Canada: Federal Court of Appeal Orders Competition Tribunal to Reconsider Legal Tests for Abuse of Dominance and Exclusive Dealing in Context of Loyalty Rebate Case

The Federal Court of Appeal (the "FCA") recently interpreted the abuse of dominance provision (s. 79) and the exclusive dealing provision (s. 77) under the Canadian Competition Act (the "Act") in its decision in Commissioner of Competition v. Canada Pipe Company Ltd., (2006) FCA 236. This marks the first time since the enactment of the Act in 1986 that an appellate court has had occasion to consider the tests for exclusive dealing and abuse of dominant position on appeal from the Competition Tribunal (the "Tribunal").

This case is of interest to any American business person or corporation that carries on significant business in Canada and offers loyalty rebate programs. The case is noteworthy because the Tribunal earlier held that an exclusivity loyalty rebate program engaged in by a dominant firm was not an abuse of dominance because it did not result in a substantial lessening or prevention of competition. Although the FCA found errors of law in the Tribunal's analysis, it refused the government's request to reverse the Tribunal's conclusions and instead returned the matter to the Tribunal for a redetermination on the basis of the evidence on record. As a result, it is possible that the Tribunal will reconfirm its earlier conclusions after applying the legal tests articulated by the FCA (all of which is subject to a possible appeal to the Supreme Court of Canada1).

Background

In October 2002, the Commissioner of Competition (the "Commissioner") brought an application against Canada Pipe which, the Tribunal found, produces and sells cast iron, drain, waste and vent ("DWV") products in 6 geographic markets: British Columbia, Alberta, the Prairies, Ontario, Quebec and the Maritimes. Canada Pipe offers a "loyalty rebate" program known as the Stocking Distributor Program (the "Program"). Under the Program, distributors can earn significant rebates and discounts if they choose to stock only cast iron products produced by Canada Pipe. These distributors are, however, free to stock other companies' DWV products which are not made of cast iron and still be entitled to the benefits of the Program. Canada Pipe's share of the cast iron DWV products market was at least 82% in each of the relevant geographic markets.

The Commissioner alleged that the Program constituted both a practice of exclusive dealing with exclusionary effects and a practice of anti-competitive acts, and was likely to have the effect of substantially lessening or preventing competition in the markets for cast iron DWV products by impeding the entry and expansion of competitors.

Tribunal Decision

Pursuant to the abuse of dominance provision and the exclusive dealing provision under the Act, the Commissioner had the burden of proving that Canada Pipe (i) occupies a position of dominance in the market; (ii) engaged in the practice of exclusive dealing with an exclusionary effect or a practice of anti-competitive acts, as applicable; and (iii) caused an actual or likely substantial lessening or prevention of competition. The Commissioner's application was dismissed by the Tribunal despite its finding that Canada Pipe substantially controls the markets in which it operates.2 The Tribunal found that the Program: (i) was not an "anti-competitive act"; (ii) did not have an exclusionary effect in the market; and (iii) did not substantially lessen or prevent competition.

FCA Decision

The FCA determined that the Tribunal had erred in its application of the law in concluding that the conduct of Canada Pipe was neither anti-competitive nor likely to prevent or lessen competition substantially. Furthermore, the FCA found that Canada Pipe, based upon the analysis of the Tribunal, did not have a valid business justification for the Program. The FCA ordered the matter back to the Tribunal for a redetermination in accordance with the analysis and tests described in its judgment, as summarized below.

Statutory Analysis

The similar requisite elements prescribed by the Act for both exclusive dealing and abuse of dominance allowed the FCA to use a parallel analysis to interpret both provisions. The FCA focused its analysis on the issue of abuse of dominance but because of the similarities between the two provisions, the FCA also ordered the issue of exclusive dealing back to the Tribunal to reconsider its decision in light of the FCA's analysis of the abuse of dominance provision.

Lessening of Competition

In its decision, the FCA first considered the appropriate test for the finding of an "actual or likely substantial lessening of competition". The FCA adopted a "but for" test by which the Tribunal should conduct a comparative assessment of the level of competitiveness in the presence of the impugned practice with that which would exist in the absence of the practice. In other words, the test could be defined as follows:

Would the relevant markets – in the past, present or future – be substantially more competitive but for the impugned practice of anti-competitive acts?

