In response to the COVID-19 virus, Canada’s federal government has restricted non-essential travel and closed the US border. Canada’s provincial governments have enacted highly restrictive measures including mandating the closure of facilities providing recreational programs (i.e. gyms), libraries, public and private schools, licensed childcare centres, bars and restaurants, theaters, cinemas and concert venues, and the list goes on. Some provinces have also banned gatherings of more than 5 people and prohibited all non-essential businesses. The status quo is likely to continue for weeks, if not months. While both federal and provincial governments have implemented measures to support businesses during this time, including tax deferrals, increased credit availability, and wage subsidies to help prevent layoffs, these programs, regrettably, may not be enough to keep some businesses afloat.

The truth is that many companies, irrespective of their size and industry, may be facing bankruptcy in the aftermath of COVID-19. This, consequently, may lead to a situation in which better positioned companies with sufficient access to financing will become keen to seize a unique opportunity to purchase the business operations of a struggling competitor. It is not unlikely that, in the coming period, the Competition Bureau (the “Bureau”) will be asked to approve otherwise ‘problematic’ mergers on the basis of the ‘failing firm’ defence.

The Bureau has the power to challenge any merger, whether notifiable under the Competition Act (the “Act”) or not, up to one year after the merger has been substantially completed. That being said, merger review typically occurs prior to the closing of a transaction and generally follows pre-merger notification. In a merger review, the Bureau assesses whether a proposed merger will have anticompetitive effects. The test the Bureau employs to assess anticompetitive effects is whether a merger “prevents or lessens, or is likely to prevent or lessen, competition substantially”.

Among the factors the Bureau considers when reviewing a merger is whether the business, or part of the business, of a party to the proposed merger has failed or is likely to fail. Known as the ‘failing firm defence’, the loss of the competitive influence of a failing firm is not attributed to a proposed merger where such competitive influence would have been eliminated in any event by way of the firm’s failure (i.e., the merger would not eliminate an effective competitor). In assessing this ‘defence’, the Bureau generally considers two issues:

  1. whether the firm’s imminent failure is probable and, in the absence of a merger, the assets of the firm are likely to exit the relevant market, and
  2. whether alternatives to the merger exist and are likely to result in a materially greater level of competition than if the proposed merger proceeds.

Where there is likely failure and exit of the target with no competitively preferable alternative, the merger can be permitted on the basis that the loss of competition is not attributed to the merger (i.e. the merger is not preventing or lessening competition substantially).

As a practical matter, parties seeking to rely on the failing firm defence will need to provide evidence that the firm is failing (e.g., that it is insolvent or in bankruptcy proceedings). The Bureau will typically require detailed information from the parties in order to assess whether a firm is failing, including, among other things, audited or independently prepared financial statements from the target, projected cash flows, whether any of the target’s loans have been called, whether suppliers curtailed or eliminated trade credit, and whether there have been persistent operating losses or a serious decline in net worth or in the target’s assets.

In addition, it must be established that the acquisition by another purchaser, retrenchment/restructuring and liquidation are not likely to result in a materially greater level of competition than if the proposed merger proceeds. In this regard, it is worth noting the following:

  • Acquisition by a Competitively Preferable Purchaser: The Bureau assesses whether there exists a third-party whose purchase of the failing firm is likely to result in a materially higher level of competition in the market (a “Competitively Preferable Purchaser”). If the Bureau is not satisfied that a thorough search for a Competitively Preferable Purchaser has been conducted, the Bureau will require 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 before the failing firm rationale is accepted.
  • Retrenchment / Restructuring: The Bureau will assess whether 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: 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 restructuring or retrenchment scenarios, it will assess whether liquidation of the firm is likely to result in a materially higher level of competition in the market than if the merger in question proceeds. In some cases, liquidation can facilitate entry into a market by enabling actual or potential competitors to compete for the failing firm’s customers or assets to a greater degree than if the failing firm merged with the proposed acquirer.

As is evident from the above, the failing firm defence raises a number of complex issues and creates a high bar for parties to meet. However, now may be the time for businesses to consider, with competition counsel, how the failing firm defence could be used in acquisitions that may not otherwise have been possible.

If you have questions about the failing firm defence or merger review more generally, you can reach out to any member of Fasken’s Antitrust/Competition Marketing group. Our group has significant experience advising clients on all aspects of Canadian competition law.

The information and guidance provided in this blog post does not constitute legal advice and should not be relied on as such. If legal advice is required, please contact a member Fasken’s Antitrust/Competition Marketing group.