New risks in M&A: EU's revised Article 22 Referral Policy and Mitigation Strategies for Business

The European Union has adopted a bold new approach towards the use of the referral mechanism set out in Article 22 of the European Union Merger Regulation ("EUMR"). As a result, transactions which do not qualify for review under merger control regimes in Member States can now be referred to the European Commission for assessment and approval.

On 20 April 2021 the first referral under this revised system was accepted by the European Commission in relation to the acquisition of the US-based healthcare company GRAIL by Illumina, Inc. ("Illumina/GRAIL").

This marks the beginning of a new chapter in merger control in Europe. Jurisdiction to assess mergers, whether at a national or EU-level, was formerly determined by applying bright-line tests which typically related to the turnover of merger parties in relevant jurisdictions. This provided a high degree of legal certainty, enabling businesses to identify in advance merger control clearances required for an envisaged transaction and evaluate related risks and timing implications for closing.

The revised use of the Article 22 referral system introduces considerable legal uncertainty and risk. It presents significant practical challenges for deal planning and execution. Merger parties will now need to consider the conditions for referral under Article 22 EUMR, assess referral risk and, in appropriate cases, consider means to mitigate such risks, for instance through informal consultation with competition authorities and the inclusion of appropriate conditions in transaction documents.

Completed transactions may be subject to referral and review under Article 22 EUMR, a notable departure from conventional practice under the EUMR.

These and other practical and strategic considerations are explored in this alert, as is the recent referral of Illumina/GRAIL.

Article 22 EUMR – original purpose and reform

Article 22 EUMR allows one or more Member States to request that the European Commission ("Commission") examine a concentration that does not have an EU dimension (i.e., does not meet the turnover thresholds under the EUMR). A referral request may be made where a relevant transaction: (1) affects trade between Member States; and (2) threatens to significantly affect competition within the Member State(s) making the request (see here for our previous bulletin on this issue).

Article 22 EUMR originally provided a means for deals to be referred to the Commission for assessment by Member States which did not have their own national merger control laws. Historically, the Commission advocated the limited use of Article 22 EUMR.

In recent years there has been much debate around the scrutiny of so-called "killer acquisitions", in which an incumbent market player buys an emerging rival, eliminating the threat of future competition. Such acquisitions, most often alleged to occur in the digital, pharmaceutical and life sciences sectors, sometimes escaped merger control scrutiny in Europe given the low turnover generated by the target businesses.

Guidance issued by the Commission on 26 March 2021 (the "Article 22 Guidance") set out a radical change in policy in relation to Article 22 EUMR, in part to address concerns around killer acquisitions. Importantly, however, revisions in the Article 22 Guidance are wide-ranging and are not confined solely to deal activity within any specific sector. (For instance, senior Commission officials have noted that the new Article 22 policy may be applied to acquisitions involving credit ratings agencies.)

The Commission has indicated that it is targeting deals where turnover values do not reflect accurately the actual or future competitive potential of a business. This will include instances where a business has access to competitively significant assets, such as raw materials, infrastructure, intellectual property rights or data, or the products or services a business provides are key inputs for other industries. The Commission will also take into account whether the deal consideration is high compared to the current value of a target business. Further relevant factors are identified below.

The Article 22 Guidance also explains that referrals may be made in relation to both proposed and completed transactions.

As a rule of thumb, the Commission considers that it will generally not find a referral appropriate if closing has taken place more than six months ago. If closing has not been made public, this six-month period would run from the date material facts on the transaction have been made known in the EU (although, as discussed below, the Article 22 Guidance does not clarify what information must be in the public domain to meet this threshold). The Commission does not exclude a later referral in exceptional cases, for instance regarding transactions that may raise significant potential competition concerns or have a significant detrimental impact on consumers.

What does it mean in practice?

It is no longer sufficient to look at the overall (worldwide, EEA and national) turnovers of the acquirer and the target in order to predict whether a transaction will require prior merger approval.

