Table of Contents 

• European Commission Provides Guidance on Foreign Subsidies Regulation
• UK CMA Clears Two Mergers on Failing Firm Grounds
• UK Court Rejects Restrictive Covenants Imposed on Business Sale
• European Commission Publishes Draft Guidelines on Exclusionary Abuses of Dominance

European Commission Provides Guidance on Foreign Subsidies Regulation

Under the EU Foreign Subsidies Regulation (FSR), the European Commission (EC) has the power to investigate financial contributions granted by non-EU governments to companies active in the EU. If the EC finds that such financial contributions constitute distortive subsidies, it can impose measures to redress their effects.

The obligation to notify certain large M&A transactions to the EC for clearance under the FSR has applied since 12 October 2023. There is a similar notification obligation for certain large public procurements, and the EC can launch its own ex officio investigations into any other market situation.

On 26 July 2024, the EC published its first guidance on the substantive operation of the FSR. This is a short Staff Working Document (SWD) that consists of questions and answers providing initial clarification on assessing the existence of a distortion caused by a foreign subsidy on the EU internal market and on the application of the balancing test contained in the FSR. It covers transactions and public procurement procedures.

In addition to a general analysis of the concept of distortion, the document clarifies the EC’s approach to subsidies “most likely to distort the single market.” Unlike the usual position when analysing distortion, the EC does not need to perform a detailed assessment of whether the foreign subsidy is liable to improve the competitive position of the beneficiary in the internal market and whether in doing so the foreign subsidy actually or potentially negatively affects competition in the internal market. The SWD states that, in practice, foreign subsidies of this nature are presumed to be distortive, unless the facts specific to the case show that there is unlikely to be a negative effect on competition in the internal market.

The SWD considers the main types of distortion that the EC assesses in relation to transactions. Foreign subsidies may lead to actual or potential negative effects on the acquisition process itself, affecting competition for acquiring the target. Foreign subsidies received by the acquirer may provide an advantage in the acquisition process, which the acquirer could use, for example, to outbid or discourage potential competitors. These foreign subsidies may consist of supporting measures including a direct grant, an unlimited state guarantee or a loan below market terms. Subsidies granted to the target (or in some circumstances, the seller) may also be relevant.

While subsidies must be granted in the three years prior to the conclusion of the agreement, announcement of the public bid or acquisition of a controlling interest in the target to fall within the scope of the FSR, the distortion may not have materialised at the time that the transaction is completed. The SWD states that foreign subsidies can lead to distortions with respect to activities in the market after the transaction. 

Under the balancing test, the EC is required to take into account whether and to what extent foreign subsidies found to distort the internal market have positive effects on the “development of the relevant subsidised economic activity on the internal market.” In addition, the EC has to “examine broader positive effects in relation to the relevant policy objectives, in particular those of the [EU].”

The SWD indicates that those policy objectives can include, for instance, considerations relating to a high level of environmental protection, social standards or the promotion of research and development.

Positive effects can, but will not always, offset the negative effects caused by the foreign subsidies. The balancing test may therefore lead to several outcomes: a “no objection decision” if the positive effects fully outweigh the negative effects of the foreign subsidies; an adjustment to required redressive measures, in order to account for those positive effects, while still ensuring that the negative effects are fully redressed; or no impact on a decision that a transaction or award of a contract should be prohibited. 

UK CMA Clears Two Mergers on Failing Firm Grounds

In common with other regulators, when applying merger control law the UK Competition and Markets Authority (CMA) compares the prospects for competition with the transaction against the most likely competitive situation without it, called the “counterfactual.”

One counterfactual is that, absent the merger, the target is likely to have exited the market. The CMA calls this the “exiting firm scenario,” but it is more commonly referred to as the “failing firm defence.”

In forming a view on a failing firm defence, the CMA’s guidance indicates that it will consider two issues. First, the CMA will consider whether the target is likely to have exited the market absent the deal, through failure or otherwise. Second, the CMA needs to confirm that, if so, there would not have been an alternative, less anti-competitive purchaser for the firm or its assets than the buyer in question. The guidance states that the CMA will usually require “compelling evidence” prepared before the transaction was under contemplation.

