This article first
appeared in the CCH Australian Competition & Consumer Law Reporter, Issue
636, 14 October 2011 ,
pp. 1-6.
Introduction[1]
On 25 August 2011, Emmett J of the Federal Court in Australian Competition and Consumer
Commission v Metcash Trading Limited (2011) ATPR ¶42-368;
[2011] FCA 967 decided that Metcash’s proposed acquisition of Franklins would
not substantially lessen competition in breach of section 50 of the Competition and Consumer Act 2010 (CCA) (formerly the Trade Practices Act 1974).[2] Indeed, Emmett J found that the proposed
acquisition was likely to enhance competition.
Subsequently, many commentators in the media trumpeted
Emmett J’s decision as a triumph of practical, commercial common-sense reasoning
over the Australian Competition and Consumer Commission’s (ACCC) increasingly
hypothetical and theoretical approach to merger analysis.[3]
The commentary went so far as to suggest that the ACCC’s entire approach to
merger analysis would have to change in the light of Emmett J’s judgment.
On 20 September
2011 , Jacobsen J denied the ACCC’s application for an interim
injunction to prevent the sale.[4] The ACCC’s appeal will be considered by the
Full Federal Court over three days, commencing on 24 October 2011 .[5]
A Comedy of Errors
The reality is that Emmett J’s judgment in the Metcash case is deeply flawed and highly
unlikely to survive an appeal. The court appears to have ignored binding
precedent in relation to market definition and made a number of significant
legal and analytical errors in applying the relevant legislation.
Unfortunately, the ACCC also made a number of significant
errors in the way it ran its case. These errors ranged from pleading errors to major
strategic errors such as selecting the wrong counterfactual prior to the trial
and then having to switch to a new counterfactual during the trial.
Background to the
case
In July 2010, Metcash entered an agreement to purchase the Franklins
Supermarket business for $215m.
The ACCC opposed the proposed acquisition because it
believed it would substantially lessen competition. The ACCC subsequently
commenced legal proceedings in the Federal Court to prevent the acquisition
from proceeding.
Metcash is a specialist wholesaling company which supplies
groceries, fresh produce and liquor products on a national basis. Metcash supplies independent retailers with
grocery products principally under the IGA brand and owns a number of private
labels which it makes available to its retail customers.
The ACCC’s case
The most significant error made by the ACCC in its case was
its failure to amend its pleadings in relation to the relevant market prior to
the trial commencing.
The ACCC initially pleaded that the market was the market
for the wholesale supply of packaged groceries to independent supermarkets in
NSW and the ACT. However, a problem
arose when the expert for the ACCC, Dr Christopher Pleatsikas, appeared to
define a different market to the ACCC’s pleaded market in his expert report. Dr
Pleatsikas defined the market as the market for the supply of wholesale
services for dry groceries (at {121}).
In order to understand the difference between the ACCC’s
pleaded market and the market found by the ACCC’s expert, one has to understand
the goods and services which Metcash supplies to its customers.
Metcash effectively charges its customers for three different
things:
·
dry groceries;
·
a service fee for providing a wholesaling
service; and
·
a fee for freight.
In other words, while Metcash charges its customers for the
dry groceries (goods), it also charges its customers for two related services –
ie wholesaling services and freight services.
The problem for the ACCC arose when Metcash’s lawyers wrote
to the ACCC on 2 March 2011
pointing out the discrepancy between its pleaded market and the conclusions
contained in its expert report (at {122}).
Metcash’s lawyers invited the ACCC to amend its pleadings at that stage
to reflect the market described in the ACCC’s expert report, but the ACCC
declined to do so.
Subsequently on the ninth day of the hearing, the ACCC sought
leave from Emmett J to amend its pleading to make the same amendment which
Metcash’s lawyers had suggested that it make three weeks previously. Justice Emmett refused the ACCC’s application
for leave to amend its pleadings (at {123}).
Justice Emmett’s decision not to grant leave to the ACCC to
amend its pleading had profound consequences for the way in which the case was
run. Indeed, the court’s decision meant
that the case was effectively fought by the parties on the wrong market
definition – ie that the ACCC was concerned that following the acquisition,
Metcash would be able to increase the wholesale
prices of groceries to independent retailers by between 5-10%. However, the
ACCC’s true concern was that following the acquisition, Metcash would be able
to increase the price of wholesaling
services to independent retailers by between 5-10%.
The practical difference between these two markets is
significant. In the pleaded market, the ACCC would have had to prove that
Metcash had the ability, following the acquisition, to increase its prices for
dry grocery supplies by between 5-10%, which would have amounted to a doubling
of its profit margin. However, under the alternative wholesale services market,
the ACCC would only have been required to prove that Metcash could have
increased its wholesale service fee from, for example, 3% of the value of the
groceries supplied to its independent retailers to 3.15% to 3.3%. Obviously it
would have been much easier for the ACCC to prove the latter.