The parties should assess whether the transaction may or may not have a significant impact on existing or potential competition within the EU. Such an assessment may be complex and burdensome, especially in dynamic markets specifically targeted by this new approach.

Should you feel concerned by the new approach?

It depends on who you are or who you are looking to acquire. Ask yourself the following questions:

The following factors also increase the likelihood of request(s) for referral:

• the target is active in the biotech, pharma, digital, or ratings agency sectors;
• the transaction is likely to give rise to concerns by any competitor or customer: in the Article 22 Guidance, third parties (competitors, customers, but also e.g., trade associations) are encouraged to inform the Commission of transactions which should, in their opinion, be subject to a referral; and/or

the transaction is subject to merger in-depth investigations outside the EU: this could be perceived as an indicia of a potential competition concern for the Commission (see e.g., the recent Illumina/GRAIL case).

What should you do if the transaction falls under any of the “yes” categories above?

You should immediately inform your corporate and competition teams/external lawyers so that they can carry out a more thorough assessment.

In the meantime, already start discussing tactics: should you make upfront contacts with the relevant national competition authorities ("NCAs") and/or the Commission to obtain some kind of comfort that the transaction will not be referred to or examined by the Commission? What is your fall-back position in case the NCAs/Commission do not reply? Should you sign and close your transaction simultaneously and take the risk of a post-closing referral request?

There is no standard answer to these questions and every option has its pros and cons. Your competition team and external lawyers will assist you in defining the best strategy, as a case-by-case analysis is required.

What are the practical implications for you?

Impact on transaction timing

From the point the Commission informs parties that a referral request has been made, they must not implement the transaction until the Commission decides to reject the referral request or, if it accepts it, until it issues a clearance decision. This can delay implementation several weeks and up to several months (or more if the Commission decides to open an in-depth Phase 2 investigation).

However, up to the point that the Commission informs them of a referral request, parties can implement (i.e., complete) a transaction.

If they do this they are taking a risk since the Commission could subsequently decide that they must unwind all/ part of the transaction. Parties should therefore take this risk into account in considering the level of integration they undertake post-closing in the period during which they are at highest risk of a referral (c.6-months following implementation being made public).

Given the uncertainty in both of these options, if parties (with their advisors) consider that there is a risk of a referral, they will need to consider whether proactively to contact NCAs and/or the Commission to get some degree of clarity as to the likelihood of referral.

The timing for a decision on a referral is as follows:

• NCAs have 15 working days from the date on which the concentration is "made known" to the Member State concerned to decide on a referral to the Commission. Parties may want to trigger this period to have certainty (i.e., if no referral is made then they can close).
  • However, the trigger is unclear: the Article 22 Guidance provides very little guidance as to what "made known" means, merely referring to "implying sufficient information to make a preliminary assessment".
  • This vague indication has already raised numerous practical questions on the substance of such information, all the more so since: (i) there is currently no formal procedure for an NCA/the Commission to confirm that the information is sufficient; and (ii) NCAs’ views could differ as to what information is deemed sufficient. A press release seems unlikely to be sufficient. Parties should therefore consider submitting a legal memorandum with sufficient information, which may need to include a preliminary competitive assessment, to each relevant NCA (and potentially also the Commission).
• If no referral is made at this point, the process ends. Parties would have some comfort that they can close without the risk of a subsequent referral being made (although even in these circumstances full certainty may not be available due to the ambiguity around the meaning of "sufficient information").
• If one or several NCAs decide(s) to formally request a referral of the case to the Commission, the Commission must "without delay" inform the other NCAs and the parties. As noted above, from this point the parties cannot implement the transaction (but are not prohibited from continuing to integrate if they have already closed the transaction, i.e., there is no obligation to 'hold separate').
• The NCAs have a further 15 working days to join the request.
• The Commission then has a further 10 working days to decide on the referral request (i.e., to reject the request or accept it).
• In practice, the factors above mean that from the point a transaction is "made known" to the NCAs, companies will have to wait up to c.8 weeks to receive a decision on the referral. If the decision is to reject the referral, the process ends and the parties can close.
• However should the Commission accept the referral, the parties would then need to notify the transaction, which would delay closing for several additional months. The Commission review period can take from 5 weeks (for a Phase 1 clearance without remedies) to 6 months (Phase 2 clearance), starting from the date of formal notification. Ahead of the formal notification, in complex cases - such as those that are likely to be subject to referral requests - the informal pre-notification period may extend to several months.

