The Intersection of Chapter 11 and Antitrust
Acquiring or selling a business in bankruptcy is somewhat different than doing so outside of bankruptcy. We focus here on one way in which asset sale procedures differ in bankruptcy—obtaining antitrust approval. The prospect of navigating the applicable antitrust rules and procedures can be daunting even outside of bankruptcy. When the target is in (or facing) bankruptcy, it is even more complicated. To do this right, you will want an antitrust lawyer on your team, preferably one with experience in distressed and bankruptcy transactions. But it also helps for bankruptcy counsel to have some familiarity with the applicable antitrust laws and procedures.
Basic Antitrust Procedural Rules
The starting point is the Hart-Scott-Rodino Act (HSR).1 HSR procedures govern how and when parties involved in transactions of a certain size must submit information to the federal antitrust agencies.
HSR requirements and the accompanying rules in 16 C.F.R. §§801-8032 (Rules)3 apply to acquisitions of stock or assets. The federal antitrust agencies are the Federal Trade Commission (FTC) and the Department of Justice Antitrust Division (DOJ).
The regulatory scheme is "soup to nuts," beginning with the requirement that parties to a transaction notify the FTC and DOJ of a potential acquisition and then wait a prescribed amount of time while one of the agencies conducts a preliminary review.4
The process can involve phases of additional investigation requiring elongation of waiting periods, submission of additional information, and an agency challenge to the transaction. Alternatively, the process can end with the transaction being green-lighted by the agencies after preliminary review. Failure to follow HSR procedures can result in significant fines of up to $11,000 for each day that an entity is found not to be in compliance.5
HSR generally requires both parties to an acquisition to notify the FTC and DOJ when certain dollar thresholds are met:
(1) (a) One entity has sales or assets of at least $100 million; and
(b) The other entity has sales or assets of at least $10 million; and
(c) As a result of the transaction, the acquiring entity will hold an aggregate amount of stock and assets of the acquired entity valued at more than $50 million; or
(2) As a result of the transaction, the acquiring entity will hold an aggregate amount of stock and assets of the acquired entity valued at more than $200 million, regardless of the sales or assets of the acquiring and acquired persons.6
The rules governing treatment of a reportable transaction are modified if the target is in bankruptcy, as we describe below.
How HSR Procedures Do and Do Not Change When the Target Entity Is in Bankruptcy
Notification. As noted above, once the parties have determined that the transaction is reportable, HSR procedures require that both parties to the transaction submit notification of the transaction to the federal agencies.7 In cases where the target is in bankruptcy, §363(b) specifies who should submit the notification on behalf of the acquired entity—either the trustee or, where no trustee has been appointed, the debtor-in-possession (DIP).8
Filing notification requires submission of a notification form9 and, in most cases, an accompanying affidavit and certification concerning the outlines of the transaction and the parties' intentions.10 These requirements are designed to ensure that the parties are sufficiently committed to the transaction such that the agencies do not waste resources reviewing hypothetical deals. The affidavit should describe the assets to be acquired and should reflect that the parties have a good-faith intention to proceed with the transaction.11 Outside the bankruptcy context, parties are required to attest to the existence of an executed letter of intent or contract; however, this requirement is waived when the sale will have to be approved by the bankruptcy court and where there may be several potential buyers that will bid on the acquired entity. It is helpful to the agencies if the notifying party attaches any order from the bankruptcy court that addresses the procedures to be followed in the sale of the target entity.
Initial Waiting Period. Where the target entity is in bankruptcy, the normal 30-day waiting period before a transaction may be consummated is shortened to 15 days.12 The truncated waiting period ensures that the agencies' assessment of a transaction will be done quickly to facilitate the overarching goal of the Bankruptcy Code to maximize the value of the distressed entity being sold. It is another feature of the modified HSR procedures designed to recognize the special circumstances of the distressed target entity.
Where the agencies determine that the transaction does not present any significant antitrust issues, they may grant early termination prior to expiration of the waiting period and allow the transaction to be consummated.13 Prior to expiration of the waiting period, the reviewing agency (DOJ or FTC) may also move to enjoin the transaction as anti-competitive or, where it determines that the competition issues deserve further scrutiny, the reviewing agency will issue what is known as a "second request."
Second Request. A second request is a "request for additional information or documentary material"14 that will yield greater insight into the parties and the markets in which they compete. Usually the particulars of a second request will be communicated through mechanisms such as interrogatories and document requests. Issuance of a second request outside the bankruptcy context starts a new waiting period. The government has 30 days after both parties have substantially complied with the second request to seek a preliminary action in federal court to clear the transaction.
In a normal HSR pro-merger notification process, responding to a second request is notoriously expensive and prolonged, and the agencies may challenge whether the parties are in "substantial compliance" even after a significant amount of material has been produced. Where a target entity is in bankruptcy, the HSR procedures in conjunction with §363(b) provide for a modified second request protocol that limits the circumstances in which the time prior to potential approval of a transaction may be extended. Moreover, if a second request is issued, the waiting period begins after only the acquiring person substantially complies with the second request.15 After the agencies have determined that the acquiring party is in compliance with the second request, a second waiting period of 10 calendar days is imposed, in contrast to the 30-day period imposed outside the bankruptcy context.16
Ultimately, however, the mere threat of a second request being issued may be sufficient to persuade a bankruptcy court judge (or debtor, bank lenders or committee) that a particular bidder cannot offer value on a sufficiently timely basis to be considered the best offer. This is because even with the more expedited procedural rules, responding to a second request can take a bidder months.
