Global merger control: Crossing the finish line

How the European Commission looks at the effect of horizontal mergers on innovation will be remembered as one of the important policy changes championed by European Commissioner Margrethe Vestager, who reminded the public that EU merger control rules ‘are there to protect innovation’, and that this objective ‘is important in [our] merger policy’.

The Commissioner’s public interventions have accompanied the rise of a novel theory of harm, which posits that horizontal mergers could ‘lead to a reduction of innovation’ in an industry as a whole. This was its position in relation to a merger between Dow and DuPont, where the Commission found the merger would significantly reduce innovation competition for pesticides. This theory led to the divestiture of DuPont’s global R&D organisation in pesticides as part of the remedies required to clear the merger. In the recent Bayer/Monsanto merger, it seems that the Commission applied a similar approach, and found that the transaction would have ‘significantly reduced competition in a number of markets’ and ‘significantly reduced innovation’. As part of the remedy package, Bayer has committed to divest three important lines of its global R&D organisation.

Although assessing the effects of mergers on innovation is not new—the Commission’s Horizontal Merger Guidelines state that ‘effective competition may be significantly impeded by a merger between two important innovators’—under Vestager’s leadership the Commission’s approach to the impact on innovation has changed dramatically.

R&D expenditures do not automatically translate into new products. Predicting the future isn’t so easy after all

Pipeline problems

Traditionally, the Commission has examined whether a proposed merger creates an overlap between a product actively marketed by one of the parties with a pipeline product developed by the other party (‘market-to-pipeline’) or whether the parties developed separately pipeline products that would eventually compete on the market (‘pipeline-topipeline’). Pipeline products include products at a relatively late stage of their development, with a good chance of launch within two to three years.

In the recent Pfizer/Hospira merger, the Commission found that the proposed transaction raised competition concerns because Pfizer was developing a competing medicine to Hospira’s. Specifically, Hospira was selling Inflectra, an infliximab biosimilar used to treat several chronic inflammatory diseases, notably the inflammation of Crohn’s disease. At the same time, Pfizer was in an advanced stage of developing its own biosimilar for infliximab. The Commission was concerned that Pfizer would likely discontinue its efforts to bring its new medicine to market, reducing competition. As a remedy, Pfizer divested its development programme.

In Johnson & Johnson/Actelion, the merging parties were separately developing new treatments for insomnia, using the same novel mechanism of action. The Commission was concerned that post-merger, J&J would have the ability and incentive to delay or abandon one of these programmes and thus required that Actelion’s insomnia research programme be divested.

In the US, the Federal Trade Commission (FTC) has followed a similar approach. For example, in Thoratec/ HeartWare, Thoratec was marketing a successful ventricular assist device (a heart pump) while HeartWare’s device achieved promising clinical trials. The FTC challenged the merger, alleging harm to innovation and to future price competition. In Nielsen/Arbitron, Nielsen offered a leading TV audience measurement service, while Arbitron offered a leading radio audience measurement service. At the time of the merger, both were developing a cross-platform audience measurement service. The FTC challenged the merger, alleging harm to innovation.

Parties should emphasise the complementarity of their R&D assets, which could lead to an increase in innovation

Dramatic shift

The Commission’s approach in Dow/   DuPont marks a dramatic shift in the way  the impact of mergers on innovation is  examined. The Commission did not focus  on specific product overlap, as it did  before, but instead it considered the  impact on innovation ‘as a whole’. Putting  it simply, the Commission found that  Dow and DuPont would likely reduce  their R&D budget post-merger, which  would inevitably lead to a smaller number  of new products brought to the market.

But is it that simple? First, if the Commission found that a ‘merger between important rival innovators is likely to lead to reduction of innovation’, how is innovation measured? Surely by considering the launch of potential new products. But future new products (or products in an advanced-stage of development) were not the focus in Dow/ DuPont. Can innovation be measured by R&D expenditures? Maybe. But R&D expenditures do not automatically translate into a guaranteed number of new products. R&D activities are a risky venture. Billions can be spent, often without immediate, or any, results. In the pharmaceutical industry, a recent study shows that only 9.6 per cent of drugs in Phase I are approved by the US FDA. The chance of success increases to 15.3 per cent in Phase II and 49.6 per cent in Phase III. Second, as the Commission puts it in its March 2017 decision (at 348), ‘innovation should not be understood as a market in its own right, but as an input activity for both the upstream technology markets and the downstream [product] markets’. If that is the case and if the ultimate goal of merger control is to protect competition between ‘downstream products’, would it not be necessary that innovations worth protecting, although inherently uncertain, be at least to some extent identifiable with existing or pipeline products?

Third, merger control is inherently forward-looking and requires making predictions, which become increasingly imprecise the further into the future one looks. In past cases, that the competitive assessment focused on pipeline products seemed justified, in particular when it was expected that these products would hit the market in two to three years. Equally, merger-specific efficiency arguments are typically accepted within such a timeframe, so that they can be verified with at least some degree of predictability. In sharp contrast, between the moment new molecules are discovered and the point that firms can launch a new product, more than 10 to 12 years can pass. It is extremely difficult to make any sound predictions so far into the future.

Fourth, firms undertake R&D investments when they expect sufficiently high returns. Expected returns on such investments depend in part on the number of firms engaged in the same ‘innovation space’. Obviously, the more firms that are involved, the lower the expected returns. Indeed, when a firm is the only one contemplating a research programme, it can expect greater reward than when others are pursuing the same research agenda. This means that a merger, by eliminating a rival, can increase the chance that the merged firm will undertake the necessary investment to pursue an ambitious R&D programme.

