Strategic Alliances - Part 3: Application of the Competition Act

3.2 Provisions Most Relevant to Strategic Alliances

There are no specific provisions within the Act dealing exclusively with strategic alliances. This is not surprising when one considers the myriad of forms which these arrangements may take. Many strategic alliances involve types of cooperation among firms which do not differ significantly from those effected in the past. Hence, the Bureau's analysis of these alliances will follow the analytical framework dictated by the applicable section of the Act. The fact that a relationship between two or more firms is called a strategic alliance does not in any material manner affect its legal status under the Act.

Most strategic alliances will pose no competition issues, because they do not maintain, create or enhance market power. Those which do, however, may be reviewable under a number of provisions of the Act, given the wide range of corporate activity which strategic alliances may include. It is possible a particular alliance may be reviewed under the criminal conspiracy provisions of the Act or any of the civil provisions related to specialization agreements, joint ventures, abuse of dominant position or mergers. In addition, an alliance between vertically related firms may also be reviewed under the vertical restraint provisions of the Act, including tied selling, exclusive dealing, market restriction, or price maintenance, (note 5) depending upon the nature of the arrangement. It has been the Bureau's experience that horizontal arrangements involving competitors are more likely to raise competition issues than either vertical or conglomerate alliances. It is only in very limited circumstances that arrangements between firms which are either vertically related or are in different lines of operation (i.e., conglomerate alliances) are likely to be found to maintain, create or enhance market power. (note 6) In light of this, the focus of this document will be the provisions of the Act most applicable to horizontal alliances.

In most of the cases where an alliance results in market power and is subject to examination, it is the Bureau's expectation that following an examination of the nature of the alliance, the alliance usually will fall squarely within a single section of the Act and the Director will adhere to the analytical approach dictated by the relevant provision. However, given the broad range of activities which strategic alliances may encompass, it is possible that several sections of the Act may apply. Parliament has clearly contemplated that there can be an overlap between various provisions within the Act. While the possibility of review under several sections of the Act exists, since 1986 there have only been a handful of cases where the Director has initiated an inquiry under both the civil and criminal provisions of the Act for a particular fact situation. While an inquiry pursuant to either the abuse, conspiracy or merger provisions may be commenced concurrently, the Act limits prosecutions or applications to the Competition Tribunal for remedies to a single section on the basis of the same or substantially the same facts. In determining which provision is the most appropriate, an analytical framework is also implicitly determined -- for example, either an undue lessening or prevention of competition test with no efficiency considerations in the case of a criminal conspiracy investigation, or a substantial lessening or prevention of competition test with an efficiency trade-off as would be the case in a reviewable merger investigation.

Generally, the Bureau will examine alliances that involve the future acquisition of control (note 7) as mergers, unless there is a basis for believing that the acquisition of control is a sham. (note 8) Where there is evidence of an agreement in violation of the conspiracy provisions arising from an alliance or discussions related to a prospective strategic alliance, the Director will launch a criminal investigation. Factors which bear on this decision include evidence of an anticompetitive objective, intent or effect, covert or fraudulent behaviour, the nature of the evidence and whether there is a need for deterrence through criminal remedies. Finally, any acquisition of control through a strategic alliance, public or otherwise, cannot insulate the parties from initiation of an inquiry under the conspiracy provisions into past criminal conduct which occurred prior to the acquisition of control.

A fuller description of the relevant provisions of the Act is provided below to assist business people in determining a particular section's applicability. Although this document provides a summary of the major considerations, more detailed information is available from the Bureau on its enforcement approach to particular provisions.

3.2.1 Conspiracy Provisions

Strategic alliances between competitors involve agreements which may be reviewed by the Director under the criminal conspiracy provisions of the Act in certain circumstances. The Crown's burden of proof is the criminal standard of "beyond a reasonable doubt". Sanctions are severe in cases of conviction, with fines up to $10 million and imprisonment terms up to five years for individuals, reflecting the serious nature of the offence.

