Economic Analysis of Insolvency Resolution Plans: A Framework for Preserving Competition and Ensuring Viability
Ari
Second Year, B.Com LL.B, Gujarat National Law University
Neha Bhambhani
Third year, B.A LL.B, Institute of Law Nirma University
Introduction
Restructuring distressed companies through mergers and acquisitions (M&As) is a critical aspect of insolvency proceedings, impacting both the firms involved and the broader market competition. The intersection of Competition law and Insolvency Resolution Plans (IRPs) of distressed firms poses challenges for companies seeking to restructure. Companies must navigate these challenges to strike a balance between maintaining healthy competition and undergoing effective restructuring through IRPs. This requires careful consideration of competition regulations to ensure fair market practices while ensuring the viability of the IRP process.
This article delves into the complex interplay between insolvency and competition laws, particularly in the context of IRPs, to highlight the evolving regulatory landscape. The authors examine the need for a balanced regulatory approach that facilitates restructuring while ensuring market competition. The authors analyse the implications of the failing firm defence, which allows mergers even if they reduce competition, and discuss the potential benefits of merging distressed firms with larger entities. By providing a comprehensive overview of merger control under the Competition Act, 2002, and the international perspective on the failing firm defence, this article aims to underscore the importance of economically evaluating merger versus liquidation outcomes. Through a cost-benefit and economic impact analysis, the authors advocate for a regulatory framework that supports the restructuring of distressed firms while preserving market competition, ultimately serving the interests of investors, consumers, and the economy.
Merger Control in Competition Act, 2002
The advent of technology and the digital revolution has paved the way for the growth of new firms, resulting in increasing competition in the marketplace. As a result, there are more stringent laws dealing with companies that are distressed and in the process of restructuring. The CCI is a Quasi-Judicial Body responsible for promoting healthy market competition, emphasizing innovation and consumer welfare. The Competition Act 2002 prohibits anti-competitive agreements and abuse of dominant position. Section 5 defines the meaning of combinations and the threshold limit under various scenarios above which any merger and acquisition activities are considered.
The term ‘combination’ refers to the acquisition of one or more persons or enterprises acquiring one or more other persons or enterprises which includes Merger or Amalgamation. Section 6 of the Competition Act makes M&A activities by the enterprises void which is causing an ‘Appreciable Adverse Effect on Competition’. (AAEC). It is a situation where one enterprise is dominant and engages in unfair advantage without facing any competition, thereby creating a negative effect in the marketplace. To avoid such situations, the person or enterprise are required to give thirty days’ notice to the CCI disclosing every detail of the combination. The CCI will approve after examining the potential impact of the combination on AAEC.
Background of the problem
In India, anti-trust laws are implemented to cover the restructuring process of distressed firms. These firms are struggling to meet their financial obligations and are at the phase of bankruptcy, making it difficult for them to compete in the market. As these firms face prompt challenges, their exit will cause upheaval in the marketplace. The Competition (Amendment) Act, 2023 has brought new changes in section 6(2)(2A)for the approval of combinations, every such firm needs approval from the CCI and the commission has to pass an order within 150 days from the date of receiving notice to approve the combination or pass the appropriate order. Although the period has been decreased from 210 to 150 days, the process remains time-consuming and burdensome for distressed firms. The firms already lack resources and are struggling for survival, and the complex process only increases the challenges.
Additionally, the process of IRP is already multifaceted and involves opportunity cost, which often results in the loss of resources. The process requires resources like manpower, time, capital, legal expenses, and other professional fees to manage the restructuring of distressed firms. These resources can be used in the restructuring of distressed firms that can help revive them and protect all stakeholders and employees. The process of antitrust scrutiny of distressed firms should acknowledge the necessity to provide business-friendly ideas that create a balance between restructuring and competition. This can be done so long as these firms get flexibility in the restructuring process, aiding them in facing challenges and positive contributions to the economy.
International Perspective: Failing Firm Defence
The Failing Firm Defence as a concept has evolved in various developed countries. Generally, the firms are prohibited from going through a restructuring process that results in negative or reduced competition. The ‘failing firm defence’ argues that the merger and acquisitions of distressed firms should be allowed even if they decrease competition and worsen the market as they cause similar conditions when these firms exit the market. The European Union Merger Guidelines laid down three tests that need to be fulfilled for the applicability of the mentioned defence. The fundamental idea remains that the parties involved in the merger need to explain the effect of competition on the marketplace which would deteriorate even without a merger. First, the allegedly failing firm would, in the near future, be forced out of the market because of financial difficulties if not taken over by another undertaking. Second, there is no less anti-competitive alternative purchase than the notified merger. Third, in the absence of a merger, the assets of the failing firm would inevitably exit the market. The concept has been evolving as it recognizes the benefits of merging a firm to preserve market stability and prevent broader economic harm.
Striking a balance between Distressed firms restructuring and Competition by Economic Analysis
Balancing distressed firm restructuring and competition regulation is a key to ensuring fairness and efficiency in the market. Distressed firms often need restructuring like mergers to survive. However, this can increase market concentration and reduce competition in a few cases. The CCI thus scrutinises such mergers of distressed firms to prevent anti-competitive effects. On the other hand, under the IBC, the Committee of Creditors (CoC) aims to maximise returns for creditors by approving restructuring plans. This may lead them to prefer larger acquirers, raising competition issues. Overall, both CCI regulation and IBC restructuring play crucial roles. There is a need to strike a balance between the twin goals of keeping distressed firms afloat through restructuring and preserving market competition by preventing undue consolidation. The framework should aim to promote both firm survival as well as competition.
