Canada’s Supreme Court of Canada issued its much-anticipated decision in the case of Tervita Corp. v. Canada Commissioner of Competition yesterday, upholding the Federal Court of Appeal’s (and the Competition Tribunal’s) treatment of likely future entry in cases involving the “prevention” of competition, but overturning their rulings as to the application of the efficiencies defence, and in the process increasing the evidentiary burden on the Commissioner to mount a successful challenge to an anti-competitive merger.
The Tervita case has important implications for risk assessment by merging parties, who must now consider what may seem to be somewhat remote alternatives to their proposed merger when considering whether the merger will “prevent” competition. It also could have significant spillover effects as the Commissioner may well now, as a result of losing this case on the grounds of efficiencies, seek to gather even more data and do even more analysis regarding quantification of anti-competitive effects than had previously been the case.
In February, 2010, Tervita Corp. (then CCS Corp.) acquired a company (Babkirk) that held a permit to develop a secure hazardous waste landfill site in northeastern British Columbia. At that time, as now, Tervita operated the only two hazardous waste landfills in the region. Prior to its sale, Babkirk’s owners had intended to operate a bioremediation facility at Babkirk, with a secure landfill to store hazardous waste not suitable for bioremediation. The transaction was not subject to mandatory pre-closing notification under the merger review provisions of the Competition Act as it fell below the thresholds. The parties closed the transaction in early 2011 - over the Commissioner’s objections – who shortly thereafter filed an application with the Competition Tribunal to dissolve the merger (i.e., force the vendors to take back the shares) or, in the alternative, to divest the shares of Babkirk.
The Tribunal held that, “but for” the merger, effective competition in the relevant market would likely have emerged, such that the merger’s effect was to substantially prevent competition in the provision of hazardous waste landfill services in British Columbia. The Competition Act includes an efficiency defence , which provides that mergers must be cleared – even where they substantially lessen or prevent competition – if they bring about efficiencies that are greater than, and offset, the merger’s anti-competitive effects. However, in its decision, the Tribunal found that the efficiencies created by the Tervita merger were not greater than its anti-competitive effects and would not offset those effects. It declined to order the dissolution of the merger as requested by the Commissioner, but did order Tervita to divest the shares of Babkirk. That order was stayed pending first the Federal Court of Appeal and then the Supreme Court appeal.
At issue on appeal to the Federal Court of Appeal and then the Supreme Court were two principal issues (in addition to the standard of review for questions of law, which the majority determined to be correctness, with Justice Abella dissenting in favour of reasonableness):
What is the proper legal test to determine when a merger gives rise to a substantial prevention of competition under the Competition Act? What is the proper approach to the efficiencies defence under s. 96 of the Competition Act and, in this respect:
a. Can “order implementation efficiencies” (i.e., efficiencies that are realized because of a delay in the implementation of a divestiture order by the Tribunal) be included as efficiency gains in the balancing analysis? b. What is the proper approach to the requirement that efficiency gains be “greater than and offset” the anti-competitive effects?
“Substantial Prevention of Competition”
The appellants argued that the Tribunal had erred in its application of the test for determining that – absent the merger – Babkirk would likely have competed with Tervita by operating a secure landfill site. Babkirk’s business plans had shown that it intended to operate a bioremediation site, not a standalone secure landfill site. The merging parties argued that the Tribunal had engaged in unwarranted speculation when it looked into the future and determined that the bioremediation site would have failed, and that Babkirk would have either itself operated the site as a secure landfill in competition with Tervita, or would have sold to someone who would have done so.