Substantively, section 45 of the Act prohibits parties from entering into an agreement which, inter alia, prevents or lessens competition unduly or is likely to do so. Several elements must be established in order for an offence to be found. First, the Crown must prove the existence of an agreement, with or without direct evidence. The Act provides for the finding of an agreement from circumstantial evidence, and in past judicial decisions exchanges of information have been used to infer the existence of an agreement in certain circumstances. (note 9) Second, the agreement is one whose likely effect is to prevent or lessen competition unduly. (note 10) Finally, the Crown must show mens rea or a "guilty mind". This involves establishing that the parties intended to enter into the agreement in question, were aware of its terms and intended to carry it out. It is also necessary to show that the parties intended to lessen competition unduly which can be satisfied by establishing that a reasonable business person, who can be presumed to be familiar with the business in which he or she engages, would or should have known that the likely effect of the agreement would be to unduly prevent or lessen competition. (note 11) The Supreme Court of Canada has noted that in most situations where it is shown that the agreement is likely to have an undue effect, the Crown could establish that this was the case. (note 12)

The Supreme Court has provided considerable guidance on the meaning of the element of undueness. (note 13) In addition to stating that an undue effect is one which is serious or of significance, the Court outlined a two-step approach which may be used to determine undueness. After determining the relevant product and geographic markets in which the parties operate, the first step is to determine whether the parties to the agreement have market power or will be likely to obtain it pursuant to the agreement. Consistent with other provisions of the Act, the Supreme Court has made it clear that market share, alone, is not sufficient to demonstrate market power. Other factors are also of importance, particularly the ease of entry. (note 14) The Supreme Court has noted that possessing only a moderate amount of market power may be sufficient to support a finding of undueness. (note 15)

In the second step the Court will evaluate the parties' behaviour to determine whether some behaviour likely to injure competition has occurred, or is likely to occur. Price fixing, restrictions on output or market sharing are almost always of competitive significance, and hence the Director will view such agreements as constituting injurious behaviour. Likewise, in cases where product quality, service, promotional activity or innovation are an important determinant of competitive rivalry such that an agreement in respect of one of these is likely to have a significant adverse effect on competition between the parties, the Director may view such agreements as providing grounds for inquiry where the parties possess market power.

The Supreme Court has stated that it is the combination of market power and injurious behaviour that makes a lessening of competition undue. In noting that many combinations are possible, the Court suggested that "a particularly injurious behaviour may . . . trigger liability even if market power is not so considerable". (note 16) It is the Director's position that the converse is also true, in that with a considerable amount of market power, a less injurious behaviour may trigger initiation of an inquiry under the Act.

Applying the above test to strategic alliances would involve the following determinations. First, have the parties to the alliance entered into an agreement? Second, does the alliance, or is it likely to, unduly lessen or prevent competition? Third, do the requisite elements of intent exist? In order to address the issue of undueness within the framework discussed by the Supreme Court, the Bureau will: (i) define the relevant product and geographic markets affected by the strategic alliance; (ii) determine whether the parties to the alliance possess market power in the defined relevant markets, or whether they are likely to obtain market power in these markets as a result of the alliance; (iii) assess what behaviour is specifically restricted or prescribed by the strategic alliance; and, (iv) determine if the alliance results in a combination of market power and behaviour injurious to competition which is serious or significant.

As the above discussion indicates, only those elements of a strategic alliance which represent a serious restraint of competition would be targeted by the conspiracy law. This means that many of the beneficial aspects of a strategic alliance may not be challenged. For example, where competitors develop technology sharing agreements and reciprocal patent licensing there may not be a serious adverse effect on competition, but where ancillary to these arrangements the parties begin to allocate markets between themselves or agree on prices, then this may run afoul of the conspiracy provisions. Unless the beneficial elements of the cooperative arrangement are tied to a broader conspiracy they will not be challenged by the Bureau.

In setting out the test of undueness the Supreme Court made it clear that the test focuses solely on the competitive effects, and not the efficiencies which may result from the agreement: "Considerations such as private gains by the parties to the agreement or counterbalancing efficiency gains to the public lie . . . outside of the inquiry under paragraph 32(1)(c) (now paragraph 45(1)(c)). Competition is presumed by the Act to be in the public benefit." (note 17) Thus, parties, in considering whether to enter into strategic alliances, should realize that if an agreement unduly lessens or prevents competition, efficiencies provide no defence under section 45.

3.2.1.1 Defences and Exceptions

Not all agreements between competitors violate the conspiracy provisions, as the Act contains twelve specific defences. Among these, the following may be more likely to have application to strategic alliances -- an agreement in respect of: the exchange of statistics; the definition of product standards; the size and shapes of product packaging; cooperation in research and development; restrictions on advertising or promotion; or, measures to protect the environment. There are also specific defences dealing with export consortia and specialization agreements, which are described in separate sections below.

It is important to note that these defences are not without limits. The Act makes it clear that what would not be acceptable under the basic conspiracy provisions will not be permitted to occur through activities related to these defences. As a result, if the strategic alliance is likely to lead to an undue lessening or prevention of competition in respect of prices, quantity or quality of production, markets or customers, or channels or methods of distribution, or if the alliance restricts anyone from entering into or expanding a business, the defence does not apply.

