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GCR Guide on Life Sciences – Merger control procedural issues
Global | Publication | June 2022
In recent years there have been a number of significant procedural developments that affect merger review of life sciences transactions. At EU level, the EC has sought to ensure that it has the ability to review so-called “killer acquisitions” that do not meet the EUMR turnover-based thresholds, using the power of member states to refer transactions. In March 2021, the EC published new guidance regarding such Article 22 referrals, setting out the circumstances in which a member state may request the EC to accept referral of concentrations over which the member state does not have jurisdiction. As a result of appeals arising out of the Illumina/Grail review, the General Court will consider the extent to which the EUMR supports the EC’s approach during the course of 2022.
In parallel with this potential broadening of the EC’s jurisdiction, the long running review of the simplified review procedures under the EUMR will also come into effect in 2022, reducing the burden for notifying parties where concentrations do not raise substantive concerns.
At member state level, there have been further refinements in the application of the German and Austrian “size of transaction” tests (also introduced to address the perceived risk of killer acquisitions going unreviewed), and practice under the foreign direct investment regime has continued to evolve.
Finally, as the CMA continues to develop its jurisdictional practice post-Brexit, its application of the share of supply test warrants careful consideration by acquirers (even of minority non-controlling interests), as does the potentially broad reaching NS & I Act.
Referrals under the EUMR
a. EUMR jurisdictional scope and historic referrals
Regulation (EC) No 139/2004 on the control of concentrations between undertakings (hereinafter the ‘EUMR’ or the ‘Regulation’)1 provides the regulatory framework for the assessment of concentrations that meet prescribed turnover thresholds, such that they have a ‘Community dimension’.2 A concentration occurs when a change of control occurs on a lasting basis.
The ‘one stop shop’ principle means that transactions that fall within the scope of the EUMR are not subject to parallel merger review in the member states. Concentrations not covered by the Regulation in principle remain under the jurisdiction of the member states. However, the EUMR provides a framework for ‘referrals’ between the European Commission (EC) and member state authorities in certain circumstances:
- at the request of the parties or a MS, the EC may refer a case in whole or in part to the competent authorities of a MS (Articles 4(4) and 9 EUMR); and
- the parties may ask the EC to assume jurisdiction where at least three member states would have jurisdiction (Article 4(5) EUMR) or one or more MSs may request the Commission to examine any concentration not having a Community dimension if it affects trade between MSs and threatens to significantly affect competition within the territory of the requesting MS (Article 22 EUMR).
Illumina/Grail (see section I.b.) has firmly refocused attention on referrals. The EC has only accepted the referral of one other concentration the pharma sector in the last ten years under Article 22 - in 2019, the French and German competition authorities referred J&J’s proposed acquisition of Tachosil to the EC. The EC considered both the substantive criteria and appropriateness of referral before accepting jurisdiction. First, it concluded that the transaction could have an appreciable impact on cross-border economic activity involving several member states, given that the parties had sales of products in almost all member states. Second, it concluded that the transaction threatened to significantly affect competition at least in France. Indeed, on a narrow market limited to haemostatic patches with dual effect, while J&J had no marketed products, Tachosil was the market leader with a 80-90% share, and the EC found that the transaction would have a negative impact on the market as it would reduce J&J’s incentives to restart distributing its product (the closest potential competitor of Tachosil) in the EEA. As a result, the EC3 concluded that a referral was appropriate because:
- The transaction was notifiable in three member states, such that review at member state level may increase legal uncertainty and lead to conflicting assessment;
- There was a need to examine why J&J decided to exit the EEA market in 2017 for its haemostatic patch;
- The parties' competitors were active throughout the EEA and it would be more efficient to centralise contacts; and
- A coherent handling of the case in relation to potential remedies was desirable.
