This article is part of our Disputes in M&A: 5 key trends for 2022 and beyond series: a collaboration between our market leading Corporate and Dispute Resolution teams.
Merger review in Australia – Mitigating Competition Risk and Disputes
During 2021 the Australian Competition and Consumer Commission (ACCC) outlined its vision for a dramatic overhaul of Australia’s merger review regime. For M&A dealmakers, this has brought into focus the allocation of risk of obtaining ACCC clearance, and the implications if clearance is not obtained. In this article, we explore the rising popularity of antitrust and competition risk shifting provisions in the United States and the United Kingdom and their efficacy in addressing competition-risk disputes in the Australian market, in light of impending merger reform.
We provide the following key takeaways for Australian dealmakers:
- Reform of Australia’s merger regime is imminent;
- Australian dealmakers can mitigate the risks of a stronger merger clearance regime by implementing competition risk shifting provisions already being applied abroad; and
- Merger reform will likely give rise to increased litigation, both between merger participants under contractual provisions and between the ACCC and merger participants.
Given the informal nature of Australia’s merger review regime and limited instances of successful action being taken by the ACCC under Australian competition laws, it is not surprising that bespoke antitrust risk shifting provisions and associated disputes are more common in jurisdictions with stronger antitrust regimes such as the United States, United Kingdom and the European nations. However, Australian dealmakers must be vigilant: unprecedented increase in market activity alongside impending ACCC reform has created the perfect storm for increased regulatory covenant litigation.
Under section 50(1) of the Competition and Consumer Act 2010 (Cth) (CCA), the ACCC has a broad ambit to oppose any acquisition of Australian assets or shares that has the effect or likely effect of substantially lessening competition in an Australian market. The CCA outlines a list of merger factors (the Merger Factors) which courts must consider when assessing any given merger or acquisition opposed by the ACCC.
|Merger Factors Indicating Anticompetitive Merger
Recent acquisitions opposed by the ACCC
In practice, the ACCC has exercised a broad ambit to oppose prospective transactions which could lessen competition in Australian markets.
Explanation for Opposition
|14 December 2017—The ACCC
opposes the acquisition by BP Australia Pty Ltd (BP) of Woolworths Limited’s (Woolworths) network of retail service station sites.
|BP proposed to acquire Woolworths’ network of 531 retail service station sites, plus 12 sites under development, located throughout Australia.
|8 May 2019—The ACCC opposes the merger between TPG Telecom Limited (TPG) and Vodafone Hutchison Australia Pty Ltd (Vodafone).
|TPG announces its plans to enter the Australian mobile network market by way of merger with Vodafone.
*On 13 February 2020, The Federal Court overturned the ACCC’s opposition, allowing the merger to proceed.
|23 July 2020—The ACCC opposes the acquisition by B&J City Kitchen Pty Ltd (B&JCK) of the business and assets of nine Jewel Fine Foods entities (Jewel).
|B&JCK proposed to acquire the business and assets from nine Jewel entities, which at the time, were under administration.
In considering widespread reform, the ACCC highlights that the Australian approach to merger control is ‘out of step with most merger regimes internationally’. Two critical issues highlighted by the ACCC are:
- the merger regime is voluntary and non-suspensory; and
- the ACCC itself is a non-prosecutorial body, requiring court orders to enforce findings. These factors, the ACCC outlines, has led Australia’s merger regime to be skewed toward clearance.1 Looking to international regimes and established best practice, the ACCC has detailed imminent merger reform to centre around four key areas:
- updating the Merger Factors;
- introducing a statutory definition of “likely” as used in the primary merger test in section 50(1) CCA;
- certain acquisitions to be deemed to substantially lessen competition where one party’s substantial market power would be entrenched, increased or extended as a result of the acquisition—this reverses the onus on the current test, causing the acquirer to prove that the prospective acquisition would not substantially lessen competition; and
- adding a provision to allow agreements between the merger parties to be considered in the merger assessment of the likely effect on competition.
With ACCC reform imminent, parties to mergers and acquisitions must be alive to prospective levels of competition risk, the importance of competition risk allocation and what competition risk allocation actually looks like in a transaction. There is presently a window of opportunity for Australian dealmakers to assess how they manage competition risk prior to reforms being introduced. The first step? Look past traditional domestic approaches and understand strategies implemented by dealmakers abroad.
