Court of First Instance Annuls Commission Decision in the Airtours/First Choice Merger Case

The Court of First Instance of the European Communities (the "CFI") yesterday annulled a Decision of the Commission of the European Community taken in September 1999 blocking a proposed merger between Airtours and First Choice Holidays plc. The judgment is significant because:

• It implicitly reconfirms that the Merger Regulation can apply to post-merger collective dominance;
• It sets out a route map for merging parties and the Commission to apply when assessing the likelihood of post-merger tacit collusion:-

First there must be sufficient market transparency for the members of the oligopoly to monitor each other's conduct and hence know that they are all following the same common policy (i.e. that they are tacitly colluding);
Second there must be an expectation that the tacit co-ordination will last - in other words that there is sufficient incentive to co-ordinate behaviour to deter the members of the oligopoly from deviating from the co-ordinated behaviour; and,
Third there must be proof that current and future competitors could not upset the implementation of the common policy of the oligopoly;

• It makes clear that a high standard of proof will be required of the Commission, particularly in four-to-three or five-to-four cases; and
  
• The Commission's fact-finding with regard to the establishment of post-merger tacit collusion has been subjected to harsh criticism.

The implications of the judgment may include:

• New guidelines on the assessment of market power, which are much needed;
• An increased likelihood that the outcome of the current review of the EU's Merger Control Regime will see the dominance test replaced by a substantial lessening of competition test;
• Improved internal procedures to address some of the shortcomings identified by the CFI; and
• Hesitancy, at least initially, to make novel and ground-breaking decisions in merger control cases.

It took the best part of three years for this appeal to be decided. This sort of timeframe means that the result of the appeal is of more relevance to other parties in future cases than to the parties to the blocked transaction. It remains to be seen whether the CFI's new fast track procedure (which may still take in excess of a year between notification and judgment) will prove more effective for the directly affected parties although there is clearly considerable scope for the Commission to improve its own procedure and safeguards.

Background to the judgment

In April 1999 Airtours plc (since rebranded MyTravel Group plc) publicly announced its bid for First Choice plc¹. The proposed merger qualified for investigation by the European Commission and a notification was duly made. First Choice's shareholders were advised by the Board not to do anything until the regulatory position was clear - on the grounds that there was a significant risk that the merger would not be cleared. On 3 June 1999 the European Commission decided to refer the merger to a more detailed investigation and on 22 September 1999 the merger was blocked.

The deal was blocked because the Commission considered that, following the merger, the combined group (Airtours/First Choice) would, together with Thomson and Thomas Cook, hold a collective dominant position in the UK market for short-haul foreign package holidays, and that this would significantly impede competition.

Airtours lodged an appeal against the Commission's decision with the CFI of the European Communities on 2 December 1999. Now, some two and a half years after the appeal was first lodged, the Court has published its decision.

Summary of the issues brought before the CFI

Airtours appealed against the Commission's decision on four grounds:

• First, Airtours considered that the Commission's definition of the relevant product market was wrong - the Commission had concluded that the relevant market in the case was the supply in the UK of short-haul foreign package holidays - Airtours considered that long-haul holidays were competitive with short-haul holidays in quality and price and should therefore have been included in the assessment of the effects on the market;
• Second, Airtours argued that the Commission had applied a new and incorrect notion of collective dominance - if the Commission had applied the usual test the merger would not have been blocked;
• Third, the Commission had incorrectly found the notified merger to result in a collective dominant position - the facts did not support this finding; and
  
  Lastly, the initial undertakings offered by Airtours should have been accepted as they were sufficient to allay the Commission's stated concerns, moreover the revised undertakings offered by Airtours (which were presented following a meeting with the Commission discussing the case) should have been considered instead of rejected as being out of time.

It is the pleas relating to the notion of collective dominance which are of wider interest and we will focus on these in this briefing.

The arguments relating to collective dominance

The principal argument between Airtours and the Commission was what elements had to be shown to distinguish a benign oligopoly from an anti-competitive oligopoly.

Airtours argued that the distinguishing factor is the presence of "tacit collusion" or "co-ordinated effects" and that this is proved by showing (i) that the oligopolists are able to reach an agreement or a co-ordinated position whereby they restrict output and raise prices above competitive levels (ii) that they are able to detect deviations from the position and (iii) that deviations can be effectively punished. The Commission did not prove any of these three elements, Airtours argued, and so there could be no "tacit collusion". Since any oligopoly arising from the merger would not be subject to "tacit collusion" it was not anti-competitive and it should have been permitted.

