Response to the consultation on the Draft Bulletin on Efficiencies in Merger Review

Memo
Date: October 7, 2008
To: Anthony Durocher, Competition Bureau
From: Larry Schwartz
RE: Draft Bulletin on Efficiencies in Merger Review

General Considerations

The Bureau’s Draft bulletin suggests that henceforth the Bureau will follow the analytical sequence of the Act when reviewing a merger. That would suggest that it will first determine whether the merger is anti-competitive without regard to efficiency considerations. Then, presumably, the Bureau will hypothesize a draft remedy, and then will test the efficiency evidence in light of that remedy to see whether an order would be issued under s.96. Then, the Bureau would decide whether to challenge the transaction.

In some respects, the new approach is surprising. The Bureau has considerable discretion in determining how it will review a merger. In past years, it may have given efficiencies little or no weight, implying that the merging parties could litigate if they were dissatisfied with the Bureau’s conclusions. The competition bar was critical of this approach and some members supported the legislative amendment to make efficiency a s.93 factor. They apparently believed that if the Act was changed, the Bureau would be bound by thereby in its internal review. Given the Bureau’s discretion, this belief was surprising.

More recently, the Bureau indicated that it could conduct an “integrated analysis”, in which efficiencies would be considered seriously in the decision whether to challenge a merger, without statutory amendment. Thus, merging parties could argue that efficiencies would lead to lower prices. The Bureau’s discretion allowed it to adopt this approach even though the Act had not changed. Doing so, however, raises important issues as to the Bureau’s understanding of s.92. As the 2004 MEGS indicate, s.92 is about market power, and efficiency has no role in this determination. However, this is a statement of statutory interpretation; the Bureau’s discretion to analyze a merger is not limited thereby.

Now, the Draft Bulletin indicates that the Bureau is following the law, relying on the Tribunal’s decision in the Propane case. However, the Tribunal’s decision in Propane is binding only on the Tribunal. While it is open to the Bureau to adopt the same analytical sequence, it is a purely legal question whether there is anything in law that limits the Commissioner’s discretion. For this reason, there may be some doubt whether the Bureau truly intends to bind itself to the analytical sequence that the Tribunal has found to be required by the Act in litigated cases.

Although the MEGs present the Bureau’s approach to particular aspects of its internal merger review process (e.g. market definition), they also provide the Bureau’s interpretation of various legal matters. This dual function of the MEGs has created confusion, because the Bureau is not necessarily bound by the prevailing legal interpretation when it reviews a merger. Thus, even after two Tribunal decisions (Hillsdown, Propane) had confirmed that efficiencies were not merger-specific, the MEG’s continued to state that the Bureau would not recognize efficiency claims if they could be achieved in another, less-anti-competitive way.

Other Issues in the Draft Bulletin

1. “Merger-specific” (p.2): This paragraph of the Draft Bulletin is somewhat unclear. In the second Propane decision [¶149], the Tribunal stated that under s.96, efficiencies were “order-driven”, not “merger-specific”.

   There may be some confusion because the definition of a cognizable efficiency claim has two parts. First, a claimed efficiency gain must be brought about by (i.e. be incremental to, or arise from) the merger. Second, it must be an efficiency gain that would not be attained if the order were made. The first part of the definition declares that efficiency gains are not merger-specific; they are included even if they could be achieved in some other way. The second part means that efficiency gains are order-driven.

   As the Draft Bulletin appears to mean “incremental to” or “resulting from”, the reference to merger specificity might well be dropped.

2. “If an order under section 92 were made” (p.3): The Draft Bulletin is correct in law. In a s.96 analysis with an order of partial divestiture, the only cognizable efficiencies are those in the proposed divested parts of the merger. This is a direct consequence of order-driven efficiencies. Those efficiencies in the divested parts of the merger must be compared with the total of anti-competitive effects that result from the merger.

   The example of the cost-savings from head office rationalization is not entirely clear because some head-office savings could be cognizable efficiency gains, even if the order is one of partial divestiture. For example, eliminating a head-office management position of the acquired firm could well lead to a savings in executive compensation to the combined firm that should be included under an order of partial divestiture.

   If the order is for partial divestiture, then the terminated head-office position must be linked to the specific divestiture order for the savings in compensation be included. This linkage is done on a “ceteris paribus” assumption; one imagines that if the operations in a given region or product-line were ordered divested, there could well be a significant impact on head office functions such as executive compensation, marketing, accounting, human resources, etc., everything else constant, if that order were made.

   There might be an uncertainty in this part of s.96 because the provision refers to “an order”, not “the order”. Thus, as was suggested in the first Propane hearing, it might be thought that the Tribunal could consider various orders until it found one that could actually issue. However, there is no uncertainty because there is only one order that the Tribunal can make. The clarification by the Supreme Court indicates that the order must be effective in restoring competition to the pre-merger state and must be the least-intrusive order that achieves that objective. Accordingly, the order is unique.