Finally, what can be an adequate remedy in such cases? Prohibit the merger as in Thoratec/HeartWare or Nielsen/Arbitron? In Dow/DuPont, in addition to product overlap divestitures, DuPont’s pipeline in herbicides and insecticides, its discovery pipeline in fungicides and its entire R&D organisation had to be divested, including some 400 to 500 employees. Contrary to past cases, where pipeline products were sold to third parties, forcing the sale of an entire R&D organisation appears far more radical. But will such a type of remedy be successful? Will the R&D organisation be equally successful under its new owner? Will the scientists stay or leave for new ventures? Only time will tell. In the 1995 AMP/Wyeth merger, the parties divested one of the two development programmes for Rotavirus vaccines to the Korean Green Cross. More than ten years later, GSK launched a rival vaccine, while the Korean Green Cross never did. In Ciba-Geigy/Sandoz, the FTC was concerned that the merger could impair the development of gene therapy, a market that the FTC forecasted to be worth US$45 billion within 20 years from then. Although the parties divested one of the gene therapy programmes to Aventis, the market for gene therapy is still very small and Aventis has not launched a product in this space. Predicting the future isn’t so easy after all.

Business impact

Clearly, the Commission’s theory on innovation is here to stay. It seems to have applied it again in Bayer/Monsanto. Therefore, companies should consider carefully any overlap in innovation activities in a broad sense, even if there is no prospect of developing concrete products in the near future. Focusing on pipeline products is no longer enough to assess the regulatory risks posed by a transaction. Further, since the Commission’s assessment relies heavily on internal documents, the parties should describe their R&D activities with care, highlighting the potential efficiencies of merging them. The parties should emphasise the complementarity of their R&D assets, which could lead to an increase in innovation. At the same time, highlighting the benefit of eliminating duplicative activities could backfire, as the Commission might interpret such a plan as a clear intent to reduce innovation competition. Finally, mergers that may be prone to the Commission’s theory on innovation are likely to face an even longer pre-notification period.

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Online markets constitute a special focus of competition law. To be appropriately applied, regulation requires a thorough analysis beyond market shares and demand-side substitutability.

 

Rapid growth and change in the global technology sector and the evolution of digital economies have created new challenges for competition authorities. To keep pace with developments, the European Commission conducted a so-called sector inquiry in the field of e-commerce and published its findings in 2017. Currently, the EU is holding far-reaching discussions that could lead to the possible regulation of internet platforms and form part of a broader EU strategy for a digital single market.

National authorities are also starting to take action. Over the past five years, the German Federal Cartel Office (FCO —Bundeskartellamt), the main body responsible for German merger control rules, has made various interventions against agreements and practices in the online distribution field. In particular, the question of how to treat bans on sales via third-party internet platforms in selective distribution systems has been on the FCO's agenda for some time. In 2015, the FCO concluded that ASICS Deutschland had restricted online sales of running shoes in an anti-competitive manner.

The FCO has also launched an investigation into discrimination by retailers against online sales compared with offline sales. In June 2017, the FCO was handed additional investigative powers covering consumer protection, under which it has already launched a sector inquiry into online price comparison websites.

Another important aspect of competition law in the technology sector is merger control. Probably one of the most frequently discussed cases has been the US$19 billion acquisition of WhatsApp by Facebook in 2014. Despite the deal's large value and the fact that WhatsApp was already widely used in Europe, the transaction did not meet the turnover thresholds of any merger control regime in the EU. Politicians and competition authorities in Europe therefore discussed additional instruments in order to review and control these market developments. As early movers, Austria and Germany amended their competition laws in order to react to such new developments in the digital economy.

Among the changes, it has been clarified that services that are rendered free of charge to consumers may nevertheless constitute a market in terms of competition law. This is particularly relevant for multilateral online platforms such as search engines, comparison websites, hotel booking portals or social networks, which offer their services for no fee.

€400m

Under new laws, merger control will be required if the value of the consideration for a transaction exceeds €400 million in Germany (€200 million in Austria) even if the companies involved do not meet the domestic revenue thresholds

 

US$19bn

The acquisition of WhatsApp by Facebook in 2014, fell below EU merger control thresholds despite its hefty price tag.

Market power

Another interesting aspect is the criteria for the assessment of the market power of companies on platform markets. The new law in Germany introduces specific criteria to be taken into account, such as: direct and indirect network effects; parallel use of multiple services and switching costs for users; economies of scale in the context of network effects; access to competitively sensitive data; and innovation-driven competitive pressure. These criteria or some of them have been applied before by other competition authorities. These legislative developments also prove that online markets constitute a special focus of competition law. To be appropriately applied, regulation in this field requires a thorough analysis beyond market shares and demand-side substitutability.

New threshold

The new laws on merger control take into account that many companies in the digital economy, especially when they are new, may offer their services without generating significant revenues but become relevant when other considerations such as personal data are taken into account. However, investors are ready to pay high prices for successful or promising digital companies. Thus, amendments include an additional merger-filing threshold based on the transaction value.

Under the new laws, merger control will also be required if the value of the consideration for the transaction exceeds €400 million in Germany and €200 million in Austria, even if the companies involved do not meet the domestic revenue thresholds. The consideration includes all assets and other monetary values or services the seller receives from the acquirer in the context of the transaction (purchase price) as well as the value of any obligations to be taken domestic operations. More jurisdictions are likely to follow in implementing these kinds of merger tests.

Given the dynamics of the technology and internet markets, one of the key challenges for competition regulation is to properly control M&A transactions without distorting incentives for competition for potential startups. From a company's perspective, merger control means additional bureaucratic hurdles, increased costs and time-consuming legal tasks. Hence, during the legislative discussions in Germany, startup companies raised concerns that an extensive merger control that included a standstill obligation until clearance may create a competitive disadvantage compared with other jurisdictions in the EU. As a result, investors might be deterred from investing in Germany. Against this background, the German national association of startups called for a European solution instead—this initiative could, however, not avoid the legislative changes.

