A Practical Perspective on Monitoring Divestiture Commitments in Multi-Jurisdictional Transactions

[1] This is a chapter excerpt from ‘Merger Remedies Guide – Fifth Edition’ which originally appeared on GCR.

Increasingly, the competition authorities deem it necessary to appoint an independent monitoring trustee to ensure the smooth implementation of and compliance with a specific remedies package. Trustee appointments are considered crucial to the success of a remedy and reduce the risk of non-compliance. The role of the trustee is to supervise the compliance of the parties with their commitments, and report to, and be available to receive instructions from, the competition authority.

The objectives of the competition authority and of the merging parties should be at the forefront of the trustee’s approach to monitoring the implementation of commitments. The trustee needs to be mindful of the requirements of the commitments and the expectations of competition authorities, and identify and highlight any potential pitfalls with the approach to the implementation of the commitments given by merging parties in each specific case, based upon the trustee’s knowledge and experience of previous cases.

In this chapter we focus on divestiture commitments. In these cases, the merging parties (the seller) are required to divest a business (the divestment business) to remove competition concerns identified by the competition authority to obtain a conditional clearance decision. Based upon the standard European Commission (EC) commitments template, during this process the seller is obliged to:

• conduct a sales process during the first divestiture period, usually up to six months;
• find a suitable purchaser for the divestment business;
• agree the terms of sale that are in accordance with the commitments; and
• ensure that the divestment business is held separate, ring-fenced and maintained as a marketable, competitive and viable business until the closing of the onsale.

This chapter provides an overview of the implementation of divestiture commitments, the challenges the seller must overcome to comply with the commitments, and practical tips for sellers to assist with confirming their compliance with their commitments.

We make reference to the best practice guidelines published by the EC and the standard EC commitments template. The general requirements of other competition authorities for divestiture commitments are broadly similar to those of the EC. Our experience of multi-jurisdictional mergers involving multiple competition authorities in parallel is that competition authorities around the world are increasingly working closely together in the context of maintaining the regulatory oversight of global transactions.

Sales process

The standard EC commitments template defines two distinct divestiture periods. During the first divestiture period, the sales process is in the hands of the seller, supervised by a monitoring trustee, whereas in the second divestiture period, the sales process is under the control of a divestiture trustee. In its best practice guidelines, the EC states that it normally considers as appropriate a period of six months for the first divestiture period and three to six months for the second period.

The proposed purchaser of the divestment business must meet the purchaser criteria as defined in the commitments. The purchaser must be independent of the seller and have sufficient financial resources, expertise and incentives to maintain and develop the divestment business as a viable and active competitive force in the market. Additional purchaser criteria may be defined by the competition authority in specific cases.

During the due diligence phase, the seller is committed to providing sufficient information to potential purchasers about the divestment business and personnel, as well as granting reasonable access to the personnel.

Challenges during the sales process

The situation to avoid is one where potential purchasers show limited interest in the divestment business. In most cases where this happens this is because of low or even negative forecasted performance of the divestment business or changes in the environment (e.g., technology or regulation). If interest from potential purchasers is limited, the seller may be in a weak position during negotiations and face an increased risk of being unable to find a suitable purchaser during the first divestiture period.

Another challenge arises where the divestment business is highly integrated into the seller’s business and it is difficult for the seller to provide financial information that relates specifically to the divestment business. Sales figures may be available, whereas corresponding costs of the running of the business are not or the current running costs are not relevant for the potential purchaser. This may make any assessment by interested parties difficult and may impact upon the due diligence phase, quality of offers and contract negotiations. Potential purchasers may make late or non-binding offers when timely binding offers were required. They may, as a consequence, offer a lower purchase price or request more guarantees to compensate for the lack of data. The parties may also find they are required to negotiate more transitional service agreements, as a result of the lack of information provided.

As is typical in M&A transactions, the seller faces the risk of losing momentum during the sales process if the right number of bidders cannot be found or where the sales process (e.g., timetable, question-and-answer process, information to be provided) has not been adequately defined. This requires a balancing act. If too many bidders are found, the seller may struggle to provide timely responses to questions, causing a delay in the sale. However, if sufficient bidders are not found, the seller may lose the competitive pressure of having more bidders involved and may lose its negotiating strength, which can also lead to delays and less attractive offers. In theory it should be confidential which bidders are in the sales process, but the practice has shown that this is sometimes not the case. In some cases bidders are well aware of other bidders in the process and adapt their offers depending on other bidders in the sales process.

