Federal Court of Appeal Upholds Competition Tribunal’s Approach to the Controversial Efficiencies Defense

Federal Court of Appeal Upholds Competition Tribunal’s Approach to the Controversial Efficiencies Defense

On August 1, 2023, the Federal Court of Appeal released its decision in Secure v Commissioner of Competition,[1] upholding the Competition Tribunal’s order requiring Secure Energy Inc. to divest 29 facilities to remedy the anti-competitive effects in 136 markets in western Canada arising from its July 2021 acquisition of Tervita Corporation.[2] It provides important guidance on the standard to be met to establish an efficiencies defense under the Competition Act.

Overview of the Efficiencies Defence

The Competition Act allows the Competition Tribunal to block a proposed merger, dissolve a completed merger or order a divestiture of assets if it finds that a merger is likely to prevent or lessen competition substantially. The efficiencies defence provides that the Tribunal shall not make any such order if the merging parties can demonstrate that the merger is likely to bring about gains in efficiency that will be greater than, and will offset, the anti-competitive effects that are likely to result from the merger and the gains in efficiency would not likely be attained if a remedial order were made.

This trade-off analysis between the harm to competition and the gains in efficiencies from a merger recognizes the benefits of efficiency gains to the economy and is aligned with the purpose clause in the Competition Act, which includes the promotion of efficiency as well as the protection of competition.

The Secure / Tervita Efficiencies and Anti-competitive Effects

Secure and Tervita competed in the supply of oilfield waste disposal services in the Western Canadian Sedimentary Basin. It was clear from the outset that the Secure/Tervita merger would raise significant competition concerns in many oilfield waste disposal services markets. The Commissioner of Competition reached this conclusion during his initial review of the merger and advised the parties he would challenge the transaction.

Notwithstanding these concerns, immediately after the Commissioner’s attempt to obtain an interim order was rejected by the Tribunal, the parties closed the transaction in July 2021.  It appears that the parties considered that Secure’s significant planned efficiencies, estimated by Secure at $138.5 million, would easily exceed the anti-competitive effects of the merger, and that the efficiencies defence would prevent a dissolution or divestiture order.

In March 2023, the Tribunal found that the merger would substantially lessen competition in 136 of the 143 oilfield waste disposal services markets initially identified as problematic by the Commissioner. Secure and Tervita are close competitors in oilfield waste services; they are two of very few, if not the only, effective options available to customers in many local markets; and there are significant barriers to entry in such markets.

Notwithstanding Secure’s efficiencies claims, the Tribunal ordered the divestiture of 29 facilities. The Tribunal’s treatment of the efficiencies defense and assessment of Secure’s efficiency claims, now confirmed by the Federal Court of Appeal, clarify the interpretation, process and evidence needed for invoking the defense in future mergers.

The Order Driven Approach for Identifying Efficiencies

A key element of the FCA decision is the confirmation and elaboration of the “order driven approach” to the efficiencies analysis, which is one of the five screens for efficiencies established in prior jurisprudence.[3]  Under this approach, (i) only the gains in efficiencies that would not likely be obtained if the remedial order was made (i.e., the “foregone efficiencies”) are recognized, and (ii) they are weighed against all of the anti-competitive effects that would arise from the merger.

Applying the order driven approach and other four screens from the jurisprudence, the Tribunal found that the foregone efficiencies, measured for 10 years post-issuance of the Tribunal’s divestiture order, were only $32.2 million — not the $138.5 million initially claimed by Secure (all on a present value basis for 10 years).

Applying the order driven approach, the Tribunal excluded certain cost savings in connection with the termination of redundant employees because it accepted the Commissioner’s argument that those positions are not likely to be required by potential divestiture purchasers and that “efficiencies that would likely be realized by any acceptable alternative purchaser should not be included”.[4]  This was a surprising finding, since none of the tentatively identified potential purchasers had provided an integration plan addressing those positions and not all potential purchasers were known at the date of the Tribunal hearing.