The Supreme Court held that a two-part test applies to determine if a firm with market power will use a merger to prevent competition that would likely otherwise arise in a contestable market. First, the Tribunal must identify the firm or firms the merger would prevent from independently entering the market. While this will usually be one of the merging parties, the Court was careful not to exclude the possibility that the potential entry may come from a third party. Second, the Tribunal must examine the “but for” market condition to see if, absent the merger, the potential competitor would have likely entered the market and, if so, whether the effect of that competitor’s entry on competition in the market would likely have been substantial. While the appellants contended that the likelihood of entry should have been assessed based upon their plans at the time of the merger (without projections as to what they may have done had those plans failed), the Court held that “any factor that in the opinion of the Tribunal could influence entry upon which evidence has been adduced should be considered,” such as the plans and assets of that merging party, current and expected market conditions, and other factors listed in s.93 of the Act. The Court warned that the Tribunal must base its decision on what the evidence shows the merging parties – as opposed to the Tribunal – would have done, but agreed that there had been sufficient evidence led in this case that the Tribunal had not engaged in speculation, and allowed the finding of fact to stand.
As to another key issue in the case – the temporal dimension within which likely entry should be assessed – the Supreme Court upheld the Federal Court of Appeal’s ruling that the time-frame must be discernible, in that there must be evidence of when the merging party is realistically expected to enter the market in the absence of the merger. The Supreme Court found, however, that the “lead time” it would likely take a typical new entrant to emerge does not necessarily terminate the acceptable time-frame for likely new entry. Rather, the Court held that the timeframe for likely entry must be considered on a case-by-case basis, and that the evidence of likely future entry by the identified potential competitor must be sufficient to meet the “likely” test on a balance of probabilities, keeping in mind that the further into the future the Tribunal looks, the more difficult it will be to meet the test. The Court recognized that lead time is an important consideration, but it must not support an effort to look farther into the future than the evidence supports.
Finally, the Court upheld the Tribunal’s analysis of whether the entry would likely have had a substantial pro-competitive effect, saying that it is necessary to assess a variety of dimensions of competition including price and output, as well as the degree and duration of any effect in the marketplace, and that s. 93 of the Act provides a non-exhaustive list of factors that may be considered (barriers to entry, effective remaining competition, likely foreign competition, etc.).
On the key issue of whether the Tribunal had engaged in unwarranted speculation, the SCC agreed with the Federal Court of Appeal that the Tribunal had made findings of fact based on the abundant evidence before it. While Justice Rothstein questioned the Tribunal’s treatment of the Commissioner’s assertion that a 10% price reduction would have been realized in the absence of the merger, he held "that “it is evident that there was sufficient other evidence upon which the Tribunal could find a substantial prevention of competition as a result of the merger.
In addition to providing guidance about the meaning of a “substantial prevention of competition”, the Supreme Court’s majority decision (with Justice Karakatsanis dissenting in some respects) provides clear instructions to merging parties and to the Commissioner as to the nature of efficiencies that “count” when assessing whether a merger’s efficiencies outweigh and offset its anticompetitive effects, as well as the nature of proof required to show anti-competitive effects.
The Supreme Court held that, while merging parties bear the burden of proving cognizable efficiencies, the Commissioner bears the burden of proving – and quantifying, wherever possible – the anti-competitive effects, so that they can be balanced against the claimed efficiencies. The Court held that “[e]ffects that can be quantified should be quantified, even as estimates, provided such estimates are grounded in evidence that can be challenged and weighed”. In order to minimize subjectivity, if effects are realistically measurable, failure to at least estimate the quantification of those effects will result in the effects being assigned a weight of zero – the Court declined to allow such unmeasured effects to be assessed on a qualitative basis or to be given “undetermined” weight. In this case, the Court held that the Commissioner’s last-minute expert evidence of an alleged 10% price reduction was – in essence – too little, too late. No evidence at all had been led as to price elasticity of demand, meaning that the possible range of deadweight loss resulting from the merger was unknown, even if the last-minute estimation of 10% (provided days before the hearing with no opportunity by the merging parties to rebut) had been accepted. The SCC held that the Tribunal should have afforded the Commissioner’s evidence as to the size of quantifiable anti-competitive effects zero weight, rather than the “undetermined” weight afforded them by the Federal Court of Appeal. It held that the “undetermined” approach brought into question the fairness of the proceedings, as it placed the merging parties in the “impossible” position of having to demonstrate that the efficiency gains exceed and offset an undetermined amount. It agreed with the appellants that they had not known the case they had to meet.
