In any transaction involving the combination of two or more competitors, M&A lawyers should consider whether antitrust issues may impact the deal, and how they can be addressed in the merger agreement. Most of the transactions closely scrutinized by the U.S. antitrust authorities are horizontal mergers--deals involving firms that sell competitive products. In the majority of those cases, the merging parties negotiate a remedy rather than litigate the matter in court.
The framework for dealing with possible objections to the transaction are often addressed in the merger agreement between the parties. In many transactions, especially those involving competitors, the merger agreement will include efforts clauses that outline each party's obligations in managing the antitrust clearance process, including how the parties will deal with any objections to the transaction. A seller will sometimes negotiate for a provision that obligates the buyer to divest assets if a government authority objects to the deal on antitrust grounds. The buyer, in turn, often pushes back on including any such provision or tries to place reasonable limits on the value of any assets to be divested.
While merger agreements sometime also include language that obligates the acquiring party to litigate any antitrust challenge to the transaction, merging parties do not usually have the appetite to subject their transactions to the additional delay and uncertainty caused by defending a merger in court. The more appealing strategy in these situations is to seek a compromise where the merging parties agree to assemble and divest a package of assets to a third party as a condition of proceeding with the transaction.
The government's objective in any negotiated divestiture is to replace the competition that would otherwise be eliminated by the transaction. Assuming the underlying transaction is still attractive to the parties once a divestiture package is assembled, such an approach offers the possibility of a swifter and more efficient resolution of the merger review process than litigation, especially if antitrust counsel are engaged early in the transaction to evaluate antitrust deal risk.
This article discusses some of the fundamental considerations in negotiating merger remedies with U.S. enforcement agencies.
As noted above, effective preservation of competition is the touchstone of a successful merger remedy. A recent U.S. Department of Justice ("DOJ") enforcement action challenging two proposed transactions by point of service terminal manufacturers VeriFone, Hypercom and Ingenico illustrates the importance of this principle. In this case, two of the merging parties identified potential competitive concerns with their deal early in the transaction planning process. The transaction was not reportable under the Hart-Scott-Rodino Act ("HSR Act"), and so before the parties engaged the DOJ and in likely anticipation of U.S. antitrust enforcement agency objections, they entered into an agreement to license the assets of one of the firms to a third party competitor. As discussed below, however, the DOJ and the merging parties fundamentally disagreed over the extent to which the proposed license arrangement actually would preserve competition in the marketplace.
VeriFone, Hypercom and Ingenico: The Acquisition and Proposed Fix
Merchants use point of sale ("POS") terminals to process credit, debit and other non-cash electronic payments at millions of locations throughout the U.S. VeriFone, one of the leading POS terminal providers in the U.S., proposed to acquire one of the other leading POS firms, Hypercom. In anticipation of the U.S. antitrust enforcement agencies raising concerns about the competitive effects of the transaction and in the hopes of avoiding a consent decree with the government, Hypercom agreed to a five-year exclusive agreement to license its assets to a third party, Ingenico, with the expectation that this agreement would fix any possible antitrust concerns and replace any competition that otherwise would be eliminated by the transaction.
The DOJ reached a different conclusion. It investigated the transactions, neither of which were reportable under the HSR Act, and filed a lawsuit challenging both. The DOJ alleged that VeriFone, Hypercom, and Ingenico currently account for 90 percent of sales of POS terminals sold to the largest retailers in the U.S. According to the DOJ, the three firms also are the only independent providers of POS terminals sold to small- and medium-sized businesses. Even though the proposed divestiture buyer Ingenico does not have any substantial sales to small- and medium-sized retailers in the U.S., the DOJ alleged that, but for this transaction, Ingenico's substantial presence in the rest of the world makes it well-positioned to expand into the U.S. As a result, Ingenico is currently acting as a competitive constraint on VeriFone and Hypercom. The DOJ discounted the market presence of a fourth firm selling in the small- and medium-sized POS terminal business segment, First Data, because it is a captive supplier that only sells terminals to retailers that use its merchant processing services.
