Court Issues Two Key Decisions Signaling Reform of European Merger Law
November 4, 2002
Only a few months after the European Court of First Instance (CFI) quashed the European Commission’s decision in Airtours, the Commission has suffered two further setbacks at the hands of the same court. The CFI overruled two Commission decisions prohibiting the merger between the two main manufacturers of electrical equipment in France, Schneider and the merger between the world leader in carton packaging and a market leader in the design and production of packaging equipment and systems used for PET, Tetra.
These decisions, along with Airtours, have raised serious questions as to the Commission’s handling of merger cases. They also serve to guide the necessary changes to the Commission’s merger control process. Competition Commissioner Monti has acknowledged that "the insights from the CFI’s rulings, will indeed represent a substantial contribution to our Merger Review process." New reform proposals, including merger guidelines and changes to the Merger Regulation, are expected to be put forward by the end of the year. As a result, it is crucial for companies to understand the core messages arising from the CFI’s recent decisions. Specifically, the judgments raise three principal issues which will be considered in turn:
- the need for the Commission to more accurately set out the basis of its economic analysis and to substantiate that analysis;
- the need for the Commission strictly to comply with its procedural rules;
- and more fundamentally, the need for reform of the Commission’s review and remedy process.
It is useful to briefly consider the two decisions in analysing these key issues.
Background
Schneider v Commission (Schneider)
In early 2001, Schneider notified its proposed take over of Legrand to the Commission. The merger involved competition in the low-voltage electrical equipment sector with substantial competitive overlap between the parties in electrical switchboards, wiring accessories and other products designed for industrial use. Schneider was permitted to complete the acquisition before receiving necessary approval from the Commission due to a peculiarity in French take-over law.
The Commission carried out an in-depth investigation which culminated in the transaction being prohibited and a divestment order requiring Schneider to sell its shares in Legrand. The Commission found that the merger would have strengthened the parties’ dominance in France and elsewhere in the overlapping electrical equipment markets. The Commission also criticised the parties for not offering adequate undertakings in a timely manner.
Schneider appealed under the expedited appeals procedure. The CFI annulled the decision holding that the Commission infringed the parties’ rights of defence by not properly identifying its concerns in the Statement of Objections (SO) before reaching its final decision. This, in turn, denied the parties the opportunity to present suitable remedies to alleviate the Commission’s concerns. The CFI also attacked the Commission’s economic analysis. In particular, the CFI criticised the Commission’s assessment of the transaction from an overall European perspective instead of proceeding on a country-by-country basis in accordance with the relevant markets defined by the Commission.
(Despite overturning the decision, the CFI’s judgment was not a complete victory for the parties. The CFI stated the parties were subject to a new investigation by the Commission in relation to the French markets¾ the only markets held to be affected by the transaction.)
Tetra Laval v Commission (Tetra)
This transaction involved the acquisition by Tetra Laval group, a major carton packaging company of the French plastic bottling company Sidel. As in Schneider, the parties were able to complete the merger pending its review by the Commission.
Despite a lack of horizontal competition between the parties, the Commission launched an in-depth investigation into the merger. The Commission was concerned that the take over would have combined Tetra’s dominant position in carton packaging with Sidel’s leading position in the PET bottling market. The Commission relied on a "conglomerate effects" analysis given that the relevant product markets for carton packaging systems and PET packaging systems were distinct with limited overlap. The Commission concluded that the merger would have created a dominant position in the PET market and strengthened Tetra’s dominant position in the carton market. The Commission prohibited the merger and ordered Tetra to divest its shares.
Tetra appealed using the CFI’s expedited process. In just over 12 months, the CFI overturned the Commission’s decision. The CFI concluded that the Commission committed manifest errors in its economic analysis of the conglomerate effects of the transaction. For example, the Commission failed to provide evidence that the parties could achieve dominance in the PET market. Moreover, the Commission did not produce sufficient evidence to substantiate its claims that the merged entity’s position would have been strengthened.
Impact of CFI Decision
The two CFI decisions, as well as the Airtours decision, provide important guidance beyond the facts of each case. The decisions demonstrate growing concern over the Commission’s merger review process. Read together, some common themes prevail.