The Commission disputed these arguments. It was enough for the Commission to find that following the merger there would be a market structure which made it rational for the oligopolists to adjust their conduct in line with each other so as to blunt competition between themselves and result in better profits for all. This could be proved by showing (i) that the conduct which is beneficial to all is apparent (ii) that the market is sufficiently transparent for the players to monitor that conduct and (iii) there were compelling reasons why a player would not depart from that conduct (for example not wanting to forego the long term profits that a return to competitive behaviour would entail).

The CFI's judgment

The CFI annulled the Commission's decision in a ruling which re-iterates the elements which must be present in order for a position of collective dominance to arise.

On the first plea regarding market definition Airtours' arguments were rejected.

Airtours' second plea (that the Commission's approach was novel and therefore unlawful as a departure from previous decisions on collective dominance) was addressed by the CFI by asking whether, on the evidence, the Commission was right to have found a position of collective dominance, having regard to the correct legal test of collective dominance. The importance of the decision is that it clearly and unambiguously re-states the law and in so-doing sets out the methodology to be used in determining the existence of post-merger collective dominance.

First the CFI noted that the Commission is bound to ascertain "whether the concentration would have the direct and immediate effect of creating or strengthening a collective dominant position which is such as significantly and lastingly to impede competition in the relevant market". In other words, it must assess the market pre-merger. Thereafter, the CFI confirmed that three conditions are necessary for a finding of collective dominance:

• There must be sufficient market transparency for the members of the oligopoly to monitor each other's conduct and hence know that they are all following the same common policy (i.e. that they are tacitly colluding);
• There must be an expectation that the tacit co-ordination will last - in other words that there is sufficient incentive to co-ordinate behaviour to deter the members of the oligopoly from deviating from the co-ordinated behaviour; and
• There must be proof (to the requisite legal standard) that current and future competitors could not upset the implementation of the common policy of the oligopoly.

The CFI reiterated that it was incumbent upon the Commission to produce convincing evidence where a merger is to be blocked on the grounds that it will create a collective dominant position. As the Commission appeared² to consider that, prior to the proposed merger, the four leading operators did not enjoy a position of collective dominance, it was for the Commission to prove that the merger would have created a position of collective dominance which was restrictive of competition - enabling the remaining three operators to adopt a common policy with respect to capacity.

The evidence which the Commission cited as supportive of its findings of a position of collective dominance was insufficient and as such the Commission's decision was "vitiated" by a series of errors of assessment. Moreover these errors related to many of the factors which form the "checklist"³ against which, as confirmed by previous Commission and Court decisions, the likelihood of post-merger tacit collusion should be assessed. For example:

• The Commission failed to consider the conditions on the market prior to the merger to assess the changes, as the merger must be shown to result in a significant change in the level of competition if it was to be blocked for creating a collective dominant position.
• The Commission rightly considered market shares of the parties but wrongly concluded that market shares were stable. The Court said the Commission was wrong on the facts to ignore growth by acquisition in this respect and hence the Commission erred when it found that the operators' shares had remained stable;
• The Commission correctly considered growth on the market but found that the market was characterised by low growth - where the facts did not support this assertion;
• The Commission was wrong to suggest that, contrary to the usual checklist, in this case volatility of demand was a factor supporting a finding of collective dominance - there were no particular facts which supported this reversal of the usual economic theory;
• The Commission was unable to prove to the requisite legal standard that the market was transparent so that the operators were able to monitor the total capacity offered by each of the others at the time that capacity decisions were taken;
• The Commission had not shown that credible retaliation mechanisms existed which would have deterred the operators from departing from the common course of conduct;
• The Commission failed to give sufficient weight to the likely response of the fringe players on the market - it could not be proved on the facts that smaller tour operators would be unable to challenge the common position of the oligopoly so as to make it unviable. The Court dedicated a significant part of its judgment to this issue, and considered that the likely reactions of smaller tour operators and their ability to increase capacity in the face of any tacit collusion to reduce capacity, was a credible threat to the oligopoly which would prevent the common policy being adopted on a lasting basis;
• The Commission underestimated the role of the individual consumer (i.e. the existence of buyer power) - if prices for foreign package holidays offered by the major operators were to rise pursuant to a position of collective dominance, the Court considered that consumers might be expected to seek better prices from smaller operators.

The Court declined to rule on the other pleas raised, given that the third plea was well founded and sufficient in itself to warrant the annulment of the Commission's decision.

¹ Herbert Smith are First Choice's long term advisers and provided advice and guidance to First Choice throughout the Commission's merger investigations. First Choice was not a party to, and did not participate in, the proceedings before the CFI.

² There was some ambiguity in this respect as the Commission also referred to an existing "tendency" towards collective dominance on the market.

³ Full details of the checklist are not set out in this briefing although the checklist items considered by the Commission and CFI are highlighted in the list cited - further information is available from Herbert Smith on request.

© Herbert Smith 2002

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