tions where we have an assertion of the failing company defense as an appropriate alternative purchaser? Mr. SHENEFIELD. I most certainly would, and indeed, the objectives of that kind of employee group in acquiring the facilities would be completely congruent with one of the basic philosophies of the antitrust laws, that is to help attempt to avoid centralized power. Mr. COOPER. Thank you. Senator METZENBAUM. Thank you very much. I voted on behalf of the Nation, and so, everything is under control. Mr. SHENEFIELD. I am happy to have been an accomplice. Thank you Senator. Senator METZENBAUM. Thank you very much. [The prepared statement of Mr. Shenefield follows:] PREPARED STATEMENT OF JOHN H. SHENEFIELD Mr. Chairman, and members of the subcommittee, I am pleased to have the opportunity to discuss with you the failing company defense to the Clayton Act's antimerger provisions. In my testimony today, I will discuss the Antitrust Division's perception of the failing company doctrine and describe how the Division attempts to apply the defense in a manner consistent with the case law and the policies that underlie it. Broadly speaking, the failing company defense provides justification for an otherwise unlawful merger based on the extreme financial difficulties of one of the parties and the lack of a less anticompetitive purchaser for that failing firm. As the Supreme Court has noted, the defense is "in a sense, 'a lesser of two evils' approach, in which the possible threat to competition resulting from an acquisition is deemed preferable to the adverse impact on competition and other losses if the company goes out of business." In this context, "failing company" cases often present antitrust enforcement authorities with difficult factual and legal questions as they make their determination whether to challenge a merger in which the defense has been raised. In making such decisions much careful and thorough analysis is required, analysis tempered by informed judgment as to the probable business consequences of the decision to oppose or not oppose the acquisition of a purportedly failing enterprise. In essence, the "lesser of two evils" choice to which the Supreme Court referred grows out of the nature of the Clayton Act's restrictions on business consolidations. The statute prohibits mergers whose effect "may be substantially to lessen competition" in a relevant market. The courts have appropriately recognized that this section 7 restriction serves a broad preventive function by outlawing mergers whose consequence is to bring about a market structure that carries with it a significant risk of decreased competitive vigor. In interpreting section 7, particularly as it relates to mergers among direct competitors, the courts have therefore prohibited mergers when the firms involved are significant market participants, generally as determined by the market shares of the two enterprises. Such a rule recognizes that the elimination of an independent competitor, coupled with acquisition of its market share by the purchasing firm, will likely reduce competition among the remaining firms in the marketplace. At the same time, the rule also recognizes that the legal sanctioning of one merger may serve to encourage, and establish legal precedent for, the combination of other, similarly sized businesses in that industry. In light of these purposes, courts, in deciding horizontal merger cases, have generally been reluctant to engage in elaborate competitive analyses once the appropriate markets have been defined and the market shares of the merger partners determined and found to be of requisite significance.3 Nevertheless, as early as its 1930 decision in International Shoe, the Supreme Court found that a merger partner's failing financial condition and the lack of an alternative purchaser for it might be a grounds for upholding a merger, 1 United States v. General Dynamics Corp., 415 U.S. 486, 507 (1974). See e.g., United States v. Philadelphia Nat'l Bank, 374 U.S. 321 (1963). a Id. even though the transaction would otherwise violate section 7 standards. This failing company defense has generally been viewed as resting on two complementary considerations." The first, and the most important one in the context of competition policy, is that the likelihood of anticompetitive harm is greatly reduced when the acquired firm would otherwise disappear from the market place, that is, when no other method than the proposed merger is available to maintain it as an independent competitor. The effects on a particular market of permitting a given acquisition, when compared to liquidation of the failing firm, may not necessarily be clear. For example, purchase of the failing enterprise by the dominant firm in a highly concentrated market might so entrench that firm that competition would be lessened to a greater extent than if the acquired firm were simply to disappear and its customers divided among the remaining firms in the industry by operation