The Commission must improve its economic analysis.
Whilst not criticising the underlying economic theories (as it did in Airtours), the CFI in Schneider and Tetra expressed significant concern over the Commission’s ability to prove its theories. These cases involved complex economic assessment on the part of the Commission, and in each case, the Commission’s analysis was found wanting. In Schneider, the CFI found that the "errors, omissions and contradictions in the Commission’s analysis are of a very serious character" and resulted in an over-estimation by the Commission of the impact of the transaction. In Tetra, the CFI held that the Commission "did not establish to the requisite legal standard that the notified merger would give rise to significant anti-competitive conglomerate effects". Taken together, these three judgments call upon the Commission to provide a more robust economic analysis in future cases.
Conglomerate effects theory not proven.
The Tetra judgment provides a detailed analysis of the CFI’s views on the "conglomerate effects" theory. The CFI confirmed that the Commission can examine conglomerate mergers but attacked its analysis and the lack of supporting evidence. The CFI found that the Commission’s decision was based on three theories: leveraging, elimination of potential competition and strengthening of the merged entities’ overall market position. The CFI acknowledged that the merger would have enabled leveraging to occur but found that the Commission failed to prove that the merged entity would have an incentive to engage in leveraging. The CFI’s views on conglomerate effects should provide greater predictability for companies active in the aerospacial sector. This theory has historically been an unpredictable risk in this sector, as witnessed by the Boeing/McDonnell Douglas and GE/Honeywell cases.
The CFI also criticised the Commission’s analysis finding that it was inadequate to support the ability of the merged entity to dominate the PET market. As to potential competition, the CFI found that the Commission failed to provide evidence that competition would have been weakened in the carton market because of the existence of other competitors (SIG and Elopak) which would ensure that Tetra continued to innovate. The third theory was not considered by the CFI due to the prevailing errors.
Portfolio effects theory not proven.
In both Schneider and Tetra, the Commission examined the future conduct of the parties with respect to possible portfolio effects (bundling or tying). Again, the CFI criticised the Commission for its lack of analytical rigour in assessing the evidence to support its theory. In Tetra, the Commission failed to adequately address the likelihood of abusive conduct by the merged firm¾ which the CFI considered to be unlikely. Specifically, the Commission failed to produce "sufficiently convincing evidence" that the new entity would be able to leverage between the two markets taking into account "conduct which would, at least probably, not be illegal." The CFI concluded that market dynamics would have prevented the merged entity from bundling products or engaging in tying.
The CFI’s decisions with respect to portfolio effects theory should be welcomed by companies active in consumer goods markets where this theory has received the most frequent application. Indeed, it will no longer be sufficient for the Commission simply to rely on the parties’ broad product range. The Commission must now show how the product range can be used to strengthen the merged entity’s position.
Finally, in Schneider, the CFI also criticises the Commissions analysis of portfolio effects. The CFI accepted the Commission’s conclusion that the merged entity would have a wide range of products and trademarks. However, it found insufficient evidence that the parties could use this "portfolio" to eliminate competition from suppliers with more limited product offerings.
Big is not necessarily bad.
The CFI’s decisions evidence unease with a perception that the Commission is employing a "big is bad" standard. Indeed, the CFI specifically held that the mere fact that the acquiring undertaking already holds a clear dominant position may be an important factor. This alone, however, does not justify a finding that a reduction in the potential competition which that undertaking must face constitutes a strengthening of its position. The CFI expressed a clear preference towards evaluating the effects of competition rather than the size of the parties.
The Commission must strictly comply with procedural rules.
In Schneider and Tetra, the CFI criticised the Commission for failure to strictly adhere to its own procedural rules. The CFI emphasises that these rules serve to provide legal certainty to the parties as well as providing the parties with the opportunity to exercise their rights of defence. Failure to comply with the procedural rules will result in the decision being annulled. Specifically, two fundamental procedural rights were put to the test in these cases¾ completeness of the SO and the parties’ right of access to the Commission’s file.