The DOJ had several concerns about the proposed license agreement between Hypercom and Ingenico. The primary one appeared to be that Ingenico already is a substantial player in the sale of POS terminals to large retailers and already is poised to enter the small- and medium-retailer market; that is, Ingenico currently is a competitive constraint in that market. The DOJ also concluded that the proposed license agreement would reduce Ingenico's ability and incentive to compete with VeriFone, which would be the only other significant remaining POS terminal provider post-transaction. As opposed to a clean divestiture, under the proposed license agreement Ingenico would not own any intellectual property rights relating to Hypercom devices and could not improve or modify them. Ingenico also would have to rely on VeriFone to provide ongoing support for Hypercom devices.
The DOJ alleged that these "ongoing entanglements" between Hypercom and Ingenico would facilitate coordination in the POS terminal markets for both large and small-to-medium-sized retailers. It certainly did not help the parties' case that in 2007 VeriFone's CEO had projected that the worldwide POS terminals industry was trending towards a "very benevolent duopoly" consisting of VeriFone and Ingenico. The DOJ referenced this statement in its complaint in arguing that the remaining POS terminal suppliers would favor cooperation over aggressive competition with each other.
The DOJ also took issue with Ingenico's plan to port certain Hypercom software to its own terminals and transition customers away from Hypercom devices to its own terminals. This would eliminate Hypercom products as a separate choice for consumers, who would be left with hybrid Hypercom/Ingenico products that the DOJ characterized as "untested and unproven."
For all of these reasons, the DOJ filed a complaint in May 2011 challenging both the VeriFone/Hypercom and Hypercom/Ingenico transactions. One week after the DOJ filed its complaint, Ingenico and Hypercom abandoned their proposed license agreement. The DOJ's challenge to VeriFone's acquisition of Hypercom remains pending while the parties look for an alternative purchaser of the Hypercom assets.
What are the key questions in negotiating structural remedies to possible merger challenges?
As the VeriFone case demonstrates, merging parties seeking to negotiate a resolution of U.S. antitrust enforcement agency concerns must be able to show that their proposed remedy is likely to preserve the competition that would otherwise be eliminated by the transaction. While this is the fundamental objective of any merger remedy, counsel should keep in mind several other practical considerations in pursuing a negotiated outcome.
What kind of relief might a U.S. antitrust enforcement agency seek?
In VeriFone, the parties were seeking to resolve the DOJ's concerns by proposing structural relief--in this case a five-year exclusive licensing agreement giving Ingenico the right to Hypercom's assets. In horizontal mergers raising competitive concerns, a structural remedy is usually the government's preferred approach, in part because once implemented it requires little continued oversight by the government. A structural remedy typically involves the divestiture of an existing business entity or group of assets.
In contrast, in transactions combining a manufacturer and supplier or other parties that have some kind of vertical relationship, the government might seek conduct remedies. Examples of conduct relief include firewall provisions, non-discrimination clauses, mandatory licensing, transparency and anti-retaliation provisions. These can be used to address the risk that the newly-vertically-integrated company will disadvantage upstream or downstream rivals.
While the DOJ has historically eschewed conduct relief in the merger context, recent revisions to Policy Guide to Merger Remedies ("Remedies Guides") suggest that the DOJ is more open to seeking conduct remedies in appropriate cases. Time will tell whether the DOJ pursues conduct relief with greater frequency, but consent decrees entered in connection with the DOJ's review of the Google's acquisition of ITA and NBCU's joint venture with Comcast are recent examples suggesting a greater willingness to pursue conduct relief. (The government's recent record in reviewing vertical mergers was discussed in more detail in our "Antitrust Enforcement Against Vertical Mergers on the Rise: Implications for Dealmaking," The M&A Lawyer, May 2011.)
What package of divestiture assets will be deemed acceptable to the enforcement agency?