Beyond the purchaser criteria defined in the commitments, the competition authority may have a clear preference for a certain type of buyer (e.g., a strategic investor that already offers comparable products to those of the divestment business, but in other geographical regions). The competition authority may have clear objections to certain parties (e.g., because of competition concerns or lack of independence from the seller). If the seller does not take into account these preferences, the proposed purchaser may not be approved or the process can be seriously delayed.

The definition of the scope of the divestment business is key to a successful sales process. When the divestment business is defined in the commitments, the seller should consider:

• who is interested in buying the business;
• why the divestment business is attractive for interested parties; and
• how easily the divestment business can be carved out from the business to be retained.

If possible, assuming alignment with regulators on the scope of the package, the seller should try to initiate the divestiture process before the date of the approval decision of the competition authority. This provides maximum time to conduct a structured process that can optimise the competitive pressure during the sales process and test the attractiveness of the divestment business in the market. Especially if the divestment business is highly integrated, the seller should start to collect data as soon as possible, prepare pro forma financial information, etc., as this can be time consuming and reduce the actual time for the divestiture process.

The seller should carefully plan the sales process before it begins and include some margin in the timetable to ensure that binding agreements are signed for the divestment during the first divestiture period. The preparation of vendor due diligence reports and reasonably complete data rooms can significantly reduce the time required for due diligence.

In our experience, close communication with the trustee and the competition authority is important. This allows the seller to exclude interested parties early in the sales process if it becomes clear that purchaser approval for certain candidates may not be likely to be forthcoming. The competition authority may raise concerns regarding the suitability of certain bidders. These concerns can be investigated by the seller to check whether they can be mitigated. An interested party, for example, may lack relevant experience and proven expertise. This issue may be mitigated by the hiring of executives or managers who have significant experience in the relevant sector.

Terms of sale

The standard EC commitments template imposes on the seller an obligation to procure the divestment of the divestment business as a going concern to a purchaser on terms of sale approved by the EC in accordance with the procedure prescribed in the commitments. Other competition authorities have similar rules.

Once a purchaser has been found and binding agreements have been signed, the sellers are required to submit a fully documented ‘reasoned proposal’, which includes copies of the final signed binding sale and purchase agreement, together with any ancillary agreements to the competition authority that verifies whether the divestiture as provided for within the agreements is in line with the commitments. The competition authorities take the review of transaction documents and confirmation that they are in line with the commitments very seriously, scrutinising the agreements, schedules and exhibits thoroughly.

In its assessment of the suitability of the proposed purchaser, the competition authorities have occasionally informed the parties that the terms of the sale have not been concluded in line with the commitments, and requested certain changes to the agreements for the purchaser and the agreements affecting the sale and transfer of the business to be approved.

The role of the trustee is to submit to the competition authority a reasoned opinion as to whether the proposed purchaser fulfils the purchaser requirements in the commitments and whether the business is sold in a manner consistent with the commitments. The trustee’s assessment provides helpful guidance and assistance in the course of the competition authority’s review and is an important element that the competition authority will consider, but it is not a substitute for the competition authority’s own assessment.

Consistency with commitments

The importance of ensuring at an early stage of the process that the transaction agreements are consistent with the commitments should not be understated. The parties should endeavour to avoid a situation in which the competition authority reaches the assessment that the agreements do not implement the sale as foreseen in the commitments. This will delay the closing of the transaction while amendments to the agreements or side letters are negotiated to bring the agreements into line with the commitments.

For companies to avoid having to negotiate last-minute amendments to the transaction agreements to demonstrate that the agreements are executed in a manner consistent with the commitments, we have some practical tips to ensure early detection of potential compliance issues and resolution at an early stage.

• The seller should share drafts of the agreements with the trustee. It is advisable to share drafts of the sale and purchase agreement and all ancillary agreements with fully completed schedules and annexes at the earliest possible point in the sales process. Where possible, it may be prudent to involve employees (e.g., the hold separate manager) who understand the scope of the divestment business that is being sold in detail to review the completeness of the draft agreements, schedules and exhibits. The seller should obtain comments on consistency from the trustee as early as possible and discuss the implementation of those changes promptly.
• If issues are identified during the review by the trustee or competition authority, the seller should discuss how to allay any concerns and potential methods of resolution as soon as possible.
• The seller should have the final amended agreements ready for final review by the trustee before submitting the reasoned proposal so these final agreements can form the basis of the trustee’s reasoned opinion.
• Finally, where changes to the agreements are difficult because of the late stage of the process, the seller may provide a letter of confirmation to the competition authority stating that the agreement is executed in a manner that is consistent with the commitments.

Hold separate challenges in practice

It is essential that the scope of the divestment business is clearly identified so that any hold separate obligations can be implemented effectively.

