Merger Review under Canadian Competition Law

George N. Addy
Director of Investigation and Research
Bureau of Competition Policy

Fordham Corporate Law Institute
21st Annual Conference "International Antitrust Law and Policy"
Fordham Law School, New York

October 27-28, 1994

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Introduction

This paper provides an overview of procedural, substantive and remedial aspects of merger review under Canadian competition law.

Antitrust merger review in Canada is governed by the Competition Act ("Act"), which came into force in 1986. The Act replaced the previous criminal merger provisions with economically oriented, non-criminal "reviewable" provisions designed to acknowledge the potentially beneficial aspects of mergers. The Director of Investigation and Research ("Director"), with the help of his staff, the Bureau of Competition Policy ("Bureau"), is responsible for the administration and enforcement of the Act. The Director's role is investigative, not adjudicative: where a merger raises sufficient competition concerns, he may apply to the Competition Tribunal ("Tribunal"), a quasi-judicial administrative tribunal with specialized antitrust expertise, for a remedial order. The Tribunal serves an adjudicative role and operates at arm's length from the Director.

 Most mergers are dealt with at the pre-litigation stage. To date only six mergers have proceeded to the Tribunal, four of which were on a consent basis. Since the Director exercises considerable discretion at the pre-litigation stage and because there exists no private action in respect of mergers, the Director's enforcement practices and stated policies are of particular relevance. The Director's approach to merger review is set out in the 1991 Merger Enforcement Guidelines ("Guidelines"), which were inspired to a considerable degree by the U.S. Merger Guidelines of 1984.

I. Procedural Aspects

Notification

The Act requires that the Director be notified of proposed transactions where two thresholds are exceeded. The first relates to the overall combined size of the merging parties. Notification is not required unless the merging parties, including their affiliates, have assets in Canada or have gross annual revenues from sales in, from, or into Canada that exceed $400 million.

The second threshold relates to the size of the transaction. The Act distinguishes four different types of transactions: asset acquisitions, share acquisitions, corporate amalgamations, and business combinations otherwise than through a corporation, such as a joint venture. Where the relevant threshold is exceeded, a transaction is notifiable unless it qualifies for an exemption. In regard to asset acquisitions, notification is required for a proposed acquisition of any assets in Canada of an operating business where the aggregate value of the assets or the gross annual revenue from sales in or from Canada generated by those assets exceeds $35 million. A share acquisition triggers notification where the acquiree has underlying assets in Canada in excess of $35 million and the acquiror obtains a voting interest of greater than 20% if the acquiree is a public company or greater than 35% if it is a private company. An amalgamation must be notified where the value of the assets in Cana da or sales in or from Canada of the continuing corporation exceeds $70 million and at least one of the amalgamating corporations carries on an operating business. In the case of a proposed combination otherwise than through a corporation, notification is required if at least one of the parties to the combination contributes assets of an operating business to the combination and the value of the assets in or sales in or from Canada exceeds $35 million.

Notification must be made by the person or persons proposing the transaction. The notifier may supply information in either "short form" or "long form". In either case, the information to be provided includes any legal documents in relation to the transaction, a description of the proposed transaction and of the parties and affiliates, sales figures, asset values, principal categories of product produced, main customers and suppliers and pro forma financial statements. The difference between the long form and the short form is that the long form requires more information on affiliates and products. All information provided pursuant to the notification under the Act is confidential and may not be disclosed except to a Canadian law enforcement agency or for the purposes of the enforcement or administration of the Act. One shortcoming of the notification process is that the information required to be filed does not provide all information necessary for a competition analysis. A s a result, many competition lawyers provide an accompanying "competition brief" dealing with potential competition concerns.

Where notification is required, parties may not complete a transaction until seven days following a short form filing, and 21 days following a long form filing. Where a person has filed a short form notification, the Director may require nonetheless that a long form notification be provided. Conversely, the Director may abridge the time periods for notification. Upon expiration of the relevant time period, the Director will inform the parties whether there is no issue or whether he requires additional time to review the transaction. In the latter case, parties may legally complete the transaction, although will often wait for "clearance" from the Director so as to avoid potential problems associated with post-closing unscrambling of assets.