The Tribunal then weighed the accepted foregone efficiencies against the estimated value of the total anti-competitive effects likely to result from the merger, which the Tribunal assessed to be between $30.2 million to $39.4 million (on a present value basis). Notably, the Tribunal included the anti-competitive effects for the two years since the merger’s closing in July 2021 plus 10 years post-issuance of the order.

The $32.2 million estimated foregone efficiencies (for 10 years from the date of the order) exceeded the low end of the estimated range of anti-competitive effects (for 12 years from the date of closing). However, the Tribunal held that Secure failed to establish the efficiencies defence because a party “must demonstrate, on a balance of probabilities, that the cognizable Foregone Efficiencies will be greater than, and will offset, the entire range of likely anti-competitive effects that the Tribunal has determined, based on the range of elasticities that it has found.”[5]

On appeal, the FCA dismissed Secure’s arguments that the order driven approach led to an absurd result that ought to be avoided. The FCA concluded that the order driven approach to efficiency analysis as applied by the Tribunal is supported by the provisions and purpose of the Competition Act.

The order driven approach, now confirmed by the FCA, results in an asymmetrical treatment of efficiencies and anti-competitive effects:

• Timing. Foregone efficiencies are limited to those gains from the merger arising after the date of issuance of the Tribunal’s remedial order. Efficiencies that occur after closing but before the date of the order are not considered, because the statutory language focuses only on those efficiencies that would not likely be attained if the order is made. In contrast, all of the anti-competitive effects from the merger are considered, including any that occur prior to the order being issued. In Secure/Tervita, this approach resulted in 10 years in foregone efficiencies being compared to 12 years of anti-competitive effects.
• Scope. Foregone efficiencies are limited to a subset of those efficiency gains from the assets and markets impacted by the Tribunal’s remedial order. In contrast, all the anti-competitive effects in all markets are considered. In Secure/Tervita, this approach resulted in the gains in efficiencies related to the 136 relevant markets which would be impacted by the Tribunal’s divestiture order being compared to all anti-competitive effects arising in each of the 271 areas of geographic overlap where both Secure and Tervita competed prior to closing.

Under the order driven approach, the timing and scope of the Tribunal’s order affects the quantification of both the efficiencies and the anti-competitive effects. As a result, the outcome of an efficiencies defense trade-off analysis may be uncertain until the Tribunal issues its order after hearing the case.

The FCA acknowledged that predictability “may be limited” by this approach, but concluded that this uncertainty is “baked in”, as “an interpretation that limits relevant efficiency gains (to those that would likely not be attained if the order were made) is the clearly expressed intention of the text of the provision.”[6] To reduce such uncertainty (for all parties), the Tribunal reminded the Commissioner that the Competition Tribunal Rules require the Commissioner specify “the particulars of the order sought” when he files an application to challenge a merger.[7] Where the Commissioner challenges a closed merger, the timing of the order would remain uncertain in part due to the Tribunal’s own pre-hearing, hearing and post-hearing timeline.

The Tribunal’s approach in excluding efficiencies that would likely be realized by any acceptable divestiture buyer, in the absence of clear evidence of the identity of such alternative buyers and their needs and plans, creates further uncertainty and challenges for quantifying foregone efficiencies. It appears to require speculation as to the identities, capabilities and plans of alternative purchasers.

These challenges can be more pronounced during Competition Bureau’s review of a merger prior to any application by the Commissioner for a remedial order.  There may be a range of possible orders and alternative buyers – in addition to timing considerations to assess foregone efficiencies – that the Commissioner and the merging parties would need to consider when evaluating the relative magnitudes of foregone efficiencies.

