The net benefit test

In some recent posts ('Your competition law exam question' and 'That competition law question') I've been asking if there is something amiss with how the Commerce Commission applies the 'net benefit test' when (for example) authorising a merger that has some anti-competitive detriments, which are more than offset by assorted benefits.

Recently the Commission put up on its website the key case on this, Godfrey Hirst NZ Limited v The Commerce Commission HC WN CIV 2011-485-1257 ('Godfrey Hirst'). Now that I've read it, I'm pretty sure the current Commerce Commission approach is indeed awry.

First some background. Here is a little schematic of all the possible benefits and detriments that might flow from a merger (or anything else with a mix of anti-competitive harm and offsetting public benefits). It is completely general and uncontroversial, and I've added in that 'net of realisation costs' bit to the 'Benefits' boxes, as again it is uncontroversial that any benefits must be counted net of the costs to achieve them (if the realisation costs were equal or greater than the benefits, there wouldn't be a benefit, would there?).

The Commission's approach is to count all benefits anywhere (i.e. A + C), but to count only detriments in the markets where competition is lessened (B), so its calculation of overall net benefit is A + C - B: all the benefits anywhere, less only some of the detriments, though in fairness the bulk of the detriments in practice are likely to arise in box B, and D may not often be large.

Even so, my contention is that this makes no logical or economic sense from a national welfare point of view: why should the detriments D caused by the merger be magicked away and ignored? The correct calculation is surely A + C - B - D: all benefits anywhere, less all detriments anywhere.

The only reasons in principle you'd go the illogical calculation route are if, despite its oddity, you believed the law required it, or courts had interpreted the law to require it (as an empirical issue, you might also feel D detriments are typically too rare or small to bother with, but let's stick to the principles for the moment). As it happens, both reasons have come into play: the approach appears to have started because that's how the Commission (in a 1987 Goodman Fielder decision) interpreted the law as it read at the time, but more recently the courts have also weighed in.

Fast forward to 2011 and Godfrey Hirst. In that High Court case, Godfrey Hirst challenged the Commission's decision to authorise a merger in the wool scouring industry. If you want to skip to the chase, my conclusion is that Godfrey Hirst endorses all-benefits-all-detriments, i.e. A + C - B - D. In its wording the court phrased it as A + (C - D) - B, which is the same thing. In the next bit I'll step through the relevant parts of Godfrey Hirst.

Wool Equities, a cooperative that supported Godfrey Hirst in the appeal, argued for the all-benefits-all-detriments approach, because it thought there were detriments to farmers in markets other than the wool scouring market. There was a bit of argy-bargy at [63] - [65] over whether the Commission had itself (accidentally) endorsed all-benefits-all-detriments, but the court found it hadn't. The court also said that a statement by the judge in the NZ Bus case endorsing the all-benefits-some-detriments approach was only a throwaway line and not settled law.

And so the court - two sharp cookies, Justice Mallon, and Kerrin Vautier sitting as lay member - came to the substance of Wool Equities' argument.

At [67] and [68] they recap that the Commission's current approach started with the Goodman Fielder decision in 1987, though even then, apparently, the Commission wondered about the oddness of it all: at [68] they note that "The Commission asked itself ―[i]f the benefit from the whole of the proposal is taken into account then why not the detriment arising therefrom?".

[69] through [71] are irrelevant for today's purposes, and then at [72] they say the Commission has consistently followed its current approach and that the approach was okayed in two cases involving Telecom in 1992.

And then at [73] we get this (footnotes omitted, and the 'emphasis added' is the court's, not mine):

[73] An acquisition may however result in detriments (other than competition detriments) beyond those markets in which an increase in market power has been found. As to such detriments, the High Court in Telecom said this:

Moreover, we would caution that the detriments attributable to the strengthening of dominance are not the only detriments that could conceivably be relevant. The very concept of benefit to the public allows for some netting out, in an appropriate case, of any detriments to the public from the acquisition itself — albeit, again, it is a question of what difference is made to the shape of the future with and without the acquisition. (emphasis added)

This makes it very clear (to me at least) that any detriments are indeed in play. Which leads us to [74], the key paragraph, and I'm afraid I'm going to have to unpack it in bite-sized chunks.