Any package of divestiture assets must identify clearly the assets a buyer needs to compete effectively in both the short and long term. In horizontal mergers, the government typically requires the divestiture of an ongoing business entity. The government may consider accepting the divestiture of less than an existing business when a set of acceptable assets can be assembled from both of the merging firms (such as one party's manufacturing facility and the other's distribution terminal). The government also may approve the divestiture of less than an existing entity when the purchaser already has or can readily obtain assets necessary to compete.
However, occasionally the government may require the divestiture of more than an existing business entity, on the ground that the divestiture buyer needs additional assets in order to compete effectively. For example, the government has sometimes required the divestiture of a full line of products, even though its competitive concerns are limited to only one of the products implicated by a merger.
In VeriFone, the proposed divestiture package--the five-year license to Hypercom assets--was less than an existing business entity. However, even if the parties had been willing to sell Hypercom's business to Ingenico, the government might still have had competitive concerns. The sale of Hypercom's business still would have reduced the number of significant competitors from three to two and, according to the DOJ, failed to preserve the competitive vigor of the marketplace.
Will the government identify a buyer of the divestiture assets for merging parties?
No, merging parties bear the responsibility of identifying a proposed divestiture buyer. As VeriFone illustrates, the DOJ's role was limited to deciding whether Ingenico was an acceptable purchaser of the divestiture assets. The government is neither authorized nor expected to present alternatives to the merging parties.
Can merging parties close the transaction before identifying a buyer of divestiture assets?
Usually, yes. The VeriFone and Ingenico transactions are atypical, given the parties' decision to have a complaint filed against them rather than continue to negotiate a resolution. In general, however, there are three possible timing scenarios:
- In the majority of cases where the parties negotiate a merger remedy, the parties are unable to identify a divestiture buyer prior to closing. Nonetheless, the government allows the parties to close their transaction after entering into a court-approved settlement with the parties--known as a consent order or consent decree--that formalizes the process and timing for securing a divestiture buyer. Consent decrees typically require the merging parties to identify with specificity the assets that will be divested, to hold those assets separate from the combined entity after closing, and to identify a suitable purchaser within a limited amount of time--typically a matter of months after closing. If the parties still have not identified a suitable buyer within the agreed upon time frame, most consent decrees provide for the appointment of an independent trustee who will assume responsibility for locating a buyer and whose expenses must be borne by the merging parties. Parties have a significant incentive to avoid the appointment of a trustee, because both the trustee and the government are more concerned about the viability of the buyer than in ensuring that the merged firm gets a fair price for the divestiture assets. The trustee also may require the inclusion of additional assets in the divestiture package in order to accomplish a sale.
- In a "fix it first" situation, the merging parties identify a likely competitive problem with the transaction and approach the antitrust enforcement agency with a proposed buyer of a package of divestiture assets before the government files a complaint challenging the transaction. If the government agrees that the buyer will use the assets to compete effectively, the parties sell the divestiture package to the buyer prior to closing their own transaction and in most cases are able to avoid the need to enter into a formal, court-approved settlement with the government.
In the balance of cases, the parties are able to identify both a suitable divestiture package and buyer--known an "upfront buyer"--but for any number of reasons do not complete the divestiture prior to closing. In this situation the parties and the government will enter into a consent decree that establishes a process and timing for completing the divestiture sale, which is typically much more expedient than the standard post-closing divestiture process. However, the decree also includes an alternative process for identifying a divestiture buyer if the sale to the pre-approved buyer does not take place. In a more limited number of cases, the government--more often the FTC than the DOJ--may require the identification of an upfront buyer and negotiation of all agreements necessary to effect the divestiture sale prior to entering a consent order. The FTC may take this approach when the parties have agreed to divest something less than an entire business entity and the agency wants greater assurance that the assets will be sold to a suitable buyer.
If the government agrees to allow the parties to close their transaction before completing any divestiture, what obligations do the merging parties have in managing any divestiture assets?
