CMA: ‘Exiting firm’ defence and speed of the CMA decision

Why this case is interesting

We have successfully gained unconditional Phase 1 clearance for Eurofins Forensics LUX Holding Sarl (Eurofins) in relation to its proposed acquisition of DNACO Limited (Cellmark). After accepting the compelling evidence provided by the parties that Cellmark was facing substantial financial challenges and applicability of the "exiting firm" counterfactual, the Competition and Markets Authority (CMA) acted expeditiously in conducting its review of the transaction, with clearance given only 11 working days after starting the investigation. This is the second time that we have effectively argued that the exiting firm scenario should be applied to a transaction which would otherwise likely give rise to a significant lessening of competition (SLC).

The transaction

Eurofins and Cellmark are both active in the supply of forensic science services, which is the application of scientific methods for the detection or investigation of a crime or the preparation, analysis or presentation of evidence in proceedings within the criminal justice system. This includes amongst others DNA testing, drugs and toxicology analysis. The customers include UK police forces, law enforcement agencies and local authorities. The CMA considered that it had jurisdiction over the transaction due to the parties' activities in the supply of "traditional" forensic sciences services in England and Wales, where the parties had a combined share in excess of 80%. 

The CMA acknowledged the unique circumstances around this transaction, in particular the long term financial difficulties faced by suppliers of traditional forensic services since the market was privatised in 2012. The House of Lords Science and Technology Committee issued a report in 2019, recognising that the market was in a "state of crisis", threatening the efficacy of the criminal justice system, with providers being on the brink of collapse. The recommendations to improve the market in 2021 were not implemented and there was evidence of a lack of profitability and losses for all main providers. Further, reduction police budgets, and the impact of the COVID pandemic, resulted in additional pressure on providers. 

Exiting firm counterfactual

For Cellmark specifically, the CMA considered whether there was compelling evidence that the following tests in the exiting firm counterfactual were met: 

• Absent the transaction, Cellmark would have exited the market (through failure or otherwise) (Limb 1).
• There would not have been an alternative, less anti-competitive purchaser for the firm or its assets to the acquirer in question (Limb 2).

In concluding that both limbs were met, the CMA did not find that there was an SLC as a result of the transaction and expedited clearance was given because of the nature of Cellmark's financial problems. 

In relation to Limb 1, the CMA agreed that:

• Cellmark had reported losses for a number of years, including £6 million in 2022.
• It is unable to meet demands to pay its debt and its financial issues make it challenging to obtain the supplies needed to provide services and generate revenue.
• Cellmark is reliant on temporary cash boosts, which are not guaranteed and are intended to cease in the near future.
• Creditors including HMRC had taken action against Cellmark in recent months, to recover debts.
• Refinancing options had been unsuccessful, with loans rejected and BACS facilities removed.
• Restructuring had been attempted but had not been successful.

The CMA concluded that Cellmark’s financial position had created a substantial risk that it would lose access to vital supplies that it required to provide services and generate cashflow. Cellmark had strained relationships with many of its creditors and was unable to reduce existing debt and pay current liabilities as they fell due, particularly as suppliers demand stricter contractual terms. As a result, in the absence of the Merger, Cellmark would be unable to meet its financial obligations in the near future and would not have realistic funding options or restructuring options available to it to avoid exit.

In relation to Limb 2, the CMA concluded that there would not have been an alternative, less anti-competitive purchaser for Cellmark. The overall pool of potential purchasers was extremely limited due to the precarious state of the market and the severity of Cellmark's financial position. Most of the potential purchasers who were identified and contacted would either not have been interested in acquiring the business as a going concern, or would not have operated the business as a competitor in the markets it currently operates in. Further, the acquisition either of Cellmark's assets or on an insolvent basis would raise the risk of Cellmark being unable to fulfil its existing traditional forensic service contracts or lose its accreditation and, consequently, the ability to complete current work and win further tenders. Finally the CMA did not consider other competitors on the market to be suitable as, in line with its guidance, it will not have as its counterfactual a sale of the target firm to a purchaser that is likely to result in a referral for an in-depth Phase 2 investigation, given the uncertainty over whether such an acquisition would, ultimately, be cleared or subject to subsequent remedial action.

As a result, the CMA concluded that there was no less anti-competitive purchaser than Eurofins and there was no SLC due to the transaction.

Conclusion

The speed at which the CMA issued its unconditional clearance is unprecedented and reflective of an understanding of the distinctive dynamics of this market and the financial position that Cellmark had found itself in. There was a very real risk that Cellmark would not be able to continue to operate for the usual length of a Phase 1 investigation and the challenges that this would bring to the criminal justice system. In addition, when another competitor went into administration in 2018, millions of pounds of taxpayers' money was spent restructuring it for sale to ensure continuity of service and minimal impact on ongoing cases. We imagine that police customers were keen to avoid such funding requirements in this case had Cellmark been subject to an uncontrolled exit of the market. The case highlights that, in specific circumstances, the CMA can act quite fast once it has understood the market's underlying forces.

Our competition team would be happy to discuss with you this or any other competition issue you might have.