A Closer Look – The Spectrum of Competition Risk Allocation
In the Australian context, where deals pose competition risk, parties usually opt to include boilerplate ‘competition regulatory approval’ as a condition precedent, on terms acceptable to the parties. Outside the Australian context, dealmakers have tended to be more risk-averse, expressly allocating risk through bespoke competition risk shifting provisions. Depending on the level of competition risk the deal creates, parties have allocated more risk to one side, usually to the acquirer. This level of risk allocation exists on a spectrum and has in recent times, been the subject of high-profile disputes.
The spectrum of competition risk allocation in M&A
|Type of risk allocation covenant*
|“Notwithstanding anything herein to the contrary, Parent shall take any and all action necessary, including but not limited to (i) selling or otherwise disposing of, or holding separate and agreeing to sell or otherwise dispose of, assets, categories of assets or businesses of the Company or Parent or their respective Subsidiaries; (ii) terminating existing relationships, contractual rights or obligations of the Company or Parent or their respective Subsidiaries; (iii) terminating any venture or other arrangement; (iv) creating any relationship, contractual rights or obligations of the Company or Parent or their respective Subsidiaries or (v) effectuating any other change or restructuring of the Company or Parent or their respective Subsidiaries”
|This covenant allocates all competition risk.
Not tempered by “effort”, this is a broad contractual obligation imposed on the buyer to take all action necessary to secure approval from competition regulators.
|“the Company, the Parent and Merger Sub shall use their best efforts to (i) take, or cause to be taken, all appropriate action and do, or cause to be done, and to assist and cooperate with the parties in doing, all things necessary, proper or advisable under applicable Law or otherwise to consummate and make effective the Merger and the other transactions contemplated by this Agreement as promptly as practicable, (ii) take such actions as may be required to cause the expiration of the notice periods under Competition Laws with respect to such transactions as promptly as practicable after the execution of this Agreement, (iii) obtain from any Governmental entities any consents, licenses, permits, waivers, approvals, authorizations or Orders”
|Originally seen as the highest standard, requiring a party to do essentially everything in its power to fulfil its obligation (for example, divestitures, demergers, or other transactions to obtain regulatory approval).
Reasonable Best Efforts
|“upon the terms and subject to the conditions set forth in this Agreement, each of the parties agrees to use reasonable best efforts to take, or cause to be taken, all actions, and to do, or cause to be done, and to assist and cooperate with the other parties in doing, all things necessary, proper or advisable to consummate and make effective, as soon as possible following the date hereof, the Mergers and the other transactions contemplated by this Agreement”
|Tempered by an express standard of ‘reasonableness’, this covenant requires substantial efforts from a party to secure the close of the transaction.
|“Subject to the terms and conditions of this Agreement, prior to the Effective Time, each of the Company, Parent and Merger Sub shall use its commercially reasonable efforts to take, or cause to be taken, all other actions and do, or cause to be done, all other things necessary, proper or advisable under applicable Law to consummate the Transactions”
|This covenant only requires actions to be taken by a party which are standard in the circumstances.
Commercially Reasonable Efforts
|“Subject to the terms and conditions of this Agreement, prior to the Effective Time, each of the Company, Parent and Merger Sub shall use its commercially reasonable efforts to take, or cause to be taken, all other actions and do, or cause to be done, all other things necessary, proper or advisable under applicable Law to consummate the Transaction”
|This covenant does not require a party to take any action that would be commercially detrimental, including the expenditure of material unanticipated amounts of management time.
|Good Faith Efforts
|This covenant allocates minimal, if any, competition risk.
This covenant only requires honesty by the party in fact and the observance of reasonable commercial standards of fair dealing. Good faith efforts are generally implied as a matter of law.
*risk allocation from most to least
As the spectrum of competition risk allocation in M&A table above indicates, on one end of the spectrum, parties are expected to engage in good-faith, and use their best, reasonable or commercial “efforts” (Efforts Covenants) to cause the successful close of the deal. These obligations were subject to dispute in the Anthem-Cigna and Sinclair-Tribune mergers. On the top end of the spectrum, we have seen the emergence of a new form of absolute risk allocation, the “Hell-or-High-Water” covenant (HOHW Covenant), an obligation rarely included and only recently critically discussed in the Akorn-Fresenius merger.
|Re Anthem-Cigna Merger Litigation
|The Efforts Covenant
|On 23 July 2015, Anthem, Inc. (Anthem) and Cigna Corporation (Cigna) (both being American healthcare and insurance companies) entered into a merger valued at USD$54 billion. At the time, Anthem and Cigna were the second and third largest health insurers in the United States. If completed, the resulting transaction would have created the nation’s largest health insurer. The Efforts Covenant in the Anthem-Cigna merger required that each party act in good-faith to close the merger and to use their reasonable best efforts to satisfy all of the conditions to consummate the merger.
