Airlines", December 21, 1999).

¹²¹The Bureau considers whether the third party is capable of exercising a meaningful influence in the market. Where an alternative buyer does not intend to keep the failing firm's assets in the relevant market, an assessment is made of the extent to which the market power arising from the original merger proposal is likely to be less than if the alternative merger proceeds.