The EC has reviewed eight cases in the last thirteen years in the pharma sector that were referred under Article 4(5). Three of them were cleared unconditionally following a simplified review (Pfizer/GSK Menacwy business – M.7716 (2015)4, J&J/Crucell - M.6033 (2011)5, Eli Lilly/Pfizer animal health assets – M.5843 (2010)6). The other five7 were reviewed under the normal procedure, and cleared without commitments. In CSL/Novartis Influenza Vaccines Business8, the EC noted that its recent experience in reviewing human vaccine cases was an additional reason for accepting the referral. Similarly, the EC accepted the referral under Article 4(5) of three medical instruments/devices concentrations in the last sixteen years. Two were cleared unconditionally following a simplified review9, and the third10 was reviewed under the normal procedure and cleared without commitments.
In contrast, the EC has only referred two cases in the sector to member states at the request of the parties (under Article 4(4) EUMR). In BOOTS/Alliance Unichem (2005)11, the relevant geographic market was limited to the UK12 - the parties were active in retail pharmacy in the UK, where the concentration would have given rise to one horizontally affected market (if defined on a national basis) or several horizontally affected markets (if defined on a local basis). The EC concluded that the principal impact on competition was likely to be on distinct markets in the UK, warranting referral. In Brocacef/Mediq Netherlands (2015)13, the EC found that the transaction gave rise to several affected markets for wholesale medical products and the retail sale of pharmaceuticals in the Netherlands. Accordingly, the EC referred the concentration. The EC has only referred two medical instruments/devices concentrations to member states under Article 4(4). In Helios/DAMP (2012)14, the EC found factors indicating regional or local markets for acute hospitals but also considered national markets for elderly care facilities, and concluded that the transaction may have had a significant impact on competition in a distinct market in Germany. In Fresenius/Rhön Klinikum (2012)15, the EC also found factors indicating the existence of regional or local markets for acute hospitals, but also considered national markets. Once again, it concluded that the transaction may have had a signification impact on competition in a distinct market in Germany.
The EC has only referred two cases in the pharmaceutical sector under Article 9 EUMR. In GEHE (1996)16, it found that the geographic market for pharmaceutical wholesaling was no wider than the UK, and could have been regional, and the geographic market for pharmaceutical retailing was local. Accordingly, the EC found that the markets were limited to the UK, and referred the concentration to the CMA.
In Alliance Unichem (1998)17, the EC found that the relevant market was limited to full-line distributors supplying pharmacies quickly (in a few hours) and frequently, with a legal obligation to keep a wide range of pharmaceuticals in stock. The EC concluded that the market was regional, because the regulatory regimes applicable to the distribution activity were differentiated across the EU, and because of regional demand differentiation. It referred the concentration to the Italian Competition Authority.
b. Broader application of Article 22
Article 22 EUMR, known as the ‘Dutch clause’18, enables the EC to accept the referral of concentrations that do not have a Community dimension where the concentration involves an undertaking supplying goods/services cross border (such that it is likely to have an actual or potential effect on trade between member states) and the NCA can provide prima facie evidence of a significant adverse effect on competition in its jurisdiction.
On 26 March 2021, the EC published new guidance on Article 22 referrals (the ‘Article 22 Guidance’)19, addressing the circumstances in which a member state may request the EC to accept referral of a concentration over which the member state does not have jurisdiction. The Article 22 Guidance reflects the EC’s view that there has been an enforcement gap in relation to transactions in certain innovative sectors (e.g., life sciences and the digital economy).
It is intended to apply to concentrations where ‘the turnover of at least one of the undertakings concerned does not reflect its actual or future competitive potential’, such as start-ups or recent entrants with significant competitive potential that have yet to generate significant revenues, that represent actual or potential important competitive forces. The EC is concerned that such companies could be acquired without scrutiny. In short, the Article 22 Guidance is intended to enable review of so-called ‘killer acquisitions’. However, the breadth of such scope for review has the potential to materially reduce transactional predictability and certainty.