of the marketplace. Nevertheless, most commentators agree that a failing firm acquisition cannot readily be assumed to lessen competition substantially in of the absence of a viable, less anticompetitive alternative. This conclusion calls into play the second policy ground upon which the defense has been based. Where the competitive harm from permitting a particular class of mergers is ambiguous, then antitrust policy can appropriately recognize considerations of equity to the parties affected. Adherence to a strict Clayton Act standard in the failing firm situation, given the small likelihood of injury to competition, might needlessly injure the failing firm's employees, creditors. shareholders and, perhaps, its community. Application of the failing firm defense may prevent this harm without undercutting the goals of antitrust enforcement. The Supreme Court has recognized this broader public policy purpose when it remarked: "The failing company defense presupposes that the effect on competition and the loss to [the company's] stockholders and injury to the communities where its plants were operated,' [citing International Shoe], will be less if a company continues to exist even as a party to a merger than if it disappears entirely from the market.” ” At the same time, the Supreme Court has held that the broad preventive purposes of Clayton Act section 7 require that the failing company defense be narrowly construed. In its decisions, particularly in 1969 Citizen Publishing Co. and subsequent Greater Buffalo Press' opinions, the Court has reiterated rather strict limitations on its availability. Under the terms of those opinions, the defense is to prevail only if it is shown: (1) That the resources of the acquired firm are so depleted and the prospect of rehabilitation so remote that it faces the grave probability of a business failure; and (2) That there is no other less anticompetitive prospective purchaser.1o Thus, when a failing company defense is raised by the parties to a merger. the Antitrust Division undertakes to analyze the validity of the defense in light of its dual obligation to construe the defense strictly and to give recognition to the broad policy concerns upon which the defense is based. This dual obligation can, and does, create a tension as to the appropriate application of the defense in a particular case. I should note, however, that in the nearly 50 years since the Although the 1950 amendments to section 7 of the Clayton Act do not expressly provide for a failing company defense, the legislative history of those amendments reveals a congressional intent to preserve the defense. See 'Sen. Rep. No. 1775, 81st Cong., 2d Sess. 7 (1950); H.R. Rep. No. 1191, 81st Cong.. 1st sess. 6 (1949). For a discussion of the policies underlying the failing company defense, see, e.g., Bok. "Section 7 of the Clayton Act and the Merging of Law and Economics." 74 Harv. L. Rev. 226 (1960); Blum, "The Failing Company Doctrine," 16 B.C. Ind. & Com. L. Rev. 73 (1974); Note, "All the King's Horses and All the King's Men: The Failing Company Doetrine as a Conditional Defense to Section 7 of the Clayton Act." 4 Hofstra L. Rev. 643 (1976): Comment. "Federal Antitrust Law-Mergers-An Updating of the 'Failing Company' Doctrine in the Amended Section 7 Setting." 61 Mich. L. Rev. 566 (1963). General Dynamics, supra, note 1, 415 U.S. at 507. The fact that the failing company doctrine is grounded upon both of these policies may also be gleaned from a close reading of International Shoe Co. v. FTC. 280 U.S. 291. 302-03 (1930). While the legislative history of the 1950 Clayton Act amendments contains several references to International Shoe, it does not reveal much about what Congress saw as the policies supporting the defense. See Note. 4 Hofstra L. Rev. 643, 674 (1976). supra note 6. Citizen Publishing Co. v. United States, 394 U.S. 131 (1969). 10 See id. at 555. Citizen Publishing Co. appears to require that the prospects for re organization be "dim or nonexistent" in order for the defense to be applicable, but at least one district court has read that decision differently. See United States v. M.P.M., Inc., 397 F. Supp. 78, 96-97 (D. Colo. 1975) (suggesting that Citizen Publishing viewed a showing of dim or nonexistent reorganization prospects as an alternative to showing no other prospective purchaser). failing company defense has been recognized, few reported judicial decisions have sustained the defense in the face of a Government challenge." I would like to think that this record reflects, at least in part, thoughtful application of the doctrine by antitrust enforcement authorities and decisions not to contest mergers when it appeared that the doctrine was applicable. With this introduction, I will now turn to a description of the way in which the Antitrust Division analyzes a merger involving an allegedly failing firm. The invocation by the parties of the failing firm defense causes us to begin an intensive investigation of