Advance Ruling Certificate

The Act sets out a procedure whereby the Director may issue an "advance ruling certificate" ("ARC") with respect to a proposed merger to indicate that he does not have sufficient grounds to make an application to the Tribunal. The effect of issuing a certificate is to preclude the Director from applying to the Tribunal in respect of the merger solely on the basis of information that is substantially the same as the information on the basis of which the certificate was issued. Parties seek ARCs for procedural as well as substantive reasons. Where a certificate is issued, parties are exempted from the notification requirements of the Act. An ARC request also triggers confidentiality protection. Any information obtained from a person requesting an ARC is confidential and may only be disclosed to a Canadian law enforcement agency or for the purposes of the enforcement or administration of the Act. Where a transaction is not notifiable, parties may nonetheless seek the comfort of an ARC, since non-notifiable transactions are still potentially subject to substantive merger review.

Advisory Opinions

The Bureau, through its compliance program seeks to aid parties in assessing whether a particular transaction or practice raises issues under the Act. In the merger context, the Director will provide advisory opinions to parties to indicate whether a contemplated transaction would provide sufficient basis for commencing an inquiry under the Act.

II. Substantive Merger Review

The Tribunal acts only "on application by the Director". Private action is limited to the exceptional case where an existing Tribunal order has been breached.

The Tribunal may proscribe, in whole or in part, a merger where it is likely to prevent or lessen competition substantially and will not give rise to offsetting efficiency gains. The analysis may therefore be divided into three issues, which shall be addressed in turn:

1. The Merger Issue (section 91): Does the transaction qualify as a "merger"?
2. The Competition Issue (sections 92, 93): Is there likely to be a substantial prevention or lessening of competition?
3. The Efficiencies Issue (section 96): Are there likely to be offsetting efficiency gains?

A. The Merger Issue

Although the notification procedure explicitly captures many of the largest mergers, it is important to note that substantive merger review is not confined to notifiable transactions. Any transaction which constitutes a "merger" may be subject to review under the Act. This potential for reviewing non-notifiable transactions should not be underestimated. The notification thresholds are considerably higher than in the United States. The result is that many of the more problematic mergers reviewed by the Bureau have involved transactions falling below the notification thresholds. Such mergers may be brought to the Director's attention either through publicity or by the parties themselves seeking pre-closing assurances that there will be no subsequent unscrambling of assets.

The term "merger" is defined broadly in section 91 to mean:

. . . the acquisition or establishment, direct or indirect, by one or more persons, whether by purchase or lease of shares or assets, by amalgamation or by control over or significant interest in the whole or a part of a business of a competitor, supplier, customer or other person.

"Control"

The Act provides that a corporation is "controlled" by a person who holds directly or indirectly, more than fifty per cent of the votes cast to elect directors of the corporation and has the ability to elect a majority of directors. With regard to non-corporate entities, neither the Act nor the Guidelines address the meaning of "control". In any event, the Guidelines interpretation of "significant interest", discussed below, subsumes a notion of "control", thereby rendering largely superfluous the need to determine whether, in addition to constituting the acquisition of a significant interest, there has also occurred a change of control.

"Significant interest"

Where something less than "control" is involved, it remains to be determined on a case by case basis how much inter-firm integration will be necessary to constitute a "significant interest". The Act provides no guidance on this point and the cases to date before the Tribunal have involved acquisitions of de jure control.

The Guidelines define "significant interest" in the following terms:

. . . a "significant interest" in the whole or part of a business is held when one or more persons have the ability to materially influence the economic behaviour (e.g., decisions relating to pricing, purchasing, distribution, marketing or investment) of that business or a part of that business.