This expansive interpretation of Article 22 was first applied to Illumina’s proposed acquisition of Grail20. On 21 September 202021, the parties announced that Illumina would acquire Grail for $8bn (approx. €7.5bn). Grail is a U.S. healthcare company developing blood-based cancer tests based on genomic sequencing. It supplied no products, generated no revenue, and had not employed personnel to prepare for regulatory approvals or distribution of a product, in the EEA.
In February 2021, the EC invited the French Competition Authority (ADC) to request the EC to accept a referral. The ADC did so, and the Dutch ACM joined the reference. The referral was challenged by the parties in both France and the Netherlands22. Both the French23 and Dutch24 courts rejected the parties’ appeals. The French Court found that Article 22 EUMR enables NCAs to ask the EC to examine deals affecting trade between member states if they could harm competition in the requesting member state. Further, it found that the ADC’s referral could only be challenged at the end of the EC merger investigation, before the EU courts. It concluded that it was not competent to hear arguments regarding suspension of the referral. The Dutch Court considered several grounds of appeal, including whether there was conflict with the ACM‘s procedural rules, and whether the referral request (and the ACM’s decision to join the reference) had occurred outside the deadline provided in the EUMR, and rejected the appeal.
On 19 April 2021, the EC accepted the referral, finding that the proposed transaction could affect trade within the single market and threatened to significantly affect competition within the territory of France, and that a referral was appropriate as Grail's competitive significance was not reflected in its (lack of) turnover. Illumina has sought the annulment of the EC decision to assert jurisdiction by the General Court26. The judgment is expected on 13 July 2022.
The EC opened a Phase II review on 22 July 202127, and adopted interim measures on 29 October 2021, following Illumina's decision to close the acquisition28. In December 2021, Illumina appealed29 the imposition of interim measures to the General Court, making three pleas in law:
- The decision is outside the EC's competence because Art 7 EUMR could not apply;
- The provisions in the decision regarding funding are disproportionate; and
- The decision is disproportionate in its treatment of Illumina’s pre-existing contractual obligations and/or the EC failed to provide adequate reasons.
The judgment is expected in the second half of 2022.
02 Reform of the EU simplified procedure rules
The EC began to review its simplified procedure rules in 2016, seeking to identify additional types of concentrations eligible for simplified review and to streamline certain procedures. For example, the proposed revisions cover transactions where two or more undertakings acquire joint control of a joint venture without current or expected turnover within the EEA, where the undertakings will not transfer assets within the EEA to the JV. In addition, the market share thresholds up to which the simplified procedure applies will be increased.
Importantly, it is proposed to provide the EC with discretion to apply the simplified procedure to concentrations that do not fall into any of the categories of concentrations eligible for review under the simplified procedure, particularly where certain markets relevant to the concentration are eligible for review under the simplified procedure, but others are not.
New safeguards and exclusions will apply to concentrations where there are horizontal overlaps or vertical relationships between the parties to the concentration, and it cannot be excluded that the concentration will raise serious doubts as to its compatibility with the internal market. Further, the EC will have the discretion not to apply the simplified procedure where one party to a concentration has significant non-controlling shareholdings in companies active in the market(s) where another party is active.
Finally, several procedural changes are proposed, including the introduction of a ‘super simplified procedure’, enabling notification using a short Form CO without pre-notification, and formalisation of the potential for clearance in less than 25 working days for certain concentrations.
03 Developments in Germany and Austria
a. German and Austrian Value-based threshold
In Germany, even when the turnover thresholds are not met, a transaction is notifiable if the transaction value exceeds €400 million and the target has ‘significant domestic operations’. In its most recently published activity report, the Federal Cartel Office (FCO) referred to pharmaceutical cases where the value-based transaction threshold (and, as a result, the significant domestic activity concept) was considered.
