United Kingdom: Merger control – the effect on banking transactions

Author: | Published: 1 Oct 2009
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It is widely known that certain mergers and acquisitions must be notified to the European Commission under the EC Merger Regulation (ECMR). Where the ECMR does not apply, it may be necessary to notify the transaction to national competition authorities in the EU. Filings outside the EU may also be required. Additionally, in the UK, where there is no compulsory notification procedure, it may be desirable to notify a transaction to the Office of Fair Trading (OFT) if there is a risk that it could be referred for further investigation to the Competition Commission (CC).

However, it is less widely appreciated that merger control does not apply only to mergers and acquisitions. Merger control laws apply whenever there is a change of control and the jurisdictional tests for its application (in the EU and most European national jurisdictions this is based on turnover thresholds) are met. The type of transaction that is caught by a merger control system will depend upon how change of control is defined. Under the ECMR, whether the acquisition of a minority shareholding will amount to a change of control will largely depend on the rights which are attached to the shareholding under the shareholders' agreement. By contrast, in the UK system, the acquisition of even relatively modest minority stakes can – regardless of any shareholders' agreement – be regarded as giving rise to a change of control. This was the case in the acquisition of a 17.9% holding in ITV by Sky, which was ultimately blocked by the CC.

In both the EU and the UK systems, restructurings, private equity acquisitions and leveraged acquisitions may be subject to the merger control rules, depending on the terms of the deal and the size of the parties.

ECMR

Acquiring control

The ECMR applies to concentrations. These are transactions in which two undertakings merge, or an undertaking acquires sole control of another, or two or more undertakings acquire joint control of another undertaking. In this context, control means the "possibility of exercising decisive influence" over the target. Whether an acquirer will have control of the target depends on the rights that it will be able to exercise directly or indirectly over the target. This includes rights arising from the acquisition of securities, contractual rights (for example, under a management contract or joint venture agreement) or other rights.

Acquiring a majority shareholding will clearly confer control on the acquirer; acquiring a minority shareholding may also do so. First, this will be the case where, despite the fact that its holding is less than 50%, previous records of attendance at shareholders' meetings indicate that the minority shareholder will be able to exercise sole control. Indeed, Electrabel was recently fined €20 million for failing to notify the European Commission of the acquisition of a minority shareholding in these circumstances. Second, the minority shareholder will control the target if the shareholder otherwise has the power to determine the strategic commercial behaviour of the company by exercising important rights. It could do so through, for example, the power to appoint more than half of the members of the supervisory or administrative board. It is also possible for two or more undertakings to jointly control a target where they must reach agreement on major strategic decisions concerning the undertaking. This is the case where minority shareholders must agree on, or can veto, decisions which are essential for the strategic commercial behaviour of the undertaking. This includes the approval of the company's budget or business plan, significant items of capital expenditure and the appointment or removal of senior executives.

In relation to the types of transactions typically entered into by banks:

  • the definition of control makes it unlikely that control can be acquired by a debt transaction. (This might not be the case where the debt carries rights similar to those rights that would confer joint control on a minority shareholder.);
  • a restructuring where debt is converted into equity but, after the restructuring, the equity will be divided among a large number of institutions, none of which will individually have any of the controlling rights referred to above, will not confer control;
  • a restructuring could result in control being acquired by the converting creditors where one creditor will have over 50% of the equity (or less than 50% but a sufficient holding, based on past voting figures to ensure a majority at shareholders' meetings) or where there are contractual rights which confer joint control;
  • where private equity funds take minority shareholdings, the funds will control the portfolio company where they are entitled to exercise the rights referred to above as conferring control;
  • where a private equity house has previously invested in a company and controls it for the purpose of the ECMR, a filing will not be required on a second round of financing unless there is a change in the nature of control (from sole to joint control or vice versa) or if a new controlling shareholder is also being introduced.

Turnover thresholds

If the transaction results in one or more shareholders having control of the target, the next question is whether the transaction meets one of the two sets of turnover thresholds [See Table A] for the application of the ECMR (this is known as having a Community dimension). If the thresholds are met, the transaction must be notified to, and approved by, the Commission before closing. It is irrelevant that the transaction has no impact on competition, although, in certain cases, such transactions can be notified in short form.

Table A: Turnover thresholds
As set out in Article 1, paragraph 2: As set out in Article 1, paragraph 3:
Worldwide turnover threshold:
combined worldwide turnover of €5 billion
Worldwide turnover threshold:
combined worldwide turnover of €2.5 billion
EU turnover threshold: EU-wide turnover of each of at least two parties €250 million EU turnover thresholds:

Worldwide turnover of each of at least two parties €100 million

Combined turnover of all the parties in at least three Member States €100 million

In each of three of those same Member States, turnover of each of at least two parties €25 million
Two-thirds rule: if two thirds of EU-wide turnover of each party is in one Member State, that Member State, and not the Commission, will have jurisdiction

If a single institution (such as a bank or private equity fund) is investing in a start-up company which is not controlled by any other person and has no (or minimal) turnover, the transaction will not be subject to the ECMR. This is because the ECMR requires that at least two undertakings must have sufficient turnover in the EU. However, the ECMR does not require that one of the two undertakings be the target. As a result, the ECMR can apply where two undertakings acquire joint control of a newly formed company (or joint venture) or where the investment is syndicated and two or more institutions will thereafter jointly control the target.