Care needed

The challenge is to strike the right balance between potential overenforcement and laxity. Predictions and projections on market development are particularly hard to make in this field. Even if a transaction falls under a broader value-based filing test, competition authorities must be careful in determining potential threats to competitors. A premature conclusion might, in fact, preclude a competitive offer to the market.

Instead of regulatory intervention, competition itself might sometimes be the solution. The next challenge for current incumbents might be waiting in the 'incubator', ready to be released for the next innovative, if not disruptive, service that will quickly change the current market shape—and welcoming competition as a discovery process.

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80%

A conditional clearance requiring the parties to divest a part of their business has been given in more than 80 percent of EC remedy cases over the past three years.

In the European Union, an increasing number of merger clearances are being given on the condition that the parties offer suitable remedies. During Margrethe Vestager's first three years as Commissioner for Competition, a total of 64 conditional clearances have been granted. This constitutes a 42 per cent uplift compared to previous Commissioner Joaquín Almunia's final three years in office.

A conditional clearance will most likely require the parties to divest a part of their business, as has been the case for more than 80 per cent of remedy cases over the past three years. (In 2015, 90 per cent of conditional clearances required a divestiture of some kind.) In fact, the European Commission's (EC's) policy explicitly prefers structural remedies—which require merging parties to make divestments that change the market structure—over other types of remedies.

Every remedy has a subtle difference. While the divested business should be viable to allow the purchaser to compete effectively with the merged entity on a lasting basis, the structure of the divestiture may vary to account for competitive concerns. For example, it may affect global R&D facilities to tackle innovation concerns (as in Dow/DuPont), employ a transitional supply agreement to address viability concerns (as in Staples/Office Depot), or licensing arrangements to enable the purchaser to market the divested business under the merged entity's stronger brand (as in Danone/The WhiteWave Foods Company).

There is also now a higher chance that the closing of the deal will be delayed as the EC increasingly requires merging parties to agree to upfront/fix-it-first purchaser clauses.

Usually, merging parties offering remedies can close a transaction once they receive the EC's conditional clearance. A suitable purchaser has to be identified following clearance within a set period. But when the EC has concerns about whether a suitable purchaser can be identified, an upfront buyer or fix-it-first clause can be used. An upfront buyer clause requires the parties to agree not to close the transaction until the EC approves the purchaser and the underlying agreements. A fix-it-first clause goes one step further, and obliges the parties to find a suitable purchaser and enter into a legally binding agreement during the EC's administrative procedure.

In 2015, one in five remedy decisions included an upfront buyer or fix-it-first purchaser clause. By 2016, this number increased to one in three—a trend that continued into 2017, when approximately 33 per cent of decisions imposed a purchaser clause.

1/3

In 2017, approximately one in three of all EC remedy decisions imposed an upfront or fix-it-first purchaser clause.

Case of delay

In practice, these clauses provide leverage to remedy buyers: Merging parties anxious to close may settle for a 'fire sale' of the divested assets. Yet Ball/Rexam is an example of the potential sluggishness of the process. This merger within the global canning sector was conditionally cleared on 15 January 2016 with an upfront buyer clause included in the remedy. Ball had noted pre-clearance that there was 'no assurance that buyers satisfactory to Ball and the regulators' could be found. Indeed, it took three months for Ball to propose a suitable purchaser to the EC. It took another three months for the EC to conclude on the suitability of the purchaser and the underlying agreements, demonstrating the delay the process can cause to closing. The deal finally closed six months after the parties received the EC's conditional clearance decision.

Under Italian merger control rules there is no standstill obligation, therefore, in principle, the parties would be free to close a deal, subject to merger control clearance, after the notification. However, the Italian Competition Authority may order the merging parties to refrain from transacting in the case of pursuing an in-depth investigation, although it has rarely done so in the past (see cases Groupe Canal+/Stream and Autogrill/Ristop, both in 2002). In addition, if the authorisation is ultimately not granted, but the transaction has already been implemented, the authority may order all measures required to restore the pre-merger status, including divestment. For this reason, in most cases the parties complete the transaction conditional upon the authorisation of the Italian Competition Authority. As a consequence, if the transaction is authorised with remedies, whether the deal can close prior to the implementation of the remedies will largely depend on what the parties agreed in the transaction agreement. For instance, in case of structural remedies, the parties must determine whether the acquisition may or may not take place prior to finding a suitable buyer for the divested business, and therefore, who should have responsibility for finding a buyer and run the risk of fines from the Italian Competition Authority for transacting without complying with the remedies, if a suitable buyer is not found. As a reference, the first threshold of the two cumulative thresholds that trigger mandatory notification in Italy has just been updated from €492 million to €495 million, i.e. (i) aggregate turnover in Italy of all undertakings involved above €495 million; and (ii) individual aggregate turnover of at least two of the parties of the transaction above €30 million. Although rare, non-structural remedies—such as promises not to act in a certain way in the future—do exist. Over the past three years, 11 out of 64 remedy cases were resolved with a purely behavioural remedy. They are accepted 'only exceptionally in specific circumstances,' such as in 'conglomerate structures'.

For instance, on 25 February 2016, the EC conditionally cleared the conglomerate concerns in Dentsply/ Sirona with a behavioural remedy. The EC maintained that the merging parties would have significant market power that could foreclose competing suppliers of dental 'blocks' from a sizeable part of the 'chairside CAD/CAM system' market. To remedy this, the EC required an access remedy from the parties, including the extension of existing licensing agreements with competing block suppliers until 2026. The EC took the unusual step and noted that 'remedies other than divestiture remedies appear best suited to directly address the [conglomerate] concerns raised.'

