Merger Law in Canada: An Update

Notes for an Address by Howard I. Wetston
Director of Investigation and Research
Competition Act
Consumer and Corporate Affairs Canada

To the 17th Annual Conference of the Fordham
Corporate Law Institute
New York

October 19, 1990

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I am pleased to have this opportunity to update you on the current status of Canadian merger law and the initiatives we are pursuing in this area. In particular, I want to spend some time discussing several recent court decisions and the first Merger Enforcement Guidelines, which we expect to circulate for consultation in the near future.

As those of you familiar with Canadian competition legislation are aware, enactment of the Competition Act in 1986 dramatically improved Canada's ability to address anticompetitive mergers. Since 1986, mergers have been examined in Canada under non-criminal standards, taking full advantage of what is often termed the "new learning" in the area of industrial organization. Principal among the economic concepts adopted is that the Act protects competition, not individual competitors, and the view that a market's performance cannot be predicted only from its structure or high levels of industry concentration. The purpose of the Competition Act, as stated in section 1.1, is in part to maintain and encourage competition in Canada in order to promote the efficiency and adaptability of the Canadian economy; competition is not a desired end in itself.

The implementation of the Competition Act could not have occurred at a more opportune time. Merger and acquisition activity in Canada has continued to grow despite difficult economic times. The supply of capital to finance acquisitions appears to have become increasingly available and sophisticated. The pressure on business to rationalize operations in response to enhanced North American and global competition is expected to continue. The need for rationalization is thought to be stronger for Canadian firms because our markets are frequently small relative to the efficient scale of most production. In the past, this has imposed cost disadvantages on Canadian firms competing at home and in international markets. To combat this, firms have combined in an attempt to realize longer production runs and other more cost-efficient processes. The importance of rationalization tends to vary by industry; we may expect to see more extensive merger activity related to rationalization in mature, commodity-based industries.

For the Competition Bureau, recent years have been exceedingly busy. Not only did we assess more transactions than in previous years, but those examined were highly complex. Since the Competition Act came into force in 1986, approximately 4000 mergers and acquisitions have taken place in Canada. In 1989, merger and acquisition activity in Canada had a total value of $30 billion, representing a 26 percent increase over 1988, and exceeding the previous record level of $28 billion set in 1987. About 15 percent of these transactions posed a competition issue of sufficient magnitude to warrant an examination by the Bureau of two or more days.

The vast majority of mergers that typically present no competition issue include: vertical and conglomerate mergers; financial transactions where there is no significant change in control; mergers which bring a new player into a domestic market (this is particularly true for many foreign investments in Canada) or a new investor from another part of Canada into a regional market.

It is interesting to note that despite high Canadian interest rates and the slowdown in North American economic activity, the number of mergers now under examination by the Bureau is at its highest level since the inception of the merger review process under the new Act. A number of factors may help explain this trend:

(1) Offshore capital is moving into Canada in order to establish a North American presence. Merieux's purchase of Connaught Laboratories is a recent example of such a move.

(2) There is a tendency for some Canadian companies, after reaching a certain scale, to seek a larger buyer--either domestic or foreign--to provide the capital, management, marketing, distribution channels, and research and development capability to support future growth. Typical examples include Canadian resource companies involved in oil and gas exploration and development.

(3) Some Canadian industries are restructuring in response to the Canada-U.S. Free Trade Agreement, although the number claiming CUSTA as the stimulus to their transaction is considerably less in our experience than has been anticipated. However, a number of mergers in the printing industry, where tariffs are being reduced to zero from 28 percent, support this proposition. Other examples include Trailmobile's purchase of Fruehauf and the acquisition of Domglas by Consumers Packaging.

(4) In other cases, companies are selling off their more peripheral activities in order to streamline their operations and return to their traditional core businesses. Both the Canadian Pacific and Bell Canada Enterprises conglomerates have been trimming businesses in recent years. CP has divested itself of a lot of its trucking businesses in addition to the airline. Likewise, BCE has sold off their interests in real estate development.