It is the Director's position that for a defence to be lost, it is not necessary that the agreement be directed explicitly at any of these fields, only that one of these dimensions of competition is likely to be lessened or prevented unduly as a result of the alliance. Consequently, a strategic alliance which may be directed primarily at research and development, but which is likely to have an undue effect on prices, for example, owing to an ancillary arrangement to jointly market and distribute the newly produced goods or services, may cause the Director to initiate an inquiry under the conspiracy provisions. At the same time, the beneficial features of the strategic alliance will not be subject to challenge by the Director unless they are seen as part of a broader conspiracy.

To date the courts have not considered a conspiracy case in which the defences and exceptions, under subsections 45(3) and 45(4) respectively, have been argued. Historically, the kind of cases brought before the courts under section 45 have generally been price-fixing or market sharing agreements. Furthermore, the Bureau has dealt with very few requests for advisory opinions in areas related to the defences. Nevertheless, the scope of the exceptions is relatively wide. This suggests that where the parties wish to avail themselves of a defence under subsection 45(3) for a strategic alliance that results in market power, caution would indicate that they may wish to strictly confine the agreement to the elements of the specific defence under subsection 45(3) in order to avoid straying into the fields listed in the exceptions in subsection 45(4). For example, firms possessing market power who enter into an agreement in respect of product packaging are advised not to extend the agreement to the marketing or promotion terms, particularly price, of the product. It should be emphasized however, that even if a party has lost the defence it had available under subsection 45(3), it would still be necessary to demonstrate in any prosecution under subsection 45(1) that the agreement unduly prevents or lessens competition.

3.2.1.2 Information Sharing

Strategic alliances often involve a considerable exchange of information between the parties. Such exchanges are generally constrained by the terms of the alliance and may not extend beyond the confines of the alliance agreement. The reasoning behind this is that it is not normally in the interest of any one alliance partner to risk losing a competitive advantage it may hold relative to its partners when these firms are its competitors. However, information sharing may also extend beyond the terms of the alliance agreement either between the alliance partners or to outside firms.

The exchange of information will not necessarily give rise to competition issues under the conspiracy provisions. Indeed, competitive markets function more efficiently when information is relatively free and openly available to market participants. At the same time, it is recognized that information exchanged among competitors who collectively possess market power may have serious adverse effects on competition, depending upon the nature and timing of the information exchange. Where markets are characterized by high levels of concentration, barriers to entry and relative stability, information exchanges in respect of sensitive commercial information may reduce uncertainty about rivals' competitive responses and so act to further temper rivalry. When the products involved are relatively homogeneous and firms compete across a limited number of competitive variables, the risk that such exchanges will have significant adverse effects on competition is further heightened. In light of this and the possible application of section 45, the parties to a strategic alliance which results in market power must remain cognizant of the risks involved when information is exchanged either directly via the alliance, or indirectly via an industry or trade association, or other third party.

In order for information sharing among competitors to cause the Director to initiate an inquiry under section 45, the information exchange would have to satisfy all of the elements of the conspiracy provisions discussed above. Hence, it would be necessary to establish that either the information exchange itself constitutes an "agreement" between the parties, or that the information exchange is part of a broader agreement in violation of section 45. Second, the information exchange must be one which gives rise, or is likely to give rise, to an undue lessening or prevention of competition. Finally, the requisite elements of intent must be demonstrated. Depending upon the type of information to be shared, the exchange may qualify for one of the defences to section 45 provided none of the exceptions apply.

The Supreme Court's discussion of undueness makes it clear that without market power, an information exchange among strategic alliance partners will not be subject to section 45. Furthermore, where the information being exchanged among alliance partners is not likely to have a significant adverse effect on competitive rivalry or relates to matters that lack competitive significance, it is unlikely to constitute behaviour injurious to competition. As a result, it is only in circumstances where the parties to the information exchange collectively possess market power and are engaged in the type of information sharing which may adversely impact competitive rivalry in a serious or significant way that section 45 applies.

The risk of initiation of a formal inquiry under section 45 is also reduced when the alliance partners design the sharing of information between themselves in a manner which preserves the ability of the individual parties to determine "independently" what strategy, outside of the alliance, they will follow in the market. It is also advisable not to use the alliance as a means of "signaling" to competitors in the market what action the alliance partners wish their outside rivals to take or what action an individual member of the alliance wishes its partners to take in an area outside the scope of the alliance agreement.

