Following an investigation on its own initiative, on 28 April 2009 the Office of Fair Trading (OFT) cleared the purchase by HMV of fifteen stores formerly owned by Zavvi on “failing firm” grounds, after Zavvi went into administration. This is the most recent example of a small number of cases which the OFT has cleared on the basis of the “failing firm” defence.
Both HMV and Zavvi were significant retailers and competitors in the UK entertainment products industry. Zavvi experienced significant supply and cash flow difficulties when its sole supplier of stock went into administration in November 2008. Zavvi could not meet its rent responsibilities and faced a working capital crisis. An emergency restructuring of the business was not successful and Zavvi entered into administration on 24 December 2008. HMV took over fifteen former Zavvi stores in various locations in three separate tranches between January and March 2009.
The “failing firm” defence
Under the Enterprise Act 2002 (the Act), the OFT has a duty to refer a merger to the Competition Commission (CC) which satisfies the relevant jurisdictional thresholds and which has resulted or may be expected to result in a substantial lessening of competition. In December 2008, the OFT published a restatement of the approach it would take in relation to acquisitions of “failing firms”. In such a case, if the target business would have failed in any case, the merger cannot be regarded as the cause of any substantial lessening of competition. There are two conditions which must be met and supported by sufficiently compelling evidence if a company wishes to benefit from the “failing firm” defence:
Without the merger, the target business would in the near future have inevitably exited the market and there is no serious prospect of re-organisation or restructure.
There must be no realistic and less anti-competitive alternative to the merger, i.e. there is no other realistic purchaser whose acquisition of the target would produce a substantially better outcome in competition terms and it would not be better for competition if the target’s business were to fail.
The OFT’s assessment
The OFT found no competition concerns at a national level but at a local level there were overlaps with existing HMV stores for seven of the fifteen Zavvi stores. The OFT did not require an in depth analysis to be carried out in relation to these stores due to clear evidence indicating that the failing firm defence might apply.
In relation to the first part of the test, the OFT considered the consistent losses which Zavvi had made over previous years, as well as the level of investment required to turn the business around and current market conditions. The OFT and the administrator were therefore of the opinion that salvaging the company as a going concern was not realistic. In addition, at the time of the first purchases by HMV the administrator had already closed 72 Zavvi stores. The OFT was therefore satisfied that the first stage of the test was met, and that the fifteen stores which HMV wished to acquire would have inevitably exited the market in the near future.
As control of the Zavvi stores lay partly with the store landlords, when assessing the “realistic purchaser” test the OFT had to consider whether any potential purchasers could have been acceptable to the relevant landlord. In relation to three of the overlap stores, aside from HMV there was no market interest. Offers made by a competitor for four other potential stores were all rejected by the respective landlords. They also confirmed that the offers would have been rejected without HMV’s offer in any event. The OFT therefore held that the other party failed to meet the “realistic purchaser” test. In addition, the OFT concluded that the closure of the overlapping stores would not have been a substantially better outcome for competition than the acquisition. The second part of the test was therefore also met.
The OFT was satisfied that it had seen “compelling evidence” that without the merger the stores would have inevitably exited the market and that there was no less anti-competitive alternative to the merger. In addition, it did not receive any objections to the merger from third parties. The OFT therefore did not believe that the merger would create a realistic prospect of a substantial lessening of competition; a reference to the CC for an in depth investigation was consequently not necessary.
This is only the fifth merger case under the Act which the OFT has cleared on the basis of the “failing firm” defence. It is also the first case to be approved on that basis since the OFT’s restatement of its position in December 2008, and provides further clarity as to the approach which the OFT will take in assessing such cases.
Competition authorities are anticipating a potential increase in the use of “failing firm” arguments in light of the current economic climate. However the OFT, amongst others, is keen to stress that the current situation will not result in any relaxation of the strict criteria. John Fingleton, Chief Executive of the OFT, has said that the OFT “will continue to scrutinise such claims carefully to ensure competition is protected”.
Although there does not yet appear to have been a large increase in “failing firm” arguments, it seems likely that such arguments will arise more often in the near future. Parties wishing to pursue a “failing firm” defence should note the OFT’s view, demonstrated in this case, that an in depth analysis may not be needed where clear evidence to support such a claim is put forward sufficiently early in the process. The OFT has also confirmed that informal advice concerning the application of the “failing firm” defence is available in appropriate cases.
OFT decision, 28 April 2009