Joint Guidance Paper on New Transaction Value Thresholds
In late summer of 2017, the 9th amendment of the German Act Against restraints of Competition (“ARC”) introduced a new transaction value-based set of reporting thresholds for merger transactions (“concentrations”) in Germany. Austria introduced a similar provision which entered into force in November 2017. The competition authorities – the Bundeskartellamt in Germany (Federal Cartel Office – “FCO”) and the Bundeswettbewerbsbehörde in Austria (Federal Competition Authority – “FCA”), after publishing a consultation paper on 14 May 2018, now issued the final Guidance Paper on the transaction value threshold (hereinafter: “Guidance Paper”) providing their interpretation of the new statutory provisions.
In addition, the Guidance paper also addresses the impact of the 9th amendment on asset acquisitions under German law.
This memo summarizes some important aspects of the Guidance Papers and will focus on the situation in Germany.
A. German Notification Thresholds
The new “transaction value threshold” comes in addition to the pre-existing “traditional” threshold. It is applied as a “subsidiary” threshold in addition to the traditional turnover thresholds. As a reminder, under the traditional threshold a concentration is notifiable (subject to certain exemptions), if in the preceding financial year the following turnover thresholds were met:
- All undertakings concerned combined: more than EUR 500 million worldwide;
- At least one undertaking concerned: more than EUR 25 million in Germany, and
- Another undertaking concerned: more than EUR 5 million in Germany.
According to the new transaction value-based threshold (which introduces an alternative size-of-transaction, or “value of consideration” (“Wert der Gegenleistung”) -based threshold), a concentration that does not fall under the traditional threshold nevertheless requires a mandatory, pre-closing notification if the following four cumulative criteria are met:
- the combined worldwide turnover of all companies exceeded EUR 500 million,
- one of the parties to the concentration had a turnover in Germany of more than EUR 25 million,
- the value of the consideration for the transaction exceeds EUR 400 million and
- the target is active in Germany to a substantial extent.
B. The Guidance Paper
The new transaction value-based threshold introduced two new components into German and Austrian merger control law which both raise significant questions:
- the definition of “value of consideration” in order to determine the EUR 400 million transaction value threshold, and
- what constitutes a “substantial” activity in Germany or – as the Guidance Paper puts it: when does the target company have substantial operations in Germany.
While the first component required input from M&A lawyers in order to consider surcharges and premiums paid at closing or later, the second component – the local nexus requirement - raises issues in particular because contrary to the intention of the legislator whose aim was to cover digitalization and certain innovative issues, the law is phrased in a general, industry-agnostic way.
When the new law came into force, the FCO and the FCA quickly decided to publish a draft guidance paper on the interpretation of the new transactional threshold. This is notable because guidance papers are typically based on existing case-law and experience of the respective authorities. In this case, however, the new threshold is brand-new, even for the competition authorities, and the existing cases after less than one year of practical application are very limited (as per June 2018 the FCO dealt with approximately 20 inquiries). One could say that the authorities are doing the job of the practitioners. The Guidance Paper is certainly a highly welcomed initiative!
It was not a big surprise that the consultation paper generated significant attention and numerous comments, some of which are reflected in the final paper.
This memo provides an overview of the principles laid out in the Guidance Paper, in particular with respect to the question of when an activity is considered to be a substantial operation in Germany.
I. Defining the Value of Consideration
According to para. 11 of the Guidance Paper, the value of the consideration encompasses all assets and other monetary benefits that the seller receives from the buyer in connection with the merger in question. It covers all cash payments and the transfer of voting rights, securities, tangible assets and intangible assets. This also includes considerations that are contingent on certain conditions, such as those specified in earn-out clauses, or agreed additional payments to the seller that are conditional on the achievement of certain turnover or profit targets at a specific point in future (e.g. license fees). Also included are payments for non-competition by the seller (to the extent not already included in other parts of the consideration). In particular, considerations also include liabilities assumed by the buyer (see para. 16).
The parties to the concentrations must describe the consideration value to the FCO “in a transparent manner” (para. 18). The closer the value is to the German threshold of EUR 400 million, the more important the accuracy of the companies’ explanation becomes. The explanation of the value assessment can be simplified if the parties to the merger believe that the value of the consideration will definitely exceed the threshold.