|“Upon the terms and subject to the conditions hereof (including Section 5.3(c)), each party will use its reasonable best efforts to take, or cause to be taken, all actions, to do, or cause to be done, all things reasonably necessary to satisfy the conditions to Closing set forth herein and to consummate the Mergers and the other transactions contemplated by this Agreement.”
|After a permanent injunction prevented the Anthem-Cigna merger from closing, the parties respectively sued for damages. In the litigation that followed, Anthem argued, and the court agreed, that Cigna expressly breached the Efforts Covenant by conducting a ‘covert communication campaign against the merger’ and withdrawing from integration planning, a process critical to the logistics of how two separate entities would operate as one post-transaction.3
|Sinclair-Tribune Merger Agreement
|The Efforts Covenant
|On 8 May 2017, Sinclair Broadcasting Group, Inc. (Sinclair) agreed to acquire Tribune Media Company (Tribune) for USD$3.9 billion (both being large American television broadcasting companies). If the transaction obtained regulatory approval, Sinclair would acquire Tribune as a wholly owned subsidiary, meaning Sinclair stations would operate across 72% of all homes in the United States.
The Efforts Covenant in the Sinclair-Tribune merger required that each party take certain actions in order to facilitate regulatory approval and consummate the deal.
|“Subject to Section 7.1(j), Parent shall use reasonable best efforts to take action to avoid or eliminate each and every impediment that may be asserted by any Governmental Authority with respect to the transactions contemplated by this Agreement so as to enable the Closing to occur as soon as reasonably practicable, including … the prompt use of its reasonable best efforts to avoid the entry of, or to effect the dissolution of, any permanent, preliminary or temporary Order that would delay, restrain, prevent, enjoin or otherwise prohibit consummation of the transactions contemplated by this Agreement.”
|In 2018, Tribune terminated the merger and announced it was suing Sinclair for breach of its Efforts Covenant. Sinclair responded, filing a counterclaim alleging that Tribune breached the agreement by failing to use its “reasonable best efforts” to consummate the transaction.
The Sinclair-Tribune merger litigation turned on the failed actions of Sinclair to understand and execute its obligations under the Efforts Covenant to secure regulatory approval. Rather than divest of companies as advised to obtain regulatory approval, Sinclair engaged in protracted negotiations with regulators, refused to divest, and proposed alternate divestiture which would not assist but only delay regulatory approval. On 6 May 2020, the Federal Communications Commission fined Sinclair USD$48 million for its conduct.
Efforts Covenants in Australia
Efforts Covenants are some of the most popular ways to apportion competition risk in M&A. Unfortunately, they are also the most generic, often in the form of a boiler-plate firm precedent. The Anthem-Cigna and Sinclair-Tribune mergers highlight pitfalls in using generic antitrust risk-shifting provisions in merger agreements that fail to specify party-to-party obligations when the deal faces regulatory scrutiny. Although presenting unique issues, both merger disputes included accusations that one party failed to use “best efforts” to consummate the transaction.
To avoid similar disputes, parties should appropriately qualify what is required to discharge an Efforts Covenant—is one party expected to demerge or divest in key assets, and if so, is this obligation unconditional or are certain assets off limits? Australian dealmakers must stay vigilant to generic Efforts Covenants in merger agreements, or risk costly and complicated litigation.
A prevailing issue with both Anthem-Cigna and Sinclair-Tribune mergers was that the obligation of each party to obtain regulatory clearance was tempered by the parties’ subjective understanding of ‘effort’. To avoid this, and where regulatory scrutiny is all but guaranteed, target companies may wish to off-load competition risk absolutely to acquirers through the inclusion of a HOHW Covenant, a novel and relatively unexplored contractual provision in Australian M&A.
In contrast to Efforts Covenants, HOHW Covenants are drafted in an unrestrictive fashion, offloading all risk to the acquirer—as such, targets wishing to include this covenant can expect push-back from the acquirer. However, with ACCC reform looking to deem certain acquisitions anticompetitive (where one party’s substantial market power would be entrenched, increased or extended as a result of the acquisition), a HOHW Covenant may be necessary to ensure the merger proceeds in the event the ACCC opposes the transaction.
Terms of the Merger
On 24 April 2017, Fresenius Kabi AG (a German pharmaceutical company) (Fresenius) agreed to purchase Akorn Inc. (a Louisiana pharmaceutical company) (Akorn) for USD $4.75 billion (the Merger Agreement).