Challenges to the Transaction. Where the target entity is not in bankruptcy, the government may challenge a transaction that it deems anti-competitive by filing for an injunction in federal district court, and private parties may also file challenges where they have antitrust standing under the Clayton Act.17 Bankruptcy does not affect the government's right to challenge the transaction, nor does it per se limit a private party's right. However, in bankruptcy, considerations of venue and standing can complicate the issue of who may challenge the transaction and where. For private third parties, the existence of the automatic stay, combined with strict standing requirements to bring a challenge to a transaction under the antitrust laws in either bankruptcy or district court, may foreclose any opportunity to launch a challenge.
For the government, there may be a question of whether to launch a challenge in the district court (where the challenge would ordinarily be filed, absent bankruptcy) or the bankruptcy court. In some cases, the bankruptcy court may believe that the government has in some way subjected itself to its jurisdiction, for instance by appearing before it or filing a proof of claim. Typically, however, the reviewing agency seeks to avoid subjecting itself to the bankruptcy court's jurisdiction so that it may file an antitrust proceeding in the federal district court of the agencies' choosing.18 The government may also contend that an antitrust challenge is subject to mandatory withdrawal of the reference under 28 U.S.C. §157(d) because of the antitrust law considerations, or alternatively discretionary withdrawal. The government may believe that it can achieve a better result in the district court on the theory that the district court will rule solely based on the antitrust law issues, while the bankruptcy court is more likely to consider the needs of the debtor and the estate. For converse reasons, the debtor may prefer to have the issues adjudicated by the bankruptcy court.
Defending Against Challenges Based on Financial Distress
The U.S. Supreme Court's opinion in United States v. General Dynamics Corp.19 established the principle that courts assessing the competitive effects of a transaction should take into account the future competitive significance of the target entity. Specifically, General Dynamics directs courts to consider the likely performance and market share of the acquired company based on its current condition and implications of those conditions for the future rather than its past performance.20 Showing that the target entity would likely leave the market or persist in a greatly diminished state allows the parties to the transaction to rebut a presumption of anti-competitive effects.21 In its most extreme state, this is called the "failing firm" defense, which is asserted by showing that:
• the failure of the target is imminent,
• there is no course other than the proposed transaction that would be less harmful to competition, and
• the company could not regain competitive stature through reorganization in bankruptcy.22
In discussing the defense, the DOJ/FTC Horizontal Merger Guidelines Section 5.1 counsels that unless the target entity's assets will exit the relevant market absent the transaction, the "failing firm" defense should not prevail.23
The U.S. Supreme Court's opinion in United States v. General Dynamics Corp. established the principle that courts assessing the competitive effects of a transaction should take into account the future competitive significance of the target entity.
While adhering to this rigid approach, courts have nonetheless rarely granted relief based on the defense. In theory, where the transaction is shown to have no effect on future competition, reviewing courts should pause in enjoining the transaction, whether the target company is shown to be truly "failing" or merely to be unlikely to pose a threat to competition.24 In practice, the standard for showing no future anti-competitive effect is a high one. In most instances, the defense may be one factor the court considers in its overall assessment of the competitive impact of the transaction and may tilt the balance to finding no violation, but will not, standing alone, be sufficient to avoid an injunction.25
Practical Tips for Proceeding
As counsel in a transaction where the target is in bankruptcy, there are a number of checklist items to keep in mind as you proceed through the HSR maze. For example:
• Be mindful of the fact that every potential buyer for the target entity represents a separate transaction for which notification may be required. Whether the sale is negotiated or occurs through an auction process, and whether there are two or 10 potential buyers, the HSR procedures need to be followed in each instance, sometimes simultaneously.
• Line up individuals to execute affidavits and certifications for submission with the notification form as soon as possible. Check the Rules to identify the proper individuals in the requisite corporate positions.
• Be realistic in advising the client as to which transactions are likely to be approved. Keep your expectations and those of the parties within reasonable limits regarding the likelihood of success with the "failing firm" defense. Although it may appear to make a great deal of economic sense for the bankruptcy company, it is very difficult to make the necessary showing in light of the antitrust laws' focus on protecting competition rather than individual companies.
• As each potential transaction appears on the horizon, consider approaching the antitrust agencies early to educate them on the transaction in the hopes that they will be in a better position to conclude their investigation quickly.
• Get customers on board. Marshalling customer support can be a crucial part of clearing the regulatory hurdles.
1 Hart-Scott-Rodino Antitrust Improvements Act of 1976 §201, 15 U.S.C. §18a (2000) (amending §7 of the Clayton Act, 15 U.S.C. §18 (2000)). The FTC maintains useful guides to the process. FTC Pre-Merger Introductory Guides, www.ftc.gov/bc/hsr/introguides/introguides.htm.