Examples of files now under review by the Bureau include the proposed joint venture between Canada's second- and third-largest flour-milling companies, Maple Leaf Mills and Ogilvie Mills; the acquisitions by Canada's largest daily newspaper chain, Southam Newspaper Group, of a number of community newspapers in British Columbia; Aults Foods' acquisition of the ice cream division of William Neilson Ltd.; and several dairy acquisitions in the province of Quebec.

The shift from a goods-based to a service- and knowledge-based economy is also leading to heightened Canadian merger activity in the financial, legal and accounting sectors. These developments will pose new and challenging issues for anti-trust authorities throughout the industrialized world.

Some have argued that with the advent of freer international trade, anti-trust policy is becoming less important and necessary in countries like Canada. I do not agree. Effective and pragmatic enforcement of anti-trust law is a complement to, not a substitute for, trade liberalization. Anti-trust enforcement that is responsive to global trends and the realities of the modern industrial economy is necessary to ensure that the economic gains and opportunities afforded by freer international trade are maintained and provide important economic benefits to consumers as well as to industry.

In Canada, new laws are often subject to constitutional challenges, and the Competition Act of 1986 has been no exception. Anyone familiar with Canadian competition policy could well have predicted constitutional challenges--they have occurred with every piece of competition legislation enacted in the country. The Charter of Rights and Freedoms has provided the basis for a number of significant challenges against fundamental areas of competition law and enforcement. In the Couture case, in a decision of the Quebec Superior Court, Judge Phillipon struck down the Competition Tribunal in its entirety. This decision is under appeal. The appeal focuses on the independence and impartiality of its lay members, and on the Tribunal's powers with respect to mergers. The arguments made in Couture have since been adopted in other non-merger proceedings before the Tribunal by the respondents in the NutraSweet and Xerox cases.

The Tribunal has since ruled on these matters in the NutraSweet case--our first case under the abuse of dominant position provisions of the Act. In addition to affirming its constitutionality, the Tribunal issued a decision which clarifies much within the law. It concluded that the NutraSweet Company's use of exclusive dealing, certain financial incentives or fidelity rebates and its exclusivity clauses has lessened, and are likely to lessen, competition substantially. A remedial order prohibiting such practices has been made.

The Competition Tribunal's judgment on the merits of the NutraSweet case is significant for a number of reasons. First, the Tribunal clearly took an economic approach to the adjudication of the case. It devoted special attention to matters such as the relevant product and geographic markets, entry barriers and market foreclosure through patents. Second, the Tribunal recognized that the illustrative list of anticompetitive acts referred to in the abuse provisions is clearly not intended to be exhaustive. Thus, the sections appear to be applicable to virtually any act employed by a firm for the purpose of excluding or disciplining its competitors. Third, the Tribunal clarified the approach to be taken in applying the test of lessening competition substantially, which is a key element of the abuse section and other sections of the Act. It indicated that the issue to be addressed in applying this test is whether the alleged anticompetitive acts preserve or add to the firm's mark et power.

In the case of the constitutional arguments, the Tribunal's finding is similarly clear and concise, concluding that the Tribunal panel hearing the NutraSweet case has been validly constituted. In its decision, the Tribunal found that a reasonable, informed person would see in the various arrangements made for membership of the Tribunal adequate protection against bias on the part of a given lay member. The validity of the Competition Tribunal was also upheld, based on the fact that there is not only judicial review of the Tribunal provided by the legislation, but also full powers of appeal from its decisions to the Federal Court of Appeal. As a result of the decision, the Tribunal remains available to hear applications by the Director, and we fully intend to make such applications as further cases arise.

Another significant constitutional challenge to the Act relates to the conspiracy provisions, the central pillar of any competition legislation. Early in September of this year, the Trial Division of the Nova Scotia Supreme Court ruled in a case involving the Pharmaceutical Association of Nova Scotia that the conspiracy section of the Act is incompatible with various provisions of the Charter of Rights and Freedoms. The Court held that the legislation is in conflict with the Charter because it allows for the conviction and imprisonment of a person without a sufficient finding of criminal intent, in that there is no obligation on the Crown to prove that an accused intended to lessen competition unduly. Further, the court held that the Act does not provide adequate information as to what business conduct is illegal because it incorporates the standard of an "undue" lessening of competition. This standard was found to be too vague, and therefore the legislation violated the Cha rter provisions that guarantee the right to fundamental justice, the right to make a full answer and defence, and the right to a fair trial.

