Antitrust regulators bare teeth on ‘common control’

Legal sources are seeing “new and unprecedented risk” for private equity firms when managing portfolio companies within the same industry, based on a recent enforcement decision by the US Department of Justice (DOJ).

The case appears to represent a deviation from DOJ’s prior interpretation of “common control,” among jointly-owned entities in a merger context.  Historically, in which companies owned or majority controlled owned by the same upstream firm have been are considered to be a single economic entity that can compete in the same market because their common owner has the ability to coordinate their conduct lawfully as it sees fit, according to antitrust lawyers Robert Reznick and David Smutny at Orrick, Herrington & Sutcliffe.

In the proposed transaction, a fund sponsored by Brookfield Asset Management entered into an agreement to sell portfolio company Ainsworth Lumber to strategic buyer Louisiana-Pacific (LP). The Brookfield fund also owned a controlling stake in a third manufacturer, Norbord. All three companies supply wood-based structural panels used for construction in Upper Midwest region of the US.

DOJ opposed the acquisition, stating in part that the merger of LP and Ainsworth would be reducing the number of players in the market from three to two.Although the DOJ’s public press release did not identify the “three” alleged Upper Midwest competitors, their position can only have assumed Ainsworth and Norbord to be independent competitive entities. The parties ultimately abandoned the transaction.

The case made a splash with lawyers because, historically, merger regulators have considered commonly-owned companies like Ainsworth and Norbard to be a single economic entity under antitrust law. However, for the first time, DOJ has publicly taken the position that two companies commonly owned and controlled could nonetheless be considered independent competitors for purposes of merger analysis, according to Reznick and Smutny.

The conclusion also contradicts the stance that regulators have taken on the other side of the equation, when private equity firms are acquiring companies within the same industry. In those circumstances, “the proposed acquisition of Company A by a private equity firm already controlling Company B, an existing competitor in the market, would be analyzed by the agencies as a de facto merger between A and B, regardless of the extent to which A and B might be integrated or continue to operate independently post-transaction,” Reznick and Smutny explained.

The change in tune – or, at a minimum, newly announced position – by DOJ presents increased risk for private equity firms, which should be prepared to face scrutiny and possible opposition from regulators for cases that were previously considered permissible.

“Unless and until DOJ takes a different position, firms will have to recognize that the agency will try to ‘have its cake and eat it too’ – treating jointly controlled entities as combined when it benefits them, and as separate when it benefits them,” stated Reznick and Smutny in an email with pfm. “Knowing this at least enables firms to take the increased risk into account up front, and to craft arguments and submissions to address it.”

Firms in a similar position as Brookfield should press DOJ “early and firmly” to explain the standard they apply to determine whether jointly-owned companies will be considered combined or separate, suggest Reznick and Smutny.  Also, before approaching DOJ, private equity firms should understand the degree of integration and/or coordination that exists between the two jointly-owned companies, in order to be well-prepared to address these issues.