Schwartz, Daniel C., Deputy Director, Bureau of Competition, Federal 34 PREPARED STATEMENTS "Plant Ownership Characteristics and the Locational Stability of Rural Iowa Manufacturers," by David L. Barkley, article, Land Economics, FAILING COMPANY DEFENSE THURSDAY, JULY 19, 1979 U.S. SENATE, SUBCOMMITTEE ON ANTITRUST, MONOPOLY AND BUSINESS RIGHTS, Washington, D.C. The subcommittee met, at 9:37 a.m., in room 6226, Dirksen Senate Office Building, Washington, D.C., Howard M. Metzenbaum (chairman of the subcommittee) presiding. Present: Senators Metzenbaum and Thurmond. Staff present: J. Michael Cooper, counsel; Peter Chumbris, chief minority counsel: Arthur Briskman, Harry Wiles, Diane Rotering, Jessica Josephson, majority counsel, and Joseph Lanham, minority counsel. OPENING STATEMENT OF SENATOR METZENBAUM Senator METZENBAUM. Please come to order. Today, the subcommittee begins an examination of the failing company defense. Under certain circumstances, the failing company defense permits a merger between two competitors which otherwise would be prohibited by section 7 of the Clayton Act. For this defense to apply, one of the merging company's resources must be so depleted that its prospects for remaining a viable competitor are nonexistent. In addition, there must not be another prospective purchaser anywhere on the horizon who is not a competitor of the failing company. In the past few years, this defense and variations upon it have been asserted with increasing frequency and increasing success in the courts and to the Government enforcement agencies. I believe that growing recourse to this defense raises several important questions about effective enforcement of the antitrust laws. Section 7 has been most effective in preventing anticompetitive mergers between competitors. So, I am concerned that acceptance by the courts and the enforcement. agencies of dubious failing company defenses will create a loophole that will, in the long run, reduce section 7's effectiveness. I am concerned that uncritical acceptance of failing company type defenses will give an incentive to some companies to drain away the assets of viable subsidiaries purposely in order to finance acquisitions. A company engaged in a strategy of this kind will fail to make the capital improvements and maintenance expenditures required for the survival of its subsidiary. Instead, the cash generated by the sub sidiary will be used to purchase other seemingly more profitable companies. The plant and equipment of the drained subsidiary are, in effect, allowed by the parent firm to deteriorate. But in spite of the rundown plant and equipment, the subsidiary may, if only because of trade names, patents or long-term contracts, be able to preserve all or a substantial part of its market share. And, an existing market share can be of sufficient value to a competing company to justify its paying a large premium to acquire the drained subsidiary. Thus, if the failing company defense is allowed in a situation like this, the parent firm can profit twice. The parent first drains the subsidiary of its assets; then proceeds to sell it for much more than the value of its remaining plant and equipment. If that plant and equipment can no longer operate profitably, the subsidiary's workers are likely to lose their jobs, the communities in which the subsidiary's plants are located are likely to lose an employer, and the Nation's consumers are likely to lose the price benefits of competition in the industry. I believe that the antitrust laws were intended by the Congress to prevent, not to promote, practices of this kind. I do not believe that a doctrine that was designed to assist legitimately troubled companies should be twisted to promote unnecessary business failure. In spite of these problems, the fact remains that when properly applied, the failing company defense can serve vital public policy purposes. In some cases, allowing a competitor to acquire and reinvigorate a truly failing company can mean saving thousands of jobs and sparing communities the loss of major employers. When this situation exists, antitrust principles should take a back seat to the welfare of the failing company's employees and of the community in which they live. Before sacrificing the benefits of free and open competition, I believe that the courts and the enforcement agencies must be certain that the circumstances in fact call for application of the failing company defense. They must be certain the failing company's jobs will be preserved and that the community will be allowed to continue to prosper. I hope that our hearings today will provide answers to some of the many questions raised by the failing company defense. For example, is it too difficult for a company to demonstrate it is failing under Justice's Douglas' decision in the Citizen Publishing case and the Department of Justice's merger guidelines? Or will a strict failing company defense discourage parent firms from draining subsidiaries and at the same time recognize the need to preserve jobs? One of the questions that particularly concerns me, as chairman of this subcommittee, whether or not a company earning a very low rate of return for several years, faced with the choice between liquidating or selling to a competitor, should be permitted to sell to the competitor? What concerns me particularly is the situation in which a company may actually be making a profit-not failing. A company might be earning 1 percent or 2 percent on its net worth. If it were to be liquidated, it could earn as much as 8 or 10 percent just by plain investment in the market place or in Government securities of the cash generated by liquidation. If that company is only earning 2 percent as ongoing business, it still is making a profit. It isn't failing, but should it be permitted to sell to a competitor? I think I can envision situations such as that. The recent case in my own State having to do with Federal Glass might have been such a situation. It was arguable whether there was or was not a profit, and if there were a profit, how large. If the failing company defense had been permitted at an earlier stage, some have said the company might have been saved. As we all know, it was not. Is there any justification for a weak competitor defense like that allowed in the International Harvester case? Should a profitable conglomerate be permitted to assert a failing division defense with respect to a subsidiary? Should the policy continue to be to look at the overall company or should it be to look at the individual components and such as done very recently in connection also with another matter in Ohio-General Motors' sale of its Frigidaire Division to White Consolidated? How can the Antitrust Division and the Bureau of Competition tell whether a firm is truly failing? Should a period of notice before a plant closing be required by statute or regulation? Should a uniform and understandable method of financial reporting also be required? How should the efforts of the so-called failing company to sell to a noncompetitor be measured? And, finally, should Congress enact legislation to improve the chances of community groups and employees to purchase plants that otherwise would be closed? I am particularly pleased that our first witness today, Representative Kostmayer, is here with us. Mr. Shenefield and Mr. Schwartz will also give the committee an excellent start in its search for answers to these and other questions. We are very happy to welcome you, Congressman Kostmayer. Please feel free to begin. Senator Thurmond will be with us shortly. STATEMENT OF CONGRESSMAN PETER H. KOSTMAYER Mr. KOSTMAYER. Senator Metzenbaum, I appreciate the opportunity to testify before your subcommittee. The growth of conglomerates, I believe, has created problems in our economy, problems which I think deserve congressional scrutiny and attention. I would like to address myself briefly this morning to plant shutdowns, and the relationship of shutdowns and unemployment to conglomerate ownership, and briefly mention how, in some instances, employee ownership of business has been used as a successful alternative to prevent such shutdowns. Plant shutdowns in the past decade have occurred with alarming frequency, hurting thousands of Americans and threatening the economic stability of their communities. When a firm closes, employees often lose more than their jobs. The economic hardship and uncertainty can wreck families, affect mental health, and cause extended personal suffering. Idleness may last for months and many workers require substantial retraining before they are again employable. The costs to society are staggering. We see examples of this phenomenon time and time again. In my own State of Pennsylvania, the city of Philadelphia has lost at least 40,000 manufacturing jobs in the last 10 years. Pittsburgh and other cities in Pennsylvania have suffered similar losses. |