In light of the current COVID-19 pandemic with declining demand and excess capacity in many sectors, companies will want to take advantage of opportunities to increase operational efficiencies, including through mergers and acquisitions. Where such mergers are efficiency motivated, there may be increased scope for merging parties to use the efficiencies defence in Canada – something that was successfully done by Canadian National Railway Company late last year in connection with its acquisition of H&R Transport Limited (the "Transaction").
Competition Bureau Review
Following its review of the Transaction, the Competition Bureau concluded that the Transaction would likely result in a substantial lessening of competition for full truckload refrigerated intermodal services in eight relevant markets in Canada. In particular, the Bureau found that CN would be able to charge higher prices and provide lower quality service to customers in those markets. However, as discussed in more detail in its New Release and Position Statement issued last week, the Bureau ultimately decided to discontinue its investigation and allow the Transaction to proceed after concluding that the efficiencies defence had been satisfied.
Section 96 of the Competition Act is commonly known as the efficiencies defence. This provision allows for a trade-off analysis between anti-competitive effects and efficiencies resulting from a transaction. In particular, if the Bureau's review concludes that the efficiencies likely to arise from a transaction are greater than, and will offset, the anti-competitive effects, the Bureau may decide not to oppose the merger on these grounds or seek remedies only in local markets. The Bureau's approach to the efficiencies defence is described in its draft document titled "A practical guide to efficiencies analysis in merger reviews" (the "Draft Efficiencies Guide").
The Competition Tribunal and the courts have allowed two contested mergers to proceed on the basis of the efficiencies defence, including Superior Propane Inc.'s acquisition of ICG Propane Inc. and CCS Corporation's acquisition of Complete Environmental Inc. Similarly, the Bureau has decided not to challenge at least three mergers based on the efficiencies defence, including Superior Plus Corp.'s proposed acquisition of Canexus Corporation (which was subsequently blocked by the U.S. regulators), Chemtrade Logistics Income Fund's acquisition of Canexus Corporation and, most recently, CN's acquisition of H&R. In addition, the Bureau has accepted a reduced number of remedial divestitures in local markets where the efficiencies that would be lost in those markets through a divestiture exceeded the anti-competitive effects in those markets, including in connection with Superior Plus LP's acquisition of Canwest Propane.
The efficiencies defence raises a number of complex legal and factual issues, including, for example, whether the efficiencies being claimed by merging parties are cognizable under section 96 of the Act. In this regard, as reflected in the Tribunal's decision in CCS Corporation and the Bureau's Draft Efficiencies Guide, efficiencies will be considered in the trade-off analysis only where they (a) result in productive, dynamic or allocative benefits; (b) are likely to be brought about by the merger; (c) do not arise only as a result of a redistribution of income between two or more persons; (d) accrue to Canada or Canadians; and (e) would be lost in the event of the order being sought by the Bureau (referred to as "order specific") (collectively, the "Five Screens").
The Bureau reviews the merging parties' claimed efficiencies very closely – often retaining an outside expert to assist in the analysis. In the case of the Transaction, the Bureau considered efficiencies related to the elimination of overhead costs, the elimination of duplicative facilities and the elimination of duplicative IT systems and software licenses. The Bureau's assessment focussed on the likelihood of the efficiencies being realized, whether or not it was the transaction that would generate the efficiencies, and the underlying calculations behind the efficiencies quantification.
Timing of Efficiencies Review
As discussed in our prior blog post titled " Competition Bureau Releases Draft Model Timing Agreement", the Bureau released a draft model timing agreement for mergers involving claimed efficiencies on July 16, 2019 (the "Draft Timing Agreement"). As stated in the Bureau's News Release announcing the consultation, "[t]he purpose of the timing agreement is to ensure that the Bureau has the time and information it requires to properly assess the parties' claimed efficiencies". In this regard, "[t]he model agreement establishes timed stages for the parties' engagement with the Bureau, including the production of evidence and information, throughout the review process". It also describes the general categories of information that the Bureau will require from the parties in order to conduct its efficiencies analysis, including (a) information on parties' operations and assets; (b) plans for the merging parties' businesses in the absence of the merger; (c) analysis and planning documents relating to the implementation of the merger; (d) analysis of merger efficiencies; and (e) information from past comparable integrations.
The Bureau used the Draft Timing Agreement for the first time in its review of the Transaction. Specifically, the Bureau entered into a timing agreement with the parties on July 19, 2019 to ensure that it had the time and information needed to assess potential anti-competitive effects and the parties' claimed efficiencies before deciding whether to challenge the Transaction before the Tribunal. Both the merging parties and the Bureau complied with their obligations under the timing agreement, which allowed the Bureau to complete its review and discontinue its investigation on November 18, 2019 – about four months later.
Implications For Business
The Bureau's review of the Transaction has several important implications for businesses going forward.
First, as was the case in CCS Corporation's acquisition of Complete Environmental Inc., the Transaction was not subject to pre-merger notification under the Act. This reinforces prior statements by the Commissioner that the Bureau will identify and closely scrutinize non-notifiable transactions that may raise competition concerns. It also reinforces the importance of performing a pre-merger assessment of the potential anti-competitive impact of any proposed non-notifiable merger to avoid an unexpected review by the Bureau. Parties who fail to do so may find themselves involved in an unexpected Bureau review of their proposed or completed merger.
Second, the Bureau insisted on using the Draft Timing Agreement. As indicated in our prior blog post, using the maximum timelines set out in the Draft Timing Agreement, the Bureau's assessment of the parties' efficiencies claims may not be completed until 110 days from the date of full compliance with supplementary information requests in the case of notifiable transactions. The Draft Timing Agreement is expected to be finalized soon and will likely include similar timelines. Merging parties that intend to raise efficiencies claims will need to ensure that sufficient time is built into transaction timelines.
Third, the Bureau required significant information from the merging parties to support the claimed efficiencies. In particular, consistent with the Draft Timing Agreement, a representative from each of CN and H&R was examined under oath in regards to the claimed efficiencies. Preparing company representatives for such examinations can take a significant amount of time.
Fourth, cognizable efficiencies represent only a subset of what most companies view as synergies. In fact, efficiencies are included in the trade-off analysis only if they satisfy the Five Screens. Given the complexity of assessing potential efficiencies against the Five Screens and the timeline imposed by the Draft Timing Agreement, parties that intend to raise the efficiencies defence should consider retaining experts at an early stage – including both an accounting expert to quantify the efficiencies likely to arise from the transaction and an economist to quantify the anti-competitive effects against which the efficiencies will be balanced.
Future of the Efficiencies Defence
After pointing to the Supreme Court of Canada's passage in Tervita stating that "the efficiencies defence was created in recognition of the size of Canada's domestic market and with an eye toward supporting operation at efficient levels of production and the realization of economies of scale, particularly with reference to international competition", the Bureau noted that "the Proposed Transaction involves purely domestic markets without any pretext of the Proposed Transaction being necessary for the merged entity to operate at efficient levels of production or to compete effectively in international markets". Although the Commissioner has previously acknowledged that "the efficiencies defence is a reality in Canadian competition law", this later statement is likely intended to send a message to Parliament that it may be time to amend the Act to remove the efficiencies defence – a position that has been advanced by both the current Commissioner and his predecessor. Whether this invitation is taken-up remains to be seen.
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