Distress signals – Cooperation agreements or mergers to the rescue in times of crisis?

Are cooperation agreements or cartels permitted territory when economic turmoil hits?

It is conceivable that, in a recession, businesses might seek to cooperate with their competitors to soften the blow and prevent potential losses. Significant pressure on profit margins can weaken the resolve to avoid cartel behaviour. Given the stringent stance of competition authorities on such conduct in the past, businesses should exercise caution. In the EU, companies must self-assess whether a cooperation agreement complies with the competition rules and decide whether to refrain because of the risk of substantial fines and possible private damages actions.

During the COVID-19 pandemic, the European Commission (EC) showed leniency by offering comfort letters to confirm that planned cooperations were permissible due to the public health crisis. However, this should not be interpreted as a green light to form “crisis cartels” to reduce capacity or fix prices in response to falling demand to survive an economic downturn. The leading case in this regard is the so-called Irish beef case (Case C-209/07). The beef sector was highly subsidised and faced considerable overcapacity and loss of profitability. Supported by the Irish government, the Beef Industry Development Society (BIDS) was established to implement a capacity reduction strategy. The Irish Competition Authority found the agreements contrary to the domestic provisions mirroring Article 101 TFEU and commenced proceedings. The ECJ delivered a preliminary ruling, finding that the BIDS accords were restrictions by object under Article 101 TFEU and were unlikely to fulfill the conditions for an exemption under Article 101 (3) TFEU. The ECJ dismissed the argument that the agreement would enhance efficiencies by removing overcapacity as irrelevant to whether the agreement had an anti-competitive object.

Contrary to the economic situation leading to crisis cartels, high surging prices, increased volatility and supply shortages might also induce firms to form illegal cartels to maintain price levels and prevent any subsequent price declines. The OECD highlighted this link in its 2022 policy paper on competition and inflation and competition authorities will be particularly vigilant regarding such conduct, especially concerning essential consumer goods.

In the EU, there is renewed political pressure to foster European industrial champions, as emphasized in the 2024 Draghi Report, with the aim of boosting EU economic resilience and global competitiveness. It will be interesting to see whether this phenomenon will lead to a more lenient enforcement approach when competition authorities face EU companies alleged to have committed infringements, particularly in key strategic sectors (e.g. technology, pharmaceuticals, defense, those relating to decarbonization, etc.).

Inability to pay as a defence?

Despite its tough stance on crisis cartels, the EC does consider current economic conditions when assessing fines for cartel conduct. While the ECJ has consistently confirmed that the EC has discretion in setting fines, the legal framework already accounts for an undertaking’s economic capabilities by capping fines at 10% of annual global turnover. Companies might still struggle to bear this burden and could consider invoking the “inability to pay” (ITP) defence in competition procedures. However, they should not rely on the authorities’ willingness to grant such a discount as this could negatively impact deterrence. Historically, the EC has been reluctant to accept the ITP defence, and the ECJ has confirmed that there is no obligation on the EC to do so, as it would provide an “unjustified competitive advantage to undertakings least well adapted to the market conditions” (see Case C-328/05 P, para.100). The EC’s 2006 Fining Guidelines set a high bar for a reduction based on ITP, stipulating that it should only be granted if, in a specific economic and social context:

• The fine would irretrievably jeopardise the economic viability of the undertaking concerned and

• cause its assets to lose all their value.

The financial situation of an undertaking can therefore be treated as a mitigating factor, but only in exceptional cases. Invoking the ITP defence requires the submission of substantial evidence. DG Competition published a detailed questionnaire outlining the required information for an ITP request.

In the UK, the Competition and Markets Authority (CMA) can impose fines of up to a statutory maximum of 10% of worldwide turnover in the preceding business year. Similar to the EC, the CMA can reduce fines in exceptional circumstances where an undertaking is unable to pay the penalty due to its financial position (this is referred to as a ‘financial hardship claim’). However, there is a high bar – as explained in its penalties guidance, the CMA requires objective evidence that the fine would irretrievably jeopardise the undertaking’s viability (the mere finding of an adverse or loss-making financial situation is insufficient). In appropriate cases, the CMA may agree additional time for an undertaking to pay its fine.

Restructuring, insolvency, and distressed assets in mergers

To the extent that the current economic upheaval leads some businesses to struggle, other companies may take the opportunity to get a good deal on acquiring them. Companies acquiring businesses facing financial difficulties, especially those targets with significant EU or UK activities, must be prepared to navigate the stringent EU and UK merger review processes, which are particularly rigorous in relation to concentrated markets.

Both the EU and UK regimes recognise a ‘failing firm defence’ (FFD). If the requisite criteria are met, this defence allows a transaction to proceed in situations where it would otherwise likely need to be modified or prohibited.

