Bankruptcy and Antitrust Law What You Dont Know Can Hurt You
Frequently, bankruptcy practitioners view the bankruptcy laws as a sort of trump card that nullifies other requirements in the law. Generally, once a firm files for bankruptcy, other proceedings are stayed or consolidated in the bankruptcy court, and the court and the debtors-in-possession (DIPs) have substantial power to control what happens next. The antitrust laws, however, do not take a back seat to the bankruptcy laws, and a basic knowledge of how the antitrust laws could affect a bankruptcy can be essential to avoiding pitfalls.
Antitrust laws and bankruptcy laws have different goals. Generally, the antitrust laws seek to encourage competition, eliminate monopolies and guard against transactions that create market power. The antitrust laws generally are not concerned with competitors and accept that some competitors may be unable to compete successfully. The bankruptcy laws, on the other hand, seek to maximize the value of the bankruptcy estate and to return the assets of the bankrupt entity to the marketplace as quickly as possible, regardless of its effect on competition.
There are two predominant areas where these different goals may intersect. First, to the extent a debtor or the bankruptcy estate seeks to sell all or part of the assets subject to the bankruptcy, the antitrust laws may require a premerger review by the U.S. government to determine if there are any anti-competitive effects possible from the bankruptcy sale. Second, creditors or other participants in bankruptcy proceedings may violate the antitrust laws by acting anti-competitively. Each will be discussed in turn.
The Antitrust Laws Affect the Distribution of Assets Out of a Bankruptcy Estate
Section 7 of the Clayton Act, 15 U.S.C. §18, is the principal statute applied to the analysis of mergers and acquisitions by the U.S. government. It prohibits mergers and other acquisitions of "stock or other share capital...or part of the assets of another person...where...the effect of such acquisition may be substantially to lessen competition or tend to create a monopoly." 15 U.S.C. §18. The Department of Justice, Antitrust Division (DOJ) and the Federal Trade Commission (FTC) primarily are responsible for reviewing mergers and other transactions.
The Hart-Scott-Rodino Antitrust Improvements Act, 18 U.S.C. §18a (HSR), requires pre-merger filing for all transactions that meet certain threshold criteria. For qualifying mergers or other purchases of assets or voting securities, the federal agencies review the proposed transaction before it is closed to determine whether it poses an anticompetitive risk. The agencies then have the opportunity to seek an injunction to block the transaction. This pre-closing review eliminates the problem of "unscrambling the eggs" post-consummation.
Under HSR, where, as a result of the transaction, the acquiring person will hold a total amount of voting securities or assets of the acquired person with a value in excess of $50 million, the purchaser of voting securities or assets and the selling entity must both file notification of the proposed transaction with the FTC and the DOJ and wait certain specified periods before consummating the transaction. For a bankruptcy sale, once both parties file the Pre-merger Notification Form describing the transactions they must wait up to 15 days before closing the deal. This waiting period can be extended or shortened by the government. Persons who fail to file or wait as required by HSR are liable for a maximum penalty of $11,000 for each day the violation continues. The acquiring party is also required to pay a filing fee ranging from $45,000 to $280,000, depending on the value of the transaction.
Even just this step, the filing itself, clearly affects the goals of the bankruptcy laws. Not only is there a mandatory waiting period that acts to slow the transfer of assets from the bankruptcy estate, but even if the government ultimately approves the transaction, the cost to the purchaser will be increased by up to $280,000 plus transaction expenses, money that otherwise might have gone to the bankruptcy estate.
After the filing, the government will evaluate the proposed transaction for any potential anti-competitive effects. If the government decides that it needs to review the transaction in detail, it has the ability to extend the 15-day waiting period by issuing what is known as a Second Request. Second Requests often impose a substantial burden on the parties to a proposed transaction, including, typically, extensive interrogatories, document requests and depositions of the parties' most knowledgeable personnel. Responding to a Second Request often takes six months or more to complete and can cost millions. Again, even if the government ultimately concludes that the transaction would not tend to substantially lessen competition, mere compliance with a Second Request is not consistent with bankruptcy's goals of maximizing the value of the bankruptcy estate and quickly returning the assets to the marketplace.
In the initial filing with the government, the parties have to include internal documents discussing the transaction and related-to market shares, competition, competitors, markets, potential for sales growth, or expansion into product or geographic markets. Frequently, these documents are the triggers for additional investigation by the government. Therefore, parties should draft these documents with care. Specifically, in creating documents, care should be taken not to use words suggesting expectations of competitive advantage to be gained from the transaction, and the parties should describe the pro-competitive business reasons for the transaction.