In November 2017, Qualcomm updated its remedy package to allay the EC's concerns in Qualcomm/NXP Semiconductors. Qualcomm first offered a set of commitments on 5 October 2017. It is understood that the October package offered to carve out all standard essential patents (SEPs) from the transaction, and committed Qualcomm not to assert certain patents owned by NXP (in particular Near Field Communication Technology – NFC). This package was market tested and viewed as inadequate by market participants. The November package added on the behavioural obligation on Qualcomm to ensure the interoperability of NXP's NFC platform with other parties.

Notably, in the most recent merger cases authorised with remedies, the Italian Competition Authority has often imposed a combination of structural and behavioural remedies and in some cases only non-structural remedies. In the RTI/ Gruppo Finelco case (2016) the authority requested only behavioural measures, including prohibiting the merged entity from concluding other advertising contracts, to limit potential vertical and conglomerate effects which could be produced by the merger. In April 2017, in the Gruppo Editoriale l'Espresso/ Italiana editrice case the authority also only imposed behavioural measures considered capable of neutralising the horizontal overlaps between the merging parties in the relevant market. In January 2018, in case 2I Rete Gas/Nedgia, the most recent merger case authorised with remedies, the authority imposed structural measures consisting of the divestment of certain local activities as well as behavioural remedies aimed at lowering barriers to entry to the market.

85%

Of the 33 transactions on which MOFCOM has imposed conditions since the Anti- Monopoly Law (AML) entered into force in 2008, all but five involved foreign-toforeign transactions.

US approach

In early 2017, the United States Federal Trade Commission (FTC) released a report analysing the effectiveness of past merger remedies (between 2006 and 2012) and outlining best practices going forward. The report confirms the FTC's preference for structural remedies, such as divestitures, over behavioural remedies that often require extensive monitoring to enforce. The Department of Justice (DOJ) has not released a similar official report, but Makan Delrahim, the recently confirmed head of the DOJ Antitrust Division, echoed the FTC's preference for divestiture over behavioural remedies in a recent appearance at New York University.

The FTC report found divestiture of an ongoing business (a set of assets immediately capable of being a stand-alone business) to be more effective than divestiture of selected assets. The distinction focuses on the ease with which a standalone business divestiture may be transitioned to the buyer, compared to assets that take more effort to be incorporated into the buyer's existing framework before successfully competing in the market. For the FTC to accept a divestiture of selected assets, the parties may be expected to show why divestiture of an ongoing business is infeasible and demonstrate how the selected assets can operate as a viable and competitive business.

The FTC also expressed concern over the 'hold-separate' period, during which assets identified to be divested remain in the control of the seller. The FTC stressed the importance of independent managers empowered to make real-time decisions to maintain the assets' competitive value during the interim period before divestiture is complete. Recent FTC and DOJ enforcement actions have been consistent with this policy directive. For example, the FTC recently required Abbott Laboratories and Alere Inc. to divest two product lines to obtain clearance, and the DOJ ordered CenturyLink and Level 3 Communications to divest certain overlapping aspects of their telecommunications businesses.

China attracts controversy

In China, the Ministry of Commerce (MOFCOM) has increasingly imposed patent-related remedies on merging parties as a condition to approval. This approach has been criticised for diverging from enforcement approaches taken in other jurisdictions. However, it appears to be an ongoing trend that may create uncertainty, particularly for mergers involving high-tech companies.

To date, a majority of mergers drawing mandatory remedies in China are foreign-to-foreign mergers. Of the 33 transactions on which MOFCOM has imposed conditions since the Anti-Monopoly Law (AML) entered into force in 2008, all but five involved foreign-to-foreign transactions.

Merging parties should be prepared for a prolonged review waiting period, particularly in mergers involving the technology industry. MOFCOM recently imposed a hold-separate period on a high-tech consolidation, a remedy that has not been used in at least four years. This controversial remedy requires the merging parties to ensure various aspects of their operations remain independent for two years. MOFCOM's reviews of proposed high-tech mergers are often influenced by local vendors' objections to sector consolidation.

Since the end of 2014, MOFCOM has penalised non-compliance with imposed remedies, including monetary fines up to ¥500,000 (approximately €64,000). That trend continued into 2017. In addition, MOFCOM maintains jurisdiction to order the dissolution of the merger, disposal of shares or assets, the transfer of the business, or adoption of other measures to restore the market situation. Despite this position, MOFCOM has never yet ordered dissolution of a non-complying merger. To date, all 19 MOFCOM penalties have been monetary fines imposed for failure to file, rather than for post-filing noncompliance.

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Some jurisdictions have created triggering events that may cover situations in which an acquirer is not seeking control

Delays or derailment of a deal by merger control considerations can significantly impact the commercial returns for both parties. But there are a number of steps that businesses can take to mitigate the risk.

Avoid unnecessary 'triggering events'

In the majority of jurisdictions, a filing is triggered only if there is a 'change in control', meaning that a party acquires de jure or de facto joint or sole control over the target. Typically, the acquirer obtains sole control if it alone can decide on strategic matters, such as the budget, business plan, major investments and appointment/removal of senior management. The acquirer would obtain joint control if it can block such decisions ('veto rights').

There would be no change in control if the acquirer obtains a non-controlling minority stake in the target company or if the transaction results in 'shifting alliances', where each strategic decision is approved by a different combination of shareholders.

Some jurisdictions, however, have chosen to create additional 'triggering events' that may cover situations in which an acquirer is not seeking control. For example, the acquisition of a certain percentage of shares or votes in a company constitutes a notifiable transaction in a number of jurisdictions, such as Austria, Germany and Brazil.

