The CMA has recently cleared two mergers on the basis of the failing firm defence, Tate & Lyle/Tereos and Eurofins/Cellmark, the latter in reportedly as few as 11 working days from initial engagement.

In this article we consider the extent to which these cases mark a change in approach from the CMA towards the failing firm defence, or whether the timing of these cases is a simple coincidence.

The failing or exiting firm defence is often talked about, sometimes deployed, but rarely successful in practice. Nevertheless, it can offer a complete answer to any competition law concerns that arise in the context of a merger review. That is to say, when accepted, the failing firm defence enables parties to obtain clearance for transactions that would otherwise be expected to give rise to a substantial lessening of competition.

The CMA has recently approved both Tate & Lyle/Tereos¹ and Eurofins/Cellmark² on the basis of a failing firm counterfactual. This article explores the extent to which these cases might be read to suggest a softening of the CMA’s historically uncompromising approach to the failing firm defence. 

Background

A fundamental building block of a competition authority’s review of a proposed merger is the identification of the relevant counterfactual. As a general rule, the starting point is the maintenance of the status quo. However, where there is evidence to suggest that an alternative counterfactual would prevail absent the merger, either because one of the firms is expecting to become either materially stronger or weaker, competition authorities can consider an alternative counterfactual.

The core of the failing firm argument is the proposition that the “correct” counterfactual shows that, absent the merger, one of the parties (usually the target) will exit the market entirely – ceasing to exercise any competitive constraint on the other. Consequently, the merger is not capable of giving rise to a loss of competition (as in the counterfactual there would be no competition between the merging parties) and, as such, should be cleared unconditionally.

In assessing such arguments, competition authorities – including the UK Competition and Markets Authority (CMA) – focus primarily on a cumulative two-limbed test:

1. there must be evidence that, absent the transaction, the firm would exit the market; and
2. there must be no alternative less anti-competitive purchaser for the exiting firm or its assets.

To successfully employ a failing firm defence, both tests must be satisfied. The CMA has generally required significant evidence both of severe financial distress/lack of available restructuring options (e.g. evidence that administrators are being or are on the verge of appointment), and that there have been constructive attempts (e.g. through arranging an auction process) to identify alternative purchasers. 

Tate & Lyle Sugars/Tereos

This case concerned the acquisition by Tate & Lyle of Tereos’ UK B2C sugar supply business (Tereos UK).  Tate & Lyle and Tereos were two of only three commercial scale sugar suppliers active in the UK (the third being British Sugar). In the first instance the parties submitted that, absent the merger, Tereos – a global sugar cooperative with revenues in excess of €7bn – would have exited the UK B2C market as it was a market Tereos viewed as loss making.

In its Phase 1 decision, the CMA concluded that the merger had the potential to give rise to a substantial lessening of competition and, at that stage, found insufficient evidence to conclude that the failing firm defence had been made out to the requisite standard.

Following further investigation, the CMA’s Phase 2 final report considered each of the two limbs in detail and ultimately concluded that the failing firm test was satisfied.  The CMA’s approach raised a number of interesting considerations, which we discuss further below. 

Market exit

First, and as addressed above, Tereos UK is a subsidiary of a well-resourced, global market participant. At no point was it suggested that the Tereos group was financially incapable of continuing to operate its UK business. Therefore, instead of considering the potential exit of Tereos UK from a purely financial perspective, the CMA considered the broader picture, taking into account the economic drivers of Tereos UK’s parent company’s decision to exit the market. 

In taking this approach, the CMA sought to identify the strategic purpose for Tereos’ UK operations. It was submitted that: 1) Tereos UK (which does not produce sugar in the UK) was originally acquired as an outlet for Tereos’ excess production of sugar from its Continental European facilities, and 2) Tereos now had more profitable alternatives for its excess sugar than supplying it in the UK .

