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By Liz Crampton
The question of whether companies can cite dismal financials as a reason to pursue last-ditch mergers could soon get addressed by a federal judge in Delaware ( United States of America v. Energy Solutions, Inc. et al , D. Del., No. 1:16-cv-01056-SLR, filed 11/16/16 ).
This challenging legal argument, the “failing firm” defense, was a core issue in the April trial in which the Justice Department challenged a merger between competing nuclear waste disposal businesses. The future viability of this defense could be determined with this case, which involves on firm that is on the verge of shutting down.
“Absolutely central to Judge [Sue] Robinson’s opinion will be a decision on the failing firm,” Van Beckwith, a partner at Baker Botts and lead counsel for one of the merging parties, Waste Control Specialists LLC, told Bloomberg BNA. “I don’t think there’s any doubt about it.”
Beckwith argued in court that his client will “exit the market” if its merger with EnergySolutions Inc. isn’t approved, leaving just one firm.
The court’s decision will give clarity to merging companies seeking antitrust approval who that say financial ruin is inevitable for one of them without a deal. A decision from U.S. District Court of Delaware Judge Sue Robinson is expected by the end of June, ahead of the companies’ mid-July walk-away date in their merger agreement.
Robinson has presided over 10 other antitrust cases, according to Bloomberg Law’s Litigation Analytics, and four of them have been reversed by the U.S. Court of Appeals for the Third Circuit. None of them involved the failing firm defense.
The stakes are high in this case because there’s little law on the books about the failing firm defense, so any ruling on the merits of the argument is significant.
The defense has its roots in a case involving two competing newspapers in Arizona that was decided nearly 50 years ago. The DOJ sued to unravel a joint venture between the Star and the Citizen in Tucson, saying the arrangement substantially lessened competition.
That case made its way to the U.S. Supreme Court, which sided with the government in a decision that forms the backbone of the DOJ and Federal Trade Commission’s current merger guidelines regarding failing firms. Antitrust officials rely on the guidelines as a framework for enforcing antitrust law.
Under the guidelines, a failing firm defense applies only when a company can prove three things — it’s unable to meet its financial obligations, it can’t reorganize after filing for bankruptcy, and it has made good-faith efforts to find alternative buyers that pose less of a risk to competition. The third requirement is considered the most difficult to meet.
Unless disclosed by the companies, it’s impossible to know how often merging parties make failing firm arguments to antitrust officials because merger investigations are shielded by the Hart-Scott-Rodino Act. Observers got some insight into regulators’ thinking last year, when the FTC allowed a health care system in Minnesota to buy a physicians group because it was a failing business.
CentraCare Health, a nonprofit system that owns a physician group, faced agency resistance over its plan to merge with St. Cloud Medical Group, a physician-owned practice group. The FTC conceded that St. Cloud Medical Group was failing financially and needed the merger with CentraCare Health to stay in business.
At the time, FTC Commissioner Maureen Ohlhausen, now acting chairman of the agency, didn’t believe that St. Cloud met the “stringent failing firm criteria.” Ohlhausen ultimately voted in favor of approving the merger with a condition that CentraCare release some physicians from non-compete agreements. She wrote a separate concurring opinion expressing her reservations.
In testimony throughout the two-week trial in Delaware, Waste Control Specialists provided a “mountain of evidence” that it’s in bleak financial shape and met all three prongs of the failing firm defense, company lawyer Beckwith said in a closing statement.
Plagued by declining revenues, the company said it lost close to $237 million since 2009. Waste Control Specialists’ approximately 160 employees at the facility in Andrews, Texas are at risk of losing their jobs, Beckwith said.
For years the company has sought buyers, but EnergySolutions was the only one to make an offer, Beckwith said, according to a transcript of the closing arguments. “So where are the offers? Where are they? They don’t exist,” he told the judge. “No one, no one except the fully integrated Waste Management Company wants this landfill.”
Waste Control Specialists’ parent company, Valhi, considers its subsidiary a “cash drain” and “money pit”. Valhi has been pouring money into the company to make up for its losses, and its stock has suffered as a result, he said.
“When you have a drain on a business, the best economic incentive sometime is to plug the drain,” Beckwith said. “We will exit the market.”
Antitrust officials don’t easily accept failing firm arguments as justification for close competitors merging. That was made clear in the trial by DOJ attorney Julie Elmer.
In a closing statement, Elmer said the companies failing firm defense was a “sham litigation strategy” and Waste Control Specialists failed to prove it’s at risk of imminent failure. She said it didn’t meet the “high burden of proof” a failing firm argument requires, partly because the company didn’t make a good-faith effort to elicit reasonable alternative offers.
The DOJ and defense clashed over what constitutes a reasonable alternative offer. Citing the legal standard, the Justice Department said it should be an offer just above liquidation value, which is the highest value that the assets could command for use outside of the relevant market. Witnesses testified that liquidation value would be a negative number because there is no alternative use for Waste Control Specialist’s facilities, and there are large costs to closing down the facility.
“The notion that WCS’s owners are left to either sell these assets to EnergySolutions for $367 million or to bring in the concrete trucks and forever entomb these assets is not only economically irrational but also implausible,” Elmer said, according to the transcript. “This is a made-for-litigation fairy tale, and the law is clear that behavior undertaken to improve a party’s litigating position are to be viewed with deep skepticism.”
To contact the reporter on this story: Liz Crampton in Washington at email@example.com
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Bloomberg Law subscribers can access Litigation Analytics at http://src.bna.com/pHs
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