Finally, at the end of this process, the government may challenge the deal as harmful to competition. In doing so, it can seek a preliminary injunction to stop the parties from closing the transaction. Generally, the agencies can bring the action in any court where the parties are subject to jurisdiction and frequently bring suit in Washington, D.C. For a bankruptcy transaction, however, there is some case law that suggests that any action brought by the government must be brought in the bankruptcy court before the presiding bankruptcy judge. In re Financial News Network Inc., 126 B.R. 157 (S.D.N.Y. 1991). This requirement is not widely enforced, and additional development of this aspect of the law is likely.
When reviewing horizontal mergers, the DOJ and FTC use the Horizontal Merger Guidelines as a basic framework. The Merger Guidelines describe the general approach the agencies take to evaluate whether a particular horizontal merger is likely to lessen competition. In addition to setting out the basic framework for merger analysis, the Guidelines also provide a description of the defenses that can counter a finding that the transaction would be anticompetitive. Specifically relevant to bankruptcy is the "failing firm" defense.
The Merger Guidelines apply this defense if there likely will be "imminent failure." This is beyond mere bankruptcy: "Imminent failure" is defined by the Merger Guidelines as (1) the failing firm would be unable to meets its financial obligations in the near future; (2) the failing firm would be unable to reorganize successfully under chapter 11 of the Bankruptcy Act; (3) the seller made unsuccessful, good-faith efforts to elicit alternative offers of acquisition of the assets that would keep both its tangible and intangible assets in the relevant market and pose a less severe danger to competition than the proposed merger; and (4) absent the acquisition, the assets of the failing firm would not be part of the relevant market. Each of these conditions must be met in order for the firms to prove the failing firm defense successfully. Although many companies seek to use the failing firm defense to justify otherwise anticompetitive mergers, rarely is it successful, even in a bankruptcy.
Firms that are struggling, but not in imminent danger of failing, cannot successfully use the failing-firm defense when merging. However, their financial condition may affect their future competitive significance in the marketplace and be relevant to the merger analysis (referred to as a "flailing" firm). Thus, there may be ongoing changes in the market suggesting that the current market share of one of the merging firms overstates its future competitive significance and overstates the merger's potential competitive concerns. Like the failing-firm defense, the government will not necessarily agree that the flailing-firm defense applies to transactions where one party is in bankruptcy. Obviously, where one party is bankrupt, these defenses are more likely to be available.
Frequently, when the government opposes a transaction, the parties will abandon it rather than fight the government's injunction action. Indeed, in the 10-year period from 1982-91, 46 bankruptcy transactions were abandoned in the face of the government's opposition. Because the initial purchaser likely was the high bidder for the bankrupt's assets, an abandonment of the transaction generally will result in a smaller purchase price and, thus, a reduced value to the bankruptcy estate.
Two recent high-profile bankruptcy matters illustrate the various outcomes when the government indicates that it intends to challenge a transaction arising in a bankruptcy. The first is the intended purchase of assets by SGL Carbon from the Carbide/Graphite Group. In 2003, the Carbide/Graphite Group filed a chapter 11 proceeding. The debtor proceeded to sell off various assets. SGL, which competed with Carbide/Graphite, sought to purchase those assets that were used by Carbide/Graphite to compete with SGL. After an HSR notification and government investigation, the DOJ sued to enjoin the transaction. In the face of the lawsuit, SGL abandoned the transaction. Ultimately, the assets were sold for about $800,000 less than SGL offered ($6.23 million vs. $7 million).
A second example is the purchase of all the assets of Comdisco out of bankruptcy by Sungard. The bankruptcy court held an auction of these assets, which Sungard won, offering $825 million. Again, after an HSR notification and government investigation, the DOJ sued to enjoin the transaction. This time, however, instead of abandoning the transaction, Sungard chose to fight it. In doing so, it forced the DOJ into extremely rapid litigation. All discovery was completed within two weeks. The court then held a 10-hour evidentiary hearing with oral arguments the following day. Within five days, the court issued its opinion, which found that the transaction did not violate the antitrust laws and allowed Sungard to complete the transaction. Not only was this a win for Sungard, but the bankruptcy estate benefited greatly as well. Hewlett-Packard's bid, which was the alternative had Sungard been enjoined, was for $610 million; a victory for the government would have cost the bankruptcy estate $215 million.