Obviously, these are important questions of law that need to be resolved expeditiously. However, in spite of these challenges, the Bureau continues to vigorously enforce competition law in Canada. While these decisions have created some uncertainty, the Director continues to promote voluntary compliance with the Act and, where necessary, take enforcement action.

A second area that merits specific mention and has received considerable attention is the merger consent order process. Practical experience before the Tribunal, particularly in the aftermath of the Imperial Oil/Texaco proceeding, has raised some concerns regarding the present use of consent order proceedings in Canada. While it is clear that the merger review process must be both certain and timely for the merging parties, it must also be enforced in a manner that balances the interests of the parties with those of the public affected by the merger. With this standard in mind we have spent considerable time reviewing the Imperial Oil and other consent order proceedings, and have concluded that the use of consent orders is still warranted in certain situations. We have also determined ways to expedite the process before the Tribunal.

The Bureau is also taking additional steps to clarify our merger enforcement procedures under the Competition Act by issuing Merger Enforcement Guidelines. The need for such clarification stems from the fact that the legislation enacted in 1986 created a new legal and economic framework for merger review in Canada. As a result, there is little in the way of jurisprudence to assist the Bureau, business or merger counsellors on merger policy.

Given the nature of Canadian merger policy, we expect that contested mergers will continue to be few in number. Where competition problems surface, it is most likely that resolution will be by way of undertakings to the Bureau of Competition Policy or possibly by consent orders before the Tribunal.

In the context of this legal and economic environment, one of the Director's top priorities has been to develop Merger Enforcement Guidelines for release to the public in the near future. The Guidelines should carefully advise the public of the Bureau's policies, be consistent with current legal and economic thinking, and reflect Parliament's clear intention that there be a meaningful role for merger policy.

There are several principal objectives in establishing Guidelines. First, the Guidelines should promote a high level of public confidence in the Bureau's merger review process. In this regard the Guidelines are not a restatement of the law. Rather, they provide a description of the Bureau's enforcement policy in sufficient detail to guide to the maximum extent possible without compromising flexibility and discretion.

Second, the Guidelines will promote a better understanding of the Bureau's merger review process, and so will reduce any uncertainty or unpredictability that is associated with, or is perceived to be associated with, Bureau merger review. The new Competition Act has created a fundamental change in its emphasis on economic analysis by highlighting matters such as barriers to entry, efficiencies and foreign competition. In order to assist business persons and counsellors to work within the new framework, the Guidelines will provide considerable detail, clear bright lines and guiding principles when appropriate. However, judgment will continue to play an important role in enforcement policy without "pretending unattainable scientific rigour."

Third, the Guidelines will, we hope, facilitate and influence business planning and practices. This last goal is important; the Competition Act should only come into play when a transaction prevents or lessens competition substantially. It should not have a chilling effect on transactions that would have benign consequences for competition.

The Merger Guidelines will not increase merger challenges by the Bureau of Competition Policy or increase the requirements for negotiated settlements. They will, however, enhance our compliance program considerably.

We anticipate that a further important benefit of issuing Merger Enforcement Guidelines will be to improve the quality and predictability of information provided to the Bureau for our assessment of particular transactions.

At the present time, we are in the process of completing a draft of the Guidelines that will be circulated to the public on a widespread basis for comment later in the year. In arriving at the positions articulated in this document, we have benefitted considerably from preliminary consultations with a small group of outside economic and legal experts, both in and outside Canada. I should make it clear that the following comments on Merger Enforcement Guidelines reflect a draft which is still being developed, and that certain changes may be made following the consultation process.

The Bureau's Merger Guidelines will begin with a section that articulates what we consider to be the legal definition of the term "merger," which is contemplated in section 91 of the Act. In this regard, the key issue to be discussed is the Bureau's approach to the term "significant interest." Our position has been that the acquisition or establishment of a significant interest in the whole or part of a business of another person occurs when a person acquires or establishes an ability to materially influence the economic behaviour of a second person.