A 6 August 2024 provisional decision by the CMA during a Phase 2 detailed investigation shows the operation of these principles in practice. The case concerns the proposed acquisition by T&L Sugars Limited (TLS) of Tereos UK & Ireland’s retail sugar business from Tereos SCA. The transaction would reduce the number of competitors in that market from three to two, which would likely mean the transaction would not be approved at the conclusion of the Phase 2 review.

However, the parties provided evidence to the CMA showing that, despite significant efforts by Tereos to improve its financial performance, Tereos’ UK retail business has been loss-making over a sustained period of time. Tereos started the sales process for the business in late 2022, and the parties were able to demonstrate that there was no alternative, less anticompetitive purchaser. 

The CMA’s provisional decision states that it reviewed “extensive evidence from Tereos’ internal documents, including [internal] email exchanges.” It also analysed the sales process for Tereos’ UK retail business in detail and was able to confirm that, although one other party made an initial bid, this was unlikely to have resulted in an agreed alternative transaction. The CMA concluded the most likely counterfactual was that Tereos would have closed the business and exited the market, in which case there would have been no competition between it and TLS in any event.

The CMA provided another example of a successful failing firm defence the same month. On 2 August 2024, it unconditionally cleared at the end of a Phase 1 investigation the proposed acquisition by Eurofins Forensics LUX Holding Sarl of DNACO Limited (Cellmark). The decision outlining the reasons was published on 19 August.

The parties both supply “traditional” forensic science services in England and Wales and would have a combined market share exceeding 80%, with a significant increment as a result of the transaction. That level of share would normally raise clear concerns and likely lead to a detailed Phase 2 investigation if suitable remedies were not agreed.

However, the CMA concluded that, absent the transaction, it was “inevitable” that Cellmark would have exited the market and the first requirement of the failing firm defence was therefore met. Suppliers of traditional forensic science services have encountered long-term financial difficulties and have limited options to increase revenue given the limited number of potential customers. Cellmark itself is not in a position to generate sufficient business and cash flow to service aged creditors at the necessary speed to avoid them taking legal action that would result in Cellmark’s exit. In addition, Cellmark’s financial position has created a substantial risk that it will lose access to vital supplies that it requires to provide services and generate cash flow. Refinancing or restructuring options are not available to enable Cellmark to materially increase cash flow so it can repay debt before suppliers are likely to take action that could lead to Cellmark’s exit.

Following its guidance, the CMA then considered whether, absent the transaction, there would have been an alternative, less anticompetitive purchaser for Cellmark. This was not the case. The overall pool of potential purchasers for Cellmark is likely to be limited, due to the limited attractiveness of the market and the severity of Cellmark’s financial position. The “most plausible” group comprised companies with some connection to forensic science, but none were considered a suitable alternative purchaser, with most either not interested in acquiring the business or companies that would not have operated the business as a competitor in the markets it currently operates in.

One alternative purchaser was ruled out because, in accordance with its guidance, the CMA will not have as its counterfactual a sale to a buyer that is likely to result in a referral for an in-depth Phase 2 investigation since it was uncertain whether the acquisition would ultimately be cleared.

In addition to the successful use of the failing firm defence, the case is also notable for the speed of the CMA’s review, with clearance given 11 working days after the investigation started. This was driven at least in part by the potential wider impact of an exit by Cellmark. Third parties said this could “cause widespread disruption to the supply of traditional forensic science services and the criminal justice system in England and Wales,” and the decision expressly took this into account. In suitable circumstances, with the position properly explained to it, the CMA can act quickly to finalise a decision.

UK Court Rejects Restrictive Covenants Imposed on Business Sale

On 31 July 2024, the England and Wales High Court rejected a request from the buyer of a business to enforce restrictive covenants and stop the seller (an individual) from competing with any of the buyer’s subsidiaries. The case serves as a reminder that such covenants in a business sale need to be considered carefully, as they may not be enforceable under the restraint of trade doctrine. The application of competition law was not considered in this case but will be relevant when the parties are both businesses.