The Commission must clearly state the legal theories underpinning its case.
The parties to a merger must be given the opportunity to be heard on any concerns that the Commission may have in relation to the transaction. To enable this, the Commission is required to provide the parties with details of its concerns in the SO. Moreover, the SO is not only designed to enable the parties to exercise their rights of defence but also has a secondary purpose to enable the parties to propose remedies to ameliorate the Commission’s concerns. In Schneider, the CFI found that the failure to provide adequate notice of its concerns or adequate opportunity to propose remedies so fundamental to due process that it constituted a basis for reversal.
The Commission must permit reasonable access to the file.
The CFI also stressed the right of the parties to be able to review the evidence relied upon by the Commission to make its case. In order to safeguard this right, the parties should be granted access to the Commission’s file. In Tetra, the court confirmed that such access could only be restricted in limited circumstances and that any restrictions on the right of access must be interpreted narrowly.
Need for Comprehensive Reform
The CFI’s judgments in Schneider and Tetra, together with Airtours, demonstrate that the Commission’s merger review practice and procedure is in serious need of reform. The Commission had already proposed reform through its Green Paper issued last December. However, the reforms are likely not to be sufficient. In light of the CFI’s recent decisions, greater reform will be necessary. The key areas which must be addressed are economic analysis and procedures.
The Commission needs to develop guidelines.
The CFI left no doubt that the Commission must improve the articulation and proof of its theories. As such, the Commission must now refine its economic analyses to assess complex theories of competitive harm. Perhaps the best way of achieving this would be for the Commission to publish comprehensive guidelines setting out its approach to analysing horizontal, vertical and conglomerate mergers. The comprehensive guidelines should also clarify "portfolio theory," the "network effects" doctrine and other difficult economic theories that the Commission uses to understand the competitive effects of mergers. Indeed, the use of guidelines has proven very successful in the United States. Best Practice Guidelines on the conduct of merger investigations and guidelines on the assessment of dominance in horizontal mergers are expected shortly.
The Commission needs procedural reform.
These decisions demonstrate that the Commission must also reform its own procedures for reviewing mergers. The need for change is most evident with respect to the period for substantive review and review of remedies. Schneider and Tetra show that the four-month time period for completion of a detailed investigation in a complex merger is not always sufficient for the Commission to do its job properly. The Commission should consider lengthening the procedure in these cases so it can undertake more detailed substantive economic analysis which would result in increased legal certainty in the long run. Similarly, the period for considering remedies also begs for reform to permit reasoned appraisal of proposed remedies. The proposal in the Merger Reform Green Paper, published at the end of last year, allowing the Commission to "stop the clock" to enable parties to discuss remedies is one option being considered. In Schneider, this may have enabled the parties to propose suitable remedies.
Impact on Companies Considering Mergers
The CFI judgments in Schneider and Tetra, as well as in Airtours, are likely to have a significant impact on parties contemplating a difficult merger.
The need for the Commission to improve its economic analysis, while resulting in more reasoned analysis, may adversely affect transaction timing. Specifically, this process may result in the lengthening of the merger investigation. If the Commission is failing through lack of time to complete its analysis, the current four-month time limit may need to be put back in more complicated cases. This would, in turn, inevitably lead to more detailed information requests being submitted to the parties and a longer review process. It is not clear that this change will be welcomed by most merging parties.
The need for the Commission to ensure that it has respected the parties’ rights of defence, especially in relation to the SO and access to the file, should improve the quality of debate over a merger’s impact. The merger parties should see a clear benefit from a more reasoned and revealing expression of the Commission’s views. The possible publication of detailed guidelines by the Commission on complicated economic theories should also provide welcome clarification to notifying parties.
Finally, reform of the four-month review period, through a stop-the-clock or similar process (as proposed in the Merger Reform Green Paper), will likely enable a more reasoned consideration of remedial procedures. Such changes will minimise the current "all or nothing" process which forces the parties to make possibly excessive proposals without sufficient opportunity to negotiate, or risk losing this window of opportunity. Again, this change should significantly benefit merging parties.