Within the Merger Agreement, the parties allocated risk through detailed representations, warranties, covenants, and conditions. Akorn made extensive representations about its compliance with applicable regulatory requirements and committed to use commercially reasonable efforts to operate in the ordinary course of business between signing and closing. Fresenius agreed to take “all actions necessary” to secure—and not delay—antitrust clearance.
|“[Fresenius Kabi] shall promptly take all actions necessary to secure the expiration or termination of any applicable waiting period under the HSR Act or any other Antitrust Law and resolve any objections asserted with respect to the [Merger] under the Federal Trade Commission Act or any other applicable Law raised by any Governmental Authority, in order to prevent the entry of, or to have vacated, lifted, reversed or overturned, any Restraint that would prevent, prohibit, restrict or delay the consummation of the [Merger]”
|The HOHW Covenant imposed a broad and onerous contractual obligation on the buyer to take all action necessary to secure approval from competition regulators. In the Australian context, this would require the Buyer to assess and implement steps, such as divestiture, to ensure that upon application to the ACCC no red flags are raised.
In this situation, Fresenius had the right to terminate the Merger Agreement if any of Akorn’s representations or warranties were not true and correct at signing or at closing which had the effect of resulting in a ‘Material Adverse Effect’.4 Importantly, however, Fresenius could not terminate the Merger Agreement if it was in material breach of its own contractual obligations.
The Cause of Dispute
After signing but before closing, Akorn’s business performance suffered an initial severe decline, followed by continued decline progressively thereafter. During investigation, Fresenius uncovered serious and pervasive data integrity problems that rendered Akorn’s representations about its regulatory compliance to the Food and Drug Administration inaccurate and misleading. This, Fresenius argued, caused Akorn to not operate in ‘the ordinary course of business’, providing Fresenius a basis for termination.
On 22 April 2018, Fresenius terminated the Merger Agreement. Akorn responded by filing an action against Fresenius for specific performance, arguing that Fresenius could not terminate the Merger Agreement because it had breached the HOHW Covenant. Fresenius counterclaimed, establishing grounds that it validly terminated the Merger Agreement and was not required to close.
Alleged breach of the HOHW Covenant
Fresenius explored two separate strategies to obtain regulatory approval. Option 1 would result in the merger closing in or around April of 2018. Option 2 would result in the merger closing in or around June or July 2018. By initially choosing Option 2, which would delay antitrust clearance by two months, Akorn submitted—with which the court agreed—Fresenius technically breached the HOHW Covenant. However, this breach was not material as Fresenius quickly abandoned Option 2 in favour of Option 1 for the Merger to close in April 2018.
Importantly, the court found that it was implicit within the HOHW Covenant that Fresenius had autonomy to explore options and strategies in obtaining antitrust approval; there was no single and obvious method for Fresenius to satisfy this obligation so long as they consulted with Akorn, and that ultimately, antitrust approval was obtained. This point is critical for Australian dealmakers. With ACCC reform expected to tighten the restraints for parties competing in concentrated markets, the absolute delegation of competition risk and autonomy may be an attractive option for parties in certain transactions.
Australia’s Regulatory Covenant Environment for 2022 and Beyond
ACCC reform is likely to revitalise and galvanize the regulation of anticompetitive mergers. With reform looking to international best practice, Australian dealmakers should look abroad and take note of tried and tested risk-shifting provisions. As seen in the Anthem-Cigna and Sinclair-Tribune mergers, Efforts Covenants are effective only when meticulously drafted. Furthermore, with ACCC reform looking to deem certain acquisitions anticompetitive, we are likely soon to see disputes arise like those in the Akorn-Fresenius merger. The inclusion of HOHW Covenants may therefore prove critical for targets operating in condensed markets who wish to delegate absolute autonomy and risk in obtaining regulatory approval to acquirers.
For more information, please contact Peter Williams, Mark Schneider and Timothy Flanagan.
2 Model Stock Purchase Agreement, supra, at 212 (citation omitted); see Ryan A. Salem, Comment, An Effort to Untangle Efforts Standards Under Delaware Law, 122 Penn St. L. Rev. 793, 800 (2018) (identifying five commonly used standards: good faith efforts, reasonable efforts, best efforts, commercially reasonable efforts, and diligent efforts).
3 Cigna Corp. v. Anthem, Inc., C.A. No. 2017-0114 (Del. May 3, 2021) at 204.
4 Material Adverse Effect Clauses, or “MACs”, are considered more extensively in Article III of our series.