Make do and mend: The European Commission changes merger referral policy to catch non-reviewable deals

In a recent speech, Margrethe Vestager revealed the European Commission’s plans to use an existing EU Merger Regulation instrument to address a perceived enforcement gap in present day EU merger control.

This enforcement gap refers largely to the practice by big tech (and also pharma) of buying up innovative start-up players (or pipeline drugs) with low (or no) turnover. These types of transactions will typically fall below EUMR thresholds and so the EC would not have an apparent route to review.

The EC’s plan is to dust off Article 22 EUMR and start accepting referrals of transactions from EU Member States which may adversely affect competition, even if they fall below the merger control thresholds of that Member State.

This would give rise to a significant change in the fundamental structure of merger control in Europe. It would also have far-reaching consequences for dealmakers, most notably in terms of legal certainty, sell-side risk and timing.

Back to the future: The genesis of Art 22

The EUMR established a system of mutually exclusive jurisdiction between the EC and the EU Member States. Concentrations that have an EU dimension are exclusively reviewed by the EC. Concentrations that do not are either subject to national merger control rules or are not reviewable at all.

Article 22 provides an exception to this system. It allows a Member State to request the EC to examine a concentration that does not have an EU dimension. This is technically possible whether the Member State has the power to review the transaction itself or not, provided that the transaction affects trade between Member States and threatens to significantly affect competition in the Member State.

This provision was originally introduced at the request of the Netherlands and as a result is still referred to as the “Dutch clause”. The concern was to do with Member States that did not, at the time, have their own merger control regimes. A transaction could fall below the EUMR thresholds but still significantly adversely affect competition within a Member State. If that Member State did not have its own merger control rules, the transaction would go unchecked.

It was widely expected back then that the provision would slowly wither into oblivion. Particularly as, within a few years, all Member States (except Luxembourg) did adopt their own merger control regimes.

But this is not what happened. Article 22 remained in place as a mechanism allowing Member States to reallocate reviews to the EC when the EC is the best-placed authority. Typically, this has implied that Member States, or at least some of them, requesting the referral have jurisdiction.

The limitations of Article 22

In practice, Article 22 has been rarely used. The EC and Member States prefer to encourage merging parties to request a referral up at the pre-notification stage (Article 4(5)) if, for example, markets are European or global in scope and the EC is deemed best placed.

This is, in part, because Article 22 is not properly fit for purpose. The premise of the EUMR referral system is to ensure transactions are dealt with by the best placed authority. But, under Article 22, the EC is only granted jurisdiction over the territories of the Member States that referred the case to it. While parallel review continues in any Member State that choose to retain jurisdiction. This can lead to multiple proceedings and potentially inconsistent outcomes (e.g. Procter & Gamble/Sara Lee Air care).

The advantage of a 4(5) pre-notification referral is that the EC acquires full jurisdiction (i.e. covering all Member States). But a pre-notification referral requires that at least three Member States have jurisdiction.

Since 2004, Member States have only made 33 referrals under Article 22 (0.6% of total notified cases). This compares with 368 referral-ups requested by the notifying parties.

There is also some legal controversy around referrals to the EC by a Member State if the transaction is not notifiable in that Member State (in particular if it is the Member State initiating the referral-up request). The "Dutch clause" was never intended as a tool to create EU jurisdiction for small mergers that fell below all existing merger control thresholds. Until now, the EC’s policy had been to discourage such referrals.

Impact on Parties and Deal Documents

The proposed policy change will have significant consequences for deal makers both in terms of certainty and timing.

First, call-in is possible in some jurisdictions (e.g. the US, Canada and the UK) and so some uncertainty as to jurisdiction is not novel. In the EU system, however, such a call-in possibility did not exist or was not deemed a realistic prospect (given the policy towards Article 22). Although it remains to be clarified via guidance when the EC and Member States will use Article 22 in this way; this proposed change in practice raises the possibility that the EC and Member States can cooperate to call in a merger with no or limited turnover in the EU for review by the EC based on elimination of potential competition grounds.

Importantly, under the EUMR, once merging parties are informed that a referral request has been made by a Member State, the suspension obligation applies. Breach comes with a risk of fines of up to 10% of global turnover and invalidity of any share transfer. So, whilst in the US and UK a call-in is viewed as a buyer risk, in the EU, referral-up by a Member State before close will also present a seller risk.

Secondly, there are serious timing issues. If a transaction falls below the mandatory notification thresholds in a Member State, that Member State is able to make a referral within 15 working days from the time the merger was “made known” to it. The EC’s Notice on Case Referral clarifies that this goes beyond mere knowledge of the merger and requires “sufficient information to make a preliminary assessment” of the criteria for making a referral request. Namely that the merger significantly affects competition within the Member State and affects trade between Member States. So, the terms of a standard press release about the deal is unlikely to be sufficient to set time running.

In practical terms

Pending further guidance from the EC:

  • Going forward parties will need to provide for an Article 22 referral in their SPA, even if neither the EC nor any Member States have jurisdiction. Although, to date, rarely invoked, Article 22 is boilerplate in most agreements where the deal triggers national filings within the EU. It is not, however, a feature of agreements which do not trigger any filing requirements within the EU.
  • Sellers will need to provide for the possibility that a ban on closing may be triggered by a referral-up request by a Member State. For deals which have closed before such an event, no breach of the suspension obligation will occur and sellers will be able to insist on closing. But if the parties are notified by the EC of a referral request, they can no longer close until clearance is obtained (at risk of significant fines and invalidity of share transfers).
  • Some bidders may want to insist on a standstill period (particularly in digital or pipeline deals) before closing occurs, even if there is no mandatory suspensory conditionality, in order to avoid unwinding of the deal at their expense.
  • Deal publicity and disclosure of facts relevant to the Article 22 criteria will become an important factor in setting the 15 WD clocks ticking. Merger parties will need to consider whether potential complainants may avail themselves of this mechanism, inciting one or more Member States to request a referral up and thereby cause delay, remedies or in the worst case, prohibition.