The risk that an inquiry may be initiated in respect of information sharing increases with several factors. First, the greater the market power collectively held by the parties to the information exchange, the more likely it is that an information exchange in respect of any significant aspect of rivalry may adversely impact on competition. Second, when particularly sensitive information important to rivalry is shared, this may be more likely to be viewed as behaviour injurious to competition. In this regard, exchanging information in respect of current or future pricing, costs, trading terms, or marketing strategies significantly heightens the risk of inquiry by the Director. (note 18) Direct exchanges of sensitive commercial information between competitors are riskier than those made through an independent third party which holds the information in confidence, although care needs to also be taken when involving these or other third parties, particularly trade associations. (note 19) Firms should also be cautious in sharing the analyses or conclusions developed from the information exchange, in order to preserve their ability to act independently beyond the alliance. Similarly, the exchange of disaggregated data which allows for identification of an individual firm's plans is riskier than exchanges involving aggregated data. Third, any evidence of anticompetitive intent increases the likelihood that an inquiry may be initiated. Evidence of coercion on the part of one or more of the alliance partners to have another party act in a prescribed anticompetitive manner may lead to an inference of anticompetitive intent.

3.2.2 Export Consortia Provisions

The importance of exports to the Canadian economy is recognized both in the purpose clause of the Act and in the export defence to the general conspiracy provisions. Subsection 45(5) of the Act provides a defence to an alleged conspiracy where the agreement relates only to the export of products from Canada.

However, like the earlier discussed defences, this is not absolute and hence the defence can be lost under certain circumstances. First, the defence applies to agreements that relate only to the export of products from Canada. Those agreements which may impact negatively on the Canadian market would therefore be subject to review by the Director under the general conspiracy provisions to determine, in particular, whether the parties to the agreement intended to lessen or prevent competition unduly in Canada. (note 20) Second, if the alliance in respect of exports is likely to reduce or limit the real value of the exported product, the defence is lost. Third, in cases where the export alliance restricts other firms from entering or expanding their business of exporting products from Canada, the defence is negated. Finally, the defence will be lost in the event that the alliance unduly prevents or lessens competition in the supply of services facilitating the export of the product from Canada.

A final consideration, which generally applies, but is particularly important in the case of export consortia, is the application of foreign competition laws. Canadian businesses need to recognize that the export defence under section 45 applies only to Canadian competition law, and provides no defence or exemption under the competition laws of foreign countries where the consortia hope to sell their products, to the extent that such laws apply.

3.2.3 Specialization Agreement Provisions

As noted above, the Act also allows an exemption from the conspiracy provisions for the use of specialization agreements among competing firms. (note 21) The provisions allow for a civil review of specialization agreements before the Competition Tribunal. In order for a strategic alliance to be reviewed under the specialization agreement provisions, it must meet certain conditions. Section 85 of the Act defines a specialization agreement as:

"an agreement under which each party thereto agrees to discontinue producing an article or service that he is engaged in producing at the time the agreement is entered into on the condition that each other party to the agreement agrees to discontinue producing an article or service that he is engaged in producing at the time the agreement is entered into, and includes any such agreement under which the parties also agree to buy exclusively from each other the articles or services that are the subject of the agreement". (note 22)

Specialization agreements are meant to provide a means by which firms may benefit from efficiencies not available except through forms of inter-firm cooperation which adversely affect competition to some degree. The wording of the section indicates that it applies only to production which is in existence at the time that the agreement is entered into, and hence it does not apply to anticipated or future products.

To be exempt from the conspiracy provisions of the Act, the specialization agreement must be registered with the Competition Tribunal. In considering whether to register such an agreement, the Tribunal will examine the alliance to determine whether it 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 are likely to result. Further, it must be established that these efficiency gains would not be attainable if the specialization agreement was not implemented.

Thus, it is only where firms decide to discontinue existing production of a particular article or service in exchange for the same with a second firm that the specialization agreement provisions will apply. Many strategic alliances contemplate more than a simple exchange of existing production, requiring cooperation across a broader range of either existing or future activities. Where this is the case or where the parties do not wish to subject their alliance to a Tribunal review process, the exemption from the conspiracy provisions afforded through specialization agreements will not apply.

3.2.4 Merger Provisions (note 23)

It is also possible that a strategic alliance may be reviewable under the civil merger provisions given the frequency of equity investments in these arrangements and the broad definition given to mergers under the Act. Under section 91, a merger is defined to be the acquisition of control over, or significant interest in, a business or part thereof. With respect to corporations, control is defined to mean de jure control, and so requires a direct or indirect holding of more than 50% of the corporation's voting rights. In the case of "significant interest", it is the Director's position that this arises when one or more persons directly or indirectly acquire or establish the ability to materially influence the economic behaviour of the business, or part thereof. Hence, where it is found that one firm's decisions in respect of pricing, purchasing, distribution, marketing or investment are materially influenced by another firm, a significant interest may be deemed to have been acquired or established.