The commitments require that the divestment business is managed as a distinct and saleable entity separate from the retained business. Typically, hold separate obligations require the appointment of a hold separate manager (HSM), supervised by a trustee, to manage the divestment business independently and in its best long-term commercial interests until closing. In addition, the commitments will usually define key personnel of the divestment business.

The HSM is responsible for the day-to-day management of the divestment business, including reporting to the trustee on the fulfilment of hold separate obligations by the parties. It is important that the HSM carries out its duties throughout the divestiture period until closing to guarantee the stability of the divestment business. The same is true for the key personnel.

One of the key issues we have observed in practice is if the HSM or key personnel leave before the divestment business is sold. This generates uncertainty for the divestment business and can jeopardise the overall performance of the divestment business, something the Commission would be very concerned about.

Whether the HSM or key personnel transfer to the purchaser will depend on the purchaser’s long-term strategic vision for its business and integration plans and motivations of these employees. Furthermore, the HSM or key personnel may not be able to return to the retained business immediately after the divestiture period as a result of, among others, ring-fencing and confidentiality constraints. In this context, it is important that the HSM and key personnel receive a remuneration package that is attractive enough to encourage them to remain with the business until the closing of the divestiture. An attractive remuneration package should seek to provide incentives to maintain the viability of the divestment business during the hold separate period and to compensate for the uncertainty after the sale of the divestment business.

If the divestment business is highly integrated in the retained business, the divestment business might not include all the required functions to operate as a stand-alone business. In these cases, staff from the retained business may provide support services to the divestment business during the transitional period. This can be especially critical if the services involve commercially sensitive functions such as sales support. If sales forces sell products from the retained as well as divestment business, proper incentives must be implemented to prevent a negative impact on sales of the divestment business. Ideally, it should also be possible to carefully track the purchasing behaviour of key customers of the divestment business to ensure that there are no sudden or significant changes during the transitional phase.

Based on our experience, we would recommend that for the successful and timely implementation of hold separate obligations, the following considerations may be relevant:

• identification of potential HSM candidates prior to the merger clearance decision. Depending on the type of divestment in question, usual candidates considered for the role vary between the following:
  • existing managing director or general manager of the business (e.g., plant managers in the case of plant divestment);
  • recent retiree senior executives with significant experience in the field that would be more likely to take on a temporary contract; and
  • external consultants appointed on an exceptional basis when there are limited suitable candidates;
• offer of attractive remuneration packages for the HSM and key personnel to ensure that the right incentives are in place to run the divestment business and to stay at least until closing. In many cases this may be only a temporary role that brings with it a lot of uncertainty as purchasers may want to install their own management, benefit from synergies, and restructure or integrate the business; and
• maintenance of incentives for staff of the retained business that provide services to the divestment business to ensure that the performance of the divestment business does not suffer.

Adequate ring-fencing provisions

The standard EC commitments template imposes ring-fencing obligations on the parties to the transaction. To address these obligations, the parties are required to implement certain measures to restrict the flow of confidential information relating to the divestment business, back to the business that is being retained and vice versa. Furthermore, the merging parties are required to eliminate confidential information obtained before the merger clearance decision; and where possible, segregate IT systems that contain commercially sensitive information of the divestment business.

In practice, where the ring-fencing obligations apply to the divestment business of the seller, it is easier to commence the planning of the ring-fencing measures before the commitments come into force. This is because the seller understands the business being sold, including the IT systems that are used to support the business and the information flows between the employees of the divestment business and retained business. This can assist with a prompt implementation of the ring-fencing commitments. Where the ring-fencing measures need to be implemented on the side of the target, particularly in an upfront purchaser scenario, the planning for the implementation of the ring-fencing measures could be delayed. This is because the seller is prevented from freely exchanging information on the target business (owing to gun-jumping rules), which, in turn, prevents the seller from understanding the scope of the business to be divested, the systems in use and therefore the measures that would need to be employed to ensure that the seller can meet its ring-fencing obligations when the approval decision is adopted.

Ring-fencing can be approached from two principal standpoints: ring-fencing of employees (combined with the hold separate obligations); and segregation of IT systems containing commercially sensitive information of the divestment business.

Ring-fencing of employees

To ring-fence confidential information pertaining to the divestment business and prevent this information flowing back to the retained business (with a view to ensuring the competitiveness of the business post-divestment), the parties typically require staff to sign confidentiality agreements. These agreements seek to clarify the confidentiality requirements in place during the transitional period and ensure that staff who come into contact with commercially sensitive information pertaining to a divestment business: share the information on a ‘need-to-know basis’ only; pass on information only to those who are entitled to receive it (i.e., those who have also signed a confidentiality agreement); and hold confidential information in confidence except as necessary to perform their role – whether that be support of the sales process, provision of hold separate or transitional support services to the divestment business pre and post-closing, or preparation of financial reports to support fiduciary reporting requirements, among others.