In the case of corporations, the Guidelines indicate that such material influence could result from holding sufficient voting shares to materially influence the board or block resolutions of the corporation. A minority voting interest of less than 10% will not generally constitute a "significant interest". Inferences are more difficult for voting interests between 10% and 50%. In such cases, the Guidelines indicate only that a higher voting interest is usually necessary to influence a private company than a public company. The Guidelines also consider that a significant interest may arise from a wide variety of means: shareholder agreements, management contracts and various contractual arrangements involving corporations, partnerships, joint ventures combinations and other entities.

Extent of "merger"

Where the existence of a merger has already been established, a different, though not entirely distinct, issue has arisen in Canadian competition law concerning the proper compass of the word "merger". Where firms merge only part of their businesses, such as to form a joint venture, and remain distinct for other purposes, there may be an issue over the extent to which ensuing commercial arrangements involving the firms and the merged entity are part of the "merger". This issue was central to the Gemini (no. 2) case where the merger of the computer reservation systems of Canada's two largest airlines, thereby creating the Gemini system, was ultimately dissolved.

The facts of Gemini (no. 2) are complex and unique. In particular, the case arose not directly from a merger, but from a 1992 application under s. 106 to vary an existing consent order governing the initial 1989 Gemini merger. The definition of "merger" was relevant because the Tribunal's power to address competition problems arising from a "hosting" relationship between one of the airlines and Gemini was dependent on whether that relationship was part of the original Gemini "merger". In deciding that the hosting relationship was an "an integral part" of the merger transaction, the Tribunal displayed a willingness to purposively interpret "merger" by looking at all of the business relationships surrounding the transaction, an approach consistent with the Guidelines.

B. The Competition Issue

The Tribunal's authority to prohibit, in whole or in part, a merger is engaged by a finding that the "merger or proposed merger prevents or lessens, or is likely to prevent or lessen, competition substantially". The analysis of this market power issue may be divided into two related considerations: market definition and assessment of various "evaluative criteria".

Market Definition

The crucial role of market definition in Canadian merger review is evidenced by the fact that the only two contested merger cases to date before the Tribunal have both turned largely on market definition. In permitting the merger of two meat rendering companies in Hillsdown,the Tribunal disagreed with the Director that the geographic market was confined to parts of southern Ontario and did not extend into neighbouring regions of the United States. In Southam, the Tribunal permitted a newspaper merger after concluding that the products of the merging parties (daily newspapers and community newspapers) were sufficiently differentiated as to constitute separate product markets.

The Bureau's approach to market definition, as set out in the Guidelines is based on a "hypothetical monopolist" paradigm. A relevant market is defined as the smallest group of products or geographic area within which sellers acting as a single firm (a "hypothetical monopolist") could "profitably impose and sustain a significant and non transitory price increase". Although the Tribunal has not explicitly endorsed this approach, the Director has viewed the Tribunal cases as reflecting the essential elements of the analysis mandated by the Guidelines.

Evaluative Criteria

Once the relevant markets have been defined, the analysis shifts to determining market shares, as well as assessing various "evaluative criteria" set out in section 93 of the Act. High market shares are a necessary, though not in themselves sufficient, condition before a merger can be proscribed. The Guidelines focus on two thresholds, dealing respectively with unilateral and interdependent market power. First, the Director will generally not challenge a merger on the basis of unilateral market power where the post-merger market share of the merged entity would be less than 35%. Second, the Director will generally not challenge a merger on the basis of interdependent exercise of market power where the post-merger four firm concentration ratio would not exceed 65% or the post-merger market share of the merged entity would be less than 10%.

Although evidence of concentration is of obvious importance, the Tribunal is precluded from proscribing a merger on the basis of market shares alone. Section 93 of the Act sets out several other factors to be considered when determining whether there will likely be a substantial lessening or prevention of competition: foreign competition, business failure, availability of substitutes, barriers to entry, effective competition remaining, removal of a vigorous and effective competitor, innovation and any other factor that is relevant to competition.