3. “Offset” (p.3): The Draft Bulletin does not clarify what interpretation it is giving to this term. In the past, the Bureau has indicated that it would do so in connection with its views on distributional issues. The term “offset” was first used in the Economic Council report on competition policy in 1969. The Council recognized that an anti-competitive merger would have a harmful effect on competition, but raised the possibility that there might be “offsetting public benefits” that required consideration in the efficiency defence that it had proposed. However, since the Economic Council had proposed a “total surplus/total welfare” approach to efficiencies, the Council’s reference to “offset” could not have been in regard to distributional considerations. It must have meant that efficiency losses in the economy arising from the merger could be offset by efficiency gains from the merger.

   The Tribunal perhaps did not deal with the meaning of “offset” as clearly as it might have done. However, it is clear that redistributional effects cannot offset efficiency losses or efficiency gains.

4.  “balancing weights” (p.4): The Draft Bulletin clearly insists that it will use the balancing weights approach to evaluating the transfer between consumers and producers. This leaves much unsaid.

• Can consumers be easily distinguished from producers (i.e. shareholders, partners, proprietors), especially when pension funds and mutual funds are owned by a large segment of the population?

• Determining whether the balancing weight is reasonable is problematic. The Draft Bulletin suggests that this could be achieved by reference to the system of taxation: since effective tax rates are generally proportional, the implication is that the transfer from consumers to producers will be treated neutrally. This implies that the balancing weights approach applied to the transfer as a whole effectively reduces to a “total surplus/total welfare” standard.

• Following the Tribunal’s attempt to implement the balancing weights approach in Propane, the Draft Bulletin indicates that there may be certain groups for whom the transfer can be weighted more heavily than the balancing weight. In litigated cases, it is the Commissioner’s burden to identify the groups and establish this effect. The Commissioner faces a heavy burden in this regard; in the past, Bureau representatives have openly questioned whether it would be possible to establish these effects.

5. regone Efficiencies (p.5): The Draft Bulletin is relying on the Commissioner’s final argument in the Propane case. The Tribunal rejected claims of foregone efficiencies (“FE”) because there was no supporting evidence in the record; however, the Tribunal did not address the legal issues.

   The Draft Bulletin’s approach raises serious issues. First, it states “there may be resource savings that will not be achieved because of the merger” (p.5). While certainly possible, mergers have many effects, not all of which are relevant under s.96. For example, a merger may result in job losses or negative community impacts; such effects arise “because of the merger”.

   However, these effects are not relevant under s.96 because a relevant effect is an effect of the prevention or lessening of competition that will result from the merger. Since job losses arise from pro-competitive mergers as well, they cannot be considered an effect under s.96. Similarly, FE do not arise from the anti-competitive element of a merger and so, as a statutory matter, probably cannot be considered by the Tribunal in the litigation context.

   The Draft Bulletin suggests an alternate approach: deducting FE from cognizable efficiency gains (p.6). This approach poses other statutory problems because the Act is clear: the relevant test for an efficiency gain is as given above, that it result from the merger and that it would not likely be attained if the order were made. The burden of proof in this regard falls on the merging parties; they must convince the Tribunal that each efficiency gain claimed meets this two-part definition.

   The Commissioner has the right to rebut such claims. However, whether the Tribunal may reduce the cognizable efficiencies by the amount of FE is a legal issue. The test in s.96 requires that the total of cognizable efficiencies be greater than and offset the aggregate anti-competitive effects of the merger. Since FE are neither cognizable efficiencies nor anti-competitive effects, it might be argued that there is no statutory requirement that FE be deducted in the manner suggested in the Draft Bulletin. However, it might equally well be argued that the meaning of “greater than and offset” allows the Tribunal to do so.

   None of these considerations preclude the Bureau from taking FE into consideration in its internal review of a merger.

6. Efficiencies outside Canada (p.6): In Propane, the Tribunal held that efficiency gains and effects outside Canada could not be included in the test in s.96. The Draft Bulletin takes a different view, at least as regards efficiencies: to the extent that externally realized efficiencies “accrue” to the Canadian economy, they will be considered under s.96. As an example, fn. 12 of the Draft Bulletin refers to external efficiencies that lower prices in Canada.

   The Draft Bulletin refers to external effects in fn. 13. Here it indicates that nationality of ownership is relevant when evaluating the wealth transfer. This discussion is incomplete, in part because it will be important for the Bureau to comply with “national treatment” provisions in Canada’s international trade obligations. The Tribunal was of the view that (i) differential treatment of foreign shareholders would violate those obligations and (ii) the Act was not discriminatory.

   Thus, there are important legal questions whether the Draft Bulletin is consistent with the Act and Canada’s international trade obligations.