Treatment of Efficiencies in the Competition Act - Part 2

Part 2: Issues for Discussion and Possible Options

The drafters of the Competition Act were clear in their decision to incorporate efficiencies into Canadian merger law, and there has been little debate since 1986 about the propriety of this decision. There has, however, been considerable discussion of whether the efficiency exception in section 96 is the appropriate means of bringing efficiencies into merger analysis in Canada.

This part of the paper discusses several areas for discussion on the topic of efficiencies, in light of the background and issues outlined in Part 1, and assesses the advantages and disadvantages of these various options. The possible options described below are by no means exhaustive and are proposed to solicit public comment. A series of questions and issues for commentators to consider when providing input on the various options follows.

Status Quo

The first option is to maintain the status quo in the area of merger efficiencies. This would mean retaining the merger efficiencies defence in section 96, without amendment, and relying on the direction provided by the Federal Court of Appeal and the Competition Tribunal in the Superior Propane case and other relevant case law regarding the interpretation and application of section 96.

Some proponents of maintaining the efficiencies defence in section 96 have observed that the Canadian economy is smaller than that of the U.S. or European Union and that greater concentration may be required to realize economies of scale. Moreover, the openness of the Canadian economy to foreign competition has meant that increases in domestic concentration are relatively less important than the gains in economic efficiency that a merger could bring. As a result, proponents argue, Parliament was correct in adopting a distinctly Canadian approach to efficiencies. The counter-argument to these points is that trade liberalization has expanded the relevant market for many goods and services, thereby permitting merged firms to achieve minimum economies of scale without raising any competition concerns. Under free trade, the portion of the economy to which the historical rationale for the defence might apply has shrunk considerably.

A further point sometimes made by those who support maintaining the status quo is that there is no "one size fits all" solution to the treatment of efficiencies. Convergence in the area of efficiencies would adversely affect the ability of firms to compete internationally, since the underlying economies of trading nations are vastly different. Convergence would also erode the competitive advantage conferred on Canadian firms by section 96. On the other hand, it should be noted that when a merger resulting in a substantial lessening of competition is allowed to proceed under section 96 and the products or services of the merged firm are used by other Canadian firms as inputs, this may adversely affect the competitiveness of the customer firms.

One significant disadvantage of maintaining the status quo relates to the experience to date under section 96. In particular, it has been argued that efficiencies have failed to exert the kind of significant influence on Canadian merger law that was envisaged when this provision was drafted. In the 18 years since the Competition Act came into effect, the defence has been successfully applied only once, in the Superior Propane case. The paucity of case law on efficiencies is due in part to the fact that very few merger cases are heard by the Competition Tribunal, which has sole jurisdiction to apply the efficiencies defence. It may also be a function of the difficulty of proving that efficiencies that may arise from a proposed merger will be greater than and offset the anti-competitive effects. In this regard, it has been argued that the Superior Propane case narrows the practical scope for application of the defence even further, by requiring the merging parties to show that efficiencies outweigh and offset not only the deadweight loss but also the portion of the wealth transfer (resulting from a post-merger price increase) that is deemed to be socially adverse. The identification and measurement of these elements pose enormous challenges and make it very difficult for parties and their advisers to forecast when the defence might be available. Therefore, it is argued, relatively few merging parties would be prepared to invest in developing and litigating an efficiencies case, given the uncertainty of whether such litigation would have any prospect of success.

Section 93 Factor Approach

A second option would be to eliminate the efficiencies defence in section 96 and make efficiencies a factor to be considered in the context of determining whether a merger leads to a substantial lessening of competition, along with the other factors listed in section 93 of the Competition Act.⁵³ As outlined in Appendix B, a factor approach is used in the United States, the European Union, the United Kingdom (hybrid regime) and Australia (hybrid regime).

In the context of a factor analysis of efficiencies (sometimes referred to as an integrated assessment), efficiencies alone cannot save a merger that is found to substantially lessen competition. However, they may make a difference -- "cleanse" the merger of its substantial harmful effects -- when they will enhance competition and increase rivalry, particularly when they will lead to lower prices, increased output or higher quality goods. Here are some frequently cited examples.