Efficiencies that Flow Outside of Canada

The Tribunal also commented that one of the five screens would exclude any efficiencies that effectively flow to foreign shareholders of the merging parties, because only gains that accrue to the Canadian economy qualify for the efficiencies defense. While the parties did not do so in Secure/Tervita, the Tribunal advised that in future contested merger cases the party invoking the efficiencies defence will be expected to provide evidence of the location of its shareholders as part of the efficiencies analysis.[8] This restrictive approach appears to assume that all efficiencies flow through to shareholders as increased dividends.

This additional test will further reduce the efficiencies that may be claimed by purchasers whose shareholders are largely outside of Canada.  This requirement raises unique issues for public companies, because the ultimate beneficial shareholders of public companies are often not known.  Given that public companies’ shares trade continuously, further guidance will be required regarding the parameters and timing for geographic searches to estimate the extent of non-Canadian beneficial shareholders. It will also be important for parties to consider whether this presumption can be rebutted with evidence that portions of the efficiencies may be passed through to customers or be reinvested in the Canadian business.

Concluding Observations

The Competition Bureau has long regarded the efficiencies defence as harmful because it allows anti-competitive mergers to proceed.  It has advocated for the repeal of the efficiencies defence in a submission to the competition policy consultation being undertaken by Canadian federal government.[9]

The Tribunal and FCA decisions in Secure/Tervita illustrate that the efficiencies defence is not an obstacle to preventing anti-competitive mergers.  The Tribunal’s decision, as confirmed by the FCA, significantly circumscribes the availability of the efficiencies defence to save an anti-competitive merger by:

• accepting the narrow scope and timing for the quantification of the foregone efficiency gains relative to the scope and timing to quantify the anti-competitive effects under the order driven approach;
• requiring the merging parties demonstrate “clear and convincing evidence” to support efficiency claims;
• rejecting efficiencies that would likely be realized by any acceptable alternative purchaser of the target or divesture assets;
• excluding efficiencies that would effectively flow outside of Canada, including those that flow to the merged entity’s foreign shareholders; and
• requiring the foregone efficiencies to be greater than, and offset, the entire range of likely anti-competitive effects.

The Commissioner’s declared intent to increase enforcement of anti-competitive mergers and the heightened scrutiny of claimed efficiencies by the Tribunal are likely to incentivize parties to enter into timing agreements and negotiate consent agreements with the Commissioner in many cases.  Closing a transaction on the expectation that efficiencies will trump anti-competitive effects predicted by the Commissioner will be a high-risk strategy.

These developments also heighten the importance that parties considering mergers that may raise competition concerns seek sophisticated legal advice at early stages to assess the risk of a successful challenge by the Commissioner and the likely time and resources involved in defending such a challenge.

[1] Secure v Commissioner of Competition, 2023 FCA 172 (“Secure FCA”).
[2] 2023 Comp Trib 02 (“Secure CT”).
[3] The five screens involve assessing claimed efficiencies to (i) ensure the type of efficiencies claimed may be considered, (ii) assess the probability that claimed efficiencies will be achieved, (iii) exclude those efficiencies that would be, or have already been, brought about by reason only of a redistribution of income between two or more persons; (iv) exclude those efficiencies that would be achieved outside Canada and would not flow back to shareholders in Canada or that would be achieved within Canada but then ultimately flow through to shareholders located outside Canada; and (v) exclude those efficiencies that would likely be attained even if the Tribunal were to make the order that it determines would be necessary to ensure that the merger in question does not prevent or lessen competition substantially.
[4] See Secure CT at para 604.
[5] Secure CT at para 713.
[6] Secure FCA at para 32.
[7] Secure CT at para 33. Also see section 36(2) of the Competition Tribunal Rules.
[8] Secure CT at para 496.
[9] See the Commissioner’s submission to the Canadian Government’ consultation  and the Commissioner’s remarks, “Seizing the Moment to Build a More Competitive Canada”, October, 2020.

by Dr. Neil Campbell, Beth Riley and William Wu

A Cautionary Note

The foregoing provides only an overview and does not constitute legal advice. Readers are cautioned against making any decisions based on this material alone. Rather, specific legal advice should be obtained.