Second, in assessing whether Tereos UK would exit the market, the CMA considered the extent to which that strategic purpose had been fulfilled, finding that:

• between FY17/18 and FY21/22, Tereos UK had been loss making in absolute terms (after taking into account its transfer price for the purchase of bulk sugar from Tereos’ Continental European facilities); 
• in FY22/23 and 23/24, whilst Tereos UK had recorded a modest profit, that profit was less than the profits that would have been earned by Tereos had it chosen to sell that sugar elsewhere.  Therefore, after taking into account the opportunity cost, from an economic perspective Tereos UK had been loss making since at least 2017; and
• Tereos UK’s volumes were comparatively small in the context of Tereos group, such that it would not be difficult for Tereos to divert the volumes it had sold in the UK to other profitable channels in Europe and/or other export markets. Accordingly, the closure of Tereos UK would not be expected to lead to Tereos having excess sugar that it could not profitably sell.

The CMA concluded that Tereos UK had consistently failed to meet its strategic purpose within Tereos’ global business. The CMA further identified a number of attempts by Tereos UK to improve its profitability (e.g. from implementing cost cutting measures, to seeking to sustain higher prices) but found that all of these were ultimately unsuccessful in realising the desired profitability.

Therefore, whilst the CMA did not find that Tereos had made a definitive decision to exit the UK market absent a divestiture, or that no alternative profitability plans could have been considered, it found that, on balance, the “most likely scenario is that Tereos would have closed (Tereos UK) (and therefore exited the UK B2C channel) absent the merger”.  As such, the CMA considered the first limb of the failing firm test to be satisfied. This finding is a marked departure from the CMA’s findings in Chemring/ Wallop, which rejected the parties’ failing firm argument in circumstances where the parent was capable of providing financial support to the purportedly exiting firm.

No alternative less anti-competitive purchaser

In considering the possibility of an alternative purchaser, the CMA examined whether another purchaser had been willing to buy Tereos UK at a price above its liquidation value. The CMA stressed that it was not simply a question of whether there would be a bidder “at any price”.

Tereos had undertaken a targeted sale process, which identified a number of potential bidders. The CMA engaged with the bidders that had shown an interest in acquiring Tereos UK, to determine the basis of their actual/potential bids and the viability of those bids in practice. 

Several bidders who had made or been willing to make offers for Tereos UK were identified. However, the CMA determined that it would have been difficult, if not impossible, for any such offers to lead to a commercially viable transaction. In each case, the (prospective) bid was conditional upon Tereos entering into a wholesale sugar supply arrangement with Tereos UK post-transaction. Without this post-transaction arrangement, the bidders did not consider the business to be a viable and/or attractive target. Rather problematically, such a supply arrangement would have defeated Tereos’ strategic rationale for the transaction, namely to cease the supply of sugar to Tereos UK and allow Tereos to redirect capacity to more profitable markets.

The CMA therefore concluded that it was unlikely that a sustainable deal could have been agreed between Tereos and any other potential purchaser, such that the second limb of the failing firm test was also satisfied.

Eurofins/Cellmark

Eurofins and Cellmark are two of the main providers of forensic science services. Their services are often used to supplement the capabilities of the police authorities, particularly for more specialist forms of testing which are not economical to operate in-house. 

Whilst the Eurofins/Cellmark case was not surprising in terms of its application of the failing firm defence, it is a notable example of the CMA reviewing a case on an expedited basis – taking only 11 working days to issue its clearance decision. Whilst unlikely to set a precedent for future cases, the CMA’s willingness to expedite its review, to ensure Cellmark’s viability and continued ability to provide key services relied upon by police forces, is encouraging.  Given the nature of the transaction and the risk of harm to Cellmark’s law enforcement customers (and, by extension, the criminal justice system), we anticipate the CMA will have engaged quickly with relevant stakeholders to enable it to reach an expedited decision and mitigate any disruption to the provision of forensic services to UK police forces. 

Market exit

Before considering Cellmark’s position, the CMA first recognised that the supply of forensic services to police forces and governments was an industry facing significant financial difficulty – a fact recognised in a 2019 House of Lords report. The CMA further noted that the industry was characterised by low margins and reduced volumes following the COVID-19 pandemic.