The buyer acquired in 2018 the seller’s 25% shareholding in Mountain Healthcare Limited, a provider of medical services to sexual assault referral centres (SARCs) operated by the police. The consideration was payable partly in cash and partly by way of a deferred loan from the seller to the buyer. The loan was to be repaid by a long stop date or earlier if Mountain was sold. The seller stayed on as a director of Mountain.

In 2021, the seller resigned from Mountain and the parties renegotiated the sale, entering into a new investment agreement and a new loan note agreement. These agreements included wide restrictive covenants preventing the seller from competing for a total of 10 years. Their scope was wider than the services that Mountain delivered when the seller worked for it, extending to competition with the businesses of any of the buyer’s subsidiaries. The geographic scope was all of the UK and the Channel Islands.

Later in 2021, the seller formed a company called Nurture Health and Care Limited in which she held a 28% shareholding. Nurture tendered in April 2024 to provide SARC services to the South Wales Police and won the contract. The buyer became aware of this and issued an application for an interim injunction to restrain her from competing with Mountain.

The court held that the restrictive covenants were void and unenforceable on the basis they infringed the public policy against restraint of trade. They extended to competition with all of the buyer’s subsidiaries, which engaged in various unrelated activities, and therefore went “far beyond” the core of Mountain’s services and any legitimate protectable interest. The duration was “far past” the duration allowed in ex-employee cases and in sale of business cases. The buyer did not provide any evidence that Mountain had contracts outside two counties in England, so the geographical scope could not be justified.

In some cases, all or part of a void provision can be severed from a contract leaving the remainder enforceable. However, the court held that the restrictive covenants “[cannot] be properly severed in a simple and clean way,” meaning the restrictive covenants as a whole would be void.

The court noted that the covenants “seek to ban the [seller] from working in her chosen field of expertise, and many other fields, for a huge duration until her retirement age of 65 [and] seek to go far beyond protecting the [buyer’s] legitimate interests in buying Mountain and protecting the goodwill received in that business.” On this basis, the normal justification for enforcing restrictive covenants was not present.

The seller did not make arguments on the basis of infringement of competition law, probably because the law only applies to agreements when two businesses are involved. When that is the case, competition law may also apply, and in practice there is frequently an overlap with the restraint of trade doctrine.

European Commission Publishes Draft Guidelines on Exclusionary Abuses of Dominance

In 2008, the EC published guidance on its enforcement priorities with regard to exclusionary abuses of dominance falling with Article 102 of the Treaty on the Functioning of the European Union, which bans abuse of dominance. The guidance promoted an “effects-based” approach to the application of Article 102 in the EU.

Since the publication of the guidance, the European Court of Justice has delivered over 30 judgments on exclusionary abuses under Article 102. These have endorsed the effects-based approach, and the EC has now decided that the clarity these judgments provide is sufficient for it to prepare draft guidelines on the topic.

Guidelines are significant because they set out the EC’s interpretation of the law, and Article 102 is currently the only area of EU competition law not covered by guidelines clarifying its application. Exclusionary abuses of dominance include, for example, predatory pricing, margin squeeze, exclusive dealing and refusal to supply.

The draft guidelines consider a range of topics relevant to exclusionary abuses. These include the general principles used to determine if conduct by a dominant company is likely to constitute an abuse and, in particular, the concepts of “competition on the merits” and “exclusionary effects.”

The draft distinguishes three categories of conduct:

• Naked restrictions that by their nature lead to exclusionary effects, such as payments to customers conditional on them postponing or cancelling the launch of products based on products offered by competitors.
• Conduct that is (rebuttably) presumed to lead to exclusionary effects, including exclusive supply or purchasing arrangements, rebates conditional upon exclusivity, predatory pricing, margin squeeze and certain forms of tying.
• Other types of conduct, for which it is necessary to analyse whether the conduct is capable of having exclusionary effects.

The draft guidelines also confirm that abusive conduct will be treated as falling outside Article 102 if it is objectively justified. This can be on the basis that it is objectively necessary or produces efficiencies that counterbalance or outweigh the negative effect of the conduct on competition.

The EC is accepting comments on the draft guidelines until 31 October 2024. Once finalised, this will be an important document, and any company with an interest should consider making a submission.