- One transaction was notifiable as a result of the target’s conduct of clinical studies and research co-operations in Germany, and the expectation that approx. 25% of the patients to be treated with the product in the future lived in Germany.31
- Other transactions were not notifiable, even though the targets’ lead products were in Phase III clinical trials globally (including in in Germany) and there were clinical trial sites in Germany. Where there was no research group leader in Germany and no patients enrolled in trials at the time of notification, such that no drugs had been administered, the FCO has declined jurisdiction. 32
Between 2017 and the end of September 2020, 45% of the 31 notifications to the FCO under the value-based transaction threshold related to the pharmaceutical sector.33
The Austrian competition authority, Bundeswettbewerbsbehörde (BWB) in 2021 published a sector inquiry report highlighting the importance of the value-based threshold for transactions in the pharmaceutical sector34, noting that pharmaceutical companies often acquire innovative rivals at substantial valuations (so-called killer acquisitions)35. The value-based thresholds enables review of such transactions.
b. Revised Joint guidance - nexus criteria
In January 2022, the German and Austrian CAs published updated joint guidance regarding transaction value thresholds (Joint Guidance)36. The ‘nexus test’ is met if the target is ‘significantly active in Germany’ or ‘to a relevant extent active in Austria’. The revised Joint Guidance makes a number of changes that are important in determining whether the “significantly active” test is met.
The location of the target is not sufficient. Rather, the focus is on whether the asset is used in an entrepreneurial activity.
Further, while R&D at facilities and using infrastructure in Germany can provide the nexus, the research results need not only to be marketable in principle. The products/services at issue need to be likely to be marketed in Germany, and there needs to be activity in Germany relating to either or both of market access and distribution, including the presence of personnel engaged in seeking authorisation or establishing distribution (including negotiation of distribution agreements).
The domestic activity must also be more than marginal. For R&D, various criteria are considered to determine materiality, including the number of employees involved in R&D, the R&D budget, the number of patents or patent citations.
In relation to Austria, the Joint Guidance37 provides that, in the context of the acquisition of a company whose business activity relates to a newly authorised medicinal product, there is no relevant nexus if no sales have been made in Austria and market entry is not been prepared38. However, a nexus may be assumed even if sales have been low, if the product is authorised, since the sales likely do not reflect market potential39.
c. Exclusive licensing agreements considered to be on all fours with ‘asset acquisitions’ by Joint Guidance
The Joint Guidance brings new types of transactions within the scope of the German merger control regimes, including exclusive licences. Previously, the grant of a licence was not notifiable if it was not associated with current revenue generating activity. For example, in National Geographic I40, the parties had concluded a licence agreement for the initial publication of the magazine ‘National Geographic’ in the German language. The Federal Supreme Court confirmed that this agreement did not constitute a concentration because the licensors had not yet marketed the magazine in the German language, so there was no existing market position. The Joint Guidance provides that a transaction may be notifiable under the value thresholds if a future market position is acquired, including cases where the turnover potential of the target only develops after the licence is granted.
To be notifiable, an exclusive licence would ordinarily need to lead to a lasting change in the market structure, excluding short-term licences. However, in the context of innovative and fast-changing markets, a shorter-term licence might have a lasting impact41. The Joint Guidance is silent on that point.
The value of the concentration comprises all assets, including payments to the seller that are conditional on the achievement of certain turnover or profit targets in the future42. In life sciences licences, payments are ordinarily a mixture of upfront and milestone payments, and royalties or a revenue share of commercialized products. The value of the transaction includes all these elements, discounted to reflect their net present value43.
In Austria, an exclusive licence must constitute a concentration to be notifiable.
d. Germany
Life- sciences transactions are potentially reviewable under the cross-sector regime applicable to operators of critical infrastructure (under the Foreign Trade and Payments Ordinance and Ordinance on the Determination of Critical Infrastructure, both adopted under the Act on the Federal Office for Security and Information Technology under the BSI Act).
UK Developments
a. Merger review
The UK share of supply test requires the merger to have a sufficient UK nexus as a result of the creation or enhancement of a share of supply of at least 25%. In several recent cases, the CMA has taken a broad view of the metrics and services that can be used to calculate shares of supply, considering services that are complementary in Roche/Spark and Sabre/Farelogix, and vertically related services in Google/Looker.
1. Roche Spark
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