the financial condition of the parties. In addition to the usual competitive analyses, we try at the earliest possible time to develop analyses of the immediate and near-future business situation of the allegedly failing com. pany. In so doing we will examine whether the failure of the business can be averted via restructuring, sale or sale and lease-back of assets, or other ways of raising needed capital. Our investigation of a failing firm claim will also focus upon whether the parties have met their burden of showing that there is no less anticompetitive purchaser. The courts have applied this requirement rigorously." What we generally look for is a bona fide attempt to find a less anticompetitive purchaser, such as the use of an investment banker or extensive search. The mechanics and scope of an investigation of a failing company claim will, of course, vary from case to case. In addition to issuing Civil Investigative Demands to the trade association and the other firms in the industry in order to construct a market profile, the staff typically will use CID's to obtain information from financial institutions including creditors and investment bankers, on the financial condition of the parties. Interviews will be conducted with past and present officers of the merging companies, other industry executives, customers, major banks, and investment bankers responsible for putting the proposed merger together. Further, the staff will meet with other interested parties and Government agencies in order to better assess the impact of the merger and of a potential business failure on the community and other interests involved. Thus far I have described how our staff investigates the merits of the two prongs of the failing company defense. I will now discuss the decisional criteria that we use in deciding whether to contest a merger once our investigation is complete. Needless to say, the lawyers, economists, and financial analysts working on a case can, and occasionally do, reach different conclusions in applying these criteria. The failing company case, like any other, is reviewed at several levels: the chief of the litigating section; the Office of Operations; the Assistant Attorney General and his deputies; and in some instances the Attorney General. Nevertheless, the following discussion gives a good picture of how, in the aggregate, we decide whether to challenge a "failing company" merger. 13 The Department of Justice Merger Guidelines, which were released in 1968, set out the general standards used by the Division in failing company cases. The Guidelines state that "a merger which the Department would otherwise challenge will ordinarily not be challenged if *** the firm faces the clear probability of business failure, and good faith efforts by the failing firm have failed to elicit a reasonable offer of acquisition more consistent with the purposes of section 7 by a firm which intends to keep the failing firm in the market." Only those firms "with no reasonable prospect of remaining viable" are regarded as failing, and a firm is not considered to be failing "merely because the firm has been unprofitable for a period of time, *** [or] has poor management ***." The Guidelines also discuss the application of the defense in the conglomerate merger context, and address the so-called "failing division" problem, a matter that I will address later in my testimony. In practice then, we must make two basic assessments, one regarding the likelihood of business failure, and the other regarding whether good faith efforts were made to find an alternative purchaser. Our decision as to the likelihood of 11 But see, e.g., United States v. M.P.M., Inc., 397 F. Supp. 78 (D. Col. 1975): United States v. Maryland & Virginia Producers Ass'n, Inc., 167 F. Supp. 799 (D.D.C. 1958), aff'd on other grounds, 362 U.S. 458 (1960). 12 See, e.g., Citizen Publishing Co. v. United States, 394 U.S. 131, 138 (1969) ("no effort was made to sell the Citizen; its properties and franchise were not put in the hands of a broker."); Heatransfer Corp. v. Volkswagenwerk, 553 F. 2d 964, 983 (5th Cir. 1977). cert. denied, 434 U.S. 1087 (1978) (no showing that the company had attempted to sell itself on the open market): Golden Grain Macaroni Co. v. FTC, 472 F. 2d 882, 887 (9th Cir. 1972), cert. denied, 412 U.S. 918 (1973) ("[m]erely proving that some or all of the most logical purchasers have declined to buy is not enough to prove that the challenged purchaser was the only prospective purchaser"). 13 The Guidelines may be found in 1 Trade Reg. Rep. (CCH) ¶ 4510. 