Confidentiality agreements should be executed as swiftly as possible after the approval decision is adopted. Furthermore, in cases involving complex ring-fencing arrangements, regular (monthly) confirmation from a ‘firewall manager’ that no breaches have taken place is helpful.

Ring-fencing of IT systems

In support of the ring-fencing measures, the parties to the transaction will need to implement logical and physical separation of the IT systems in place that house confidential information relating to the divestment business. This approach often requires cross-functional consultation with the business to map: which employees have access to information of the divestment business; and the specific applications or systems that permit this access. Once this has been established, the parties will need to determine the feasibility of segregating each application or restricting access through strict access controls. IT separation is often more resource-intensive than the merging parties assume, but should go as far as possible in the time available and be implemented expeditiously.

In certain situations the requirement to implement IT ring-fencing measures has come as a surprise to the parties concerned, and therefore little planning has taken place prior to the merger approval decision. A failure to appreciate this commitments obligation can place unnecessary pressure on the parties and requires immediate resources to accelerate the implementation of the measures to meet the expectations of the competition authority. Furthermore, in the case of complex enterprise resource planning tools or raw data databases, this can be rather a complex exercise, particularly with systems that are difficult to segregate.

If the confidential information in an application or tool cannot be separated, access permissions cannot be switched off, or the viability of the business would be compromised as a result of the proposed segregation or the time needed to implement such segregation implies that the measure will not be in force during the transition period, the competition authority will require a detailed understanding of:

• what the application or system does, and how it is used and by whom;
• whether confidential information is contained in the system. If so, what type of information and what the categories of data are;
• why it is not possible to ring-fence the information at all, or within the time frame of the commitments; and
• what other measures can be put in place. This justification can often be supported by the proposal that staff sign an agreement acknowledging the confidentiality requirements, as described above.

Provided that the justifications from the parties are well reasoned (and the trustee, sometimes with help from a technical expert, supports the conclusions reached), the competition authorities have, in the past, adopted a pragmatic approach on the condition that supporting measures (such as the confidentiality agreement approach) are also implemented. In general, caution should be taken with the implementation of any ring-fencing measures that, if implemented, cause harm the viability of business continuity.

For companies to avoid unforeseen issues with the implementation of ring-fencing commitments, we would recommend the following:

• ensure planning starts as soon as possible if the divestment is on the acquirer side and that the scope of the requirements in the commitments are fully understood, especially by the IT function within the business;
• appoint suitable senior IT managers to take responsibility and oversee the sometimes complex separation process;
• if the implementation of the measures is feasible and simple, progress as rapidly as possible;
• if it is not feasible to separate information in complex IT systems (such as SAP), ensure that there is a robust justification as to why, which will withstand the scrutiny of the trustee and the competition authority. If possible, adopt an alternative approach that ensures the obligations are met. Some parties have prepared detailed training (in person or via an IT platform) that can be delivered to employees to ensure the confidentiality requirements are well understood;
• execute confidentiality agreements on a timely basis and be rigorous in the mapping of employees who may have access to confidential information of the divestment business. It is better to be over-inclusive than to miss a key function or individual; and
• finally, take a sensible approach and always seek to balance the maintenance of the viability of the divestment business against the requirement to implement ring-fencing measures. If the implementation of IT ring-fencing measures would hamper the divestment business operations, this is a practical and important consideration that should be brought to the attention of the trustee and the competition authority.

Maintaining viability

The standard commitments template addresses the issue of preservation of the economic viability, marketability and competitiveness of the divestment business to minimise any risk of loss of competitive potential. Specifically, the merging parties are required to commit:

• not to carry out any action that might have a significant adverse impact on the value, management or competitiveness of the divestment business, or that might alter the nature and scope of activity, the industrial or commercial strategy or the investment policy of the divestment business;
• to make available sufficient resources for the development of the divestment business, on the basis and continuation of the existing business plans; and
• to take all reasonable steps to encourage all key personnel to remain with the divestment business.

Challenges to maintaining viability

The availability of and access to financial information supported by a strong finance function are important for maintaining viability on an ongoing basis. In addition, insight from business people on the performance of the business is essential. In one case, the business was previously highly integrated and no prior year figures were available. At the same time, the finance function was performed by the retained business. Financial information during the hold separate period was provided, but no deeper analysis of the customer data was made available. Because of this situation, the divestment business was only able to identify with significant delay that, in fact, some small customers were leaving the divestment business. In the first few months that customers started leaving, this effect was overcompensated for by seasonality effects and therefore not directly visible in the monthly income statements.