Ultimately, the ACCC attempted to circumvent this pleading
problem by arguing that the market it has pleaded was effectively the same as
the wholesale services market. However, Emmett J did not accept this argument.
The other significant mistake made by the ACCC in the case related
to the selection of its counterfactual.
The ACCC claimed prior to hearing, and for the first few days of the
hearing, that SPAR was the likely counterfactual in the event the proposed
acquisition by Metcash did not proceed. However, it should have been abundantly
to the ACCC, based on even a cursory review of SPAR’s financial accounts, that
it simply did not have the financial resources to purchase the Franklins
On the other hand, the strength of the alternative consortium
headed by Supabarn made it a much superior counterfactual to SPAR.
Not only did the Supabarn-led consortium have greater
financial resources, but it had significant wholesale grocery volumes which it could
have redirected to Franklin Franklins
Mr Perlov, the Managing Director of Franklins advised TMT,
the advisers to the Supabarn-led consortium, that the Franklins wholesale
operations were currently operating at only 60% capacity and that it needed
another 20 good stores to achieve scale efficiency (at {373}). The consortium itself could have added 13 quality
stores to the Franklins
Unfortunately, the ACCC did not recognise that the Supabarn-led
consortium was the most likely counterfactual until after the trial had
commenced. The ACCC had to change its
position mid-way through the trial by abandoning SPAR and embracing the
Supabarn-led consortium as its preferred counterfactual. The ACCC’s decision to change counterfactuals
in the middle of the case significantly undermined the credibility of its arguments
in favour of the Supabarn-led counterfactual.
Federal Court
Judgment
The first unfortunate decision made in the conduct of the
trial was the refusal by Emmett J to allow the ACCC to amend its pleadings. In deciding not to allow the ACCC to amend
its pleadings, the court treated the ACCC as a private litigant to private
proceedings, rather than a public interest litigant. The court appears to have
taken the view that because the ACCC had not amended its pleadings when it had
a chance to do so prior to the commencement of the trial, it had lost its
opportunity to do so once the trial started.
Despite the ACCC not being permitted to amend its pleadings
to include the wholesale services market, the ACCC still had every right to
expect that they would be successful in establishing the market which they had
pleaded – namely the market for the supply of wholesale groceries to
independent grocers. This was because there was a clear binding precedent which
should have determined the issue in the ACCC’s favour.
In 1996 the Full Federal Court handed down its judgment in Davids Holdings Pty Limited & Ors v
Attorney-General of the Commonwealth (1994) ¶ATPR 41-304 In this case, Davids was proposing to
acquire another independent wholesaler, Queensland Independent Wholesalers. Therefore, the market definition issues
considered in the Davids case were
identical, in product and functional terms, to the market definition issues
raised in the Metcash case.
The Attorney-General[7] was
successful in arguing both at first instance and before the Full Federal Court,
that the relevant markets in the Davids
case were:
·
the market in Queensland
·
the market for retailing groceries, including
independent retailers and chain stores.
Not only did the court in Metcash define a different market to the market found by the Full Federal
Court in the Davids case, but Emmett J
did not discuss the Davids case in
his judgment. It is surprising that Emmett
J did not at least try to distinguish the Davids
decision as it related to market definition before defining a completely
different market.
Unfortunately it is not a simple exercise to state with
precision the market which Emmett J ultimately found in the Metcash case. This is because his description of the
relevant market is far from clear. However, it would appear that Emmett J
defined the relevant market as follows:
·
the national market for the supply of packaged
groceries, encompassing both the wholesale supply of groceries and the retail
supply of groceries by independent grocers and vertically integrated chains.
The other significant mistake which the court made in the Metcash case relates to the appropriate counterfactual
test to apply in merger cases. In his
judgment, Emmett J defined the counterfactual test as involving the following two-step
process (at {146}):
·
“that
it is more probable than not that one of the Commission’s counterfactuals will
come to pass if the proposed acquisition does not proceed; and
·
that
there is a real chance that, if the proposed acquisition does proceed, that
would result in a substantial lessening of competition compared to the scenario
in which one of those counterfactuals comes to pass.”
While Emmett J cited French J’s decision in the AGL case[8] as
establishing the relevant test for assessing competing counterfactuals, a close
reading of the two tests shows that Emmett J’s formulation is significantly
different to the French test.
In AGL, French J explained
the test for assessing the counterfactual as follows:
“The ACCC submits that AGL must satisfy the Court that
its hypothesis against any likely substantial lessening of competition in any
relevant market is more probable than the competing hypotheses which are
advanced to suggest a real chance of competition being substantially lessened
in any such market. I accept that formulation of the approach which should be
taken in this case. I accept also the proposition advanced by the ACCC that AGL
is not entitled to relief if:
(a) the Court is left in a position of uncertainty
about the competing hypotheses; or
(b) the Court concludes that the hypotheses suggesting
a real chance of competition being substantially lessened are more probable
than the opposing hypotheses.[9]
The
formulation established by French J in AGL
is that the counterfactual has to be “more
probable” than the competing hypothesis. This is clearly a relative test
which looks at the likelihood of one of two competing hypothesis eventuating.