Chunk 1 : "[74] It is well accepted that, in assessing public benefits, a net approach is taken whereby the costs in realising the efficiencies are deducted. This point was expressly noted by the Commission in this case." All good, and covered in the wee schematic at the head of this post.

Chunk 2: "The above passage [i.e. the High Court Telecom bit] refers to a wider concept of net benefit to the public than that". Indeed it does: it clearly means, don't forget about those detriments in box D.

Chunk 3: "We are not aware of any New Zealand decision, after these comments by the High Court in Telecom, which has viewed net benefit in this wider way". This could mean several things. It could simply mean the point has simply never come up in the period between the Telecom cases (1992) and Godfrey Hirst (2011). It could mean that the opportunity for courts to take the all-benefits-all-detriments approach did come up, but nobody took it. Either way it still leaves the all-benefits-all detriments approach alive. And it also means the Telecom case is the up-to-date statement of the law on the matter.

Chunk 4: "That is, where there are other detriments that fall outside the defined markets [i.e. the ones where competition has been lessened], these can be considered as disbenefits or negative benefits and then offset (along with the costs of realizing efficiencies) against the (positive) public benefits claimed". This probably means, calculate C - D. It might mean calculate A + C - D, but in any event on either reading it says, take note of D.

Chunk 5: "The assessed detriments from the loss of competition in the defined markets would then be weighed against the net public benefit (ie deducting negative benefits as well as realisation costs) from the proposed acquisition to give the overall result". This says, weigh B against A plus the (C - D) calculated from Chunk 4, which means calculate A + (C - D) minus B. Which is of course the same as A + C - B - D, which is all-benefits-all-detriments.

And than at [75] there's this: "Although counsel for Wool Equities did not accept that this was the analytical approach by which detriments outside the defined markets could be taken into account, it would meet the point he was making". This nails it. The court said, Wool Equities were arguing for A + C (all benefits) minus B and minus D (all detriments), but the court's preferred formulation was A + (C - D) (all benefits, but netting off the D detriments against the C benefits in the same way you would net off realisation costs), minus B (detriments in the defined markets). But the outcome is exactly the same.

To recap, counting all benefits and all detriments is obviously the right approach from any commonsensical view. It is also, at a minimum from Godfrey Hirst, permissible. And if it's permissible (and, perhaps, either advisable or even required), why would you stick with the non-commonsensical approach?

So let's go back to the Commission's Authorisation Guidelines, which say in a footnote

32. Godfrey Hirst, above n 11, at [72]. Observation by Wilson J in New Zealand Bus Ltd v Commerce Commission [2008] 3 NZLR 433 (CA) at [271]. In Godfrey Hirst while the court endorsed this settled approach, it observed that ‘disbenefits’ or negative benefits that arise outside the affected markets may be relevant to the public benefit test.

First of all, that observation by Wilson J doesn't matter, as Godfrey Hirst said. And it's debatable, as you've just seen, whether Godfrey Hirst "endorsed this settled approach" (i.e. all-benefits-some-detriments). It's possible that Godfrey Hirst said it's not wrong, but it's also clear that Godfrey Hirst said, all-benefits-all-detriments is, at a minimum, okay and perhaps even required under the Telecom ruling.

All this may seem technical and picky, and maybe nothing will ever turn on it. In practice, though, every imaginable set of business circumstances sooner or later comes in the Commission's window, and it's possible a merger or a restrictive trade practice will indeed involve a sizeable D, a detriment to the community that is being ignored. If the courts have said you can safely take a better, more logical route, why wouldn't you?