The CMA identified a trend of increasing financial difficulty for Cellmark starting in 2017 that escalated to the company recording losses in 2022 and 2023. These losses prompted Cellmark to focus on increasing cashflow and profitability in order to meet creditor arrears and satisfy ongoing supplier commitments. However, having reviewed these goals against Cellmark’s budget and financial forecasts, the CMA considered them to be unrealistic. 

The CMA also recognised that Cellmark’s increasingly difficult relationship with its suppliers impacted its ability to deliver services to customers and generate revenue. Cellmark was often unable to maintain sufficient stock of certain inputs, leading to a backlog in delivery of its services. This meant that Cellmark was required to outsource certain work or redirect its customers to alternative laboratories, both of which exacerbated its financial difficulties.

Finally, the CMA took the view that there were no viable refinancing options available to Cellmark, which had already taken steps to seek to restructure its business in order to reduce costs.

For these reasons, the CMA concluded that it was inevitable that Cellmark would be unable to meet its financial obligations and would therefore exit the market. 

No less anti-competitive purchaser

Unlike the facts of Tate & Lyle/Tereos, the sellers had not undertaken a formal auction process for Cellmark. Rather, from 2021 to 2023, the sellers had tentatively engaged with potential purchasers but failed to originate a viable transaction. 

The CMA considered that there was only a small pool of potential purchasers for Cellmark, given the structural challenges facing the industry and Cellmark’s poor financial position. The potential purchasers were companies that were, to some extent, already active in forensic services or those with related activities.

The CMA considered two potential purchasers with which Cellmark had engaged, but ultimately concluded that neither was a suitable purchaser, albeit for different reasons:

• the first because it had shown no interest in and made no bid for Cellmark; and
• the second because, even if its interest was more than speculative, the transaction was not clearly less anti-competitive than an acquisition by Eurofins. The CMA considered it could give rise to a realistic prospect of a substantial lessening of competition in its own right, and therefore was not a viable counterfactual.

The CMA did not consider any other potential purchaser in great detail, including purchasers that might have been interested in acquiring Cellmark following a pre-pack administration. The CMA also recognised that if Cellmark were to enter administration, it would risk losing accreditation and therefore its ability to provide service to UK police forces, which would materially change the scope of its operations.

For these reasons, the CMA accepted the parties’ failing firm argument and cleared the transaction in Phase 1 on an expedited basis.

Conclusions

It is tempting to view two successful failing firm defences in quick succession as evidence of a sea change in the CMA’s approach. However, caution must be exercised in drawing any conclusions. In contrast with the above cases, in the Phase 2 Provisional Findings in Spreadex/Sporting Index⁴ the CMA provisionally found that it was not persuaded that there was no less anti-competitive purchaser, and therefore provisionally rejected the failing firm defence.

That said, the CMA’s approach in Tate & Lyle/Tereos and Eurofins/Cellmark suggests a degree of pragmatism, looking to the commercial reality of the situation. This is particularly so in Tate & Lyle/ Tereos, with the CMA accepting that Tereos’ decision to sell Tereos UK reflected its broader group strategy. It is, therefore, encouraging to see the CMA accepting a failing firm defence in a case where it might instead have fallen back on the argument that a large corporate group would tolerate underperformance and the opportunity cost of continuing to support an unprofitable subsidiary, as it did in Chemring/Wallop³.

Eurofins/Cellmark could be seen an exceptional case given the importance of the target’s activities to UK policing and the potential impact on the public purse. Although the outcome is a positive sign for businesses, as also is the speed at which the CMA reviewed the case, the factors underlying the decision are perhaps only of limited application.

In sum, whilst by no means do these cases suggest any major shift in policy on the CMA’s part, they are at least suggestive of a more pragmatic approach from the CMA to the application of the failing firm test.

¹Tate & Lyle/Tereos ME/7074/23

²Eurofins/Cellmark ME/7098/24

³Chemring/Wallop ME/6523/15

⁴ Spreadex/Sporting Index ME/7085/23