Given the wide range of ownership structures and various arrangements that can be implemented pre- and post-closing, the determination of whether a "significant interest" exists can only be made by considering the particular facts surrounding each alliance on a case by case basis. In advisory opinions in this area, consideration has been given to the collective influence of a number of factors including: equity ownership; board participation; shareholder agreements, management contracts and other contractual arrangements; roles of the parties, be they financier, supplier or competitor; access to commercially sensitive information; extent of collaboration; advisory role to be taken or other participation in day-to-day operations; long-term supply agreements; asset acquisition; or leases, subleases and rights to purchase assets. Ultimately, where the effect of the strategic alliance is to give one party the ability to materially influence the economic decisions of another, then the definition of a merger is likely satisfied.

When strategic alliances are examined as mergers, they will be reviewed following the analytical framework set out in the Merger Enforcement Guidelines. The applicable legal test is whether the merger prevents or lessens competition substantially or is likely to do so. The provisions of the Act are expressly formulated to reflect that mergers are recognized as a legitimate way for companies to grow and consolidate. Hence in analyzing any merger, markets are defined on an economic basis, with a focus on demand and supply responses. Market share or concentration, alone, cannot be used to challenge a merger. The Act also requires an assessment of foreign competition, the availability of substitutes, whether one of the parties is failing, barriers to entry, the effectiveness of remaining competition, whether the merger removes a vigorous and effective competitor, change and innovation, and any other relevant factor. Finally, even if a merger is challenged by the Director and it is found to (likely) prevent or lessen competition substantially, the Competition Tribunal may allow the merger to proceed if it finds that it is also likely to result in gains in efficiency that are greater than, and will offset, the reduction in competition, and that these efficiency gains would not be attained if an order of the Tribunal were made.

3.2.5 Joint Venture Provisions

An exemption from the merger provisions may be made for strategic alliances which fall within the joint venture provisions. To be exempt from a Competition Tribunal order under the merger provisions, section 95 requires the joint venture to meet the following criteria:

• the joint venture cannot be structured as a corporation;
• the joint venture must be formed to undertake a specific project or a program of research and development, where it can be demonstrated that the project or program would not reasonably have taken place in the absence of the joint venture;
• no change of control over any party to the combination resulted or would result from the joint venture;
• the agreement is in writing, requires that one or more of the parties contribute assets, and governs a continuing relationship between the parties;
• the agreement entered into restricts the range of activities that may be carried on, and provides for termination on the completion of the project or program; and
• the combination does not prevent or lessen, or is not likely to prevent or lessen, competition except to the extent reasonably required to undertake and complete the project or program.

Given that section 95 only covers agreements related to a specific project or program of research and development, and hence does not cover the broader collaboration often witnessed in strategic alliances, the provision's application to strategic alliances may be somewhat limited.

3.2.6 Abuse of Dominant Position Provisions

In other situations, a strategic alliance may be reviewable under the abuse of dominant position provisions. Several conditions will need to apply in such a case. First, the parties to the alliance will have to collectively control a class or species of business. The wording of the section refers to substantial or complete control of a class or species of business by "one or more persons", and hence it contemplates situations where a group of firms, perhaps through a strategic alliance, holds substantial or complete control of the class or species of business. In its interpretation of the word "control", the Competition Tribunal has adopted the economic test of market power. (note 24) Hence, a "class or species of business" involves defining relevant product and geographic markets. Because control requires market power, market share alone is not determinative. Other factors, most notably conditions of entry, are equally important.

Simply finding a dominant position, however, is not enough. The section also requires that the parties involved in the strategic alliance be engaged in a practice of anticompetitive acts. A non-exhaustive list of anticompetitive acts is found in section 78. In its decisions to date, the Competition Tribunal has taken a broad view of what constitutes a practice of anticompetitive acts, allowing for consideration of any act, the intended effect of which is either "predatory, exclusionary or disciplinary". (note 25) While anticompetitive purpose is a necessary ingredient in making this determination, the Competition Tribunal accepts that evidence related to the likely effect of the act itself can be used to establish purpose. (note 26)

Finally, the practice of anticompetitive acts will need to have led to, or be likely to lead to, a substantial lessening or prevention of competition. The likelihood that this may result from the anticompetitive acts can be assessed by reference to the level of competition in the relevant market in which the alleged anticompetitive acts occur and its likely level of competition in their absence. (note 27) In determining whether a practice is likely to prevent or lessen competition substantially, the Tribunal may consider whether the practice is the result of "superior competitive performance", as referenced in subsection 79(4).