In practical terms, the FCA suggested that the proper application of the "but for" question might include an examination of the following considerations: whether entry or expansion might be substantially faster, more frequent or more significant without the Program; whether switching between products and suppliers might be substantially more frequent; whether prices might be substantially lower; and whether the quality of products might be substantially greater.

The FCA concluded that a plain meaning interpretation of the statutory language mandates a comparative analysis and the "but for" test is such an approach and, therefore, must be considered in all cases. The FCA did, however, suggest that the Tribunal may, in addition to the "but for" test, develop or adopt other appropriate tests in future abuse of dominance cases.

Engaging in a Practice of Anti-Competitive Acts

The FCA confirmed that a "practice" is more than an isolated act but may be one occurrence that is sustained and systemic, or that has had a lasting impact on competition. It was clear that Canada Pipe was engaging in a practice as the Program was found to be structured, organized and applied throughout Canada and this finding was not contested by Canada Pipe.

The Act does not define an "anti-competitive act" but instead, provides illustrative examples to be used as guidelines. The FCA confirmed that the common denominator of the examples provided in the Act is that (i) an anti-competitive act will be identified by reference to its purpose; and (ii) the purpose must be an intended negative effect on a competitor that is predatory, exclusionary or disciplinary. The FCA emphasized that the anti-competitive act must have a negative effect on a competitor and criticized the Tribunal for requiring evidence of a link between the alleged anti-competitive act and a decrease in competition. The FCA held that whether an anti-competitive act substantially lessens or prevents competition is an issue to be dealt with separately.

Business Justification

In appropriate circumstances, proof of a valid business justification can overcome the deemed intention of engaging in anti-competitive behaviour if it can be shown that there is an overriding business purpose to justify the conduct in question. In this case, the FCA refrained from providing examples of what might constitute a valid business justification.

The FCA did determine, however, that the two business justifications put forth by Canada Pipe were not valid: (i) that the Program's uniform rebate structure encourages competition, by creating a level playing field between small and large distributors3; and (ii) that the Program makes possible the high-volume of sales necessary to enable Canada Pipe to maintain a full line of products and achieve economies of scale which benefits both its distributors and consumers. In the FCA's view, the Tribunal's reasons failed to establish the necessary efficiency-related link between the Program and Canada Pipe; "improved consumer welfare is on its own insufficent to establish a valid business justification". The FCA's decision will likely create uncertainty as to whether and under what circumstances there exists a business justification that may be successfully raised by a defendant or whether the FCA has essentially closed the door to a defendant's ability to rely on the use of a valid business justification as a defense.

Conclusion

Depending upon a possible appeal to the Supreme Court of Canada, the FCA's judgment may have engendered a new level of uncertainty in the Tribunal's case law on abuse of dominance and exclusive dealing.

Footnotes

1. We understand that Canada Pipe will be seeking leave to appeal the FCA decision to the Supreme Court of Canada. It is expected that a decision on the application for leave will be released by the spring of 2007.

2. Canada Pipe brought a cross-appeal to challenge the Tribunal's finding that it held a position of dominance in the Canadian marketplace based upon a definition of the relevant products market that was too narrow. This issue was dealt with in a separate decision, delivered on the same day. The Tribunal had determined that high profit margins and Canada Pipe's ability to vary prices across the regions were good indicators of market power. The cross-appeal was dismissed as two of the three judges found the Tribunal's conclusion, that Canada Pipe enjoyed market power, was reasonable. The third judge, observing that market power was "the ability to set prices above competitive levels for a considerable period of time", questioned how the Tribunal could conclude that Canada Pipe had market power when, in the face of competition in British Columbia, Alberta, the Prairies and Ontario it lowered its prices. Pelletier J.A. was of the opinion that "reducing prices to respond to the emergence of new competitors is inconsistent with the ability to set prices above competitive levels for a considerable period" and, accordingly, was of the view that the question of Canada Pipe's market power in British Columbia, Alberta, the Prairies and Ontario should be returned to the Tribunal for reconsideration.

3. To qualify for the Program, distributors are required to purchase a minimum amount of product. So long as distributors qualify, Canada Pipe will provide its rebates and discounts to distributors no matter what quantity is actually purchased.

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.

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