14 failure and alternatives to it is largely one of technical judgment, based upon the evidence uncovered in the course of our investigation. While some commentators have suggested that a mechanical, quantitative test be used by antitrust agencies to determine the probability of failure on the basis of available accounting information, I believe that such an approach is too inflexible to be the key element of our decision whether or not to challenge a merger. Not only would its use deprive us of the ability to take into consideration real-world business considerations at the heart of any failing company situation, but reliance on such a test also disregards the importance of considering the views of banks, investment houses, and others in the financial community as to the availability of alternatives to failure. In that regard, I should note that the Supreme Court has indicated that the availability of reorganization under the bankruptcy laws should be taken into consideration before a determination as to the applicability of the defense can be made, and that the prospects for a successful reorganization should be found "dim or nonexistent." " In practice, the process of bankruptcy is an uncertain one for the parties involved. The trustee, after all, owes his first duty to creditors, not to the preservation of competition. Particularly in the case of a multiproduct company, a successful reorganization from the creditors' point of view might involve liquidation of precisely that portion of the business whose preservation is most crucial to competition in a relevant market. Consequently, the Antitrust Division has regarded the availability of bankruptcy as an alternative to a merger as creating especially close judgment calls. We do not view the possibility of a technically successful reorganization as an inflexible barrier to invocation of the defense, but a consideration to be taken into account in determining its appropriateness. Satisfaction of the alternative purchaser issue requires considerably more than showing that no one sought to buy the firm after the merger in question was publicly announced." It has been our experience, however, that a firm whose case as to probability of failure is fairly convincing may nevertheless publicly announce a merger without previously having made a bona fide attempt to find a less anticompetitive purchaser. On at least one occasion, the 1974 sale of Motorola's television business to Matsushita, the Division publicly stated that it would give the selling firm a fixed time period in which to look for an alternative purchaser, and when none was found, stated its intention not to challenge the merger. I should emphasize, however, that parties expecting to use a failing company defense should not expect such treatment in the future-we want to avoid situations in which the seller can conduct a pro forma search for alternative purchasers after making an otherwise unlawful merger proposal. Thus we expect companies to engage in bona fide efforts to find a purchaser before reaching a merger agreement. 17 18 As I noted at the outset of my testimony, the factual and legal questions presented in a failing company case are often complex and close ones. If we have been convinced on the basic factual assessments that there is indeed a “grave” or "clear" probability of a business failure and that bona fide efforts have uncovered no less anticompetitive purchaser, then we are not likely to oppose the merger. Sometimes, despite extensive investigatory efforts, it is clear that there is some risk of business failure but much less clear whether this risk amounts to a "grave probability." When this is the case, we try not to be overly rigid and mechanical in applying the defense. Consciously or not, we undoubtedly engage in some degree of balancing. For example, if the substantive case on lessening of competition is only marginal, particularly where the projected impact of business failure on employees and other affected parties is great, we will be more likely to stay our hand than if the substantive case regarding competitive impact 14 Blum, supra note 6. 15 Citizen Publishing, supra note 8, 394 U.S. at 138. 16 See "Government Litigation Under Section 7: The Old Merger Guidelines and the New Antitrust Majority," remarks by Donald I. Baker before the Southwestern Legal Foundation International Center for Advanced Continuing Education at 17 (Dallas, Feb. 24, 1977). 17 See Department of Justice press release. Apr. 23, 1974. 18 We have not as yet faced a case in which we deemed a merger violative of section 7. despite the presence of failing company doctrine requisites. Whether the fail'ng companTM defense operates as an absolute defense or whether it may be overcome in a particular case is largely an open question. We do note that the FTC has held the failing company defense not to be an absolute defense. United States Steel Corp., 74 F.T.C. 1270, 1288 (1968). The sixth circuit remanded the case, without reaching the issue. United States Steel Corp. v. FTC, 426 F. 2d 592, 607 (6th Cir. 1970). is overwhelming. Although such an evaluate process may occasionally result in our not bringing a case that we might have won, we view this result as a proper exercise of prosecutorial discretion. I would like now to address two particular problem areas which we face under the failing company rubric; the so-called "failing division" issue and the notion that financial weakness short of failing company dimensions may serve as an alternative defense. In recent years, we have begun to encounter cases in which a profitable parent corporation seeks to justify a sale of a division (or subsidiary or affiliate) on grounds that the division is failing. The handful of judicial decisions that touch on the issue of whether and how the failing company defense applies to divisions give us little guidance, as they do not satisfactorily analyze whether the reasons underlying the defense, or perhaps some other reasons, justify its application to divisions." The Department of Justice Merger Guidelines state that we will apply the failing company defense to a division "only in the clearest of circumstances." This strict approach is due to such factors as "the difficulty in assessing the viability of a portion of a company, the possibility of arbitrary accounting practices, and the likelihood that an otherwise healthy company can rehabilitate one of its parts *." Such concerns prompted the Division, in a recent administrative hearing in a "failing newspaper" case arising under the Newspaper Preservation Act. to seek an incremental analysis that would show the net profit or loss realized by the parent as a result of the operation of its subsidiary."1 20 As the Guidelines note, it is difficult to determine if a division faces a grave probability of business failure. However, enforcement authorities face the additional problem of a parent corporation that says: "Whether you think we are failing or not, we intend to shut down the division and will do so absent the merger." The "floundering" division may not be close to business failure, but may merely be earning a lower rate of return than other divisions. In a sense, the antitrust enforcement authorities are put in the position of speculating about the likely conduct of a parent corporation that has the ability to shut down a division rather than maintain it under undesirable conditions if approval for the acquisition is not given. As you are probably aware, we have on occasion somewhat reluctantly decided not to challenge mergers involving such floundering divisions. In these troublesome cases, clear and convincing proof of bona fide efforts to find a less anticompetitive purchaser is vital, and, as I discussed earlier, these efforts should be made before the merger arrangement is worked out and announced. Indeed, evidence of such a timely effort may be crucial to our determination not to challenge the transaction. A potential problem area which we may be confronting more frequently in the future is the contention that financial weakness which falls short of a "grave probability of a business failure" may serve as a "General Dynamics" defense; that is, a defense that argues that market share statistics do not accurately depict the competitive impact of a merger, and thereby attempts to overcome a prima facie case based on them.22 19 Those courts which have addressed the issue all have found the division or subsidiary not to be in the requisite financial straits and therefore have not had to decide whether the finances of the owner or parent should be considered. One court in dictum stated that the failing company defense should be applicable to an unprofitable subsidiary of a prosperous parent. United States v. Reed Roller Bit Co., 274 F. Supp. 573, 584 n. 1 (W.D. Okla. 1967). Another court considered the net income both of the division-although stating that this was somewhat unrealistic in view of the integrated operations of the parent-and of the parent as well, finding that no failing condition was present under either analysis. United States v. Phillips Petroleum Co., 367 F. Supp. 1226, 1259-60 (C.D. Cal. 1973), aff'd, 418 U.S. 906 (1974). A third court seemed to look at the financial condition of the entire company whose division was acquired by a competitor. United States v. Blue Bell, Inc., 395 F. Supp. 538, 550 (M.D. Tenn. 1975). 2015 U.S.C. §§ 1801-1804 (1976). 21 The Antitrust Division supported the request for approval of a joint operating arrangement Involving two Cincinnati newspapers. The administrative law judge recently made a recommendation to the Attorney General favoring approval of that arrangement, but opted against employing an incremental analysis because of the statutory definition of a failing newspaper as one that "regardless of ownership of affiliations" is in probable danger of financial failure. Recommended Decision, Docket No. 44-03-24-4 (May 1, 1979). 22 In General Dynamics, supra note 1, the Court found that uncommitted coal reserves, rather than past production, determined a company's ability to compete. 415 U.S. at 501-04. A company which had committed the vast majority of its reserves to long term contracts and could not secure additional reserves exhibited such "weakness as a competitor" that its acquisition was held not to violate section 7. Id. at 503-04. |