To assess the impact of such mergers, authors have done an economic analysis of restructuring such mergers:
1. Cost Benefit Analysis
Cost-benefit analysis is a systematic approach to evaluating the strengths and weaknesses of a proposed project or decision by measuring the expected costs against the potential benefits. Finding the right balance between corporate restructuring mechanisms for distressed firms and preserving market competition involves navigating complex trade-offs. When a company faces insolvency, two main options arise – liquidation or merger by a larger player. Each route entails distinct economic costs and benefits.
Liquidating the distressed firm via selling its assets and repaying the creditors to some extent but loses jobs and economic activity. Additionally, it impacts competition ambiguously – the firm’s exit increases others’ market share but also removes an inefficient player. On the flip side, acquisition by a dominant player infuses capital and keeps operations afloat, benefiting creditors through potentially better repayment and the economy via preserved jobs. However, it risks increasing market concentration and dampening competition.
Thus, while liquidation ensures creditors are compensated, it can reduce productivity. Similarly, although a merger supports the continuity of the distressed firm, it may weaken competitive forces in the market. There are merits to both approaches and the trade-offs are complex. Perhaps a balanced framework that allows judicious liquidation or restructuring of non-viable firms, while monitoring acquisitions for undue consolidation, can help strike an optimal balance between the twin goals of keeping distressed firms alive and preserving market competition. This might lead to adverse impact on competition in some cases but the same adverse impact can arise in the case of liquidation of the firm as well.
Comparing the two options, acquiring a distressed firm can lead to a more optimal outcome for creditors and the economy. While liquidation may seem like a straightforward way to repay creditors, its long-term effects on the economy and competition must be taken into account. In contrast, acquiring a distressed firm can lead to a more optimal outcome for both creditors and the economy, as it preserves jobs, maintains economic activity, and can lead to the revival of the distressed firm.
Moreover, the argument that liquidation avoids adverse effects on competition is not entirely accurate. Even in the case of liquidation, the exit of the distressed firm can lead to increased market share for other companies, potentially resulting in reduced competition as the share of the firm that exits the market will be gone to other firms and potentially the big firms of the same sector. Therefore, the benefit of merging a distressed firm with another company is always going to be greater than the cost incurred for the same.
2. Economic Impact Analysis
Economic impact analysis evaluates the effects of a firm, project, or sector on the economy, including production, jobs, and taxes. In an economic impact analysis comparing the liquidation of a distressed firm versus its merger with another company, the implications for the economy are significant.
Liquidating the distressed firm stops operations, causing job losses, reduced economic activity, and decreased market competition per se. This can have a ripple effect on suppliers, customers and the wider economy. Lessened competition itself may enable surviving players to raise prices and disincentivise innovation, ultimately slowing economic growth.
In contrast, merging the distressed firm with another entity presents revival potential. The acquiring company can inject much-needed capital and resources to help the distressed firm recuperate. This preserves employment, maintains economic activity, and promotes economic growth. Additionally, the merger can create synergies between the two enterprises, forming a more competitive combined entity.
From an economic standpoint, merging distressed firms is preferred to liquidation. Besides saving jobs and sustaining economic activity, merger aids long-term economic expansion by enabling continued operations. This allows the distressed firm to keep contributing to its employees, suppliers, and the overall economy. Hence, a merger entails both maintaining the status quo and enabling future value creation through synergy.
Therefore, it is in the best interest of the economy to encourage the merger of distressed firms with other companies. Government policies and competition regulations should support such mergers, relieving distressed firms and promoting a competitive market environment. This approach not only saves valuable resources but also contributes to the overall health and growth of the economy.
Way Forward
The authors have identified several key recommendations that can be considered. Firstly, enhancing transparency and consultation between competition authorities and insolvency professionals can ensure effective coordination. Secondly, implementing a pre-merger notification regime for IRPs can prevent mergers that harm competition. Thirdly, promoting competition advocacy to educate stakeholders about the intersection of competition and insolvency laws. Fourthly, the Implementation of government policies such as providing tax benefits, financial backing, and regulatory release will help distressed firms undertake restructuring measures without harming competition. Importantly, there has to be a continuous tracking and monitoring process to evaluate any challenges and identify prospects for improvement in the restructuring process. These measures can help maintain a competitive market while facilitating efficient insolvency resolutions for distressed firms.
Achieving an optimal balance between corporate restructuring of distressed firms and maintaining market competition warrants relaxing competition regulations for struggling companies. Instituting can expedite approvals through implementation of green channelling for mergers of distressed entities which can accelerate the process and preserve market efficiency. Such leniency does not inexorably undermine competition. Rather, it enables faster resolution of insolvent firms, freeing up tied resources through curtailed insolvency proceedings. Additionally, facilitating the consolidation of distressed and healthy firms helps conserve employment, sustain economic activity, and promote long-term growth.
In conclusion, the interplay between merger, competition, and insolvency laws underlines the importance of creating a balance between restructuring of distressed firms and competition rules. Economic analyses suggest that merging distressed firms would benefit stakeholders and the economy as a whole. Thus, policymakers should engage themselves in formulating policies with a balanced regulatory approach that promotes insolvency and market competition to protect sustainable economic growth.
