April 2020 will be the first full month in which many businesses in South Africa, in particular small and medium sized businesses, will reflect no turnover, as a consequence of the national lockdown to address the COVID-19 pandemic.  

A rapid response survey conducted by Stats SA asked businesses how the current crisis has affected their operations in the two-week period from 30 March to 13 April 2020.[1]  A total of 707 businesses in the formal sector responded to the survey – 54% indicated that their business could survive between one and three months without turnover.  

While it is difficult for most businesses to predict exactly how severely they will be impacted, it is clear that to survive the crisis, many will need to consider options including streamlining operations, bringing on board a financial investor, or opening themselves up to being acquired.  

As a result, some increase in M&A activity can be expected and, where a transaction triggers mandatory merger notification obligations in South Africa, the Competition Commission (Commission) will need to assess and approve it.  Mergers that may have raised competition concerns in the past could benefit from the ‘failing firm’ doctrine.  The Commission is also prioritising mergers involving ‘failing firms’ or ‘firms in financial distress’.      

In South Africa, the failing firm doctrine is captured in section 12A(2)(g) of the Competition Act, No. 89 of 1998 (as amended) (Act), which provides that ‘when determining whether or not a merger is likely to substantially prevent or lessen competition, the Competition Commission or Competition Tribunal must assess the strength of competition in the relevant market, and the probability that the firms in the market after the merger will behave competitively or cooperatively, taking into account any factor that is relevant to competition in that market, including… whether the business or part of the business of a party to the merger or proposed merger has failed or is likely to fail…’.    

As such, in South Africa the failing firm doctrine is not a ‘defence’ to an anticompetitive merger, but rather, the fact that the ‘business or part of the business of a party to a merger has failed or is likely to fail’ is one of several factors that the Commission or the Competition Tribunal (Tribunal) must consider when assessing a merger before determining whether the merger raises competition concerns.

This differs from the position in certain other jurisdictions, where merging parties may raise a failing firm ‘defence’ after it is established that the merger is anticompetitive, in order to ‘save’ an anticompetitive merger. 

As a result, in South Africa, when balanced against other factors that the Commission or Tribunal is required to consider when assessing a merger, a credible failing firm argument may not save a merger that raises significant competition concerns. This means that, even if a firm is failing, merging parties may still need to raise ‘efficiency’ or public interest arguments, or propose remedies for a merger to be approved.   

While the South African competition authorities have not provided a strict test for the application of the failing firm doctrine, certain key elements that merging parties should substantiate when seeking to rely upon the failing firm doctrine were discussed in the Tribunal’s decision in the case involving the acquisition of Saldanha Steel by Iscor Ltd (Iscor case):[2]      

• The business or part of the business of a party to the merger has failed or is likely to fail. Merging parties are required to demonstrate that there will be an inability to meet financial obligations. The Tribunal has previously employed a profitability and liquidity ratio analysis to determine likelihood of failure and the ability of a firm to meet its short-term obligations.[3] It is not necessary for ‘insolvency’ to be established in order for a firm to be considered as ‘failing’. Further, likely failure in the medium-term, rather than the short-term, will be sufficient for purposes of demonstrating that a firm is failing, and signs of improvement will not necessarily mean that the failing firm argument is no longer applicable. However, the Tribunal has also noted that evidence of the extent of failure (or imminent failure), will be weighed up against evidence of the anticompetitive effect of the merger – the greater the anticompetitive threat, the greater the need to demonstrate that failure is imminent.^[4] This element can be supported by a firm’s books of account as well as submissions from independent financial auditors or other consultants. Merging parties may also have to show that a simple reorganisation will not be sufficient to address the financial difficulties that are raised.[5]
• There are no less anticompetitive alternatives. In the event of the merger raising significant competition concerns, for example, where a merger is proposed between close competitors in an already concentrated market, merging parties will be required to provide evidence of having conducted sufficient market enquiries to establish that a less anticompetitive alternative is not viable.
• Absent the merger, the business or part of the business of a party to the merger that has failed or is likely to fail will exit the market. This consideration was mentioned in the Tribunal’s analysis of the facts in the Iscor case and was applied by the Tribunal in the case involving Phodoclinics (Pty) Ltd / Protector Group Medical Services (Pty) Ltd (in liquidation).[6]  This consideration is concerned with the exit of a competitor rather than the significance of such exit on the market structure.

Merging parties seeking to rely on the failing firm doctrine bear the burden of substantiating the elements set out above.[7]  Accordingly, a detailed basis for reliance on the failing firm doctrine should form part of the original merger notification and should not be a post hoc argument raised by merging parties.

While the Commission and the Tribunal will need to consider the public interest when assessing a merger involving a failing firm or a firm in financial distress, as with all mergers they assess, the Tribunal has warned against conflating the failing firm defence with public interest considerations, as public interest considerations comprise a separate (albeit related) enquiry in the merger assessment process.

In this regard, the Act requires the Commission or the Tribunal when determining whether a merger can or cannot be justified on public interest grounds to consider the effect that the merger will have on (i) a particular industrial sector or region; (ii) employment; (iii) the ability of small businesses and medium businesses, or firms controlled or owned by historically disadvantaged persons, to become competitive, effectively enter into, participate in or expand within the market; (iv) the ability of national industries to compete in international markets; and (v) the promotion of a greater spread of ownership, in particular to increase the levels of ownership by historically disadvantaged persons and workers in firms in the market. 

Historically, the Commission and the Tribunal have placed emphasis on the impact of a merger on employment and it is likely that this will continue to be a key public interest consideration in mergers going forward, in particular, where they involve failing firms.

[1] Business impact survey of the COVID-19 pandemic in South Africa report dated 21 April 2020, Stats SA.

[2] Case No. LM047Dec01.

[3] See para. 20 of Robor (Pty) Ltd and Macsteel Service Centres South Africa (Pty) Ltd / The steel tube and pipe businesses of Macsteel Services Centres South Africa (Pty) Ltd and Robot (Pty) Ltd, Case No. LM110Jul18.

[4] See the Iscor case at para. 110.

[5] See para. 23 K2018239983 (South Africa) (Pty) Ltd / The business of Hernic Ferrochrome (Pty) Ltd, Case No. LM141Jul18.

[6] Case No. 122/LM/Dec05 21/02/2006 para. 90-98.

[7] See the Iscor case at para. 110.