C. The Efficiencies Issue

The appropriate role of efficiency considerations in competition policy poses challenges well known in most antitrust jurisdictions. The interplay between such concepts as "competition", "efficiency" and "welfare" is central to any debate over the proper purpose of competition law. This is particularly evident in the context of merger analysis. In Canada, the issue is brought to the forefront by the Act's express recognition that efficiency gains to the economy may outweigh the potential harmful effects of lost competition. Section 96 of the Act creates an "efficiency exception" which exempts the Tribunal's authority to proscribe a merger where there are sufficient efficiency benefits:

96. (1) The tribunal shall not make an order under section 92 if it finds that the merger or proposed merger in respect of which the application is made has brought about or is likely to bring about gains in efficiency that will be greater than, and will offset, the effects of any prevention or lessening of competition that will result from the merger or proposed merger and that the gains in efficiency would not likely be attained if the order were made.

This provision has been the subject of considerable comment in Canadian competition circles. Much of the dispute has centered on the proper interpretation of the phrase "the effects of any prevention or lessening of competition." The Guidelines consider wealth transfers as neutral, limiting the anti-competitive effects to allocative inefficiency (or "deadweight loss"), thereby favouring total welfare over consumer welfare:

Section 96(1) requires efficiency gains to be balanced against "the effects of any prevention or lessening of competition that will result or is likely to result from the merger or proposed merger". Where a merger results in a price increase, it brings about both a neutral redistribution effect and a negative resource allocation effect on the sum of producer and consumer surplus (total surplus) with Canada. The efficiency gains described above are balanced against the latter effect, i.e. the deadweight loss to the Canadian economy.

In seeking to resolve the potential tensions in section 96, the Tribunal, the Guidelines and various commentators have all turned for enlightenment to the purpose clause in section 1.1 of the Act. However, the competing goals of the purpose clause may have fueled, as much as clarified, the efficiencies debate. Section 1.1 reads:

The purpose of this Act is to maintain and encourage competition in Canada in order to promote the efficiency and adaptability of the Canadian economy, in order to expand opportunities for Canadian participation in world markets while at the same time recognizing the role of foreign competition in Canada, in order to ensure that small and medium-sized enterprises have an equitable opportunity to participate in the Canadian economy and in order to provide customers with competitive prices and product choices.

In the first contested merger case, Hillsdown, the parties to the merger and the Director agreed in law on the interpretation of section 96, but disagreed only on whether in fact the various efficiencies claimed would likely be realized. The Tribunal's finding that the merger was unlikely to lessen competition substantially obviated the need to directly address the efficiency issue. However, the Tribunal took the opportunity, in obiter, to criticize the Guidelines' approach as unnecessarily confining the anti-competitive effects of the merger to allocative inefficiency..

In coming to its view that the anti-competitive effects of a merger were not necessarily limited to deadweight loss, the Tribunal acknowledged the policy debate which has raged particularly in the United States over the proper role of efficiencies in merger policy. The Tribunal did not offer a definitive approach to section 96. Instead, it limited its comment to posing the question of whether the wealth transfer must always be considered neutral, such as where the relevant product is a life saving drug or where a dominant firm is foreign-owned and the wealth transfer leaves the Canadian economy.

It is not yet clear the extent to which the obiter comments from Hillsdown will affect merger policy in Canada. The Director has recently reaffirmed his commitment to the approach set out in the Guidelines and the practical significance of any divergence between the two approaches remains to be seen. In that regard, it is noted that since the Act came into force in 1986, there has yet to be a case where, notwithstanding a determination of a substantial lessening of competition, the Bureau chose not to challenge a merger on the basis of efficiencies. This is not to minimize the importance of efficiencies, but rather to highlight the economic sophistication and flexibility of the substantial lessening of competition analysis. For example, a careful determination of relevant markets (does the market extend into the United States?) or of section 93 factors, such as business failure (are economies of scale and economic conditions such that a firm is likely to leave the mar ket in any event?) may address many of the competition concerns. Further, although efficiencies have not been determinative, they have added "comfort" to borderline conclusions that a merger is not likely to lessen competition substantially.

