Indefensible? An examination of Canada’s efficiencies defence

January 2023 | SPOTLIGHT | COMPETITION & ANTITRUST

Financier Worldwide Magazine

January 2023 Issue

Despite much of Canada’s competition regime mirroring in substance the regimes of other mature jurisdictions, its framework is almost unique in one respect: Canada has a statutory efficiencies defence, which allows otherwise anti-competitive mergers to proceed if the merging parties can prove that their efficiency gains are greater than and offset the effects of any prevention or lessening of competition caused by the merger.

Rightly or wrongly, the efficiencies defence has been the subject of much criticism in recent years, with the commissioner of competition and the Competition Bureau fiercely advocating for its removal from the Competition Act, or at least its relegation from a statutory defence to merely one of many merger assessment factors, as it is treated in the US, the European Union (EU), the UK and Australia. Given that the government announced in November 2022 a comprehensive review of the Act, including a discussion paper that highlights Canada’s “unusual approach” to merger efficiencies and which indicates “Government is resolved to examine possible reform of the efficiencies defence”, it seems probable that the efficiencies defence’s days – at least in its current form – are numbered. In this article, we discuss the arguments for and against the inclusion of the defence in Canada’s merger review framework, while ultimately reflecting on whether the controversy it generates is justified.

Why is there a debate regarding the efficiencies defence?

To level set, under the Act, the Competition Tribunal (Canada’s specialised competition court) may dissolve or block a merger only where it finds that the merger “prevents or lessens, or is likely to prevent or lessen, competition substantially”. A merger may substantially prevent or lessen competition where it creates, maintains or enhances the ability of the merged entity, post-closing, to exercise market power, either unilaterally or in coordination with other firms. This assessment relies on numerous inputs, but traditionally focuses on the extent to which a merger will lead to a substantial, non-transitory increase in prices, or a substantial decrease in non-price dimensions of competition, such as product quality or innovation. Upon challenging a merger before the Competition Tribunal, the Bureau bears the burden of proving that significant anticompetitive effects will arise from the merger if it is permitted to proceed.

Where the Bureau establishes that a merger is anti-competitive, the merging parties can still right their ship, by establishing that the merger will bring about cognisable efficiencies (there is a complex method for identifying transaction synergies that ‘count’ for this purpose) that will be greater than, and will offset, the anticompetitive effects of the merger. In coming to its determination, case law requires the Tribunal to conduct a trade-off analysis, weighing the quantitative anticompetitive effects presented by the Bureau against the quantitative efficiencies presented by the parties, before deciding whether the anticompetitive effects are indeed offset, and the merger may proceed.

The architecture for the efficiencies defence is rooted in Canada’s economic circumstances in the mid-1980s, which many supporters of the defence stand by today. At the time, Canada was a relatively small economy, heavily reliant on exports for its international competitiveness. The Act’s purpose clause defined the pursuit of economic efficiency as the lodestar for competition policy in Canada, with consumer welfare (i.e., low prices) only one of several legislative objectives. The efficiencies defence was created to further this overarching objective: its supporters argued – and still argue – that the defence is necessary because Canada’s relatively small domestic market often precludes more than a few firms from operating at efficient levels of production. Further, Canadian firms need to be able to exploit economies of scale to remain competitive internationally. In short, concentration in certain instances benefits the Canadian economy, even if Canadians face higher prices in some circumstances.

Though this rationale may seem sensible and at least economically coherent, the prescriptive nature of the trade-off analysis sets Canada apart from peer jurisdictions. For example, in the US, EU, UK and Australia, efficiencies can be used to inform the overall competitive effects of a transaction, but efficiency gains do not form a full statutory defence. Moreover, to ‘count’ in the effects assessment in these countries, merging parties must demonstrate not only that the efficiency gains will accrue to the economy as a whole, as is required in Canada under the efficiencies defence, but that they will accrue to consumers specifically, such as in the form of improved product innovation or lower prices.

Supporters of the efficiencies defence tie its continuing existence to the Act’s purpose clause: given the Act’s broader commitment to “efficiency and adaptability”, the repeal of the efficiencies defence would inevitably require dismantling the entire legislative architecture. These supporters’ general hypothesis is that transactions are part of a beneficial process of creative destruction in the marketplace. The acquired firm is cannibalised by the acquiring firm, which can then discard inefficient components and incorporate only the best parts of the target, to the betterment of the Canadian economy. Ignoring efficiency gains in assessing a merger would ignore the very metric by which the merging firms assess such transactions, divorcing the competitive assessment from its commercial reality.

Critics of the efficiencies defence, of whom the commissioner of competition is a leader, have their own set of arguments. Most critics accept that efficiency is a valid objective of competition law, but object to its outsized role in the Canadian landscape. Why should mergers with proven anti-competitive effects proceed because the cognisable efficiencies are marginally greater than the anti-competitive effects? Put another way: why would efficiencies be determinative of the issue, rather than one factor to be considered? The importance of efficiency is insufficient to justify its primacy over the many other purposes which competition law serves. In other countries, for instance, the approach has been to require evidence that these efficiencies would in fact benefit consumers by preventing price increases – and even then, efficiencies are not a standalone defence but merely one assessment factor.