The court went on to clarify the framework for the application of the efficiencies defence. Application of the efficiencies defence will be framed as a two-step inquiry:
The quantitative efficiencies of the merger (adduced by the merging parties) should be compared to the quantitative anti-competitive effects (adduced by the Commissioner); if the anti-competitive effects outweigh the efficiencies, the defence will not apply. If quantitative efficiencies are the larger, then the Tribunal must balance qualitative anti-competitive effects (those that are not capable of measurement), to determine whether total efficiencies offset the total anti-competitive effects.
Critically, the Court held there is no basis in law for introducing a threshold for the margin by which efficiencies must exceed anti-competitive effects, nor for requiring that proven efficiencies be more than marginal. If the efficiencies accepted by the Tribunal exceed the proven anti-competitive effects – even by a very small amount – the merger must be cleared.
The Court held that the Commissioner had not proven any quantifiable anti-competitive effects, while the merging parties had established overhead efficiency gains resulting from Babkirk’s access to Tervita’s existing administrative and operating functions. However small, they were greater than zero, and the efficiencies defence was made out.
As to the nature of efficiencies that “count”, the Supreme Court distinguished between “early mover efficiencies” (those a merging party would be able to realize faster as a result of the merger), and “order implementation efficiencies” (those that could be realized sooner than a competitor only because the competitor would be delayed because of legal proceedings associated with a divestiture order). While “early mover efficiencies” count, “order implementation efficiencies” do not. In another important clarification, the Supreme Court also held that environmental anti-competitive effects could be counted in the analysis – provided they are properly quantified.
Justice Rothstein admitted in a postscript that this case “does not appear to me to reflect the policy considerations that Parliament likely had in mind in creating an exception to the general ban on anti-competitive mergers” , because the case deals with competition on a small, local scale and efficiencies were not a central motivation for the merger. By contrast, Justice Rothstein noted that the efficiencies defence was created in light of Canada’s small domestic market “with an eye toward supporting operation at efficient levels of production … particularly with reference to international competition.” Notwithstanding this policy rationale, the Court found that the efficiencies defence, as worded, applied in this case.
Although the Commissioner lost the appeal, the Supreme Court’s decision is not all good news for merging parties. The Supreme Court’s decision affords the Commissioner with considerable room to conclude that a merger will lead to a “substantial prevention of competition” based on evidence about what might happen in the future. In this case, the Supreme Court accepted that the merger of Tervita and Babkirk had resulted in a substantial prevention of competition even though Babkirk was not competing, and did not even plan to compete, with Tervita. The Commissioner’s case was premised on the argument that Babkirk’s plans would fail, and its “backup plan” (or someone else’s plan) would result in competition. Going forward, merging parties will need to carefully consider even what may seem to be remote potential alternatives to their transactions in order to assess antitrust risk.
At the same time, the Supreme Court’s decision in Tervita clearly increases the burden on the Commissioner in bringing a contested merger case before the Tribunal. Going forward, such a case will necessarily entail estimation of likely price increases as well as of price elasticities of demand, because the Commissioner must not just prove, but also quantify (where possible), the alleged anti-competitive effects. This requirement may have a spillover effect for merging parties, as the Bureau may rely more heavily on data in its merger reviews, and request more extensive data, documents or information from merging parties. Indeed, a statement from the Commissioner following the decision notes that “[t]he Bureau will consider … any changes to our analysis and information gathering that may be required during merger review.”
To be sure, as recognized by the Supreme Court, the number of cases in which proven efficiencies will outweigh proven anti-competitive effects may well not be large. So long as the Commissioner fails to prove the size of anti-competitive effects, however, parties can win their cases even with cognizable efficiencies the size - as found by the Tribunal - of half of the annual salary of a junior employee.