Assessment by the European Commission

Within 25 working days of notification (Phase I), the Commission must decide whether the ECMR applies and, if it does, whether the concentration can be cleared within that 25-working-day period or whether it raises serious competition concerns so as to require full investigation. The 25-working-day period is increased by 10 days where the parties propose remedies to ameliorate the damage to competition identified by the Commission, such that the Commission can approve the transaction. Where a full investigation is required, the Commission must complete its investigation within a further 90 working days (Phase II), although this period may be extended in various circumstances.

Where the Commission, having undertaken a Phase II in-depth investigation, cannot give outright approval to the concentration, it can either prohibit it or permit it subject to remedies, in the form of conditions or obligations on the parties. Such obligations could include modification of the concentration or divestment of other assets or businesses held by any of the parties.

The test against which concentrations are assessed is whether they will significantly impede effective competition in the EU or in a substantial part of it, in particular as a result of the creation or strengthening of a dominant position. A number of acquisitions by private equity funds have raised difficult issues. For example, in 2001, the Commission prohibited a private equity investment because the acquirer already controlled the target's principal rival in the EU and its only US rival in a number of fibre markets.

UK merger control

Acquiring control

Where the ECMR does not apply, the merger provisions of the Enterprise Act 2002 (the EA) may do so. As explained below, the definition of the transactions that are caught by the EA is significantly wider than those that are caught by the ECMR. In fact, there have been transactions where the parties have, in response to difficulties under the ECMR, restructured the transaction in order to take it outside the ECMR, only to find that it falls within UK merger control (as in the Microsoft/Telewest/Liberty Media case).

The EA regulates "relevant merger situations". A merger situation arises where two or more enterprises "cease to be distinct". This happens when there is a change of control or ownership of an enterprise. A change of control occurs where a person's interest in an enterprise reaches one of three levels. The levels of control are as follows:

(a) the acquisition of the ability to exercise material influence. A shareholding of 25%, enabling the acquirer to block special resolutions, will usually amount to material influence, even if all the other shares are held by one person; and a shareholding of 15 to 25% may give material influence, depending on other shareholders' interests. Occasionally, a holding of less than 15% may amount to material influence where there are other factors that suggest an ability to exercise influence over the enterprise's policy;

(b) the acquisition of the ability to control policy (that is, de facto control). This arises when the acquirer has a sufficiently large shareholding and/or other rights in the target to enable it, in practice, to control the policy of the target, even though it has less than 50% of the voting rights; and

(c) the acquisition of outright legal control. This normally means a shareholding with more than 50% of the voting rights in the target.

A relevant merger situation arises either when control, at whatever level, is first acquired by the party concerned or when someone who already has control (at the material influence or de facto control level) acquires a higher level of control.

Investigation thresholds

A merger situation will be a "relevant merger situation" and will qualify for investigation under the EA where either the turnover test or the share-of-supply test is satisfied:

(a) the turnover test is satisfied when the annual UK turnover of the enterprise which is being acquired exceeds £70 million;

(b) the share-of-supply test is satisfied when, as a result of the merger situation, at least 25% of all the goods or services of a particular description are supplied or consumed in the UK (or a substantial part of it) by the acquiring group and the target. The share of supply test is not a market share test and is not based on an economic assessment of the market. Generally, the OFT will have regard to the narrowest reasonable description of a set of goods or services to determine whether the share-of-supply test is met. If the merger does not result in any increase in the share of supply or acquisition of any product or service in the UK at all, the test is not satisfied. If, however, one of the parties already has a share of supply or acquisition exceeding 25%, any enhancement, no matter how small, will mean that the merger situation qualifies for investigation.

The definition of control means that a leveraged acquisition, debt-to-equity restructuring and private equity investment will generally involve the acquisition of control. As under the ECMR, it is unlikely that control can be acquired by a debt transaction (but this might not be the case where loan documentation gives the lender rights which would confer control on a minority shareholder).

In practice, a restructuring or buyout is unlikely to be referred to the CC unless it gives rise to competition issues. The test which the CC applies in deciding whether to block a merger is whether it results, or would result in a substantial lessening of competition within any market or markets in the UK. If such issues arise, they will do so from any horizontal or vertical overlap between the target and the controlling shareholders, together with any other businesses under their control.

