News
Warehouse decision sets high threshold for clearance
The recent proceedings in relation to Woolworths' and Foodstuffs' applications for clearance to acquire The Warehouse raised two important issues in relation to the test for clearance.
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First, how clearance decisions should be made in situations of uncertainty. The Court of Appeal adopted a precautionary approach of declining clearance if it is not certain that there will not be a substantial lessening of competition.
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Second, the threshold for determining what is a "substantial" lessening of competition. The High Court found that a price impact below 4-5% may be substantial, depending on the market.
The approach taken by the courts to these issues sets a difficult threshold for clearance applicants and calls into question the purpose of the voluntary clearance process.
Background on the proceedings
New Zealand's major supermarket operators, Woolworths and Foodstuffs (comprising the three Foodstuffs co-operatives), each applied for clearance under s66 of the Commerce Act to acquire The Warehouse, New Zealand's largest general merchandise retailer.
At the time, The Warehouse had recently launched its "Extra" strategy, combining both general merchandise and a supermarket in one store. Extra stores were opened in Auckland, Whangarei, and Hamilton. Woolworths and Foodstuffs argued that the Extra strategy should not prevent a clearance as the concept would not succeed (which has since proven to be correct). They argued that, even if The Warehouse rolled out its maximum proposed number of Extra stores, it would still lack the economies of scale required to be viable. It was therefore unlikely that the existing Extra stores would continue and, if they did, they would not have any material impact on competition.
After considering the applications for more than six months, the Commission declined them on the grounds that the acquisition of The Warehouse by either supermarket operator was likely to substantially lessen competition in the local markets in which Extra stores were already operating or were likely to. On the viability of the Extra concept, the Commission took the view that it should not second-guess The Warehouse Board, which had made a commercial decision to invest in the Extra strategy.
Woolworths and Foodstuffs appealed to the High Court, where they were successful in overturning the Commission's decision.1 Justice Mallon and a lay member, Dr Stephen King, accepted the supermarkets' argument that the Extra strategy was unlikely to survive and, even if it did, it would have minimal competitive impact.
The Commission appealed. The Court of Appeal overturned the High Court's decision on the grounds that it could not exclude the possibility that the Extra strategy would succeed and that it would have a material impact on competition.2 The Court of Appeal held, in effect, that it should take a precautionary approach and decline clearance if it could not be positively satisfied that there was no likelihood of a substantial lessening of competition (SLC), even if it did not consider that there was such a likelihood.
Woolworths applied for leave to appeal to the Supreme Court but withdrew its application following the recent announcement by The Warehouse that it was withdrawing from Extra because, after analysing its economic performance, it had concluded that the strategy would not succeed and would not meet its return on investment criteria.
Approach to uncertainty
A key issue in this case was how the Commission and the court should deal with the uncertainty about the continuation and impact of the Extra strategy.
The High Court took the view that uncertainty was not of itself a reason to decline clearance. It held that it was not open to the Commission or the Court on a clearance application to say "we are not sure" and therefore "we are not satisfied". Rather, the High Court took the view that the Commission or the Court must decide on the evidence whether a proposed acquisition is, or is not, likely to have the effect of substantially lessening competition in any market.
The Court of Appeal disagreed with this approach, deciding the Commission was entitled to decline clearance on grounds of uncertainty. In other words, the Commission does not need to make a positive finding that an SLC is likely, it is enough to decline a clearance if it is not satisfied that an SLC is not likely.
This precautionary approach significantly reduces the attractiveness of the clearance regime to potential applicants. The clearance regime is voluntary – it is designed to provide assurance to parties in cases where there is uncertainty about the competition effects of a transaction. If that very uncertainty means that a clearance will be declined, there is no longer any benefit in making a clearance application. Instead, parties will form their own view of whether an SLC is likely and rely on the fact that, if proceedings are brought against them, the burden will be on the Commission to prove that there is a likelihood of an SLC.
SLC threshold
The High Court took the view that the level of price increase that constitutes an SLC may vary from market to market. It held that, because supermarkets are a high volume, low margin industry, price rises of less than 4-5% would be a cause for concern, because small price increases could have a substantial impact on profits (it did not accept the argument that the impact on consumers was also a relevant factor). However, while price rises of less than 1-2% could be a concern, the Court held that they would not be reliable evidence of an SLC, due to the difficulty of distinguishing an effect of this size from ordinary price volatility. The Court emphasised that price impacts were merely a starting point for determining an SLC, with non-price impacts also requiring consideration.
The Court of Appeal held that what constitutes an SLC must be a matter of judgment in each case and did not identify a particular threshold. But it is relevant to note Justice Wilson's observation in the Court of Appeal's recent NZ Bus decision that the SLC test is "a low one" which captured the "only very minor" lessening of competition which would have resulted in that particular case.3
This demonstrates that it is not safe to rely on a 4-5% price impact as a rule of thumb for determining whether an SLC is likely. Instead, parties to proposed mergers and acquisitions must consider the particular market they are in and whether a lower price impact (or non-price impact) may be considered substantial in that context.
Is it worth it?
Overall, the decisions in the Warehouse proceedings set a difficult threshold for clearance applicants to meet. Potential applicants will need to carefully consider whether the cost and delay which a clearance application entails is worthwhile, given the risk of an outcome which may provide no greater certainty than they had at the outset. Indeed, it may result in a greater barrier to a transaction than would have been the case if clearance had not been sought at all.
Note: Bell Gully represented Woolworths in the proceedings described in this article.
1 Woolworths Ltd v Commerce Commission (2008) 8 NZBLC 102,128.
2 Commerce Commission v Woolworths Ltd [2008] NZCA 276.
3 New Zealand Bus Limited v Commerce Commission (2008) 12 TCLR 69.