The value of the consideration can fluctuate over time. This usually applies to securities but may also affect cash held in foreign currencies. Therefore, in contrast to a turnover analysis for a specific period of time, the relevant value of the consideration has to be calculated per the completion date of the merger. The parties bear the risk of value fluctuations: if they submit and later the value falls below the EUR 400 million threshold, the parties can withdraw the filing. However, if the consideration value increases to more than EUR 400 million, the parties cannot close without clearance (see para. 28).
Finally the Guidance Paper describes various assessment methods and case scenarios in detail, providing guidance for specific transaction structures such as cash transaction, securities transactions, mergers involving asset swaps, assumed liabilities etc.
II. Local Nexus – Substantial Target operations in Germany
1. The complexity of the issue
The application of national merger control law requires a local nexus, i.e. the acquisition of a target company operating only abroad, is typically not subject to German / Austrian merger control law. Moreover, as stated above, the intention of the legislator was not to introduce a new threshold for all industrial activities in addition to the existing traditional threshold. The legislator made it clear that the transaction-based threshold should not be applied to transactions carried out in industries in which turnover of the target company reliably reflects the competitive strength (or as the Guidance Paper states in para 65: a mature market that is characterized by turnover generation).
Rather, the driving force behind the amendment was the thinking that a disproportionality high purchase price (i.e., more than EUR 400 million) and a low turnover achieved by the target company typically reflects the presence of innovative business ideas with high market potential. According to the legislator, the amendment aims, in particular, to address increasing digitalization and networking effects (such as the acquisition of WhatsApp by Facebook in 2014, which was not reportable in Germany), and to “protect innovation” and create a “safeguard to structural market foreclosure”.
However, the language of the new threshold merely requires that the target must be active in Germany to a considerable (or substantial) extent, which is a neutral or industry-agnostic description. This broad language does not expressly exclude traditional industries. This makes things quite difficult. For example, what is the distinction between a “traditional” market (i.e. a mature market where turnover reliably reflects the competitive strength) and innovative markets, or what happens if a target in a traditional industry that just made a disrupting innovation is acquired? And also: when is a Target’s activity in Germany substantial?
2. Clarification of the Guidance Paper
For the interpretation of the local nexus, the Guidance Paper makes two general statements:
- domestic activity has to be measured on the basis of the market-related activities of the target company (see para. 65), and
- if a company is taken over that exclusively or primarily operates on the domestic market, it is usually safe to assume a substantial level of domestic activity (see para. 64).
It is important to note that the relevant date to assess the domestic activity is not the previous business year but the current activity at the time of the notification. However, according to the Guidance Paper, domestic activity is also deemed “current” if it is carried out for the purpose of market entry, e.g. a drug approval on the domestic market (see para. 70).
The Guidance Paper considers (a) the relevant criteria to measure domestic activity, (b) when an activity is attributable to Germany, and (c) clarifies that only certain market oriented activates can have a domestic effect. Finally, it clarifies when a domestic activity is substantial enough to trigger domestic effects requiring a notification (see (d) below).
a) Measurement Criteria
In accordance with the reasoning of the legislator, the Guidance Paper states that turnover is not deemed to be the key measurement criteria for domestic activity. Different industry sectors may require different criteria, for example in the digital sector user numbers or access frequency of a website may be a relevant criteria.
In Germany, the location of the target company alone is not regarded as a sufficient indicator for a significant domestic activity (the FCA has a different view, see para. 68). Rather, when establishing domestic activity for the new threshold, the key factor is the use of the asset for business activities (para. 69).
b) Assessment of Local Nexus – Attribution to Germany
The measurement criteria are also important when it comes to assessing the local nexus of the relevant target company’s activity. This activity is attributable to the place of the intended use, which is usually the place where the customer is located. Consequently, domestic activity must be presumed to exist, for example, if the target company’s products and services are taken up to a significant extent by domestic users, even if this happens free of charge (see para. 72).
With respect to an acquisition of (mere) R&D activities, the Guidance Paper refers to several cumulative requirements to establish a significant local nexus:
- the results of the R&D activities must generally be marketable;
- there must be the intention to market the results of the R&D activities in Germany; and
- the R&D activities must have taken place in Germany or there must be activities in Germany preparing for domestic market entry (such as approval for a specific drug on the domestic market or the creation of a sales structure in Germany, e.g. employment of personnel or entering into sales contracts - see para. 74).
c) Requirement of Market Orientation
Domestic activities are only relevant in so far as they are market orientated. Market orientation definitely exists if the target company provides a service against payment on an existing market.
