EU UPDATE – When Failure Brings Success: A Rare Example of the Failing Firm Defence
Executive Summary: The European Commission approved a proposed acquisition which would create a merged entity that would be the only producer of naphthenic base and process oils in the EEA. The Commission’s investigation found that failure to approve such merger would result in a loss of refinery assets and significantly reduce production capacity in the EEA, resulting in higher prices for EEA consumers would follow any closure.
On 2 September 2013 the European Commission adopted a decision under the EU Merger Regulation approving the proposed acquisition by Nynas AB of Shell Deutschland Oil GmbH’s Harburg refinery assets (close to Hamburg, Northern Germany), leaving the merged entity as the only producer of naphthenic base and process oils in the EEA. The Commission’s Phase II investigation established that the closure of the Harburg refinery and the exit of those assets from the EEA market would be the most likely result in the absence of the proposed acquisition. No causal link could therefore be established between the proposed acquisition and the deterioration in competitive market structure. Furthermore, as closure would significantly reduce production capacity in the EEA, the Commission determined that higher prices for EEA consumers would follow any closure.
Article 2(3) of the Merger Regulation requires the Commission to prohibit concentrations which significantly impede effective ‘competition, in particular through the creation or strengthening of a dominant position.’ However, Article 2(2) emphasises that the impediment to effective competition must be ‘as a result’ of the concentration. This causal requirement forms the basis of the development by the Commission and the European courts of an exception to the prohibition requirement: the so-called ‘failing firm’ defence. This has been incorporated into the Commission’s Horizontal Merger Guidelines, in particular at paragraphs 89-91. Where the deterioration in competitive market structure after a concentration would result even if the transaction had not occurred, the Commission may approve a concentration reducing the number of competitors in the market.
A successful failing firm defence requires the establishment of the following criteria:
(a) the failing firm would in the near future be forced out of the relevant market because of financial difficulties, if not taken over by another undertaking;
(b) there is no less anti-competitive purchaser or alternative course of action, as may be demonstrated by the fact that various other scenarios have been explored without success; and
(c) in the absence of the merger, the assets of the failing firm would inevitably exit the market. In the case of a merger between the only two players in a market, this may justify a merger-to-monopoly on the basis that the market share of the failing firm would in any event have accrued to the other merging party.
Although recognized by the Commission since 1993, the failing firm defence is exceptional in nature and, in practice, is only rarely successful. The burden of proof to show the above criteria lies with the notifying parties, and in practice tends to necessitate a full Phase II investigation.
THE COMMISSION DECISION
Nynas produces and sells naphthenic base oils for industrial lubricants, process oils and transformer oils (TFO). Base and process oils are intermediary products derived from crude oil and used in the further production of numerous applications, including industrial greases, metalworking fluids, adhesives, inks, industrial rubber and fertilisers. Nynas has its core business in Nynashamn, Sweden.
Shell Deutschland Oil GmbH is part of the Shell Group: a global group of energy and petrochemical companies engaged in exploration, refining, distribution, retail sales and many other aspects of the value chain. The refinery assets which are being sold to Nynas comprise a base oil manufacturing plant and certain parts of the refinery needed to produce distillate from crude oil. Shell will retain the remaining parts of the Harburg refinery.
The Commission initiated an in-depth Phase II investigation on 26 March 2013 because of concerns that Nynas would have a near-monopoly in the EEA market for naphthenic base and process oils. Nynas would be the only remaining producer of naphthenic base and process oils and the largest producer of TFO in the EEA. The only other credible competitor would be Ergon, a US-based company importing into the EEA market since 2008.
Notwithstanding the Commission’s concerns, the parties were able to demonstrate that it was not economically sustainable to continue operating the Harburg refinery in its current form. However, Nynas’s business model offered more opportunity for success. The parties also demonstrated that Nynas was the only buyer interested in acquiring the Harburg assets and that, absent the acquisition, the most likely alternative scenario would be the closure of the refinery. The reduction in the number of competitors was therefore inevitable. Moreover, the exit of the Harburg refinery assets would significantly reduce production capacity in the EEA and almost certainly lead to higher prices for EEA consumers.
More positively, the Commission also found that the proposed acquisition would have some positive effects on competition, as Nynas would be able to achieve significant reductions in supply costs and would likely pass on these efficiency benefits to customers.
In light of these considerations, the Commission concluded that the proposed acquisition did not raise competition concerns.
5. Commission temporarily approves rescue aid for Slovenian banks Factor banks d.d. and Probanka d.d. —The Commission has temporarily (for two months, or until the Commission adopts a final decision on a restructuring or orderly winding down) approved Slovenian plans to grant State guarantees on newly issued liabilities of two Slovenian banks. It found that the guarantees were necessary to ensure the continuing stability of the financial system and market in Slovenia and that they did so without unduly distorting competition. The reforms meet the requirements of Section 4 of the “New Banking Communication”, in particular being limited to the minimum necessary, adequately remunerated and providing safeguards to minimise the distortions of competition during the rescue period (IP/13/822, 06.09.2013).