The performance of the divestment business might also suffer from the main transaction. In another case, the divestment business was part of the target of the main transaction and a challenger in the market. The buyer in the main transaction was the market leader. With the announcement of the main transaction, the divestment business was unable to continue its growth path any more as the market considered that the divestment business was part of the buyer in the main transaction and also because of the uncertainty about the future purchaser of the divestment business. The initial budget of the divestment business was no longer realistic, and the performance of the divestment business could not be assessed by comparing it with the business plan.

Another challenge for the viability can be the maintenance of the appropriate level of capital expenditure during the transition. Significant levels of capital expenditure may be required to ensure the divestment business can operate effectively and enable the execution of existing business plans. It is clear that capital expenditure for maintenance is required to maintain the viability. However, the divestment business might also want to make additional investments. Whether the divestment business is allowed to execute such investments depends on the specific situation. The effects on the viability as well as on the sales process need to be considered. Typical questions raised in this context are the following.

• Are these investments included in the budget and would they have been performed in the ordinary course of business?
• Can the required assets be rented instead of purchased?
• How will these investments affect the sales process?

The examples show that the divestment business needs to have proper access to financial data that the HSM can use for the management of the divestment business. For the assessment of the actual performance of the divestment business during the hold separate period, the appropriate comparators need to be identified. If, for whatever reason, historical figures or the business plan are not useful for this assessment, the issue must be explained to the trustee and competition authority so that the seller, divestment business, trustee and competition authority have the same expectations regarding the performance of the divestment business during the hold separate period.

We recommend clear communication between the seller and the divestment business to solve issues around capital expenditure to find a balanced solution. We also recommend ensuring the HSM has the authority to action capital expenditure within specific thresholds, with agreed policies and procedures to be followed for these to be exceeded.

Recent trends

We have noted that the number of upfront purchaser remedies has been increasing in Europe in recent years while they tend to be the norm in the US jurisdiction.

In an upfront purchaser remedy, the main transaction may only close once the purchaser of the divestment business has been approved by the competition authority. The upfront purchaser remedy provides a higher degree of certainty for the competition authority that a remedy will be effectively implemented, especially in cases where there is a perception that it might be difficult to find a purchaser for the divestment business, particularly in carve-out cases. The upfront purchaser requirement places considerable demands on the seller who must organise a sales process while remaining responsible for holding separate the assets (possibly of the target) before it may consummate the main transaction. When an upfront buyer is required, the merging parties must sign an acceptable purchase agreement with an acceptable buyer to clear the transaction. An upfront buyer is not necessary in circumstances where the package will be sufficient to attract a purchaser in whose hands the assets will effectively preserve competition, and there will be a sufficient number of acceptable potential purchasers for the assets.

Conclusions

The seller’s situation is a complex one. The main transaction is often yet to be completed and the business operations of the merging parties must be integrated. At the same time, the seller must dispose of and maintain the viability of the divestment business. Customers and staff of the divestment business must be retained during a long period of uncertainty that begins with the planning of the main transaction and does not end until the divestment business is sold.

The divestment business needs to focus on the market, but at the same time it may be required to support the sales process by management presentations and Q&A sessions during the due diligence phase. The seller must ensure that the divestment business is held separate and confidential information is ring-fenced and eliminated from the retained business (with some limited exceptions). The transaction documents need to reflect the commitments and, if it is a global divestment business, the seller will need to consider the requirements of different regulators around the world.

Our key messages for ensuring a smooth implementation of the commitments are as follows.

• Properly define the scope of the divestment business including clear management structures and reporting lines. This comprises the assets, identification of HSM candidates, key personnel, shared services and required IT systems, as well as plans for the carve-out and required transitional service agreements.
• Detailed planning of the sales process will help the seller to maintain momentum and competitive pressure in the process, and maximise the prospects of concluding a sale with a suitable purchaser.
• An upfront buyer requirement can have considerable implications for deal timing and value, and the merging parties are often well advised to begin seeking interest from potential buyers the competition authorities are likely to find acceptable well before they wish to close.
• The considered appointment of the HSM and the implementation of attractive remuneration schemes to incentivise the staff of the divestment business during the transitional period lay the groundwork for the successful disposal and viability of the divestment business.
• The hold separate structure and ring-fencing measures should start well before the decision of the competition authority is made.

Close communication with the trustee and the competition authority is essential. This ensures that any compliance issues regarding terms of sale or the commitments implementation generally can be identified at an early stage and be resolved so as to smooth the pathway to a successful onsale.

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