Despite the absence of monetization, an activity could conceivably still have market orientation in the following scenarios:
aa) A service is remunerated by means other than monetary payment, for example when a user “pays” by supplying data or by consuming advertising. This also applies, for example, when an app that is initially offered for free until it reaches a certain level of proliferation and a certain degree of popularity is then offered against payment or in the form of a paid premium version.
bb) The activity consists of R&D of (future) products or services. In these cases it is irrelevant whether turnover has already been generated or whether the product has been launched (see para. 79). Rather it is decisive whether the results of the R&D will be marketable:
In pharmaceutical research, for example, this applies to the planned acquisition of rights to substances that have started the third phase of clinical trials unless the parties can demonstrate that despite reaching Phase III the product is not close to being marketed.
In medical or medical engineering research, this may involve the acquisition of property rights (especially licenses), which may be required for the development of new diagnostic procedures, new imaging procedures, orthopedic aids or surgical instruments.
The same applies to plant protection, where the acquisition of rights to recently discovered molecules that are now in the product development stage (“development” as opposed to “discovery”) can be the basis for the establishment of a marketable domestic activity.
A similar tiered assessment must be applied to research and development activities in other industries.
d) Significance of Domestic Activities
Already the language of the new transaction value threshold makes it clear that marginal activities in Germany are not sufficient to trigger a notification obligation. The Guidance Paper also makes it clear that the test relates to “current” domestic activities, therefore a purely future nexus alone is not sufficient.
The Guidance Paper refers to the legislator’s aim for the 9th amendment of the ARC to cover those cases that have thus far not been subject to merger control because the target company is not (yet) generating appreciable turnover but shows a high degree of economic and competitive potential, for example, because the target company’s product is not yet ready for market or because the buyer is interested in it for reasons other than potential turnover.
Treatment of traditional industries
Against this background, the FCO will find that there is no significant domestic effect if the target company generated a turnover below EUR 5 million in Germany and if this turnover adequately reflects its market position and competitive potential. This is likely to be the case if the company’s products generate significant turnover abroad but not in Germany, for instance, because the company has not (yet) established a sales structure in Germany. The catch-all element of the transaction value threshold does not apply in these cases and notification is not required (see para. 82).
The situation is different, however, if domestic turnover is not an adequate indicator, for instance, because the company is active on a market that is not characterized by turnover or because its product has only recently come onto the market so that the low turnover generated so far does not reflect the competitive potential. In this case, significance must be determined on the basis of the above criteria. The legislator provided an example stating that where a cost-free app is targeted to be used by any consumer in Germany, one million “Monthly Active Users” in Germany would be considered to be significant within the meaning of new threshold, based on the ratios between users and targeted consumers (see also the example provided in the Guidance Paper).
Treatment of R&D activities
The Guidance Paper remains pretty vague when it comes to the assessment of the degree of significance associated with the planned acquisition of R&D activities. It states that there are various conceivable criteria, including the number of staff engaged in research and development or the research and development budget, for example. The number of patents or patent citations “can also be an indication”.
However, if a transaction primarily involves the acquisition of a domestic research site with sufficient domestic market orientation, it is safe to assume significant domestic activity (see para. 84).
Overall it appears that these criteria are pretty technical and do not really assess the degree of economic and competitive potential of the R&D activities in question. Hence one should expect further fine-tuning by the authorities in their future practice.
III. Impact of the Amendment on Asset Acquisitions
The Guidance paper also addresses the possible impact of the 9th amendment of the ARC on asset acquisitions under German law. The acquisition of assets is only deemed to constitute a concentration if the assets are purchased in full or to a substantial extent. Before the 9th amendment, the question of whether an asset was substantial depended, in particular, on whether it was notionally capable (in qualitative terms) of changing the buyer’s position on the relevant market. In addition, the asset had to offer the possibility for the buyer to assume the existing market position of the seller.
The Guidance Paper clarifies that after the 9th amendment a market can exist even if goods or services are provided free of charge and hence a transferable market position can also exist on such markets (see para. 111), and that the acquisition of assets or of control can constitute a concentration even if the target has not yet achieved any turnover (see section 37 (1) No. 1 and No. 2 ARC). Therefore, it cannot be excluded that for example the acquisition of certain R&D assets is notifiable under the new transaction value-based threshold if this involves the acquisition of a future market position (see para. 112). In so far, the Guidance Paper concludes that it may be sufficient that the acquisition of assets may have an impact on the future market position of the buyer either based on the use of the acquired assets or even if they are not used (but the acquisition is useful to foreclose the market – see para. 113).