In a minority of jurisdictions, a transaction constitutes a notifiable transaction where the acquirer obtains some form of 'material influence', but less than control. In Germany, for instance, the acquisition of the 'ability to exercise competitively significant influence' constitutes a notifiable transaction. This provision is triggered when the acquisition of less than a 25 per cent stake is accompanied by so-called 'plus factors', such as information rights, the right to appoint board members or certain blocking rights. Although not very commonly used, this provision is relevant where the investor is a strategic acquirer with stakes in competing businesses.

Delays caused by notifiable transactions can significantly impact the commercial returns for both parties. Therefore, it may be more commercially attractive to structure the deal to ensure that there is no triggering event. However, it's important to ensure that the structure and deal documentation reflects the parties' true intentions, as competition authorities will assess the economic reality of the transaction and consider whether a situation may give rise to de facto control.

The parties can carve out assets likely to be causes of concern to the authorities before launching the transaction.

Make use of a put and call option agreement

Entering into a put and call option agreement allows the parties to postpone a filing obligation up to the moment in time when the option is exercised, and where a filing obligation may no longer interfere with deal imperatives or competitive conditions may have changed.

There are two scenarios in which such a move could delay timings of aspects of the transaction that may lead to trigger events: where an acquirer is attempting to purchase multiple businesses; and where an acquirer is looking at a large business that can be carved up to be acquired in stages. In the first of these scenarios, acquirers may wish to combine two similar or complementary targets to create synergies, which can give rise to antitrust scrutiny.

Even if the transactions are undertaken separately (i.e., no mutual conditionality) such that separate filings are triggered, both sets of competition authorities (which may or may not be the same) will review the combination if the transactions run in parallel (i.e., simultaneous closing). Even if they are sequential but overlap to some extent, such that the competition authorities reviewing the second of the two transactions would review the combination, the combination would in practice impact the review by the first set of authorities (in particular if the same authorities review both transactions). This could delay closing of both deals, which can put an acquirer at a disadvantage notably in a competitive bidding context. The acquirer would therefore have to balance two potentially conflicting priorities: ensuring that it signs both deals to realise the envisaged synergies, while not jeopardising its chances of signing each one of them because of the implications the combination may have on the process.

One way to manage this balancing act is to proceed with the more pressing deal first and agree on a put and call option on the second deal. Provided that the second seller is willing to wait, the potentially problematic combination is not reviewed until the acquirer exercises the option, which allows the acquirer to put forward a competitive offer for the first deal while securing both deals.

Where the acquirer is looking at one target which alone gives rise to competition issues, it may be possible to acquire part of the business (for example, one manufacturing plant) or a minority stake initially, alongside a put and call option for the remainder of the business. At the point that the acquirer decides to exercise the option, competitive conditions may have changed or the parties could have used the longer lead time to develop remedies to tackle the authorities' scrutiny.

When exercising staggered acquisitions of several parts of a business involving the same acquirer and seller in the EU, even for acquisitions which are not mutually conditional, extra caution needs to be taken. Even if each individual acquisition would not trigger any filing obligations because the revenue of each part does not hit the filing thresholds, all the staggered transactions involving the same acquirer and seller over a period of two years' time would become notifiable with the most recent acquisition, if one or several of the transactions taken alone or together triggers the revenue filing thresholds.

Offer an up-front carve-out or remedies

If a merger filing is required and it is expected to give rise to in-depth scrutiny, the acquirer can ensure that competition concerns are addressed up-front to avoid slowing down the overall process.

The parties can carve out assets likely to be causes of concern to the authorities before launching the transaction. However, it must be made clear to the authorities reviewing the transaction that the carved out assets will not fall within the scope of the main transaction nor their review. The authorities will also want to satisfy themselves that the problematic assets have indeed been carved out before the main transaction closes.

An alternative to an up-front carve out is up-front remedies, where the parties offer a comprehensive and clear-cut remedy package in Phase 1 to avoid going through the lengthy and in-depth review of a Phase 2 investigation.

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A clampdown by governments across the world on potential security threats has increased the scrutiny of participants seeking clearance for cross-border mergers and acquisitions.

With governments around the world placing foreign direct investment under ever greater scrutiny, an increasing proportion of big cross-border mergers and acquisitions are being subject to national security review procedures. Keeping abreast of new laws and engaging early with national bodies has never been more important when navigating this new landscape.

Australia

Australia Infrastructure security spotlighted

The Foreign Investment Review Board has the power to intervene on any transactions that lead to the acquisition of a ‘substantial interest' in an Australian company, land, land-rich entities, agricultural land and agribusiness, or acquisitions by foreign governmental investors. The Treasurer may prohibit or order broad divestments when a transaction appears contrary to the national interest based on its impact on national security, competition, government laws and policies, the economy and community or the investor's character. In January 2017, the Australian government launched the Critical Infrastructure Centre to independently advise the Treasurer on national security risks in respect of access and control of the country's critical assets, such as ports and storage, and energy supply. In March 2018, the Security of Critical Infrastructure Act was passed to give the Minister for Home Affairs a broad power to take action to protect against threats of espionage and foreign interference to critical infrastructure. The legislation established a register of Australia's high-risk critical infrastructure, including information on asset ownership, access and control.

45 days

The minimum period required for parties in a Canadian transaction raising national security concerns to seek clearance before closing.

Canada

Canada Increased transparency is encouraged

The Canadian government has the power to review transactions that exceed a specific threshold or transactions (including minority investments) where there are ‘reasonable grounds to believe that an investment by a non-Canadian could be injurious to national security'. Although there is no definition for the latter, authorities' examination of the potential effects on national security include the areas of defence, technology, and critical infrastructure and supply. Parties in a transaction raising national security concerns are encouraged to seek clearance at least 45 days before closing. Authorities can block the investment, ask for undertakings and/ or provide terms or conditions. Recent trends show an encouragement of foreign investment, prompting the government to issue guidelines that increase transparency.