Part II of the Guidelines will articulate the general circumstances in which the Bureau considers that a merger may "prevent or lessen competition substantially," as that notion is contemplated by section 92 of the Act. In short, as with the U.S. Department of Justice and other enforcement authorities around the world--the Australian Trade Practices Commission, for instance--the Bureau will adopt a market power approach that focuses primarily on whether prices are likely to be higher than they would be in the absence of the merger or a part of the merger. The Bureau will also examine any potential for anticompetitive effects relating to various non-price dimensions of the transaction, such as a reduction in service, quality, variety, advertising or innovation, where rivalry in terms of these dimensions of competition is important.

Part III of the Guidelines will provide a comprehensive presentation of the Bureau's approach to market definition. This approach is based on the now well-known hypothetical monopolist framework that was first described in the U.S. Department of Justice's 1982 and 1984 Merger Guidelines, and has recently been endorsed in the Australian Trade Practices Commission's bulletin, Misuse of Market Power. Our analysis suggests that this framework will yield a more accurate and rigorous anti-trust market for merger analysis under the Competition Act than alternative approaches. An additional benefit for parties to mergers spanning the Canada-U.S. border is that markets will be defined in a consistent manner by enforcement agencies in the two countries. This benefit will become increasingly significant as progressive tariff reductions under the Canada-U.S. Free Trade Agreement result in greater integration of markets spanning both nations.

After articulating the conceptual framework of the hypothetical monopolist approach to market definition, the Guidelines will deal with the various criteria that the Bureau assesses in applying the approach in practice. These include price relationships, ease of product substitution, views of buyers and others in the industry, end use, physical characteristics, switching costs, transportation costs, local set-up costs and shipment patterns.

The section on market definition will be followed by a detailed discussion of the Bureau's approach to each of the evaluation criteria that are mentioned in section 93 of the Competition Act, together with a statement of our approach to market share/concentration and to various additional criteria that staff typically address in the context of the subsection 93(h), "any other relevant factor" stage of the assessment process. In this latter regard, the general criteria discussed may include countervailing power, the level of market transparency, and the frequency and value of transactions in the market. In addition, the Guidelines will outline the limited circumstances in which enforcement action may be warranted in respect of a vertical merger, and one circumstance in which concerns could be raised by a conglomerate merger.

Insofar as information relating to market shares and concentration is concerned, subsection 92(2) of the Competition Act prevents the Tribunal from making an order solely on the basis of such evidence. Accordingly, we do not intend to adopt "likely challenge" market share and concentration bright lines. Nevertheless, given that high market share is a necessary condition that must exist before anticompetitive outcomes can result from a merger, the Bureau's Guidelines will set forth a market share "safe harbour" and a concentration "safe harbour" bright line in CR4 terms. It is evident that, inter alia, a merger will be increasingly likely to raise concerns as the market share or concentration levels rise above these levels.

Finally, in Part V of the Guidelines, the Bureau will describe its approach to the efficiency exception provisions that are set forth in section 96 of the Act. In very general terms, efficiency gains that are not redistributive in nature and that would not likely otherwise be attained are balanced against the dead-weight losses attributable to the likely prevention or lessening of competition that will result from the merger. However, this approach would be adapted to account for matters such as: (i) qualitative efficiency gains and anticompetitive effects; (ii) timing differences between the gains and the losses; and, (iii) the fact that the costs savings may not be generally realized across the entire market.

To summarize, this update on merger law in Canada addressed three major considerations:

1. Statistically, we believe merger activity in Canada will continue at a high level.
2. The Competition Act, including portions dealing with mergers, is presently under court challenge, but enforcement has not as yet been seriously impacted.
3. We soon will be issuing Merger Enforcement Guidelines, which will make merger analysis more transparent and increase public confidence in the Bureau's merger review process.

Merger enforcement is not a precise science. It poses challenges not only for anti-trust authorities but also for the parties who want to see their transactions finalized as quickly as possible. A set of Canadian guidelines should reduce misunderstandings, better focus information collection and analysis, lead to better and faster merger decisions by anti-trust officials, and result in Canadian mergers that support our competitive position domestically and worldwide. I am confident that the publication of the Bureau's Merger Enforcement Guidelines will, over time, provide these benefits.

Thank you.