Following the COVID-19 pandemic, there was extensive debate about whether merger rules regarding distressed assets should be relaxed. This debate was spurred by an increase in merger notifications where parties claimed that the target company was financially failing and would exit the market without the merger. In the EU, former Commission Executive Vice-President Margrethe Vestager addressed these concerns, asserting that it was unnecessary to relax the existing merger control standards (see MLex: Lewis Crofts, “Failing firms won’t get more EU leeway to plead for mergers, Vestager says”, 24 April 2020). As in cartel enforcement, the declared goal to strengthen European companies and to support European industries, for example in the defence sector, might influence the regulator’s future approach to merger reviews. The EU’s Competitiveness Compass published in January 2025, clearly stated that merger control should allow companies to “scale up in global markets”.

The failing firm defence doctrine in EU merger control

Under EU merger control, the Horizontal Merger Guidelines issued by the EC in 2004 recognise the Failing Firm Defence (FFD), which allows an otherwise problematic merger to proceed if certain requirements are met. The EC is currently revising these guidelines, which may affect the application of the FFD in the future.

The fundamental requirement is that the deterioration of the competitive structure following a merger cannot be attributed to the merger itself. This applies when the competitive structure of the market would deteriorate to at least the same extent in the absence of the merger.

The Guidelines outline three cumulative criteria relevant for the application of the FFD:

1. The allegedly failing firm would, in the near future, be forced out of the market due to financial difficulties if not taken over by another undertaking.
   
   The merging parties must demonstrate that the failing firm is likely to enter bankruptcy or similar restructuring proceedings in the near future if the merger does not occur. The prospective buyer can substantiate this by showing that the target lacks the necessary financing to remain in the market. While bankruptcy or similar proceedings need not have been initiated, the buyer must prove that, without the transaction, the target is likely to enter such proceedings. If the target is part of a larger group with sufficient resources to keep it in the market, satisfying this criterion may be challenging.
2. There is no less anti-competitive alternative purchase than the proposed merger;
   
   To satisfy this criterion, the seller must demonstrate that alternative investors were given the opportunity to negotiate the acquisition of the failing business. However, it is not necessary to show that a formal tender procedure was conducted.
3. In the absence of a merger, the assets of the failing firm would inevitably exit the market;
   
   This criterion requires the buyer to show that bankruptcy would not be less anti-competitive than the proposed transaction. The buyer must demonstrate that, because of bankruptcy or similar proceedings, the target’s production assets would not be acquired by third parties who would keep them in the market, competing with the buyer. This criterion can be the most difficult to satisfy, as the assessment is highly speculative unless the target is already in bankruptcy.
   
   Additionally, the FFD is not the only legal framework under which a transaction raising significant competition concerns can be approved due to the financial difficulties of the target. Even if the FFD test is not met, the EC must approve a transaction if, with the merger, the competitive structure would not deteriorate more than, under the most likely hypothetical scenario, absent the merger (‘the counterfactual’).
   
   The EC has approved several transactions using this logic finding, for example, that absent the merger the target’s assets would most likely exit the market, which would weaken competition much more than the concentration.

The UK CMA’s approach to acquisition of distressed assets

The CMA’s approach to the FFD is outlined in its Merger Assessment Guidelines and decisional practice. Like the EC, the CMA considers the FFD during its merger assessments.

The CMA Guidelines set out a two-part framework for assessing the exiting firm scenario, requiring the CMA to assess:

• Whether the firm would have exited (through failure or otherwise) absent the transaction;

Where a firm is exiting due to financial failure, this criterion essentially requires the buyer to show that the target cannot meet its financial obligations in the near future and cannot successfully restructure itself. The CMA will analyse cash flows over time and examine the target’s balance sheet to assess its profile of assets and liabilities. Additionally, the CMA will review management actions and may involve external legal, financial and insolvency advisers, as well as external auditors. The CMA may also request evidence from the company’s debt or equity providers.

• Whether there would have been an alternative purchaser of the firm or its assets.

The second criterion of the framework requires the buyer to demonstrate that there was no substantially less anti-competitive purchaser for the business or its assets. The CMA will examine available evidence to support claims that there was genuinely only one possible purchaser and will consider the prospect of alternative offers for the business above liquidation value. As part of its assessment, the CMA will review the marketing process through which the business was sold and determine whether other realistic prospective purchasers had sufficient opportunity to make an offer.

If the CMA considers that a more competitive realistic counterfactual or the most likely counterfactual (as applicable) would have involved an alternative purchaser, it will assess whether the effect of the merger under review would be substantially less competitive than the effect of an acquisition by the alternative purchaser. In practice, meeting the two conditions has proven extremely difficult due to the high evidentiary burden required by the CMA. In Phase 1 the parties must provide ‘compelling evidence’ that the fulfilment of the two conditions was inevitable while in Phase 2 the CMA has to determine what outcome was ‘most likely’. 

If the CMA finds that the target would not be likely to exit absent the merger, it does not follow that it may instead decide that the firm would be a weaker competitor in the counterfactual. However, if the CMA does consider that the firm will be a weaker competitor in the future it is likely to assess the strength of competition between the parties in its substantive assessment.