An example occurred in the late 1980s when Gillette acquired an interest in the consumer products division of Stora, which included the wet-shaving business of Wilkinson Sword, Gillette's principal competitor. Gillette acquired a 22% non-voting equity interest and a tranche of mezzanine debt. The Monopolies and Mergers Commission (MMC – the predecessor to the CC) decided that this gave Gillette the ability to exercise material influence (and therefore control) over Wilkinson Sword's commercial policy. The MMC found that the overlap between the companies created serious competition problems and, as a result, Gillette was required to divest its interest in Wilkinson Sword.

A more recent example occurred when Terra Firma acquired UCI Cinemas. This created a competition issue because funds controlled by Terra Firma had previously acquired Odeon, the largest cinema exhibitor in the UK. Prior to the acquisition, UCI was the fourth largest cinema exhibitor in the UK and the acquisition gave Terra Firma a share of cinema exhibition of 25 to 35% in the UK (representing a 10% increase). The OFT was not concerned about the loss of competition at the national level as distributors had, and would continue to have, a strong negotiating position relative to the exhibitors depending on the attractiveness of the films that they offered. The OFT was, however, worried about competition in 11 local markets (based on the distance consumers are able or willing to travel to the cinema). Ultimately, Terra Firma gave undertakings to divest cinemas in the affected areas in order to address the OFT's concerns, which the OFT accepted in lieu of making a reference to the CC.

Assessment process

The EA is a voluntary system of merger control, except in the water sector. This means that there is no penalty for failing to notify a merger. However, for a period of four months from the time that the merger comes to the OFT's attention, the OFT may refer a completed merger to the CC for an in-depth investigation. The four-month period starts to run when material facts about the merger have been (i) notified to OFT, or (ii) made public. Failure to seek clearance from the OFT means that, if a reference is made after completion, subject to any contractual arrangement between the parties, the risk of the reference to the CC is with the purchaser. Although the CC may, following an adverse reference, impose a range of remedies on the merged businesses including divestment, it may not require the vendor to repurchase the business.

There are two ways of making a full notification to the OFT, either informally (before or after completion of the transaction) or by using the formal Merger Notice (only for pre-notification of proposed mergers already in the public domain). Following the statutory pre-notification procedure, the OFT must consider an anticipated public merger within 20 working days, with a possibility of a maximum of 10 working days' extension. Subject to some exceptions, a merger is automatically cleared if, by the end of the time period, no reference has been made.

If the CC concludes that the merger may result in a substantial lessening of competition, it will go on to decide whether action should be taken by it or by others for the purpose of remedying, mitigating or preventing the substantial lessening of competition, and what the action should be. In some cases, it might recommend that the merger should not take place. It can also recommend that assets, shares or interests in shares already acquired should be disposed of, or that the merger should only be allowed subject to conditions. Following consultation on its provisional findings and proposed remedies the CC will publish its report.

As mentioned above, there is no requirement that transactions over which the OFT has jurisdiction be notified to it and therefore that they be conditional on clearance being given. This means that a transaction can be investigated after closing has taken place and, ultimately, divestments can be required. A divestment may mean that a shareholder who has had to sell its shares in a forced sale will take a loss on its investment. However, there are likely to be unfortunate consequences for others too. There may be other shareholders who took their interests because of the strategic links between the divesting shareholder and the target company (as was the case with Gillette and Wilkinson Sword). If so, other shareholders such as private equity houses may see the value of their investments decline as the strategic links between the target company and the divesting shareholder have to be severed. Banks that have loaned to the acquisition vehicle will need to consider how the removal of the divesting shareholder (and therefore the strategic link) affects the value of the target, since it may affect the target's ability to service the debt and the value of the security where there is a default under the loan agreement. Other shareholders and investors will also need to consider whether it has an impact on their anticipated exit from the company (for example, by trade sale or flotation).

About the author

Sam Szlezinger is a partner in, and head of, Denton Wilde Sapte’s Competition and EU Law practice and specialises in UK and European competition law. He has 18 years of experience advising on, and seeking clearance of, mergers and joint ventures from the UK and EU authorities. 

Outside merger control, Sam has a strong cartels and behavioural practice. He also represents clients in contentious cases involving competition law. Recently, he successfully represented the British Horseracing Authority in the first Court of Appeal case to consider Article 82 abuse of dominance issues.
Contact information

Sam Szlezinger
Denton Wilde Sapte

One Fleet Place
London
EC4M 7WS
UK
Tel: +44 (0)20 7242 1212
Fax: +44 (0)20 7246 7777
www.dentonwildesapte.com


About the author

Jonathan Tatten is a consultant to, and former managing partner of, Denton Wilde Sapte. Jonathan has very wide experience of advising on competition law including merger control. He regularly advises clients on the compatibility of agreements and projects with EC competition law and on the application of state aid law. Jonathan is particularly known for his litigation experience which, in addition to competition law, includes advising on wider issues of European law.
Contact information

Jonathan Tatten
Denton Wilde Sapte

One Fleet Place
London
EC4M 7WS
UK
Tel: +44 (0)20 7242 1212
Fax: +44 (0)20 7246 7777
www.dentonwildesapte.com