China

China Cybersecurity law adds requirements

In 2011, China's Ministry of Commerce (MOFCOM), the regulatory body that has oversight for reviewing acquisitions, introduced a set of temporary provisions aimed at assessing the overall impact of foreign investments on China's national security, defence, economy and public interest. In 2015, China promulgated its first National Security Law, which provides more detailed rules under which MOFCOM will review, approve or terminate any transaction and to impose sanctions or divestments on acquiring companies. In addition, China's 2017 Cybersecurity Law provides for additional requirements to be placed on companies engaging in critical informational infrastructure or network and data operations.

EU

EU Juncker outlines new measures

In September 2017, European Commission President Jean-Claude Juncker outlined legislative measures on the screening by EU Member States of foreign takeovers and investments following a significant increase of foreign direct investment into European technology assets, particularly from companies in China with links to the Chinese government. The proposed EU Regulation, which can still be amended by the EU legislature (Parliament and Council), and is currently expected to be passed by the end of Q1 2019, stops short of forcing Member States to establish or maintain investment review mechanisms. However, if they do so, frameworks should be in line with EU law. According to the non-exhaustive list of pertinent considerations, critical infrastructure and technology, security of supply of critical inputs, and access to or control of sensitive information are included. The new screening system aims to improve cooperation between Member States in vetting transactions affecting security and public order, although the Commission's views are not binding and an ultimate decision rests with the Member States.

France

New ‘Pacte' law will extend the foreign investments control mechanism

All foreign investors are required to file a request for prior authorisation over defence, security-related activities and dual-use technology, or activities such as gambling by non-EU investors, so that potential harm to public order, safety or national security can be assessed. The Ministry of Economy may authorise the transaction unconditionally, subject it to mitigating conditions or prohibit it. Prior clearance of the transaction should constitute a condition, whereas buyers should consider including break-up fees or opt-out clauses if conditions imposed are too burdensome. The French Government is contemplating amending the current legal framework in the Loi PACTE (Plan d'Action pour la Croissance et la Transformation des Entreprises – action plan for business growth and transformation) and is debating the law in Parliament. Notably, it will set up a list of sensitive French groups that deserve particular attention. This list will be monitored monthly by a Council of defence and national security comprised of relevant ministers. The French Government will extend the list of sensitive sectors subject to review notably to digital data storage, artificial intelligence, nanotechnologies, financial infrastructures and robotics. Sanctions for infringement to mitigations requirements will also be refined (for example, suspending the voting rights of the foreign investor and introducing fines based on the turnover realised by the target company). It is also expected to help introduce state ‘golden shares' in certain strategic assets and use BPI France state funds to encourage engagement in the event of hostile takeovers of French strategic businesses by foreign investors.

Germany

Germany Amendments introduce new criteria

German law provides for a cross-sectoral review of transactions by non-EU/EFTAbased investors in all industries that are likely to pose a serious threat to public order or security. Recent amendments introduced a non-exhaustive list of criteria to determine the threat. The Ministry of Economic Affairs and Energy can also review sector-specific transactions in sensitive industries, such as arms, military equipment, encryption and other key defence technologies. Foreign investors are generally advised to apply for a clearance certificate in early stages of a transaction. Furthermore, there are proposals to reduce the entry level for foreign investment reviews from a 25 per cent threshold down to 10 per cent in equity and/or voting rights.

Italy

Italy Shares acquisitions may be subject to scrutiny

In Italy, the acquisition of shareholdings of companies engaged in activities deemed to be of strategic importance may be subject to certain limitations by the Italian Government (so-called Golden Powers). In particular, in case of purchase of shareholdings in strategic businesses operating in the defence and national security sectors, the Italian Government may impose specific conditions in relation to the security of supply, the security of information, technological transfers, and the control of exports. On 16 October 2017, in the context of the Vivendi-TIM transaction, the Italian Government exercised this power for the first time, imposing restrictions on certain strategic assets including a network unit and a software division. Both companies have challenged the decision before the President of the Italian Republic and the case is currently pending.

Japan

Japan 2017 sees enhanced enforcement

Japan's Foreign Exchange and Foreign Trade Act authorises the competent ministry to review the acquisition by a foreign investor of shares, loans and bonds of a Japanese company (known as inward direct investment), as well as the acquisition of shares of a non-listed company from other foreign investors (designated acquisition), and to change the content or discontinue the transaction. Designated acquisitions are subject to advance notice where they are relevant to Japan's national security. Advance notice is also required for inward direct investments if they affect national security, public order or safety, the Japanese economy, or involve investors from certain countries. In 2017, amendments were introduced to widen the scope of review and enhance enforcement mechanisms.

25%

ownership of an entity performing activities deemed of ‘strategic importance’ to Russian national defence and security will trigger the need for approval for potential foreign acquirers

Russia

Russia Review extended to reach off-shore companies and potentially any transactions posing a threat to the national defence and state security

The Government Commission on Control over Foreign Investments in the Russian Federation is responsible for reviews. It oversees transactions that result in acquisition of control over Russian entities engaged in activities of strategic importance. Currently, the law lists 46 activities that include both those directly related to the state defence and security, and certain other indirectly related activities, such as TV and radio broadcasting over certain territory, extraction of water resources and publishing activities. The criteria for determining control are wide and vary according to the target in question. Foreign investors must also obtain the Government Commission's consent for certain transactions involving acquisition of a strategic entity's property. Foreign public investors are not permitted to obtain control over ‘strategic' entities or acquire more than 25 per cent of their property, and must obtain Commission consent for acquisitions of the reduced stakes in strategic entities. The special, stricter regime established for such investors has recently been extended to ‘off-shore companies' in jurisdictions such as the United Arab Emirates, Jersey, British Virgin Islands and Bermuda. The statutory period for reviewing the application is three months from the date of its acceptance for review. The Commission can extend the review period for an additional three months. In practice, the review depends on the availability of the Commission's members and may take longer. The Commission may approve a transaction with or without certain obligations of the foreign investor or reject it. Amendments to the law introduced in 2017 gave the Commission Chairman the right to decide that approval is required with respect to any transaction by any foreign investor with regard to any Russian company (not necessarily strategic) if this is needed to ensure national defence and state security. As such, the definition of ‘foreign investor' was extended to include Russian nationals holding other citizenships and Russian companies under foreign control.