• Two small firms merge and are better able to compete with a larger rival.
• The merged entity increases its investment in research and development to improve its product, which enhance rivalry with competitors.
• The merger results in efficiencies that create a maverick firm and undermine conditions for coordinated conduct.
• The merger results in cost-reducing efficiencies that are likely to lead to lower (or not significantly higher) prices, increased output or higher quality goods.

Many proponents of a factor approach argue that the Competition Bureau would consider efficiencies in merger cases more routinely, if they were a factor rather than a defence. In the proponents’ view, parties have been reluctant to raise the defence, because it may only be invoked after the Tribunal has found that the proposed merger would prevent or substantially lessen competition within the meaning of section 92. As a result, a choice by the merging parties to put forward efficiencies claims might be seen as an acknowledgement that a merger contravenes section 92. Moreover, given the uncertainty of predicting efficiencies and effects and, in particular, of predicting the extent of socially adverse effects following Superior Propane, it is argued that few parties are willing to invest in developing an efficiencies case under the section 96 defence, even when their merger generates significant efficiencies. As a result, legitimate merger efficiencies are being ignored under the current regime. Currently, there is relatively little scope for consideration of merger efficiencies at the stage of determining whether a merger substantially lessens competition, particularly in light of the Tribunal's observation in the first decision in the Superior Propane case that, under the current legal regime, "it is plainly Parliament's intent that, in merger review, efficiencies are to be considered only under section 96 and not under section 92" (n. 37, para. 137).

Many of those who support a factor approach to efficiencies also believe that it would bring Canada's laws closer to those of its major trading partners (e.g. the United States and the European Union) and that many of the macro-economic reasons that motivated Canada to adopt a distinct approach to efficiencies in the first place have been overtaken by changes in the global economic environment and, in particular, to the liberalization of trade.

In most jurisdictions that use a factor approach (e.g. the United States, European Union, United Kingdom and Australia), there is some form of explicit requirement that efficiencies be passed on or produce some form of benefit for customers.⁵⁴ Such a requirement may apply to both intermediate customers and final consumers, and may be a short-or long-term requirement. Therefore, a variation on the factor approach would limit the efficiencies recognized under section 93 to those passed on in some form to customers.

It has been argued that the principal advantage of incorporating a customer benefit requirement into the analysis would be that it makes explicit what is probably already implicit. Under a factor approach, efficiencies that would be generally considered are those that enhance the incentives for the merging parties to reduce prices, increase output or innovate. These efficiencies are likely to bring benefits to consumers. One possible disadvantage of including an explicit customer benefit requirement is that it may lead enforcement authorities to discount or ignore efficiencies that do not produce short-term benefits for customers (see, in this regard, footnote 37 of the U.S. merger guidelines, which states that efficiencies that produce long-term benefits are given less weight). For example, mergers that produce fixed-cost savings may have no short-term effect on price but may result in increased rivalry and lower prices in the long-term. Similarly, many dynamic efficiencies generate long-term customer benefits. The wording of any customer benefit "test" would have to set out the time frame during which benefits to customers must be achieved.

Merger to Monopoly

A third option is to retain the efficiencies defence in section 96 but add an explicit exception that would bar the successful application of the defence when a merger created a monopoly or near-monopoly. The rationale for making such an amendment was outlined by Justice Gilles Létourneau in his dissent in both appeals of the Superior Propane case to the Federal Court of Appeal. Justice Létourneau wrote that section 96 was not meant to authorize the creation of monopolies, since that would defeat the purpose of section 1.1. On this point, Justice Létourneau said the following:

The advantage of barring on the application of the efficiencies defence in merger to monopoly or near-monopoly cases would be that it might reflect greater responsiveness to the purposes of section 1.1 than did the result of the Superior Propane case. Opponents of this approach might, however, argue that where a merger produces significant efficiency benefits that are greater than and offset the effects of any lessening or prevention of competition, it should be permitted to proceed, no matter how great the anti-competitive effects so long as the efficiencies outweigh those effects. In addition, it may be argued that the Court of Appeal in the Superior Propane case considered it important that the Tribunal retain the discretion to assess the full range of the effects under section 96 in any particular case, and that a complete ban on relying on an efficiencies defence in merger to monopoly-type cases would remove this discretion.