Impact on target valuation

As the Commission has to accede to a request for referral, and it is more inclined to do so if the deal raises competition concerns, it follows that transactions subject to referral will likely present higher antitrust risks (and may be more likely to require remedies to achieve clearance). Bearing in mind the possibility of referral, the acquirer/parties should carefully assess antitrust risks, including the possibility of potential remedies (including divestiture remedies), which may entail revisions to valuation.

All these implications need to be reflected in the transaction documents

• A long stop-date accommodating possible referral scenarios.
• A related condition precedent.
• Appropriate cooperation obligations requiring the seller to assist if a referral request is made.
• The seller may also consider requiring the purchaser to provide a substantive competition analysis on the (lack of) risk of referral, and appropriate protections in the event of remedies/prohibition of the transaction, e.g. a "hell or high water" clause or a "reverse break fee".

Does it mean that the parties should reach out to all 27 Member States ? Learning from Illumina/GRAIL

It seems that some NCAs may be more likely than others to request referrals to the Commission.

Indeed, the French Competition Authority ("FCA") had called for the Commission’s new approach to Article 22 referrals and has already referred one case, Illumina/GRAIL, which the Commission has decided to examine. The Slovakian authority also stated that it had no objection to the new policy.

Conversely, it has been reported that the Spanish, Austrian, Slovenian (and potentially Hungarian) authorities are unlikely to refer deals which do not fall within the scope of their domestic national rules since they have expressed concerns as to the legality of such referrals.

Illumina/GRAIL sheds some interesting light on the potentially divergent views among NCAs.

This deal between two US-based companies active in the bio-tech sector did not satisfy the turnover thresholds under the EUMR or the applicable domestic thresholds in any EU Member States. As such, the transaction did not require merger control clearance in the EU. In February 2021 – i.e., ahead of the publication of the Article 22 Guidance - the Commission actively invited NCAs to refer the case to it under Article 22 EUMR. A referral request was made by the FCA and joined by five other NCAs (in Belgium, Greece, Iceland, Norway and the Netherlands).

It is reported that some NCAs expressly considered either that they were not empowered to make a referral request (Slovenia, Spain and Austria) or that the conditions for referral under Article 22 EUMR were not met in their Member State (Latvia, Lithuania). It is understood that some NCAs (Ireland, Slovakia) also argued they did not have sufficient information to decide on a referral.

Illumina challenged the decision of the FCA to request a referral to the Commission and filed an injunction against the Dutch State to try to stop it from joining the French request. Both actions were dismissed.

While the French court only ruled on procedural aspects, the Dutch court dismissed Illumina’s application on the merits:

• The French highest administrative court dismissed the request to suspend the FCA’s referral request on the grounds that such request could not be challenged as such, independently from the Commission’s assessment of the merger.
• The Hague District Court dismissed the application for an injunction taking into account that:
  • It was not proven that the 15-working-day period had elapsed for the French state, despite media reports on the deal and the fact that the deal had been made known to the UK Competition and Markets Authority. The court reiterated that the clock only starts when the deal has been made known to the Member State concerned.
  • As to the significant threat to competition, the court held that it could only grant the injunction if the lack of negative effects on competition was obvious, which was not the case.
  • The fact that the parties were not competitors was also deemed irrelevant as the Commission’s concerns related to their vertical relationship.

While these rulings are controversial, and the new policy toward Article 22 EUMR has yet to be tested before the EU courts, where a transaction raises a referral risk it would seem wise to inform all relevant NCAs of the existence of the deal to trigger the 15-working-day period as soon as possible and, alternatively or in addition, the Commission to confirm whether it is minded to accept referral requests.