Competition Commission accepts failing firm defence to clear stilton merger
30 January 2009
The Competition Commission has cleared the acquisition by Long Clawson Dairy Limited ("Long Clawson") of the Stilton and speciality cheese business of Dairy Crest plc ("Millway"). Its final report was published on 14 January, just 14 weeks after being referred, the shortest reference since changes were made to the UK merger control regime in 2003. The Competition Commission concluded that the merger would not result in a "substantial lessening of competition" in the market for blue Stilton in the UK as the failing firm defence applied.
We acted for Long Clawson in the present case, the first where the Competition Commission has accepted the failing firm defence. In the current economic climate, where businesses may be considering the acquisition of distressed companies or assets, this decision is particularly welcome.
In August 2008, Long Clawson acquired the trade and assets of Millway, the Stilton and speciality cheese business of Dairy Crest plc. Long Clawson and Millway are two of the largest manufacturers of Stilton in the UK supplying supermarkets, wholesalers, food manufacturers and exporters.
On 8 October 2008, the Office of Fair Trading (the "OFT") referred the Long Clawson / Millway merger to the Competition Commission, arguing that despite the buyer power of supermarkets, the merger gave rise to a realistic prospect of a substantial lessening of competition in the market for blue Stilton in the UK. Although the OFT accepted that Millway had been struggling financially, it did not consider that it was necessarily "a spent force". However, the Competition Commission comprehensively overturned the OFT's decision and concluded that Millway was not economically viable as a stand alone business and would inevitably have been closed by Dairy Crest plc absent the merger.
Long Clawson is a farmer-owned cooperative producing blue Stilton, white Stilton and blended cheese. Dairy Crest plc is one of the UK’s largest producers of chilled dairy foods.
Failing firm defence
Although the Millway business retained a significant market share for blue Stilton in the UK, it had been loss making for many years and had recently lost a number of its most significant customers. Long Clawson, therefore, argued that absent the merger Dairy Crest would have closed the business in the very near future and that the failing firm defence applied.
Essentially, the failing firm defence applies where a business will exit the market if the merger does not go ahead and that any consequent loss of competition is, therefore, attributable to the anticipated failure of the target business rather than to the merger itself. Both the OFT and the Competition Commission have previously made it clear that they will only clear a transaction based on the "failing firm defence" where the following conditions are met:
- it is inevitable that the target business will exit the market in the near future; and
- there is no serious prospect of the target business being reorganised; and
- there is no realistic and "substantially less anti-competitive" alternative to the merger.
Although the OFT has applied the failing firm defence in four previous cases, it has been very reluctant to do so without "sufficient and compelling evidence". To date, the only circumstances in which it has accepted this defence have been: (i) the disposal of individual loss making DIY and grocery stores; (ii) a freight business being forced to cease trading due to financial irregularities; and (iii) a loss making bus operator exiting the market due to the ill health of its proprietor.
This is the first case where the Competition Commission has accepted a failing firm defence since changes were made to the UK merger control regime in 2003. The decision, therefore, provides helpful guidance for both merging parties and the OFT on what constitutes "sufficient and compelling evidence" that a firm is "failing".
In the present case, the failing firm (Millway) was a loss making subsidiary of a profitable parent company (Dairy Crest plc). The Competition Commission noted that, in such cases, it applies more stringent evidentiary standards to establish whether a firm is indeed failing (taking into account intra-group transfers and the value of the target business to the wider group). In reaching its conclusion that Millway was a failing firm, the Competition Commission took into account the following factors:
- Millway had been loss-making for many years and had been dependent on the support of its parent company. This was confirmed by the Monitoring Trustee's report which found that Millway was not a viable standalone business and would be unable to meet its financial obligations without the support of its parent company
- more recently, it had lost many of its most significant customers, principally due to recurring problems with the quality and consistency of its product. Following discussions with these customers, the Competition Commission therefore concluded that Millway had little prospect of recovering this lost volume
- evidence from Dairy Crest, that although it had invested significantly in the business, it had been unable to make the business profitable. Dairy Crest had, therefore, decided to close the business and focus on its core branded dairy products
- although there were likely to have been some other companies which, in principle, might have been interested in acquiring Millway it was unlikely that, having undertaken due diligence, any of them would have completed the acquisition.
Although the Competition Commission found that there was likely to be some loss of competition as a result of the merger, as Long Clawson would be acquiring all of Millway's remaining customers, it was likely to acquire a substantial proportion of them absent the merger. The loss of competition was not substantial compared with the situation in the absence of the merger.
In December last year, the OFT issued a restatement of its position regarding the acquisition of "failing firms" confirming, inter alia, that they will provide informal advice on whether the relevant conditions are met. Taken together with the Competition Commission's decision in this case, these provide helpful clarification of the procedural and evidentiary requirements for a "failing firm defence". In the current economic climate, where a number of clients may be considering the acquisition of distressed companies or assets, this is particularly welcome.
Both the OFT and the Competition Commission are at pains to emphasise that they have not relaxed the evidentiary requirements for a "failing firm defence" as a result of the current economic downturn. However, prevailing economic conditions may now mean it is easier to demonstrate that exit is inevitable (e.g. due to cash flow or inability to raise capital) or that there are no realistic alternative purchasers (e.g. due to the difficulty of raising finance).
With regard to buyer power, the Competition Commission has in previous cases stated that the larger multiple retailers are likely to have countervailing buyer power. In the present case, the Competition Commission concluded that multiple retailers were likely to have some bargaining power in their negotiations with the suppliers of blue Stilton, but did not conclude to what extent this power could be relied on to constrain the behaviour of the producers of blue Stilton. However, as the Competition Commission noted that its findings in this and other areas were not critical to its decision, it is unclear how much weight should be given to this view.
The Competition Commission recognised the need to reach a swift decision in such failing firm cases and significantly shortened the usual reference period from a maximum of 24 weeks to only 14 weeks (and published its provisional findings after only 10 weeks) – the shortest reference since changes were made to the UK merger control regime in 2003.
As well as acting for Long Clawson in the present case, we also acted in one of the other four OFT failing firm cases referred to above.
For further details on this case please contact Laura Claydon or Andrew Borer. For further information on how we can assist you with business acquisitions please contact Camilla Usher-Clark.