Anticompetitive Conduct by Participants in the Bankruptcy Proceeding May Give Rise to Antitrust Liability
A second antirust statute likewise may have applicability for entities involved in a bankruptcy. Section 1 of the Sherman Act, 15 U.S.C. §1, prohibits agreements or understandings between two or more firms that unreasonably restrain trade (price fixing, market division, customer allocation, etc.), while Section 2, 15 U.S.C. §2, prohibits monopolization, attempted monopolization and conspiracies to monopolize.
Under Section 1, the greatest risk of an antitrust violation occurs when competitors discuss price. Setting price among competitors is per se illegal and can result in criminal prosecution and jail time. Importantly for bankruptcy practitioners, credit terms are considered a component of price, and agreements regarding credit terms among competitors have been viewed as price fixing. Catalano Inc. v. Target Sales Inc., 446 U.S. 643 (1980).
Because agreements regarding credit can be considered price fixing, the members of a creditors' committee and committee counsel should be circumspect and vigilant in their activities. Members of the committee may be viewed as competitors, and so an agreement among such members regarding credit terms for the debtor could be alleged to be price fixing. Certainly, the antitrust laws do not restrict the creditors' committee from discussing the debtor for legitimate reasons, but care should be taken in discussions regarding actual credit terms that may be extended by creditors to the debtor, and the creditors should not agree to refuse to extend credit to the debtor, keeping in mind that it was an agreement not to extend credit that the Supreme Court found per se illegal in Catalano.
While subject to the antitrust laws, the creditors' committee may have some limited protection in the Noerr-Pennington doctrine, which provides antitrust immunity for the conduct of private actors in petitioning the government regardless of the potential for anti-competitive activity that is the subject of the petition. The doctrine applies to petitioning each of the three branches of government. As the Supreme Court explained:
The federal antitrust laws also do not regulate the conduct of private individuals in seeking anti-competitive action from the government. This doctrine...rests ultimately upon a recognition that the antitrust laws, "tailored as they are for the business world, are not at all appropriate for application in the political arena."City of Columbia v. Omni Outdoor Advertising Inc., 499 U.S. 365, 380 (1991). This doctrine apparently has never been applied in the context of a creditors' committee in a bankruptcy proceeding, but it likely provides some protection to the legitimate activities of the committee.
There is a sham exception to the Noerr-Pennington doctrine. In general, the sham exception applies to attempts to use the means of petitioning the government as an anticompetitive weapon, without regard to any eventual action taken by the government. City of Columbia, 499 U.S. at 380. "A 'sham' situation involves a defendant whose activities are 'not genuinely aimed at procuring favorable government action' at all, not one 'who genuinely seeks to achieve his governmental result, but does so through improper means.'" Id.
Participation on a creditors' committee also may present the opportunity for competitors of the debtor to act anticompetitively. For instance, the creditor/competitor may seek to delay the debtors' exit from bankruptcy or use the bankruptcy process to otherwise reduce the competitiveness of the debtor, either before or after exit from bankruptcy.
The FTC has taken action where companies have used their position on a creditors' committee to hurt competitors who are in bankruptcy. In re AMERCO, 109 F.T.C. 135 (1987). In this case, U-Haul/AMERCO was a legitimate member of a creditors' committee in Jartran's bankruptcy. Jartran and U-Haul both competed in the "one-way rental market," although U-Haul had dominated that market for at least 10 years.
As a member of the creditors' committee, U-Haul proposed several actions that "were inconsistent with U-Haul's legitimate interests as a creditor, and in fact were intended primarily to delay or prevent Jartran's reorganization as a competitor." Id. These actions included opposing a settlement between the purchaser of Jartran's stock and the creditors. This settlement would have increased the distribution from the bankruptcy estate to U-Haul. U-Haul sought to void the acquisition of Jartran, although the acquisition provided financial support to Jartran that "was necessary for Jartran's survival." Id. U-Haul also sought to have the reorganization plan vote resolicited and delayed confirmation of Jartran's reorganization plan.
After the FTC filed suit, U-Haul agreed to a consent decree that restricted its future ability to participate in bankruptcy proceedings. It was not allowed to participate in bankruptcy proceedings involving its competitors, and it was prohibited from initiating or participating in judicial or administrative proceeding against any competitor without prior notice to the FTC. While this case is 15 years old, the recently departed chairman of the FTC discussed it in a speech in 2002, and the issue could arise at any time if competitors are using the bankruptcy process to gain a competitive advantage.