2 FTC Subchapter H - Rules, Regulations, Statements, and Interpretations Under the Hart-Scott-Rodino Antitrust Improvements Act of 1976, 16 C.F.R. §§801-803 (2005). The FTC guides noted above also provide guidance with regard to the rules in conjunction with the requirements of the HSR Act. See supra n.1.
3 For convenience, we use "HSR" to refer to the statute and/or the Rules.
4 The agencies determine which of them will review a transaction.
5 15 U.S.C. §18a(g)(1) (2000); see also United States v. Hearst Trust, No. 1:01CV02119, 2001 WL 1478814 (D. D.C. Oct. 15, 2001), |73.451 (D. D.C. 2001) (imposing $4 million in civil penalties for non-compliance with HSR procedures).
6 See 15 U.S.C. §18a(a). The FTC publishes additional information on determining whether a transaction is "reportable." FTC Guide, To File or Not to File: When You Must File a Pro-Merger Notification Form, available at www.ftc.gov/bc/hsr/introguides/guide2.pdf.
7 16 C.F.R. §803.2(b) (2005).
8 11 U.S.C. §363(b)(2)(A) (2000); see also Instructions to FTC Form C4 (rev. 04/07/05), available at www.ftc.gov/bc/hsr/050407InstructRpt.pdf (specifying that either an appointed trustee or the DIP may submit the form).
9 16 C.F.R. §803.1 (2005). The form is available at www.ftc.gov/bc/hsr/050407Rptform.doc.
10 16 C.F.R. §§803.5, 803.6 (2005).
11 16 C.F.R. §803.5 (2005) (outlining what the affidavit should contain).
12 11 U.S.C. §363(b)(2)(B) (2000).
13 15 U.S.C. §18a(b)(2) (2000).
14 Id. at §18a(e)(1)(A) (2000); 16 C.F.R. §803.2 (2005).
15 15 U.S.C. §18a(e)(2) (2000).
16 Id. at §803.20(c)(2) (2005). This can be helpful in two ways. First, it shortens the time prior to consummation of the transaction. Second, it may encourage the agencies to think realistically when requesting material in light of the limited timeframe for review.
17 15 U.S.C. §26 (2000).
18 The bankruptcy court may find that it has jurisdiction to entertain all antitrust claims. See In re Adelphia Commc'ns. Corp. v. Amer. Channel LLC, et al., ___ B.R.___, Bankr. No. 02-41729, 2006 WL 1731147 at *10 (Bankr. S.D.N.Y. June 26, 2006) (finding that in absence of affirmative relief from automatic stay, bankruptcy court was only appropriate jurisdiction for antitrust claim of private litigant attempting to enjoin purchase of bankruptcy estate); In re Fin. News Network Inc., 126 B.R. 157 (S.D.N.Y. 1991) (district court opinion finding that bankruptcy court had jurisdiction over FTC and state regulatory agency claims seeking to enjoin sale of bankruptcy estate).
19 415 U.S. 486, 501 (1974).
20 Id. at 503.
21 Id.; FTC v. Univ. Health Inc., 938 F.2d 1206, 1221 (11th Cir. 1991); FTC v. Arch Coal Inc., 329 F.Supp.2d 109, 153 (D. D.C. 2004).
22 Gen. Dynamics, 415 U.S. at 507; Dr. Pepper/Seven Up Cos. Inc. v. FTC, 991 F.2d 859, 864-65 (D.C. Cir. 1993); Michigan Citizens for an Indep. Press v. Thornburgh, 868 F.2d 1285, 1288 (D.C. Cir. 1989).
23 FTC & DOJ, Horizontal Merger Guidelines §5.1 (rev. 1997). The section reads in full: A merger is not likely to create or enhance market power or facilitate its exercise if the following circumstances are met: (1) the allegedly failing firm would be unable to meet its financial obligations in the near future; (2) it would not be able to reorganize successfully under chapter 11 of the Bankruptcy Act; (3) it has made unsuccessful good-faith efforts to elicit reasonable alternative offers of acquisition of the assets of the failing firm that would both keep its tangible and intangible assets in the relevant market and pose a less-severe danger to competition than does the proposed merger; and (4) absent the acquisition, the assets of the failing firm would exit the relevant market. Id. (footnotes omitted), available at www.usdoj.gov/atr/public/ guidelines/hmg.htm#51.
24 Id.; cf. Dr. Pepper/Seven Up Cos., 991 F.2d at 865 (finding, based on three-element test, that target entity in acquisition had "colorable" claim under the failing firm doctrine and remanding for further explanation by FTC as to why transaction should not be consummated); Arch Coal, 329 F. Supp. 2d at 156-58 (explaining that although target entity not "technically" a failing firm, its dismal future prospects should be considered when determining the competitive effects of the proposed acquisition).
25 See Kaiser Aluminum & Chem. Corp. v. FTC, 652 F.2d 1324, 1339, 1341 (7th Cir. 1981) (finding that "financial weakness, while perhaps relevant in some cases, is probably the weakest ground of all for justifying a merger" and "certainly cannot be the primary justification of a merger in resistance to a [§]7 proceeding").