Is your company contemplating a merger or increasing its shareholding in a competitor? Is it embarking on a joint venture with a competitor? Is there talk of acquiring an interest in an entity that operates upstream or downstream to your business operations? If a member of your board also sits on the board of a competitor, or a substitute or complementary company, an assessment of the implications of cross directorships and the resulting coordinated effects are integral in the initial stages of any proposed deal.
M&A – the legislative and ACCC approach
Section 50(3) of the Trade Practices Act 1974 (TPA) provides a non-exhaustive list of matters to be taken into account when assessing whether a merger or acquisition would be likely to substantially lessen competition in a market. The ACCC Merger guidelines 2008 (Guidelines) specify, in addition to the legislated list, other factors relevant to the ACCC's assessment of a proposed merger.
The Guidelines are illustrative of the types of mergers that are subject to the TPA. In relation to the implication of partial shareholdings and minority interests, the Guidelines identify the composition of the board of directors as a factor that the ACCC will take into account when considering whether a shareholding and/or other interest is sufficient to deliver control of a company. Irrespective of whether a controlling interest is actually attained, the ACCC's focus is on whether the merger or acquisition will have an effect on competition. To this end, it is possible partial directorships arising from horizontal minority acquisitions, third party minority acquisitions and vertical minority acquisitions, where the shareholding is sufficient to secure a position on the board, may be perceived to have the potential to foster an environment for coordination.
What are coordinated effects?
In the merger context, coordinated effects arise where a merger assists firms in the market to implicitly or explicitly coordinate pricing, output or related commercial decisions. It follows that horizontal, vertical and conglomerate mergers may give rise to such coordinated effects when they alter the interdependence between rivals. Coordinated effects are relative to the merging firms' pre-merger relationship in the market and the ability of the firms to use knowledge, know-how and other information not generally available to the public to distort the competitive tension that would otherwise exist between the companies.
Does the structure of the merger pre-empt the effect?
Horizontal minority acquisitions
Minority acquisitions in a rival firm may be perceived to heighten strategic incentives not to compete. In particular, even in minority acquisitions, a significant shareholding in a rival firm may create, or be perceived to create, a disincentive to compete head-to-head. The Guidelines highlight that due to commonly held assets, firms competing horizontally would have a significant disincentive to compete in order to maximise joint profits.
Joint venture or third party minority acquisitions
A joint venture between competitors in a market, other than that market in which the joint venture competes, or the acquisition of shares by two rivals in an unrelated company competing in a separate market, may also raise questions of the impartiality of directors with respect to the operations of a third party acquisition. The coordinated effect is not likely to be felt in the market in which the acquisition has taken place, but the heightened risk of coordination is in the market within which the acquirers' reside. Cross directorships will be examined by the ACCC where the overlapping directorships create opportunities to limit competition between rival firms.
Vertical minority acquisitions
Complementary products, and upstream or downstream supply, are noted in the Guidelines to create an incentive for a firm with significant market power to discriminate in favour of its related firm in the upstream or downstream markets. In particular, power held in one market may be viewed as being exacerbated where the dominant firm can exert pressure for discrimination in the supply chain.
Is the risk of coordinated effects at odds with director duties?
A director of a company has a fiduciary obligation to act in the best interests of the company. Discretion is to be exercised bona fide in the best interests of the company and not for any other collateral purpose. These principles are replicated in section 181 of the Corporations Act 2001 (Cth) requiring a director, in exercising their powers and discharging their duties, to act in good faith in the best interests of the company and for a proper purpose. But, are these obligations enough to prevent coordination?
It is possible that the statutory duties of directors are insufficient to protect against coordinated effects, as their overarching obligation is to act in the best interests of the company. Knowledge of the competitive practices of a rival or an upstream supplier may be used in the best interests of the company, and therefore in line with directors' duties, but may also raise competitive concerns as to coordinated effects.
It is not a breach of a director's duty to be a director of competing companies and therefore exposure to confidential information is inevitable in these circumstances. Sections 193 and 194 of the Corporations Act do, however, place restrictions on the use of that information. Common law obligations require consideration of the degree of likelihood that information will be available to a non-executive director in their capacity as a director of the first company which would be likely to be exploited in their other capacity with a second company.1
Although the Corporations Act imposes obligations with respect to use of information and the manner in which a director should make decisions, the coordinated effects argument can be made both ways. The ACCC might argue that coordination falls outside the bounds of directors' duties at common law and under the Corporations Act. Decisions made that enhance business operations, thereby increasing the profitability of the company, are in line with directors' overarching obligations and are likely to be perceived as in the best interests of a company. However, it is also arguable that acting contrary to the TPA by engaging in conduct that fosters collusion between competitors is not in the best interests of each company upon which a director has a seat on the board. To this end, the level of engagement, standing and independence of persons sitting on a board of directors will be of interest to the ACCC, with cross directorships perceived as potentially fostering coordinated conduct.
Global consideration of cross directorship in mergers
The United Kingdom Office of Fair Trading (OFT) has recognised cross directorships as a structural mechanism used by competitors to establish and sustain collusive arrangements. In British Sky Broadcasting groups plc's (BSkyB) acquisition of a 17.9% shareholding in ITV plc, the OFT stated that "BSkyB may use its shareholding in ITV to influence ITV's behaviour and may also have strategic information which it could use to its advantage". The OFT further expressed the view that where the board includes a representative(s) of an important competitor, this gives rise to material coordinated effects concerns.2 The OFT's investigations resulted in a recommendation to the Secretary of State of a partial divestiture of BSkyB's equity shareholding to below 7.5%.
The European Commission also assessed the opportunities and probability of coordinated effects post-merger in the Allianz/AGF decision. Specifically, it highlighted the risk that the two companies would not compete in the market but would act in "a complementary manner dividing up product and geographical markets".3 The European Commission has expressed such views regularly, with similar concerns raised in the Volvo/Renault V.I. merger in 2000 and the Nordbanken/Postgirot merger in 2001.
The Australian experience
The ACCC has publicly expressed its concerns on cross directorships in only a limited number of merger assessments to date. Having said this, cross directorships are given thorough consideration in the ACCC's assessment of any proposed merger or acquisition, as detailed in the Guidelines.
For example, in its initial assessment of Alinta's proposed acquisition of AGL in 2006, the ACCC highlighted concerns with respect to cross directorships and confidentiality regimes. The ACCC expressed the view that coordination and competition concerns would arise from the proposed acquisition. The vertical integration of gas retailing and electricity generation, in addition to the aggregation of interests in pipeline management, meant an overlap of directors and influence between the entities and undertakings were accepted by the ACCC to limit the potential for coordination.
Remember the overlap
It is apparent that, globally, regulators are considering the probability of the dampening effect of the incentives of merger parties to engage in aggressive strategic rivalry where cross directorships exist. The ACCC continues to consider, and all companies considering a merger that will result in cross directorships or an increased presence on a board of directors should also consider, coordinated effects. The shareholding a company has in a direct competitor, or an entity upstream or downstream in the market, may affect the ability to gain informal merger clearance from the ACCC. With consolidation increasingly prevalent in many industries, cross directorships and the potential for coordinated effects are factors that should be considered at the inception of merger talks.
1 Riteway Express Ltd v Clayton (1987).
2 OFT Report to the Secretary for Trade and Industry re the Acquisition by British Sky Broadcasting Group plc of a 17.9 per cent stake in ITV plc - 27 April 2007 at 36.
3 European Commission Decision of 8 May 1998 (Case: M.1082 - Allianz/AGF) at 56.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.