Other critics contend that, while there may have been a time and a place to be concerned with efficiencies to the exclusion of other considerations, these concerns no longer apply to Canada. Canada can no longer be appropriately described as a small domestic market given the significant globalisation that has taken place since the 1980s, exemplified in Canada’s many free trade agreements with major global economies. As home to many global multinationals with an increasingly services-oriented economy, Canada no longer needs the Act to prioritise the enhancement of economies of scale over vigorous competition. Indeed, critics point out that merging firms that have successfully used the efficiencies defence tend to be domestic players with no ambitions to expand overseas.

Finally, some (namely, the Bureau) argue that the jurisprudential development of the efficiencies defence has rendered it disproportionately difficult for the Bureau to meet its legal burden and successfully challenge anti-competitive mergers. As transactions and markets become more complex, and as the Competition Tribunal has placed more weight on quantifying anti-competitive effects to facilitate a more straightforward trade-off analysis, the Bureau argues that winning a contested merger where the efficiencies defence is deployed is extraordinarily challenging. As a result, contesting an efficiencies defence requires large volumes of expert evidence, adding huge time and financial costs to the proceedings, and inevitably favouring merging parties whom the Bureau argues are better placed to prove efficiencies (than the Bureau is to quantify anti-competitive effects). The efficiencies defence not only renders administrative proceedings inefficient, but it also distorts the Bureau’s ability to administer the Act.

Is the efficiencies defence really a problem?

As is clear from this catalogue of entrenched opinions, the efficiencies defence receives a lot of attention in Canadian antitrust circles, particularly now that the government has signalled a willingness to reform this pillar of the Act. However, it must be asked whether all this attention is warranted. Few mergers have ever hinged on the defence, and even fewer have been saved by it. In 2015, the Supreme Court allowed two hazardous waste disposal service companies to merge (Tervita) on the grounds that the quantified efficiencies were greater than, and offset, the quantified anticompetitive effects. However, the Bureau’s case failed not because of the magnitude of the efficiencies gained, but because the Bureau had, according to the court, not quantified any anti-competitive effects for the trade-off analysis. The very modest proven efficiencies therefore prevailed. The next year, the Bureau allowed a merger between two chemical producers, on the basis that the parties had presented clear evidence that the efficiency gains would, in its words, clearly outweigh the anti-competitive effects. This matter was notable as the US subsequently blocked the deal.

We cannot undertake a fulsome study of all merger decisions given the Bureau publishes the reasons for its decisions in only a handful of cases per year; this means that the efficiencies defence may be used during the Bureau’s administrative procedure in some cases that do not reach the public domain. However, even in complex cases requiring remedies, the Bureau and merging parties, by definition, are reaching a negotiated settlement in which anti-competitive effects are acknowledged, even if they are not accepted, making the use of the efficiencies defence less likely.

As a result, the prevalence of the defence as a determining factor in Canadian merger review since Tervita likely remains relatively limited. In 2022, the Bureau’s challenge of a grain merger failed because the Bureau did not prove that the transaction would result in a substantial prevention or lessening of competition, meaning the Competition Tribunal did not even need to consider the parties’ efficiencies submissions. Interestingly, the Competition Tribunal nevertheless covered efficiencies in its decision, indicating that the merging parties had failed to demonstrate clear and convincing evidence that the claimed efficiencies would be greater than, or offset, any anti-competitive effects (had they hypothetically been proven). If anything, the Tribunal’s finding reinforces that the efficiencies defence is not a ‘get out of jail free’ card, but rather a significant hurdle for merging parties to clear. It is far from automatic that an otherwise anti-competitive merger can be saved.

As the government contemplates its review and overhaul of Canada’s competition laws and policy, with the stated aim of addressing the consumer harms flowing from unchecked market concentration, we would argue that the efficiencies defence may not be the ‘elephant in the room’ as it is characterised in certain circles. Neither a foundation stone of Canada’s competition project automatically deserving of protection nor the ready tool of unscrupulous corporations seeking to generate more shareholder value at consumers’ expense, the efficiencies defence is an important, but seldom used, provision of the Act. Whatever issues exist with competition in Canada, they do not derive from the existence of an efficiencies defence.

Michael Caldecott is a partner and Erin Keogh is an associate at McCarthy Tétrault LLP. Mr Caldecott can be contacted on +1 (416) 601 7738 or by email: mcaldecott@mccarthy.ca. Ms Keogh can be contacted on +1 (416) 601 4320 or by email: ekeogh@mccarthy.ca.

Michael Caldecott and Erin Keogh

McCarthy Tétrault LLP