In brief

  • Justice Emmett has delivered his decision in ACCC v Metcash Trading Limited [2011] FCA 967—the first merger to proceed to court since 2003. The ACCC’s application for an injunction to prevent Metcash from acquiring the Franklins supermarket business in New South Wales was dismissed by Justice Emmett on all counts.
  • Justice Emmett’s decision is not a mandate for wide market definition, despite suggestions to the contrary by some commentators. The decision highlights that economic theory must yield to objective evidence and commercial reality.
  • Justice Emmett clarified the test for the counterfactual—the ACCC must establish that the counterfactual is more likely than not to occur. This is a higher threshold than proposed by the ACCC and applied in its merger reviews to date.
  • Both sides used well-known economists as expert witnesses. Justice Emmett stated that he did not find helpful the application by the economists of economic principles to the specific circumstances of the case. He rejected the parts of their evidence where they expressed opinions about the application of the relevant principles to the facts.

The proposed acquisition

In July 2010, Metcash applied to the ACCC for informal clearance to acquire the shares in Franklins from South African retail giant Pick n Pay.

Metcash is Australia’s largest independent grocery wholesaler. It supplies groceries and fresh food to independent supermarkets, including those trading under the IGA banner. Franklins operates a supermarket business in New South Wales, and supplies its own stores and a small number of franchisees with grocery products and fresh food.

In November 2010, the ACCC decided to oppose Metcash’s acquisition of Franklins, stating that the acquisition would remove ‘Metcash’s closest and only genuine competitor for the wholesale supply of packaged groceries in NSW’. The ACCC said that other parties had expressed interest in acquiring Franklins and their bids would not raise the same competition concerns as Metcash’s bid.

Following the ACCC’s decision, Metcash announced that it intended to take further steps to proceed with the acquisition. The ACCC then applied to the Federal Court for an injunction to stop Metcash from buying Franklins.

The Federal Court’s decision

The ACCC’s task

In order to obtain an injunction restraining the acquisition, the ACCC had to establish three things:

  • the relevant market
  • the counterfactual or counterfactuals against which the merger should be assessed, and
  • that, compared to the counterfactual, there was a substantial lessening of competition in the market it defined.

The ACCC failed on all three counts.

Market definition

The ACCC contended that Metcash operates in a market for the supply of wholesale packaged groceries to independent supermarket retailers in New South Wales and the ACT. The ACCC said that the main players in this market are Metcash and Franklins. Metcash disagreed, arguing that the grocery market also includes Coles and Woolworths.

Justice Emmett rejected the ACCC’s market definition. He found that the true competitive constraints on Metcash come from Coles and Woolworths, not Franklins. He identified these constraints by looking to commercial reality, not economic theories.

Justice Emmett’s rejection of economic theory inconsistent with commercial reality is evident in his discussion of the hypothetical monopolist test. The test is used to define markets and involves determining whether a hypothetical monopolist supplier could profitably impose a small but significant non-transitory increase in price. The ACCC argued that the wholesale grocery market is a services market and that, for the purpose of applying the test, the relevant price is, not the wholesale price of groceries, but rather the margin that Metcash makes for providing services in respect of wholesale groceries to retailers. Justice Emmett disagreed, stating that characterising the wholesale market as a services market has ‘no foundation in logic or reality’. He concluded that the hypothetical monopolist test should be applied to the wholesale price of packaged groceries.

Counterfactual

The parties disagreed about what would happen if Metcash was prevented from acquiring Franklins (ie the counterfactual).

At the beginning of the trial, the ACCC identified SPAR and a consortium of Metcash-supplied retailers (dubbed ‘KKK’ in the trial) as the main alternative acquirers of Franklins. However, in its closing submissions the ACCC relied on only KKK as a likely buyer.

The ACCC contended that, in considering the counterfactual, the correct approach is to ask whether:

  • there is a real chance that the counterfactual will come to pass, and
  • there is a real chance of a substantial lessening of competition relative to the counterfactual.

Justice Emmett rejected the ACCC’s contention. He concluded that the ACCC had to show that:

  • it is more probable than not that one of the ACCC’s counterfactuals will come to pass, and
  • there is a real chance of a substantial lessening of competition relative to that counterfactual.

Justice Emmett was not persuaded that it was more probable than not that KKK would acquire the Franklins business. His Honour went on to say that the ACCC’s evidence was not sufficient to meet the lower, real chance test.

Substantial lessening of competition

Justice Emmett was not persuaded that, if Metcash purchased Franklins, there would be, or would likely to be, a substantial lessening of competition in the market propounded by the ACCC. On the contrary, his Honour concluded that it was quite likely that the acquisition would strengthen the capacity of IGA retailers to compete more vigorously with Coles and Woolworths.

Significance of the decision

Justice Emmett’s decision is an important reminder that ultimately it is for the courts and not the ACCC to determine whether a merger contravenes the Competition and Consumer Act 2010 (Cth). The ACCC is not the final arbiter of the legality of mergers in Australia and merger parties who disagree with the ACCC are able to go before a court and test the facts asserted and evidence put forward by interested parties.

More broadly, Justice Emmett’s decision provides important guidance as to the correct principles and process that should apply in the assessment of mergers:

  • Market definition needs to take account of commercial realities rather than relying only on economic theories; it is necessary to identify the true competitive constraints on a merged firm, rather than defining an artificially narrow market and finding a substantial lessening of competition in that market.
  • The Metcash decision raises the threshold for the ACCC in opposing mergers. The ACCC should oppose a merger only if satisfied that it could prove the counterfactual on the balance of probabilities, and that there is a real chance of a substantial lessening of competition relative to that counterfactual. This is a higher threshold than that applied by the ACCC in its merger reviews to date.
  • Granting strict confidentiality to third party submissions during the informal merger clearance process comes with risks. During its review of the Metcash/Franklins merger, the ACCC kept third party submissions confidential, including those of SPAR and KKK. When the claims of SPAR and KKK were tested in court, they were found wanting. SPAR was abandoned by the ACCC as a likely alternative buyer, and the evidence about KKK failed to meet even the lower standard of proof argued for by the ACCC.
  • The decision highlights the importance of documentary evidence in merger reviews. Justice Emmett relied heavily on historical internal documents from Metcash, Woolworths and Pick n Pay in determining both the relevant competitive constraints on Metcash and the counterfactual. In assessing their prospects for obtaining informal clearance, merger parties should consider their internal documents, and when they apply for clearance, they should expect to be called on to provide all such documents to the ACCC.