In practice, the most relevant issue with respect to efficiencies is whether the claimed efficiencies are likely to be realized. This was the area of disagreement between the parties and the Director in Hillsdown and is likely to be the primary focus of efficiency disputes in the future. The Tribunal has made it clear that the onus is on the parties claiming efficiencies to prove that they are likely to be realized. Since the Act refers not simply to efficiency gains which the merger is capable of bringing about, but more specifically to gains which the merger is "likely" to bring about, there is scope for discounting where the best evidence suggests that some or all of the claimed efficiencies are unlikely to materialize.

III. Remedies

Orders in Contested Cases

As a creature of statute, the Tribunal has only those remedial powers as are expressly set out in the Act. In the case of a completed merger, the Tribunal is confined to ordering the parties to "dissolve the merger", "dispose of assets or shares" or , with the consent of the parties, "take anything other action".Therefore, in the absence of consent, the Tribunal's powers are limited to the "blunt instrument" of ordering dissolution and divestiture. The Federal Court has reasoned that the all or nothing nature of the Tribunal remedies serves a desirable policy goal of motivating parties to negotiate more finely tuned remedies upon consent:

. . . it is also my view that the policy of the Act, and more particularly of the provisions relating to mergers, is to favour solutions which the parties and the Director, with the guidance and consent of the Tribunal, fashion for themselves and to that end to do everything within reason to encourage them to negotiate. That, as I see it, is the rationale for what I have described as the "blunt instrument" of subparagraphs 92(1)(e)(i) and (ii) which are designed to lead to the sophisticated solutions of subparagraph 92(1)(e)(iii).

The Tribunal has also recognized this principle that, in the absence of consent, the Act mandates straightforward structural remedies for completed mergers.

By comparison, where the contested merger has not yet been completed, the Tribunal's arsenal is not so blunt as to be confined to dissolution or divestiture. Even absent consent, the Tribunal may make an order:

. . . prohibiting the person against whom the order is directed, should the merger or part thereof be completed, from doing any act or thing the prohibition of which the Tribunal determines to be necessary to ensure that the merger or part thereof does not prevent or lessen competition substantially.

Consent Orders

Where the parties and the Director agree on how to condition a merger so as to address competition concerns, they may submit their proposal to the Tribunal for approval as a consent order. However, the process is not merely a rubber stamp. To date, three consent orders have been issued and one proposed consent order has been rejected. The Tribunal will be willing to go beyond structural remedies where behavioural terms and conditions may be particularly appropriate, but only where they do not involve ongoing monitoring which is tantamount to regulation. For example, in ABB, the Tribunal was willing forebear from ordering divestiture on the condition that certain tariff reductions be implemented. In Gemini, the Tribunal addressed certain access concerns by promulgating "CRS Rules" as a temporary measure on the understanding that they would be superseded by regulations.

Unfortunately, the protracted hearings leading to the issuance of the Imperial Oil consent order may have dissuaded parties from exposing their proposed transactions to the public scrutiny and potential delays and costs associated with the consent order process. However, subsequent Tribunal experience suggests that process concerns may be exaggerated in many cases. In the recent Gemini (no. 2) case, a fully contested matter before the Tribunal, complex matters were dealt with in a very time sensitive manner. In addition, procedural matters such as streamlining intervenor rights, have been achieved. It is hoped that such developments will lead to increased use of the consent order procedure, with its potential for more sophisticated remedies, thereby creating a more transparent process.

Conclusion

The merger review process under Canada's Competition Act is still in the early stages of its development. The limited jurisprudence to date has highlighted the importance of market definition, provided guidance on the applicability of the consent order process, and offered obiter comments on the role of efficiencies. Future cases will help fine tune these central issues, as well as address other important questions, such as the meaning of "merger". In that regard, the next few years will be pivotal in determining how much life will be breathed into Canadian antitrust merger law.