However,
Emmett J described the counterfactual test differently as requiring that the court
be satisfied that the counterfactual be “more probable than not.” This is an entirely different test to the
test established in AGL.
The
French test looks at how probable one counterfactual is when compared to
another counterfactual. This means that
a counterfactual with say, a 30% chance of occurring would be selected as the
counterfactual if the competing counterfactual only had a 20% chance of
occurring. However, under Emmett J’s
formulation the only way that any counterfactual could succeed is if its
probability of occurring was more than 51% - ie more probable than not.
The
mistake of using this test was further compounded by Emmett J’s application of the
test to the relevant facts. In his judgment, Emmett J set out an extensive
range of factors which the ACCC’s counterfactual would have to meet in order
for it to be considered as the likely counterfactual. The actual application of the test to the facts
raised the standard of proof significantly higher than even the balance of
probabilities. Indeed the standard bears more resemblance to proof beyond
reasonable doubt.
Furthermore,
Emmett J did not apply his counterfactual test with the same rigour to the
counterfactual put forward by Metcash and Franklins – namely, that there would
be a store sale if the acquisition did not proceed.
Conclusions
The
claims that Justice Emmett’s judgment represents a triumph of common sense over
economic theory are entirely misplaced. Nothing could be further from the
truth.
It
was the ACCC which argued a common-sense market definition. The ACCC asked the
simple question – to whom will independent grocers turn if Metcash increases
its wholesale grocery prices? The ACCC believed that these independent
retailers would have nowhere to turn because Franklins
In
reality, it was the court in the Metcash
case which defined the more economically theoretical and speculative
market. The court found that because competition
at the wholesaling level is constrained by downstream competition at the retail
level, that the functional dimension of the market should be broadened to include
this downstream retail competition. Put another way, the court found that
Metcash would not increase its prices to its independent retail customers
because it would recognise that if it tried to increase its prices to these
captive customers, this action would make these customers uncompetitive against
Coles, Woolworths and Aldi stores at the retail level which would in time force
these customers out of business.
It
is highly unlikely that the decision in the Metcash
case will survive an appeal, despite Jacobsen J’s recent comments. The court
has made too many fundamental legal and factual mistakes for the judgment to be
allowed to stand.
The remaining question is why has both the ACCC and the court
made so many apparent errors. The simple
explanation is “time”. It is not
possible for the ACCC to prepare a merger case properly in the very short time
frames imposed upon it by the court. In
both the AGL case and the Metcash case, the ACCC had only a couple
of months to fully prepare its cases. It is no coincidence that the ACCC lost
both of these cases quite comprehensively.
The court will also struggle to
properly adjudicate on all the relevant (and irrelevant) issues raised during a
merger case.
Given the importance of merger analysis under section 50 of
the CCA – namely to ensure the future competitiveness of Australian markets in
the medium to long term – more time should be given to both the ACCC and the court
to get the decision right.
Postscript
On 20 September
2011 , the Full Federal Court handed down its decision in Australian Competition and Consumer
Commission v Metcash Trading [2011] FCA 1079[10],
rejecting the ACCC’s appeal against Emmett J’s judgment. Accordingly, my
prediction that Emmett J’s judgment would not survive an appeal has proven to
be incorrect.
I will be discussing the Full Federal Court’s Metcash decision in an upcoming post, where
I will be arguing that the Court’s decision should be characterised
as Act 2 (and fortunately the Final Act) in the Messcash Comedy of Errors.
[1] I acted
for TMT, the financial adviser to the Supabarn led consortium, in the Metcash
case.
http://www.austlii.edu.au/au/cases/cth/FCA/2011/967.html
[3] For example Bryan Firth, “Metcash black eye puts ACCC's new boss Rod Sims in a spot”, The Australian, http://www.theaustralian.com.au/business/opinion/metcash-black-eye-puts-acccs-new-boss-rod-sims-in-a-spot/story-e6frg9kx-1226122403750
http://www.austlii.edu.au/au/cases/cth/FCA/2011/1079.html
[5] See
Postscript at end of article.
[6] I
expressed the view to the ACCC’s lawyers prior to the Metcash trial commencing
that they were arguing the wrong counterfactual and should change their focus
from SPAR to the Supabarn-led consortium.
[7] The
Davids proposed acquisition of QIW was challenged under section 50 of the Trade Practices Act 1974, by the
Commonwealth Attorney General.
[8] Australian Gas Light Company v Australian
Competition and Consumer Commission (No.
3) [2003] 137 FCR 317.
[9] AGL at 356.
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