UK

UK Proposals aim to strengthen powers

While acquisitions in sensitive industries do not require prior approval, the Secretary of State for Business, Energy and Industrial Strategy (SoS) may intervene under the Enterprise Act 2002, based on public interest considerations related to national security, media plurality, quality and standards, and stability of the financial system. If the SoS intervenes, the Competition & Market Authority (and Ofcom in media cases) will investigate and report to the SoS who will then decide whether the transaction should be subject to a Phase II review or accept undertakings. The Government recently reduced the thresholds for intervention in cases involving military or dual-use (i.e., military and civilian) goods, computing hardware and quantum technology. In addition, recent proposals consider introducing a mandatory notification regime for the civil nuclear, defence, energy, telecommunications and transport sectors.

USA

USA New legislation would extend investment oversight

The Committee on Foreign Investment in the United States (CFIUS) has the authority to review any transaction that results in foreign control of a US business. Under the Trump administration, there has been rising sensitivity towards in-bound investment and acquisitions by Chinese companies, as well as investment from traditional allies in certain sectors. Politicians have proposed strengthening the CFIUS process against emerging threats in sensitive technologies and in November 2017, US Senator John Cornyn and Representative Robert Pittenger introduced the Foreign Investment Risk Review Modernization Act of 2017 (FIRRMA), which intends to expand the scope of the CFIUS review process. As currently proposed, the legislation would extend the CFIUS review time frames, increase the scope of transactions subject to CFIUS's jurisdiction, make certain notifications mandatory, and establish a process for expedited review of certain transactions.

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We are hoping to get more information from the JFTC in the future, for example regarding analyses of market definition in real-life cases

 

The pervasive influence of data has prompted the regulator in Japan to rethink its approach to merger control regimes. In June 2017, the Japan Fair Trade Commission (JFTC) and the Competition Policy Research Center (CPRC) jointly published their Report of Study Group on Data and Competition Policy. The study group began in January that year and the report discussed how Japan’s Anti-Monopoly Act (AMA) can address issues created by today’s data-driven society.

Defining markets

The JFTC is the sole regulatory authority that enforces merger control under the AMA, and when analysing a business combination, it starts by defining what constitutes a market in terms of size and geographic scope.

The JFTC looks at this from the perspective of a consumer’s ability to purchase a substitute product or service, and may also analyse the issues from the vantage point of supplier substitutability.

Traditionally, substitutability is determined using the SSNIP test (small but significant and nontransitory increase in price). But the proliferation of data requires a different approach. The report highlights that a digital platform comprises several layers of markets with different types of consumers or users (also referred to as a ‘multilevel market’), where ‘free’ services might be provided in one market (for example, the social media service market) but compensation is paid in another (for instance, the online advertisement market). The report argues that the SSNIP test does not necessarily apply to this type of ‘free’ market, and suggests considering the substitutability of consumers and/or suppliers using another method, such as the SSNDQ (small but significant and non-transitory decrease in quality) test, which focuses on functionality and quality rather than price.

Pre-notification amendments

When determining whether or not a specific business combination should be reported, the JFTC currently looks only at the parties’ Japanese turnover for the previous business year. If their turnover does not meet the thresholds, JFTC pre-notification is not required, even if their turnover may dramatically increase after the business combination is consummated (that is, if the following year’s turnovers greatly exceed the thresholds for pre-notification), and even if such a business combination then exerts a substantial influence on the relevant market(s).

The report recognises that it may take some time for data resources to be converted into increased turnover from innovation and/or sales of new products or services. In addition, the aggregated accumulated data may result in the parties being able to obtain or strengthen market power. The report therefore suggests considering a revision of the current pre-notification requirements to allow the JFTC to review certain important transactions that may be missed under the current system. It refers to a 31 March 2017 amendment to the German business combination regulations, which adds the value of an acquired company as a factor in determining whether or not pre-notification will be required. Under such a system, pre-notification could be required even in a situation where the turnover of the interested parties does not meet the thresholds.

Information disclosure

In November 2017, the JFTC introduced quarterly disclosure for proposed business combinations including the following information: filing date; the names of the parties involved; major business category; type of business combination (for example, merger or share acquisition); clearance date; and whether the waiting period was shortened.

The cases cover both Phase I and Phase II combination reviews, subject to the exclusion of some confidential cases. The new level and frequency of disclosure by the JFTC is a welcome and positive development. We are hoping to get more information from the JFTC about this issue in the future, for example regarding analyses of market definition in real-life cases.

45

In 2017, the JFTC reviewed approximately 45 relevant markets when analysing two high-profile mergers

High-profile mergers

In June 2017, the JFTC published its annual business combination report looking at the biggest transactions in the fiscal year 2016. That year, two deals in Japan’s petroleum refining and wholesale industry were noteworthy—the acquisition of TonenGeneral Sekiyu K.K. by JX Holdings to create Japan’s biggest oil refiner and the purchase of Showa Shell Sekiyu K.K. by domestic rival Idemitsu Kosan Co.

The JFTC reviewed approximately 45 relevant markets, including those with high combined shares, such as the LP wholesale gas market of approximately 80–90 per cent.

The JFTC conducted reviews of both transactions in parallel. On 19 December 2016, the JFTC published a press release announcing its decision to grant clearance to both transactions, subject to the remedies proposed by the relevant parties.