A variation on the complete ban would be an amendment to give expanded remedial powers to the Tribunal in the case of a merger to monopoly, which would have the advantage of preserving the Tribunal's discretion. As currently drafted, section 96 prohibits the Tribunal from making any type of remedial order when the efficiency gains generated by a merger are greater than, and offset, the effects of any prevention or lessening of competition.⁵⁶ An alternative approach is to allow the efficiencies defence to save a merger to monopoly but to give the Tribunal the power to impose conditions or other remedies sufficient to address concerns about the monopoly market conditions. As a further alternative, or in addition, this option might authorize the Tribunal to impose remedies that reduce the anti-competitive effects of a merger to monopoly to the extent feasible without significantly impairing the efficiencies.

As noted in part 1, partial precursors to this approach are found in two previous attempts to amend the Combines Investigations Act (Bills C-42 and C-13). Under those Bills, the efficiency exception would not have applied when the merger would have created a monopoly or near-monopoly; rather, a board would have been required to make an order against the merger. However, both Bills also specified that a merger to monopoly could proceed on the condition that customs duties or other trade barriers would be removed, with the result that the substantial lessening of competition would be negated due to import competition. (See also information about Bill C-29 in on page 12. This Bill contained a similar conditional order power, but without reference to merger to monopoly.)

Merger Outcomes

One further option relates to so-called "merger outcomes." The literature on this subject points out that many mergers fail to achieve the predicted synergies and efficiencies. It has been argued that all these studies show is that some mergers succeed while others do not, and that they should not be relevant at the point when mergers are reviewed -- that is, they should not be used to discount the parties' efficiencies claims.⁵⁷

Under section 97 of the Competition Act, the Competition Bureau retains the jurisdiction to make an application to the Competition Tribunal under section 92 for up to three years after the merger has been substantially completed. If efficiencies were to be a factor in merger review upon which the Bureau bases a decision not to challenge a merger initially, it would retain jurisdiction (unless it has issued an advance ruling certificate) to monitor the merged firm post-merger and to refer the matter to the Tribunal if the predicted efficiencies were not achieved.

In the context of a successful efficiencies defence under section 96, however, neither the Tribunal nor the Bureau appears to have the jurisdiction to review whether the parties have actually achieved their anticipated efficiencies once the merger has been completed (although the Bureau does have jurisdiction to attack specific anti-competitive post-merger conduct under other provisions of the Competition Act, such as the abuse of dominant position provision).

The option, then, would be to amend section 96 to allow the Tribunal to include a condition in its finding that a successful efficiencies defence relied on a post-merger assessment of whether efficiencies have been achieved. This would allow the case to be re-opened if the efficiencies realized were significantly less than predicted.

The principal advantage of introducing a requirement that parties live up to their efficiencies promise would be increased certainty that the efficiency-enhancing benefits promised by a merger will actually be achieved. A second advantage might relate to the burden on the parties in advancing their efficiencies claims. In particular, it may be less burdensome for parties to convince the Bureau and/or the Tribunal of their efficiencies claims when the relevant decision maker has the comfort of knowing that it will be able to assess the achievement of the projected efficiencies post-merger.

The disadvantages of an approach under which parties are required to demonstrate that planned efficiencies are actually achieved would be the mirror image of its advantages: it would create post-merger uncertainty for merging parties, who might not achieve their efficiencies for a whole host of reasons that were beyond the scope of contemplation at the time when they made their efficiencies. As well, it would create a substantial administrative burden for the Bureau and/or the Tribunal post-merger due to the need to monitor transactions.