The merged firm typically is obligated to maintain the value and goodwill of any assets to be divested. For example, in the case of a business entity, the merged firm must continue to operate it in the ordinary course of business and provide it with the support and resources it normally would receive if it were not going to be sold to a third party. This includes making sure that the entity has sufficient working capital, maintaining its assets, and not selling or encumbering those assets. The government also may require the merged firm to appoint an independent operating or monitoring trustee responsible for the management of the business or assets to be divested.
Can merging parties retain control over deciding which third party will purchase the divestiture assets?
No. While the parties must identify possible candidates to purchase a package of divestiture assets and propose their first choice to the government, the government retains the authority to reject or accept a proposed buyer.
What factors will the antitrust enforcement agency consider in approving a purchaser of divestiture assets?
The government will take into account three factors in evaluating a proposed purchaser.
- The divestiture of the assets to the proposed purchaser must not itself cause competitive harm. For example, as in the VeriFone case, the divestiture of assets to a proposed buyer should not itself increase market concentration and reduce the competitive incentives or market power of that buyer.
- The government must be certain that the purchaser has the incentive to use the divestiture assets to compete in the relevant market. The purchaser must satisfy the government that it does not intend to take the divestiture assets and put them towards other uses.
- The government will perform a "fitness" test to ensure that the purchaser has sufficient ability, experience, and financial capability to compete effectively in the market over the long term.
Another practical consideration to keep in mind is that the government is generally loathe to support seller-financing of a divestiture package. The government is unlikely to approve a financing package that allows the seller to reclaim the divestiture assets if the buyer defaults on the financing arrangement. Seller financing can undercut both the seller's and buyer's incentives to compete. The seller may have a disincentive to compete vigorously, so as not to put at risk the divestiture buyer's ability to operate successfully and repay the seller. The buyer's incentive to compete, in turn, could be weakened if it is concerned that doing so will cause the seller to exercise any rights it might have under the financing arrangement. Alternatively, if the seller retains some degree of control over the assets through the financing arrangement, that could diminish the buyer's ability to compete. Finally, the government has taken the position that the existence of an ongoing relationship between the buyer and seller could make it easier for the two parties to exchange sensitive business information with each other.
Do the FTC and DOJ analyze merger remedies in the same way?
The FTC and DOJ both have responsibility for enforcing the U.S. antitrust laws. The agencies share the same policy objective in securing merger remedies: to preserve the competition that a merger otherwise would eliminate. However, there are some differences in how the FTC and DOJ achieve that objective. Historically, two of the more fundamental differences related to the FTC's greater affinity for "crown jewel" provisions and "upfront buyer" requirements.
A crown jewel provision requires the divestiture of an alternative and often more valuable or expansive package of assets if the merging parties are unable to identify a suitable divestiture buyer in a timely manner. The DOJ has in the past disfavored the use of such a provision, but the most recent version of the DOJ Remedies Guide eliminates language expressing its reluctance to use crown jewel remedies.
The FTC also has tended to require the identification of an upfront buyer more often than the DOJ. In such cases the FTC requires the merging parties and divestiture buyer to sign all necessary agreements before entering into a consent order and allowing the parties to proceed with their transaction.
While the vast majority of transactions do not raise any possible competitive concerns and even fewer are the targets of U.S. antitrust enforcement, M&A counsel to horizontal merger parties are well-advised to consider whether the deal presents any concerns. Counsel should work with their clients early in the transaction planning process to identify any such concerns and consider whether they should be addressed in the merger agreement. When and if the government does raise any concerns about the transaction, counsel should work with the merging parties to review their strategic options--litigate or settle. A large part of that assessment also likely includes determining whether there is a workable "fix" that can resolve the agencies' concerns short of litigation without compromising the business case for the transaction.
Courtesy of The M&A Lawyer. By Phil Proger, Craig Waldman, and Margaret Ward of Jones Day.