These cases are significant because although the notification for the Idemitsu transaction was submitted several months before that of the JX transaction, the JFTC reviewed both transactions together, rather than applying the European Commission’s ‘first- come, firstserved’ approach.

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In 2017, the European Union (EU) General Court annulled two merger decisions of the European Commission. In March, the Court overturned the Commission's 2013 decision to block the proposed €5 billion acquisition by United Parcel Services (UPS) of Dutch delivery group TNT Express NV (TNT). The Court annulled this decision on the basis that the Commission had failed to communicate a final version of its econometric analysis—which had been used in support of its objections—to UPS, breaching UPS's rights of defence.

When prohibition decisions are annulled, there is no guarantee that winning the court battle will save the deal

Then in October, the Court annulled a decision by the Commission to clear the €10 billion acquisition of Dutch cable operator Ziggo by Liberty Global of the US. That decision, taken in 2014, was appealed by a competitor and annulled because it did not sufficiently explain why some of the negative vertical effects raised by this competitor during the administrative procedure could be excluded. As a result, the parties had to re-notify the transaction and the Commission to re-examine it under market conditions applicable at the time of re-notification.

Such annulments are rare. EU Courts had previously annulled only eight Commission decisions under the Merger Regulation over a span of 25 years. Annulments of clearances are even rarer, with only four precedents: Kali und Salz/MdK/ Treuhand; RAG/Saarbergwerke/ Preussag; SEB/Moulinex; and Sony/ BMG. Both recent cases, however, illustrate the challenges of judicial review of merger decisions.

Annulment of prohibition decisions

When prohibition decisions are annulled, there is no guarantee that winning the court battle will be sufficient to save the deal, nor does it automatically mean that the Commission was wrong to prohibit a transaction.

The prohibition by the Commission of the 2001 merger between French industrial groups Schneider and Legrand (Schneider/Legrand), in which the Commission was faulted for a breach of the rights of defence, was annulled. But after the annulment, the Commission confirmed its suspicion that the transaction would raise competition issues. As a result, Schneider decided to sell Legrand (which had already been acquired by means of a public exchange offer).

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A rare annulment saw Liberty Global and Ziggo re-notify a merger transaction to the European Commission

Sometimes, there is actually nothing to be fixed. For example, UPS's recent victory will not allow it to win its prize:

Its main rival, FedEx, acquired TNT in the meantime. What is left is the possibility to seek damages. At the time of writing, UPS had filed an action before the General Court seeking US$2.1 billion in damages. However, such damages are notoriously difficult to obtain and generally of a very limited amount. In Schneider/Legrand, the Court of Justice merely granted damages of €50,000 for expenses incurred by Schneider in relation to the re-examination of the merger.

There are cases that have had a positive outcome for the parties involved. For example, Sweden's Tetra Laval eventually obtained clearance for its €1.6 billion acquisition of French packaging equipment maker Sidel following the annulment of the Commission's initial prohibition. In that case, the Commission decision was annulled by the Court for failure to meet the burden of proof. On its second attempt, the Commission found that the standard set out by the Court for prohibiting a merger because of risks of tacit collusion was not met. It then cleared the merger.

Clearance appeals

When a clearance decision is successfully appealed by a third party, the acquirer faces a risk of seeing the corporate integration being called into question years after its implementation. The parties must submit a new notification and the Commission has to take a fresh decision in light of current market conditions. This process, known as 're-adoption', can be lengthy and potentially cause the Commission to impose new remedies, or even to prohibit the transaction.

Sometimes there is nothing to be fixed. For example, UPS's recent victory will not allow it to win its prize

This can give rise to considerable complexity. After the European Commission's decision cleared the proposed merger between Sony and Bertelsmann in 2004, a third party successfully challenged the ruling before the General Court. The Commission then cleared the transaction again. In parallel, the merging parties successfully appealed the General Court's judgment before the Court of Justice. But in the meantime, the same third party who had challenged the first decision also appealed the second clearance decision. Sony eventually acquired sole control of the joint venture, leading to the closing of the pending appeals as they had become devoid of purpose.

Expedited action

It is essential that EU courts decide on Commission merger decisions as quickly as possible. The parties should therefore apply for an expedited procedure when appealing a prohibition decision. This will allow a priority treatment and a shorter written phase, usually with only one round of written submissions, and a shorter deadline for the defendant to file its submission.

In four previous cases of annulments of Commission decisions, the General Court granted the expedited procedure when the parties requested it and ruled within a period of between nine and 19 months. The request was, however, refused in the UPS/TNT case when the General Court's review turned out to be particularly lengthy (four years), which was surprising given that the proceedings ultimately led to a short judgment, annulling the decision on a procedural ground.

In the Liberty Global/Ziggo case, neither the third party appealing the decision nor the Commission requested an expedited procedure. Because of the Court's rules of procedure, the one that really had an interest in such expedited treatment— namely Liberty Global—had no right to request it, even if it had intervened in the case (which it had not).  And an intervention by Liberty Global in the case would have likely slowed down proceedings even more. As regards possible mitigating strategies, if the parties to a transaction cleared by the Commission suspect that a third party might appeal that decision, they can try to safeguard their interests by, first, trying to accelerate the publication of the Commission decision. They can do this by submitting confidentiality requests on the decision as soon as possible in order not to delay the publication of the non-confidential version (the clock for third parties to appeal the decision starts ticking when the non-confidential version is published). Likewise, during the court proceedings, they will be asked to submit a confidentiality request, and may accelerate proceedings by not making unduly broad confidentiality requests. Finally, if they believe that there is a material risk of full or partial annulment of the clearance decision, they could take ring-fencing measures in order to facilitate the unscrambling of the eggs, should they eventually have to divest part of the target business.

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