Specialization Agreements, Joint Ventures and Strategic Alliances

Efficiencies may also be considered in the context of proposals to create a civil strategic alliances provision. The Competition Bureau's June 2003 discussion paper on section 45 included a proposal to limit the criminal prohibition to hard-core cartels. Under this proposal, a new civil strategic alliances provision would be added to the Act's reviewable practices provisions. The new provision would apply to horizontal and vertical agreements that prevent or substantially lessen competition, or are likely to, but that are not covered by the criminal provision. The discussion paper invited public comment on whether efficiencies should be considered as a factor in the civil strategic alliances provision,⁵⁸ and the discussion draft legislation contained in Appendix 6 of the discussion paper included efficiencies as a factor relevant to the assessment of whether a strategic alliance would substantially lessen competition. The relevant provision in Appendix 6 incorporated a consumer benefit requirement that paralleled the one proposed in Bill C-249. It read as follows:

In its April 2004 final report on the discussion paper consultations, the Public Policy Forum reported that participants generally agreed that if section 45 were to be amended, any new strategic alliances provision should allow efficiencies to be considered. There was, however, a divergence of views on how best to deal with efficiencies, including whether efficiencies should be dealt with as a factor or a defence, and whether the consumer benefit requirement proposed in the discussion paper should be retained.⁵⁹

The issues related to the proper scope for the treatment of efficiencies are identical in the strategic alliances and merger context (discussed above). In particular, there is a need to consider whether efficiencies should be treated as a factor or a defence, whether there should be a consumer benefit requirement as part of the efficiency analysis, and whether an efficiencies factor or defence should be available when an agreement leads to monopolization or near monopolization of an industry by the parties to the agreement.

If efficiencies were to be made part of a civil strategic alliances provision, there may be a need to consider whether sections 85 to 90, relating to specialization agreements, should be repealed. There may also be a need to consider the implications of such a proposal for the joint venture exception in section 95.

Specialization Agreements

If a civil strategic alliances provision incorporating a consideration of efficiencies were to be adopted as part of section 45 reform, then the specialization agreements provisions of the Competition Act (sections 85 through 90) may no longer be necessary.

There has never been an application to register a specialization agreement with the Competition Tribunal. A well-drafted civil strategic alliances provision may be broad enough to capture all types of specialization agreement, prohibiting them only when they would prevent or substantially lessen competition, with due regard to an efficiencies factor or defence. It is noteworthy that specialization agreements are generally prohibited in the European Union but that the European Commission has created a block exemption for certain categories of specialization agreements, including reciprocal and unilateral specialization agreements and joint production agreements. ⁶⁰

On the other hand, it may be argued that the economic underpinnings of the specialization agreements provisions (in particular, the need to achieve longer production runs and lower unit costs) are still relevant in some industries, and that there is a need to retain specific legislative provisions relating to such agreements. If this is the preferred option, there may be a need to consider broadening the specialization agreements provisions in some manner in order to encourage parties to rely on them.

Joint Venture Exception

Section 95 of the Competition Act allows non-corporate combinations for a specific project or a program of research and development that would not otherwise take place, or be likely to, and that meet certain specific criteria. Although section 95 makes no explicit reference to efficiencies, it does incorporate notions of dynamic efficiency. When Bill C-91, now the Competition Act, was first introduced in the House of Commons, the Minister of Consumer and Corporate Affairs referred to the joint venture exception and stated that joint ventures may "bring about gains in efficiency by allowing temporarily joined corporations to share the high risks involved in projects requiring major investments."⁶¹ Section 95 reads as follows:

The type of combination currently covered by section 95 would likely fall under any new strategic alliances provision, since a joint venture is no more than an agreement or arrangement between two or more persons to undertake a specific business or project. Thus, if a combination within the meaning of section 95 were to prevent or substantially lessen competition, the Tribunal could issue an order prohibiting it.

There is a need to consider the value of retaining the section 95 exception for joint ventures as they relate to mergers and creating one for strategic alliances. On the one hand, retaining the exception, and perhaps adopting a parallel exception to the civil strategic alliances provision, would promote the type of gains in efficiency initially envisaged for section 95. On the other hand, a well-drafted civil strategic alliances provision that gives proper scope to the consideration of efficiencies would not prohibit efficiency-enhancing joint ventures in the form contemplated by section 95.

Important Questions

In assessing the different options proposed above, there are many issues that may vary from one option to the next. The Competition Bureau would like to obtain your views on the following. The Competition Bureau also invites you to comment on any issues or options in the area of efficiencies that are not specifically raised in this paper.

Merger Review

1. For each option, we would like to know what you like about it and what are your concerns:
   • Status quo;
   • Section 93 Factor Approach;
   • Merger to Monopoly; and
   • Merger Outcomes.

