Takeaways
- Amid continuing financial pressure, healthcare providers are expected to raise the “failing firm” defense as justification for anticompetitive transactions.
- Ian Connor, director of the FTC Bureau of Competition, told Reorg that the agency will not consider the failing firm defense “when parties have failed to meet the requirements” of that defense.
- Many healthcare companies have financially sound assets and will reorganize using chapter 11 bankruptcy, predicted Peter Mucchetti, former chief of the DOJ’s healthcare and consumer products section.
- However, Alexis Gilman, who previously reviewed healthcare transactions at the FTC, said the agency may need to be more flexible in allowing companies to be acquired rather than face bankruptcy.
As the “failing firm” defense re-emerges in uncertain financial times, the FTC is expected to face its own challenges in deciding whether to allow greater flexibility for healthcare companies to be acquired rather than declare bankruptcy.
In recent weeks, there has been increased
discussion of the failing firm defense, in which a company argues that its poor financial condition justifies a merger that otherwise may be unlawful.
The failing firm defense is a “hard defense for a company to qualify for, but it’s not impossible,” said Peter Mucchetti, former chief of the DOJ’s healthcare and consumer products section. He recently joined Clifford Chance as a partner.
In the healthcare industry, the failing firm defense is most likely to be made in the months ahead by provider groups, Muchetti told Reorg. Health providers and systems are facing historic financial pressure related to the coronavirus pandemic, as previously
reported.
There are essentially three prongs for meeting the definition of a failing firm. The first requirement is that the company must truly be running out of money. Second is that the company would be unable to reorganize successfully in bankruptcy. Third is whether there is another potential buyer that raises less antitrust concern.
Alexis Gilman, a partner at Crowell & Moring, said that while the FTC is going to have high standards for meeting these criteria, the agency needs to have some tolerance for the failing firm defense in order for the defense to be meaningful. The FTC does not want hospitals to shut their doors, said Gilman, who previously worked as assistant director of the FTC’s Mergers IV division, which reviews transactions involving healthcare providers.
Despite the possibility of an extended financial downturn, the FTC’s head of competition conveyed no additional flexibility on the issue of failing firms. “We will consider a failing firm defense in any situation where the parties have met the multiple, rigorous requirements of that defense, but we do not consider that defense when parties have failed to meet the requirements,” Ian Connor, director of the FTC Bureau of Competition, told Reorg.
The result, according to Muchetti, is that a lot of companies are going to reorganize using chapter 11 bankruptcy. “The agencies are going to keep using that yardstick,” he said, noting that many healthcare business assets are fundamentally sound despite the broader economic picture. “Those businesses are going to be successful again. Their business model wasn’t flawed,” he added.
In the context of deciding whether an anticompetitive merger should proceed or if the seller could successfully reorganize through bankruptcy, the FTC may face its own challenges. Bankruptcy, though a viable option for some health providers, might also have unintended consequences such as scaring away patients and staff, potentially putting a healthcare system into a long-term downward spiral. Meanwhile, an anticompetitive transaction would have its own adverse effects.
Gilman, in response to this dilemma, said the FTC might show some flexibility on the bankruptcy prong of the failing firm defense if there are significant risks involved for a company to go through the bankruptcy process.
“I think the two most important prongs are whether the firm is in failing financial condition and whether there was a good-faith search for another buyer,” he said. “If those are satisfied, then there’s usually a pretty good claim.”
Gilman also said the FTC has allowed some transactions to proceed “based if not mostly, then at least in part” on failing firm arguments. While the details of these decisions are typically not released publicly, he said the agency will be skeptical of failing firm arguments when a company’s profits are recovering and financial setbacks appear temporary.
A common stumbling block for merging parties in the context of a failing firm argument is that the seller failed to conduct a robust search for other potential buyers, an issue that Gilman noted the FTC examines closely. “That’s where the agency typically kicks the tires,” he said.
--Ryan Lynch