• Please explain which option best supports the overall objectives of the Competition Act as set out in section 1.1:

• Various foreign jurisdictions recently proceeded with the review of their merger policy and examined what would be the role of gains efficiencies in that context. What lessons learned from our foreign counterparts should Canada be considering more closely (e.g. whether efficiencies should be "cognizable" or verifiable; whether efficiencies should be passed on to consumers; etc.)
• As part of the merger assessment, would the types of efficiencies generally considered vary under the different options? Should the types of efficiencies generally excluded differ between options (e.g. savings resulting from a reduction in output, gains that are redistributive in nature, gains that are likely to be attained by another means)?
• Section 96 includes a trade-off that requires the gains to be greater than and offset the anti-competitive effects. Section 93 does not have an explicit trade-off. Would the magnitude of efficiencies required to successfully make a claim vary between options?
• It is expected that any assessment of efficiencies is highly complex and requires elaborate evidence in support of the claim. What are the evidentiary implications of the different approaches proposed?
• Are significant increases in the real value of exports or significant import substitutions still relevant in the assessment of efficiencies?
• Should gains in efficiencies realized in market(s) other than the relevant market be considered?
• What is your preferred option? Why?
• More specifically on the option to adopt a factor approach under section 93:

• a. Should there be a mandatory review of efficiencies in the overall assessment of the merger whether or not they are raised by the merging parties or should efficiencies be treated consistently with the other factors?
  
  b. Would the time frame over which the merger analysis occurs under section 93 (generally within two years) limit the consideration of anticipated efficiencies to the same timeframe? If so, will the relevance of fixed-cost savings be limited?
  
  

• Do you have additional comments?

Specialization Agreements, Joint Ventures and Strategic Alliances

1. Should efficiencies be considered under a new civil strategic alliances provision? If so, how? If not, why?
2. Do you agree that a new civil strategic alliances provision with an efficiency consideration would replace the provisions on joint ventures and specialization agreements?
3. What types of efficiencies would be considered under a new civil strategic alliances provision?
4. Do you have additional comments?

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⁵³ Section 93 contains a non-exhaustive list of the factors the Tribunal may consider when reviewing a proposed merger. These factors are as follows:

• the extent to which foreign products or competitors will provide effective competition to the merged entity;
• whether the business of a party to the merger is likely to fail;
• the extent and availability of substitutes for the products supplied by the merged entity;
• barriers to entry and the effect of the merger on such barriers;
• the extent of effective remaining competition post-merger;
• whether the merger will remove a vigorous and effective competitor;
• change and innovation in the relevant market;
• and any other factor that is relevant to competition in a market that is or would be affected by the merger.
  

⁵⁴ Bill C-249 would have introduced a factor analysis of efficiencies with an explicit customer benefit requirement into Canadian law.

⁵⁵ N. 39. p. 335, para. 15 of dissenting opinion of Justice Gilles Létourneau.

⁵⁶ But see the opinion of Justice Létourneau, n. 43, para. 79, in which he argues that the Tribunal possesses sufficient discretion under section 92 to issue an order that would ensure that the merger does not create monopolies in particular geographic areas. Justice Létourneau stressed that “the remedy should be tailored to correct the problems created by the merger without, if possible, compromising it and its resulting gains in economic efficiency.”

⁵⁷ W. J. Kolasky, “Effectively Advocating Efficiency Claims in Merger Review,” Antitrust Report 3 (Spring 2003), p. 12.

⁵⁸ Discussion Paper, n. 3, p. 17, Question 39. Question 39 also asks whether efficiencies should be considered a factor in merger review.

⁵⁹ Public Policy Forum, National Consultation on the Competition Act: Final Report (April 8, 2004), p. 18, and transcripts of roundtable discussions, available at the Public Policy Forum Web site (www.ppforum.ca/home).

⁶⁰ Commission Regulation (EC) No 2658/2000 of 29 November 2000 on the application of Article 81(3) of the Treaty to categories of specialisation agreements, O.J. L 304 , 05/12/2000, p. 3.

⁶¹ Debates of the House of Commons of Canada (April 7, 1986), p. 11928.